The introduction of open banking has been one of the most significant shifts in the financial services landscapes in decades, if not centuries. While its primary goal may have been relatively simple - merely to allow customers access to and ownership of their own financial data - the knock-on effect has allowed whole new areas of financial technology to develop, rapidly propelling modest start-up companies to a level of success that traditional banks have taken centuries to earn.
The applications of the new open banking regulations are many and varied, with new innovations still popping up. However, perhaps one of the most significant is in making foreign exchange (FX) and cross-border payments seamless, significantly easier and cheaper.
What is open banking?
We have talked about open banking in a previous post but we will summarise it again here. In essence, open banking is exactly what it sounds like - it is the act of making banking more open and accessible. While it has been approached by difference countries and regions in different ways, the trailblazer and most noteworthy example is the European Union, which introduced the Revised Payment Services Directive (PSD2) in October 2015, with the goal of increasing pen-European competition in the financial services sector, including making it possible for non-banking institutions to get a slice of the pie.
On a more technical note, open banking requires that financial institutions use open application programming interfaces (APIs), which allow third-party developers the opportunity to build new applications around those interfaces. More specifically, the APIs give access to account information services (AIS) or payment initiation services (PIS). The former is required to give access to a customer’s account information and transactions while the latter allows outside organisations to make a payment from that account. Between them, these services make it possible for more apps to directly interface with your bank account, which is where major developments in the worlds of FX and cross-border payments come in.
How does open banking impact global payments?
While getting permission to use the APIs at the heart of open banking is quite a challenge since the compliance frameworks are very demanding, doing so has rapidly proved to be a massive benefit for FX and cross-border payment firms. Sending money overseas has always been a challenge, whether that’s paying for products from an overseas account or remitting your own money from an overseas account back to a home account and vice versa. One of the main obstacles for non-bank firms hoping to simplify these processes has always been enabling their customers to make transactions directly from or into their own overseas accounts. Access to PIS makes things blissfully easy.
But we are getting ahead of ourselves. Before a firm can make their services simpler and more convenient for their customers, they must first have services to offer and have customers to offer them to. In both of these cases, AIS has unlocked a lot of potential. Firstly, credit risk management is made much simpler. Those firms that do not collateralise FX forwards (either fully or at all) can now immediately check how much cash their customer has and can therefore set precise limits and facilities to make working with that customer effectively risk-free. Open banking AIS can also reduce recourse risks and those associated with insufficient funds for pre-authorised debits. Put simply, and risks inherent in services that require a firm to forward funds on behalf of a customer are significantly reduced because that firm can now check that the customer can afford to repay the debt. There is even further room for innovation, now that this data is available, potentially leading to new services and opportunities in the financial services sector.
The second issue we mentioned above is having customers to work with - specifically, onboarding. Access to open banking AIS makes it far simpler to use electronic know-your-customer (eKYC) solutions, which we’ve also talked about in a previous post. Indeed, the whole process can now be entirely digitised, making financial services available in a matter of moments instead of numbers of working days as was previously the case. This makes it comparatively frictionless and significantly more convenient for customers to start using a third-party service, enabling fintech firms to grow their customer bases far more rapidly.
How does open banking help the customer?
Open banking is very much a two-way street. The benefits to non-bank firms we have barely touched on above are numerous, which obviously directly benefits the customer as they now have access to more choice in which company and services they use. However, technology built on the data that open banking provides can also provide further benefits in the form of completely new services and features. Examples that have already seen some significant success include API-driven live FX pricing and API-based hedging automation.
There are plenty more opportunities available. Open banking is still quite a recent innovation and one that is continuing to evolve. New and extremely convenient tools are constantly being launched and iterated to serve different markets and functions. International students and educational institutions are finding benefits, as are cross-border crowdfunding firms and international ecommerce innovators.
What are the risks of open banking?
Given how personal and important financial data is, the term ‘open banking’ will naturally be a little disconcerting for some. However, it is very important to note that security has been a primary consideration from the very start. Customers retain absolute control over what data they are prepared to share, as well as who they want to share it with and for how long. Open banking is not about letting every potential scammer, identity thief and crook see every detail of your financial history, but about breaking the monopoly that traditional banks have held on customer data, which has long been an obstacle for fintech firms.
Of course, breaking monopolies can have its downsides. There is the potential for industry consolidation along the lines of what happened in the world of search engines. From the initial surge of competitors that all appeared around the same time (Google, Lycos, Yahoo, AskJeeves, etc.), how many remain strong competitors in that market and how many have largely disappeared into obscurity? To put it another way, how many of the names in the list above have become common verbs for the act of searching the internet for information? Some critics are concerned that the same may happen in the world of financial services, with one or two firms dominating the landscape, making it harder and harder for new start-ups to get a foothold.
It’s worth noting that all of these risks have been identified and continue to be addressed. Regulatory frameworks are already in place to minimise the risk of industry consolidation and to ensure the security and privacy of customers and their data. The rapid innovation of the open banking era will obviously put these frameworks to the test, but regulations are able to innovate and evolve, too.