What is Open Banking?
By Isabella Laine
Open Banking was introduced in 2018 to enable individuals and businesses to grant third-party (financial services) providers secure access to their real-time current account information and to let them initiate payments directly from their bank account. Designed to improve competition and innovation in financial services, it has huge potential to create value for its adopters and the wider marketplace.
Open Banking and PSD2 are often talked about together. PSD2 is the EU’s Second Payment Services Directive, which was implemented in each member state in January 2018. This legislation aimed to improve digital payments across Europe and heighten data protection for individuals. The same year, the Open Banking initiative was launched in the UK by the Competition & Markets Authority (CMA), on behalf of the government. It required the nine largest UK banks to give regulated third parties secure access to their customers’ financial data via application programming interfaces (APIs). The UK has also passed its own laws based on PSD2; The Payment Services Regulations 2017.
Since then - recognizing the advantages, Open Banking could bring - many smaller banks and financial institutions have willingly followed suit.
Key concepts of Open Banking:
Licensed third-party providers (TPPs) gain access to financial data from banks and other financial institutions via APIs.
Open source technology enables TPPs to build applications and services around the specific needs of the consumer.
It removes the centralized control of banks, instead allowing the networking of accounts and data across institutions for use by financial institutions and TPPs.
Improves competition, speed, and transparency for the benefit of the customer.
The user consents to specific access and use of certain data for a predetermined length of time.
How does it work?
Banks allow access to customers’ financial data to authorized TPPs. With the customer’s consent (and under PSD2), these TPPs can use the Open Banking APIs in two ways (and must have different authorizations for each):
To share account information:Account information services providers (AISPs) provide third parties,such as budgeting apps or lending platforms, with read-only access to customer financial data, including information like their balance, limits, and transaction history.
To initiate payments: Payment initiation service providers (PISPs) allow third parties such as online retailers and fintechs to initiate payments directly from the user’s bank account (instead of via Mastercard or Paypal, for example). Customers can make bank-to-bank payments without manually typing transfer details by simply logging in using their online banking credentials.
Who does it benefit?
At its heart, Open Banking is designed to improve outcomes for the customer. Target benefits are delivered through speed, transparency, and security, and their impact can be seen across a diverse range of use cases.
Perhaps the most immediate effect of Open Banking was felt in payments, where the real-time movement of money has been a game-changer. PSD2 has been a catalyst for this, requiring that all banks in Europe allow authorized PISPs to initiate payments. Once customers have authenticated themselves, Open Banking allows customers to send a request to their bank via an authorized PISP for a payment to be initiated. The bank must then accept this request just as they would normally accept their customers’ requests made via online banking. This setup enables the immediate transfer of funds and eliminates the need to enter card details or credentials every time a transaction is made—no payment gateways, bank interfaces, or fees. Using a Payment Initiation Service means removing the middleman for easy and fast payments that are integrated into the product. It also incentivizes merchants to process orders directly without waiting for the payment to clear into their bank account because the PISP makes assessments of whether a payment will be executed successfully or not. Overall, it makes transactions simpler, faster, safer, and more cost-effective.
But sharing financial data across providers has a much broader impact, providing insights at the individual and corporate levels. It can enable a customer (individual or business) to have real-time access to multiple bank accounts across multiple institutions all in one platform, saving time and improving financial oversight. It can help consumers get a more accurate picture of their own finances before taking on debt. An Open Banking app for customers who want to buy a home, for example, can automatically calculate what they can afford based on all the information in their accounts history, providing a more reliable indication than mortgage lending guidelines currently do.
Third parties can automate tasks and reduce manual workloads for companies, for example, recording and matching cash hitting the bank account to a company’s outstanding invoices. Alternatively, flexible payment modules can initiate multiple batch payments including those across borders and in foreign currencies.
Open Banking can also widen the net of prospective lenders by providing an immediate and accurate understanding of a customer’s financial history, allowing more lenders to better understand the specific risk profile and hence drive a more competitive loan product for the end customer. And because lenders can access robust and accurate data in real-time, the lending application process can be much faster. For the customer, it means less time manually filling out application forms and reports.
