Dorota Jasińska
Paweł Scheffler
The rapid growth of technology has significantly influenced our lives, and it’s not slowing down. Only a few years ago, we heard about open banking, the system of safely sharing one’s financial data with third-party service providers. Thanks to this system, customers could gain access to a wide range of products. Open banking was just the beginning, as it’s evolved into open finance, opening new opportunities for customers. It was a gateway for open finance to emerge and embrace even more services.
The origin of open banking and its purpose
The advancement in technology has also influenced the financial industry. The development of algorithms, genAI, and machine learning has also made it into banking. It has emerged as a means to share various data with verified and regulated third-party services to spur innovation in the financial sector. The goal was to empower customers by providing them with new and diverse services.
The main assumption of open banking was for banks to share customer information with third parties. This has raised some concerns about the safety and security of such data sharing. In 2007, the first Payment Services Directive (PSD1) was implemented to address safety issues and to stimulate competition in the banking sector. It allowed non-banks to execute financial transactions and led to the growth of the fintech sector.
In 2018, PSD1 was replaced by PSD2 and has set a regulated framework for open banking in the EU. Now, open banking is based on data sharing with trusted providers through the use of APIs (Application Programming Interfaces). However, the data is never shared without the customers’ permission, so they can keep control over their personal information. Open banking grants access to innovative services of online vendors who offer advice on investment, loans, and many more. This way, customers can take advantage of a wider choice of services while keeping their data secure.
With time, the safety concerns were addressed by proper directives and frameworks, and banks followed the AI trend in finances. Currently, open banking is widely used by various financial institutions. Thanks to the PSD directives, not only banks can provide customers with financial services. This has significantly influenced the competitiveness within the financial sector.
Banks had to embrace open banking to keep up to date with the growing innovation and competition in the fintech market. The directives also covered safety and security issues to ensure the customer is well protected.
The difference in scope between open banking and open finance
As open banking is the base for open finance, the scope and regulatory framework of these two are different. Open banking enables Account Information Services (AIS) and Payment Initiation Services (PIS), allowing third-party providers access to transaction data from bank accounts and payment services. It is partly regulated by legal frameworks such as the EU’s PSD2. The framework defines standardized rules for data access and sharing.
There’s no doubt the financial sector has experienced significant transformation. With the growing popularity of electronic payments, new payment providers, and solutions, the framework has to adjust to the changes. To make sure the innovation, competitiveness, and security in financial services are up to date, the EU is working on a new directive – PSD3. It’s still in the works, and the timeline is yet to be set. However, we may expect it to be implemented in a few years.
Open finance includes a broader range of financial products and services. These are, for example, investments, insurance, loans, etc. When it comes to regulation, at this moment, it’s not strictly controlled by frameworks. However, it may change soon, as it was the case for open banking as well.
What these two have in common is the assumption that customers should have a choice in determining who can access their data and make payments on their behalf. However, the evaluation of PSD2 has shown there’s a need to revise the framework to improve customer safety and competition in electronic payments.
How does open finance expand open banking?
Let’s start with how open finance expands on open banking by providing a wider scope of services using some real-life examples. Starting with account information, open banking allows third parties to safely access customers’ transaction data, such as transaction history and account balances. Open finance extends access to other financial products. This means a customer can use one app to check not only one’s account balance but also an investment portfolio or insurance policy.
Payments and lending are another example. While open banking simplifies Payment Initiation Services by initiating payments directly from the customer’s current account and making transactions more efficient, open finance expands to savings accounts, investments, insurance policies, and even easy lending. It can be used to get a loan based on the whole financial history and transactions, not just the customer’s bank account.
As we’ve already mentioned, open banking allows third-party services to access data from the customer’s bank through safe APIs; open finance takes it one step further. It enables the aggregation of customer data from multiple sources. This opens new possibilities for a complete financial overview of a person and can be used, for example, by finance management apps like Mint.
This app helps track customer’s expenses, draw up budgets, and manage financial accounts in one place.
Open finance offers a better grasp of what the market offers to customers. They can take advantage of customized insurance policies, personalized investment advice, a comprehensive view of the finances and insurance plans, and more.
What are the benefits of open finance?
