Open banking is changing the financial services industry, paving the way for innovations that are redefining how businesses and financial institutions interact. The shift towards a more open infrastructure has created opportunities for accelerated modernisation and service diversity. And regulatory trends are driving adoption rates, with a 2023 report by Juniper Research predicting that open banking payment transaction values will exceed US$330 billion globally by 2027.

Data plays an important role in the shift to open banking. With access to detailed financial data, companies can make more informed strategic decisions, from risk mitigation to investment planning. However, it's about more than data access. Speed, adaptability and a comprehensive set of offerings are equally important. The financial services market is transitioning from siloed operations to a more interconnected environment, where financial institutions and tech companies work together to offer broader services.

But open banking is not without its challenges. Issues such as data privacy, inconsistent service quality and potential security vulnerabilities require careful consideration. As developments in financial services continue to evolve, businesses need to stay ahead of these challenges in order to fully access open banking's potential. Here's what you need to know.

What's in this article?

• What is open banking?
  
• How does open banking work?
  
• Examples of open banking services
  
• Who uses open banking?
  
• Benefits of open banking
  
• Challenges of open banking
  

What is open banking?

Open banking is a financial services model that allows third-party developers to access financial data in traditional banking systems through application programming interfaces (APIs). This model completely changes the way financial data is shared and accessed.

Open banking can give consumers more control over their financial information and provide new services and applications. For non-financial companies, this shift means they are able to offer customised financial services to their customers, make more data-driven decisions, and innovate in payments and account management. With better access to financial data, businesses can also simplify payment processes and generate new revenue streams.

How does open banking work?

Open banking enables interoperable financial services through the use of APIs. These APIs facilitate the secure exchange of financial information between banks and authorised third-party providers. Unlike traditional banking services, which often operate within a closed environment, open banking decentralises financial services.

In traditional banking, data is often siloed within individual institutions, making it challenging for outside applications to interact directly with financial accounts. Open banking disrupts this by mandating standardised data formats and secure communication protocols. This creates a level playing field where third-party services can integrate with multiple banks under a common set of rules, regulations and technical standards.

The APIs in open banking are typically categorised into three main types:

• Data APIs: These provide read-only access to account information, balances and transaction history.

• Transaction APIs: These APIs allow for transferring funds, setting up direct debits and initiating payments.

• Product APIs: These enable third parties to list financial products, rates and terms. They're often used for comparison websites or marketplaces.

In breaking down data barriers and enabling interoperability between platforms, open banking can accelerate innovation in the financial services industry by providing businesses with more granular data insights and an expanded range of financial services options.

Examples of open banking services

Open banking is not one discrete product or service. Rather, it's a framework within which any number of financial services can be enabled. This is an actively evolving field, so the scope of financial services coming to market is likely to expand. Here are some of the ways in which open banking is currently used:

• Payment initiation services
  Retailers can initiate payments directly from a customer's bank account, bypassing the need for a traditional payment gateway. This method could lead to faster settlements and reduced transaction fees.

• Account aggregation
  Financial advisors and wealth management firms can pull in data from multiple accounts, giving them a more comprehensive view of a client's financial status. This enables more accurate and personalised advice.

• Automated budgeting
  Businesses can offer their employees a smart expense management system that automatically categorises and tracks spend from multiple bank accounts, simplifying financial reporting and oversight.

• Instant loans and credit scoring
  Financial institutions can access real-time data to assess credit more accurately, speeding up loan approval processes.

• Automated invoice reconciliation
  Businesses can use open banking APIs to automate the process of matching invoices to transactions, reducing administrative work and improving accuracy.

• Multi-banking platforms
  A corporation operating in multiple markets could consolidate its accounts from different banks into a single dashboard, making it easier to monitor global operations.

• Personalised marketing
  Retailers can analyse transaction data to provide targeted promotions or loyalty rewards that are directly relevant to an individual's spending habits.

• Real-time fraud detection
  By analysing transaction data instantaneously, businesses can detect unusual activity quicker than ever before to reduce the risk of financial loss.

Though these examples are just the start of what's possible, they offer a glimpse into how open banking can change the financial services industry.

Who uses open banking?

Open banking completely restructures how businesses and customers access and use financial data. Within the open banking framework, there are new financial services that cater for nearly every customer and B2B segment. Here are some of the groups most affected by open banking so far:

• Individual customers
  People use open banking to access a wide range of financial services through third-party applications. They can review their spending patterns, get highly personalised financial advice, or automate transactions such as bill payments.

• Financial institutions
  Traditional banks, credit unions and other financial service providers use open banking to modernise their offerings and create better customer experiences. They can also collaborate with smaller technology companies to bring innovative services to the market.

• Fintech companies
  Newer, technology-focused companies use the secure data-sharing features of open banking to create specialised services. These range from budgeting apps to complex financial management solutions for businesses.

