Open banking has come to encompass so much that it can be hard to define. At its heart, open banking is about opening consumer financial data—once the sole domain of banks—to third-party service providers that manage the data using APIs.
In a recent PaymentsJournal podcast, Vladimir Jovanovic, VP of Innovation at Velera, and James Wester, Co-Head of Payments at Javelin Strategy & Research, discussed open banking’s evolving regulatory framework, its benefits for banks and credit unions, and its accelerating adoption in the United States.
A Changing Perspective
Most consumers don’t understand the infrastructure or the technological innovations driving open banking, but they are fully aware of its benefits.
“They understand it in terms of access to third-party services, streamlined onboarding processes, and embedded finance and payments,” Wester said. “They may not know the umbrella term, but they have adopted open banking, and they’ve come to expect it. Whether they know it or not, open banking has affected the way consumers view banking and financial services.”
The days of screen scraping, a method third-party providers used to access financial data, are over. Now platforms like Plaid and MX are, in many instances, required to use structured APIs to pull consumer financial data back. Banks and other payment ecosystem participants are joining with other providers of financial services to participate in consortiums like the Financial Data Exchange (FDX).
The members of the FDX consortium work together to standardize the APIs that enable data exchange between participants. Concerted efforts like the FDX will be a principal driver for U.S. open banking adoption in the years ahead.
The Regulatory Environment
In other countries, governments have mandated the creation of open banking standards. Though there are many regulatory bodies in the U.S. banking space, such as the FDIC, there isn’t likely to be a government mandate any time soon for U.S. open banking adoption.
However, the Consumer Financial Protection Bureau is emerging as the regulatory agency that could help shape open banking requirements in the financial services market.
“The CFPB is going to be heavily involved because banks and credit unions are opening up protected consumer financial data to third parties,” Jovanovic said. “The CFPB is going to scrutinize that process and make sure any approach is aligned, centralized, and regulated properly, and centered around consumer rights and protections related to financial data sharing.”
To expand that reach, the CFPB proposed Rule 1033, which addresses personal financial data rights from a consumer standpoint. Though Rule 1033 has yet to be approved, banks and credit unions might have to make significant adjustments to their data management practices, privacy policies and security practices to comply with the new regulation.
In data management, organizations will have to determine the appropriate IT infrastructure to support consumer permissioned data sharing. When consumers give a third party access to their financial data, institutions must have the infrastructure to accept and standardize data sharing across different participants.
Banks and credit unions will also have to determine which privacy policies and security practices should be in place to prevent breaches and unauthorized access.
“Open banking might give financial institutions the chance to broaden their products and services, but it presents an opportunity for fraudsters as well,” Jovanovic said. “Banks and credit unions need to understand how they can deploy the right tools and processes to ensure the consumer has consented and any emerging fraud schemes are managed effectively.”
A Marathon, Not a Sprint
Many banks and credit unions might be tempted to trust the technological aspects of open banking to a third-party partner. However, they must still fully understand the process because the institution is ultimately accountable for compliance.
“Oftentimes, institutions look at compliance as a box to be checked and a cost to be borne,” Wester said. “But the open banking shift is an opportunity for banks and credit unions to rethink their overarching strategy and identify new revenue drivers. It shouldn’t be an onerous task. It’s a way to become more embedded in your customers’ financial lives.”
Though the switch to open banking might be daunting, the model has been implemented successfully elsewhere. In the European Union, open banking was regulated under the Payment Services Directive (PSD), which was subsequently replaced by PSD2.
However, when PSD2 was released, key financial innovations like crypto and blockchain weren’t part of the picture. That is why PSD3 will be implemented, and it will include additional data sharing, standardized APIs, and expanded financial services.
As in the EU, any regulations instituted in the U.S. are likely to evolve to accommodate new innovations, different business models, and niches that haven’t been considered yet. However, just because the regulatory framework might shift is no reason to delay implementation.
“Other open banking ecosystems have evolved in iterations, and they will continue to evolve,” Jovanovic said. “Many banks and credit unions are concerned about open banking, the new regulations, the unfamiliar ways to share data, and about selecting the right technology solutions. But the objective should be to develop a long-term strategy and work it incrementally. It’s a marathon, not a sprint.”
Leveling the Playing Field
Consumers want personalized experiences and services, and open banking offers ways to customize their services and get a consolidated view of their financial information across multiple institutions and providers.
More service providers are involved in the banking system than ever before, which will increase competition and create better products and services for consumers.
“The opportunity for collaboration with new financial players gives banks and credit unions a chance to reinvent the way they serve their customers,” Jovanovic said. “Consumers won’t have to open another account elsewhere, because they can obtain the products and services they need from their primary financial institution. Open banking levels the playing field and creates opportunities for community banks and credit unions to compete with their larger counterparts.”
Scratching the Surface
Though the new model offers a substantial opportunity, the potential for the misuse of consumer data means any new open banking initiatives will face regulatory scrutiny.
“I would emphasize that regulation is coming,” Wester said. “Regulators care about this and they are very serious when it comes to handling consumer data. There may be polarized politics in the U.S., but all sides band together when consumers are victimized and their personal data is exposed.”
Most financial institutions enter customer relationships with the best intentions, but a few wrong moves can taint an organization’s reputation and draw regulatory attention. Third-party partners can help institutions mitigate those risks while giving banks and credit unions full visibility into the process.
Regardless of an organization’s strategy, open banking is gaining momentum. Banks and credit unions should plan accordingly to meet their cardholders’ rising expectations.
“There is still a long way to go, and we’re just scratching the surface,” Jovanovic said. “In the end, it might not matter if consumers understand open banking as a concept. Consumers are after an experience, and as long as they have the freedom to structure that experience, they are going to continue to demand open banking in the future.”