Over the last few years, Open Banking has become somewhat of a buzzword. The term gets thrown around a lot in the media but often little effort is made to explain what it actually means and what it involves for banks and businesses.
Open Banking is our bread and butter, so to remedy this we decided to put together an in-depth explainer of what Open Banking means and how it will affect the world of finance as it gains traction with the implementation of PSD2 across Europe. If you had questions on Open Banking, hopefully, this piece will answer them.
Open Banking: The origin of the concept
The concept of Open Banking comes from the idea of “open innovation”, a term promoted by Henry Chesbrough in 2005 which has strong links with the changes in the attitude towards data ownership, which crystallized into the GDPR and the Open Data movement.
The Open Data movement refers to the idea that certain types of data should be available for everyone, without copyright restrictions, patents or other control mechanisms.
Open Banking is an extension of this idea. The premise is that personal banking data should be more accessible, so that companies and individuals can leverage it in different ways to provide better services and offer more benefits to customers.
To adapt to this new reality, promote competition on the market and promote Open Banking, the European Union passed a new directive on financial payments in 2015, PSD2, updating the legislation from 2009.
The approval and implementation of PSD2
In October 2015, the European Parliament passed the European Payment Services Directive, otherwise known as PSD2 . This new regulation was passed with the aim of creating a single payments market, in line with the European Union’s goal of standardizing laws and regulations across Europe, and promoting innovation, competition, and greater efficiency in the online payments space. The law came into force for the 27 EU countries on 13 January 2018, with a transition period that ends in mid-2019.
The regulation forces banks to open up their databases to third-party companies, known as Third Party Providers (TPPs), as long as they have the user’s consent. This works out as permission for third parties to access the bank’s customers’ accounts, and share financial information in order to customize the services for customers.
Until now, TTPs had a lot of barriers when it came to entering the payments market. However, once PSD2 is fully implemented, it is hoped that new players will come into the scene which will in turn boost competition.
Open Banking regulations require large banks to allow their customers to share data from their own transactions with third parties. This sharing is enabled with open APIs, which the software tools TPPs will use to interface with banks’ databases to obtain customers’ banking data. With this data, TPPs will be able to offer more personalized services to their customers.
Open Banking is still in a development phase, but one country in Europe is ahead of the rest and has become a pioneer in this space: the United Kingdom.
AISPs and PISPs
Probably the most important part of Open Banking are the two forms that Third Party Providers can take on under PSD2. These are AISPs and PISPs, which stand for Account Information Service Providers and Payment Initiation Service Providers, and are the two legally recognized figures that can provide certain services under the PSD2 framework.
As the name suggests, AISPs are organizations that are licensed to use banks’ open APIs to access customers’ banking data to provide different kinds of services. A common example are the well-known PFM mobile Apps — personal financial managers. These applications help people manage their finances better by reading their bank accounts, analyzing the data, and offering a more in-depth view of a person’s finances and personalized advice based on their individual needs.
PISPs are organizations that handle payments using direct bank transfers. Instead of the traditional method, in which a customer submits their personal and payment data to a payment processor, the payment processor then submits a payment request to the customer’s bank for a payment to be issued, and the bank approves or rejects the request, payment initiation providers use the customer’s online banking credentials to issue a payment on their behalf directly from their own bank account with no middle step. This has the advantage of being safer, faster, and less demanding of the customer. Instead of having to input all their personal information or facilitate their credit card details, this payment system allows customers to make a payment with only a user name and a password.
These services aren’t confined to the future — they’re already available on the market through APIs such as Unnax’s Account Aggregation and Payment Initiation engines. Businesses aiming to upgrade their offerings with Open Banking technology can already do so with tools like these.
The United Kingdom, the leader in Open Banking
The United Kingdom is one of the European countries that is promoting Open Banking the most. In fact, one year after PSD2 was passed in 2015; the Competition and Markets Authority (CMA) issued a ruling that required nine of the largest banks in the UK (HSBC, Barclays, RBS, Bank of Ireland, Allied Irish Bank, Danske Bank, Lloyds and Nationwide) to allow companies to access data from their transactions.
