United States

The digital transformation’s next frontier: Open banking

Learn about the principles behind open banking

INSIGHT ARTICLE  | 

The coronavirus outbreak has accelerated digital transformation in the banking industry. From providing a frictionless customer experience, to allowing for easier payments, to adopting artificial intelligence technologies, banks of all sizes are scrambling to adopt new digital strategies that serve customers better.

But there is one trend that is challenging the very nature of the relationship between customers and their banks, and it has the potential to reshape the industry. Known as open banking, it allows banks to gather more data from consumers—even those who do not have accounts with a particular bank—and offer services to a wider range of customers. In the end, it promises to provide greater value, at lower cost, for consumers.

The principle behind open banking is simple. Consumer data is made available to application developers like fintech companies through publicly available APIs, or application program interfaces.

Open banking, as a standard, is a regulatory framework that guides how financial institutions create, share and access consumer financial data. That data is shared freely through a network of financial institutions and financial technology companies.

But there are two important traits in open banking that distinguish it from traditional approaches:

  • Consumers consent to the banks to share the consumers’ data publicly
  • All financial institutions open their programs and interfaces to third-party developers

These attributes aim to help consumers better understand their financial data so they can make better decisions. Banks, in turn, can provide a more seamless consumer experience through the use of mobile applications.

Technology makes this all possible. For consumers, the infrastructure increasingly is there. Smart mobile devices have become smarter and more powerful, and they have continued to shape consumer behavior. More and more, this means that consumers are demanding digital conveniences like paperless use of money and virtual banking.

The shift to mobile banking has only accelerated amid the spread of the coronavirus. In the first three weeks of April, BBVA USA reported 16% more logins than March 2020. In addition, mobile banking has grown among the four largest banks (Bank of America, JP Morgan, Citigroup and Wells Fargo). Indeed, mobile banking grew 72% during the first quarter of 2020 compared to a growth of 63% for the entire year in 2019.

All this is happening while open banking is in its infancy in the United States, unlike in Europe, where it is revolutionizing the financial services industry. Already in Europe, it has sparked the creation of standards and regulation on how banks are to operate in such an environment.

As an example of how open banking works, take the case of a consumer who wants to find an ATM. The consumer may type “ATM near me” in Google. Google then sends out a request for information to several banks’ websites and then returns the information to the consumer. An API makes it possible to read the request and retrieve the information.

Applications being developed go far beyond this simple task, and financial institutions are working to develop mobile applications to satisfy their customers’ needs, including ways to manage finances, shop and initiate transactions.

APIs come in three forms—private, partnered or public:

  • Private: These are developed internally, or by developers working for the bank, for the use of the bank’s consumers, employees or anyone directly associated with the bank. Think of it as an application that can only access a consumer’s bank website to get information the consumer needs.  For example, the location of the consumer’s bank’s ATMs.
  • Partnered: These are developed in partnerships with strategic alliances.  For example, an application providing a realtor with instant access to interest rates and closing cost discounts from the bank.
  • Public (open): Data is made available to developers to build applications around a bank’s data.

This is good news for consumers, who are facing fewer barriers in opening digital accounts and finding e-payments easier to make, among other services and products.

For banks, open banking has a flip side: It demands a free flow of data among financial institutions, and in doing so puts banks in a position of losing control of being the primary relationship manager with their customers.

It also increases competition, especially for established banks as fintechs and other, smaller banks enter the market. But the result is that established banks must deliver products like checking accounts and payment processing in new ways, all of which would require more capital expenditures on technology.

In the end, this competition is expected to result in an improved customer experience through improved technology.

Consumers, for example, would have access to information such as a new savings account that would earn a higher interest rate or a credit card with a lower interest rate. At the same time, lenders would get a more accurate picture of a consumer’s financial situation and risk level in order to offer more appropriate loan terms.

Then there are the fintechs. Whether they are third-party developers of applications or APIs, or companies such as Apple, Amazon and Alibaba hinting at entering the banking arena, open banking is good news because it lowers the barriers to entry for startups while simultaneously reducing requirements to meet regulations mandated on banking organizations.  By partnering with banks through open banking channels, fintechs gain access to the banking system and customer data while, for now, not subjecting them to the regulations that banks face.

The takeaway

Open banking is a next logical step in the digital transformation of the banking industry by removing barriers and creating a more seamless consumer experience. Consumers, after all, will demand it. Banks that do not embrace this change do so at their own risk, missing out on client base growth, higher consumer satisfaction, a more agile digital transformation and better compliance readiness.

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