• Small and medium-sized businesses (SMBs)
  These organisations use open banking to automate various tasks, such as reconciling invoices with bank transactions and gaining a clearer picture of their financial status.

• Regulatory bodies
  The organisations that set and enforce financial rules find open banking useful for creating a standardised environment. This helps protect customers and ensure secure data handling practices within the financial services industry.

• E-commerce companies
  Businesses selling products or services online can process transactions more directly, often bypassing traditional payment systems and reducing costs.

• Accounting platforms
  Financial software can access real-time transaction data, making it easier to manage accounts and reducing the need for manual data entry.

• Software developers
  With open banking APIs, software developers can create a range of beneficial services and tools for both individual customers and businesses, opening up new avenues for innovation.

• Credit and lending institutions
  These entities can make faster and more accurate decisions by accessing financial data quickly, optimising loan provision and credit scoring procedures.

Benefits of open banking

Open banking provides businesses with a variety of opportunities to improve operations, comply more easily with regulations, and offer value-added services that can position them effectively for the future. Here's how businesses can benefit from open banking:

• Data-driven decision-making
  Open banking allows businesses to obtain detailed financial data that can inform strategic choices, from risk assessment to investment planning. The depth of available information surpasses that of traditional financial statements.

• Operational agility
  Open banking offers accelerated data flow, expediting transactions and enabling quicker reconciliation. This speed translates into greater adaptability in fast-paced market conditions.

• Interoperable collaboration
  Open banking creates an environment where financial institutions and tech-driven companies can innovate jointly. This translates into a broader and more sophisticated service offering for business customers.

• Optimised payment processes
  Open banking APIs allow for more direct payment methods, often bypassing traditional gateways and resulting in lower transaction costs.

• Regulatory alignment
  Open banking frequently incorporates standardised protocols and strong data protection measures, helping businesses meet regulatory requirements more easily.

• Customer personalisation
  Businesses can offer customised financial services to their customers, from specialised lending solutions to treasury services, all enabled by the rich data accessible via open banking.

• Resource allocation
  Simplified financial operations mean staff can focus on other areas of the business. Whether it's automating reconciliation or smoothing out invoicing processes, open banking APIs can lead to more effective use of human resources.

• Market penetration
  Open banking can help businesses enter new markets, facilitated by partnerships with local fintech companies and easier access to customer data for localised customisation.

• Innovation catalyst
  For businesses in the tech and financial sectors, open banking provides a dynamic way to offer new services that can be monetised, increasing revenue streams and customer retention.

Challenges of open banking

While open banking offers many benefits and opportunities for innovation, it also has challenges that businesses and financial institutions need to be aware of. From integration issues to security vulnerabilities, here are some of the potential drawbacks of open banking:

• Inconsistent quality
  While some third-party services are excellent, others may not meet the strictest standards. Inconsistencies in quality could lead to service interruptions or unreliable data, causing operational difficulties and necessitating costly adjustments.

• Integration issues
  Combining multiple third-party services and APIs might cause unanticipated technical challenges. These complications often require specialised expertise and additional hours to troubleshoot, affecting operational timelines and potentially increasing costs.

• Limited standardisation
  The absence of universal standards complicates the way services talk to each other. This lack of consistency may require manual intervention to ensure that the systems are compatible and functional.

• Regulatory hurdles
  As open banking evolves, so do its regulations. Keeping up to date with these changes can be a resource-intensive task, requiring a dedicated internal team or external experts to help your business stay compliant. Failing to adapt can result in penalties or legal issues.

• Accountability gaps
  With various parties involved, determining fault in the case of an error or security breach is more complex. This ambiguity can slow down problem-solving and lead to prolonged downtimes or unresolved customer issues.

• Hidden costs
  Beyond API subscription fees, there may be hidden costs tied to compliance or technical adjustments. These expenses can mount over time, possibly offsetting any cost-saving benefits of open banking.

• Dependency risks
  Outsourcing core financial functions to third-party services puts businesses under their control, to some extent. Any change in their service availability or terms of use could necessitate an abrupt shift in the operations that use those services, which could become costly and time consuming.

• Market uncertainties
  Open banking is still an evolving field, subject to changes in technology and public sentiment. These unpredictable factors could influence long-term strategies, making it challenging to plan with certainty.

• Security vulnerabilities
  Despite best efforts to keep systems safe, potential gaps in data protection and security protocols could be exploited. The repercussions of a data or other security breach could extend beyond financial loss to reputational damage, affecting customer trust and possibly leading to legal consequences.

The potential of open banking to elevate customer service and generate new revenue sources is not without added risks. Businesses should exercise prudence when adopting this technology and take stringent steps to safeguard security and privacy. There are many benefits to be gained for businesses that enter this space thoughtfully, strategically and with the right risk-mitigation measures in place.