What Is Open Banking?

This concept could transform how Americans approach financial services.

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Keeping up with your financial affairs generally requires managing numerous accounts across several different websites and apps. Checking your accounts with multiple logins can be cumbersome. Aggregate sites such as Mint or Personal Capital do a good job of simulating an overall dashboard, but there are drawbacks. Reports produced by these third-party tools aren't 100% accurate and these tools require access to your personal financial information. 

Enter open banking, a concept that has the potential to change the way we approach our finances.

What is open banking?

Open banking refers to a concept where banks and financial service providers have consensual access to your financial data and account information through application programming interfaces, or APIs. An API facilitates the development of new financial products and services that can be accessed directly through your bank account, eliminating the need for you to open a new account or transfer funds between accounts.

Open banking grew its roots in Germany between the late 1990s and 2010s with the development of an open standard for communication between self-service customer banking machines. The European Union devised its first Payment Services Directive, or PSD1, a regulation to integrate financial payments across its member countries.

Since then, the adoption of open banking in parts of the European Union and Asia has taken off. Americans, however, are less well-versed on this new form of finance. A 2021 survey by GoCardless found that 89% of Americans had neither heard of nor had knowledge of open banking. 

Opportunities presented by open banking

Open banking has the potential to transform the financial services industry by increasing competition and offering consumers more choices and control over their financial data and decisions. New financial products and services can be tailored to meet the needs of each person. This could include services such as opening a high-yield certificate of deposit at a new bank without having to download the bank's mobile app, linking your accounts to loyalty programs or sharing data with an accountant or financial adviser.

Another opportunity with open banking lies in the financial services industry's ability to improve financial inclusion. This technology has the potential to reach underserved populations including low-income individuals, those who have poor credit or those who live in rural communities. 

Open banking tools are being developed to help previously unbanked individuals use data sharing and payment information to generate a more accurate financial profile. People traditionally excluded from banking services can now meet eligibility requirements for such services as being approved for an unsecured credit card.

What is the status of open banking in the US?

There are a number of ways that opening banking is being implemented in the financial services industry, including payments, lending and personal financial management. Open banking allows for the development of new payment methods and a platform that allows two separate entities to communicate and transfer money with identities and bank account numbers verified before the transfers are authorized. 

Open banking can also be used to improve the speed and accuracy of loan assessments by using a person's data to better understand their creditworthiness, rather than rely solely on a credit score. Personal finance tools are using such technology to allow customers to track and manage their finances more effectively by giving them a dashboard to connect and see all of their financial accounts in one place.

Risks associated with open banking

Open banking has the potential to positively impact the way we manage our finances. New technology inherently introduces a new level of risk. Protecting data privacy and eliminating unauthorized account access are among the main concerns of a cautious public. Allowing third-party vendors to access your financial data increases the risk that our data could be misused or accessed by malicious actors. To avoid these risks, open banking systems will have to implement robust security measures such as strong encryption and secure APIs.

How does open banking work?

Open banking is a concept in which your financial data is shares across multiple platforms using APIs rather than accessing your data and resources through centralized repositories such as traditional financial institutions. The APIs facilitate communication between third-party apps and, ideally, provide enhanced security through encryption and other security mechanisms. 

Pros

  • You gain greater control of your financial data and are able to make decisions more efficiently with more options.
  • Businesses will better understand your financial needs, allowing them to tailor solutions and financial services.
  • Innovation by financial service providers will grow, resulting in more competition and more tailored financial products and services to meet your specific financial needs.

Cons

  • The potential risk of data breaches as a result of third-party access to financial information.
  • Unwanted marketing solicitations as third-party service providers tailor their marketing strategies.
  • The lack of regulation can create confusion in standards for how private companies can leverage open banking technology.

Which companies offer open banking?

Several companies are taking the lead in adapting to the open banking space. Some examples include big banks such as Wells Fargo and Bank of America, fintech firms Robinhood and Chime, and technology behemoths Google and Apple. Capital One has launched the DevExchange which gives third-party vendors the ability to build tools that can seamlessly integrate with Capital One's existing infrastructure. For example, a wedding registry app can communicate with a Capital One account allowing friends and family to contribute directly to a new couple's wedding planning account.

The bottom line 

Open banking has the potential to bring significant benefits to consumers while transforming the financial services industry. However, it also carries risks that need to be managed. As open banking technology continues to evolve, adoption in the US will undoubtedly expand to more financial platforms. The challenge is to ensure systems are secure, transparent and fair for all involved.