Under the scope of the UK Competition and Markets Authority (CMA), these banks created the Open Banking Implementation Entity (OBEI) to promote the opening up of financial data in the United Kingdom. As such, British banks have been among the first to create open APIs that allows TPPs to access banking data, and the UK has also been a pioneer in issuing AISP and PISP accreditations to interested companies so that they can begin to operate under this new paradigm.
The British model in promoting Open Banking has been an inspiration for others, and many EU and non-EU states are now seeking to replicate it.
Open Banking beyond Europe
Australia is one of the countries that have taken most inspiration from the British experience in implementing Open Banking. In this respect, the Australian Government issued a report with 50 suggestions related to the implementation of Open Banking. It has set the first phases for large banks to open up their data in July 2019.
The Canadian Government has already sent out a report assessing how Open Banking should be introduced which, at the time of writing, has riled the main banking association. However, in recent months, it seems that the larger banks are starting to come round to the idea.
The attitude of the Japanese Government regarding Open Banking is notable because of its discretion. However, PSD2 coming into force in Europe has led to the Amended Japanese Banking Act to request that banking institutions create APIs to collaborate with FinTech firms in coming years. At least 80 institutions are forecast to get on board with open APIs by 2020.
Open Banking has reached New Zealand through the Payments NZ association, and a test run in which all of the main banks in the country took part. This is an experience that draws inspiration from the UK initiative.
On a global scale, nine years ago an initiative was created to promote open source code in order to develop the APIs necessary to implement Open Banking.
Open Banking Project, a global initiative
In 2010, the CEO of TESOBE, Simon Redfern, started up the Open Bank Project (OBP), an initiative to provide open source code to develop applications that would help Open Banking to evolve.
The OBP is an open source code and an app store for banks that allow financial institutions to safely and rapidly improve their digital offer by using an ecosystem of third-party apps and services.
OBP was inspired by and is compatible with regional standards and frameworks such as UK Open Banking, STET and Berlin Group.
Open Banking is a global proposal which, apart from increasing competition on the banking market, provides a lot of advantages for users.
The benefits of Open Banking for the user
In practice, Open Banking disintermediates payment services and banking data access. Instead of payments being processed by a payment services provider, Open Banking enables payments to go directly from consumer to business in real time, and the same is true of obtention of banking data. This gives people greater control over their money and their personal data and allows companies to create better user experiences.
On the business side, increased access to banking data has the potential to make many business processes easier. With money movements and banking data obtention being API-controlled, it’s possible to completely automate many processes, increasing their speed and reliability and reducing costs.
PSD2 removes many of the entry barriers that were keeping companies out of this market, so it will create an exponential effect in the development of new products and services serving both businesses and private consumers.
Users’ security above all
Despite the benefits offered by Open Banking, there is still a certain lack of trust among users regarding open data.
One of the changes PSD2 introduces to make the online payments space safer for users is the requirement that TPPs comply with the same security standards as traditional payment service providers. That means that companies that don’t obtain the proper accreditation from the competent regulatory body won’t be allowed to operate in the online payments space at all. What’s more, the new security requirements included in the PSD2 text mean that all payment service providers must increase security around online payments by implementing what is known as Strong Customer Authentication, or SCA.
SCA consists of an authentication method under which users must provide two of three different authentication factors. These are something that they know, such as a password or PIN code; something that they own, such as a phone or USB drive; and something that they are, such as a fingerprint or a biometric sign. To be able to use the new payment and banking data services that Open Banking enables, users will have to provide a combination of two of these.
The future of Open Banking
Open Banking is here and it’s set to transform the way in which we can pay for goods and services and manage our finances. Open Banking creates an important opportunity and offers great potential for turning the financial services environment on its head.
According to data from PWC in a study alongside the Open Data Institute, the revenue opportunities created by Open Banking by 2022 could reach £7.2 billion. In terms of adoption, 71% of SMEs expect to use an Open Banking service, and 64% of adults think that they will be making the most of an Open Banking service by that year.
The tech consultancy firm, Gartner, goes even further in its predictions and assures in a recent report that by 2030, many of today’s top banks will have shrunk considerably and FinTech firms will become the leaders in a market shaped by Open Banking.