By aggregating and categorizing the data from across participating financial institutions, companies can create carefully refined marketing profiles and therefore, finely tune their services to the specific need. It also provides a unique opportunity for businesses to overlay additional tools that add real value for users and deepen their customer relationships.
The increased transparency brought about by Open Banking also brings additional benefits, such as helping fraud detection companies better monitor customer accounts and identify problems much earlier.
The list of new value-add solutions continues to grow.
In its broadest sense, Open Banking has created a secure and connected ecosystem that has led to an explosion of new and innovative solutions that benefit the customer. It is rapidly revolutionizing not just the banking industry but the way all companies do business.
How is it regulated?
In the UK, enforcement rests with the Competition and Markets Authority (CMA), while the Open Banking Implementation Entity (OBIE), set up by the CMA, provides a framework of software standards and industry guidelines that all regulated providers should follow. The Financial Conduct Authority (FCA) is responsible for consumer protection, oversight, and supervision of the complete legal framework in account information and payment initiation services under Payment Services Regulations 2017. The same applies to the relevant authority in each European country under the EU legislation. All providers must comply with data protection rules, including GDPR, and must outline to their users which data they will use, how they will use it, and for how long before sign-up.
The benefits of Open Banking have seen widespread uptake across the world since its introduction in 2018, although each country has its own way of regulating, implementing, and promoting it.
Given its origins, the UK is arguably one of the most mature Open Banking markets in the world. According to the UK’s opening banking website, there are 339 regulated providers, of which 247 are TPPs (as of 31st March 2022).
A recent change to the 90-day rule means consumers in the UK will no longer have to provide their credentials to their bank every 90 days (also called re-authentication). Now, they only need to provide reconfirmation to the TPP that they consent to have their data accessed. With reduced friction in the user journey, we expect drop-off rates and adoption to increase significantly.
As a group of individual countries, there will always be some local differences in adoption and infrastructure quality in Europe. But, as a unit, the EEA has created its own Open Banking standard. In the context of open banking, PSD2 has provided a European-wide regulatory framework that allows the use of open APIs to help TPPs access customer banking data. Just like in the UK, TPPs can use the EEA’s Open Banking system via either AIS or PIS.
In the Nordics, a collaborative approach between countries and the P27 initiative has helped most of the big banks develop an Open Banking strategy. While in Southern Europe - France, Italy, and Spain in particular - Open Banking is transforming local payment ecosystems.
Germany, although one step behind the UK in terms of Open Banking readiness, has long been a leader in interoperability and connectivity, with the Klarna-powered payment method SOFORT implementing domestic bank connections since 2005.
Outside Europe, a few countries are taking a regulatory-driven approach to Open Banking adoption. The Hong Kong Monetary Authority delivered its Open API framework for the banking sector in July 2018 and has been pushing for its adoption on the island. In 2020, Brazil’s Central Bank and the National Monetary Council launched their own Open Banking regulations, which are largely inspired by the European regulations. Having started with the passing of a Consumer Data Right Act in the same year, Australia completed a phased timeline of Open Banking development in February of this year.
In contrast, the approach to Open Banking in the US has so far been largely industry-led. There are no standardized rules and guidelines for Open Banking ecosystem participants. This means the US currently lacks robust data privacy protection and standardized technical architecture. But the US government has taken some critical steps to reform its regulatory framework. On July 9th last year, for example, US President Joe Biden signed an executive order to promote competition in the American economy by giving banking customers the right to switch banks and, in turn, the ability to port their data from one bank to another. This should significantly boost Open Banking adoption in the country.
Similarly, India, Japan, Singapore, and South Korea currently have no formal Open Banking regulations, although policymakers are taking steps toward establishing a data-sharing standard in their respective banking industries. This is also the case in Mexico where there is an ongoing effort to introduce Open Banking.
Where do we fit in?
Klarna Kosma can help your business navigate the Open Banking standards within your chosen markets. We are available in more than 25 markets globally, including the UK, EU, and the US, with new markets being added all the time.
Offering access to both financial data and bank payments, we can help you build a product that’s easy to use and understand for your customers, boosting conversion and adoption rates and directly impacting your topline.
There are no limits to the use cases that Open Banking can address. From automating processes to going the extra mile with personalizing your offering to end consumers. We provide the tools so your vision can become a reality.