Open finance and open banking contribute to competition and innovation in the financial sector and give customers better control over their finances. Account owners benefit from simplified transactions with safe authorization while they also get a holistic view of their finances. This makes it easier to make decisions concerning finances when a customer sees all the bank accounts, investments, loans, etc., in one place. This allows for better financial management, and once customers have detailed information on their financial situation, they can make a more informed decision.
Apart from the greater insight into one’s financial health, open finance offers another significant advantage to customers — service personalization. Thanks to access to all financial data, open finance can learn about the customer’s financial situation and propose tailored services and advice.
These include loan offers, finding a bank with a competitive service, giving suggestions on investments, and many more. Customers can go over current services and offers without the need to do their own research or meet with consultants.
For example, customers in the UK who struggle with their financial situation can use the services of the Tully platform. Tully operates on the information from the customer’s bank account and bank statements shared through open banking and draws up a personalized payoff plan.
A live agent is replaced by Sadie, a budget robo-assistant who makes sure all provided information is correct. This way, Tully can provide the customer with a personalized plan tailored to their financial circumstances.
Through open finance, customers, in some cases, get an online advisor who is ready to address their financial needs quickly. This means they can get a few loan options from many providers in real time and find the best offering. It works just the same in the case of insurance plans, investing, and any other products. Customers can get offers adjusted to their financial situation and make a choice knowing they’ve seen all the options.
What’s more, if a bank refuses to grant a loan to a business or customer based on their account history, open finance gives them an alternative. With full access to all accounts and transaction history, the creditworthiness of the applicant can increase. This may be a game changer for small businesses who haven’t been able to build up financial strength or credibility in their bank.
Let’s not forget about the incentive of innovation that open finance brings. This technology has already significantly boosted the development of fintech companies. It has contributed to the creation of new services on the market. Innovation in the financial sector is ongoing, with open finance continuing to offer new opportunities. Open banking started a new era in financial services. Easy instant transfers, increased security of transactions with proper authentication, and mobile banking apps are just a few examples of the advancement.
Banks need to make use of technological advancements to attract customers. Their competitiveness depends on what they can offer and how profitable it is for potential customers. That’s why they need to come up with new solutions and adapt to the open finance trends on the market.
The threats and risks of open finance
The banking industry is, without a doubt, an object of fraudulent operations, and open banking has created new possibilities for data breaches and privacy issues. As banks started sharing customer information through APIs, they were a natural target for attacks. For example, API calls can be emulated, and the customer doesn’t know if the API is legitimate or not. Attackers search for any vulnerabilities in APIs and any weak points in the chain for the data-sharing process.
To secure the exchange of information through APIs and to prevent attacks on customer information, the companies must be transparent about any security attacks and exchange their experiences. That way, they can prevent such incidents from happening in the future.
Open banking has introduced a specific way of sharing customer data with third party providers. The more complex the services, the bigger the risks in the process. That is why it’s so important that every element of the data-sharing chain is secure. Regulations such as PSD2 are necessary to keep the data safe from leaks and fraud. They help prevent unauthorized access to customers’ accounts by adding strong authentication.
As the PSD2 was being implemented in Europe, Neontri stepped in with a solution for KIR, the key partner in the Polish payment system. We created a PSD2 hub to integrate Polish banks with third party providers.
But even the most complex regulations and authorization won’t prevent all fraud attempts. That’s why it’s so important to be alert when customers are approached by financial institutions via for example e-mails. Even though algorithms are somewhat successful in detecting phishing attacks, cybercriminals are getting better at impersonating financial institutions to trick people into revealing financial and personal information.
Preventing data breaches and unauthorized access to customer information is extremely important for financial institutions in open finance. To succeed, they need to cooperate, ensure the best user authentication, and educate their customers about potential phishing threats.
Conclusion
Open banking and open finance offer a powerful financial ecosystem with lots of benefits for customers. It gives them more control over their finances and empowers them to safely access a wider range of financial services. Thanks to access to all relevant financial data, customers can benefit from the best offers from banks and other financial institutions.
Customers have a clear overview of their financial capabilities that allows for using customized services when investing, applying for credit, and more. Open finance enabled the growth of the fintech industry but also has stirred some risks and threats to customer data and information processing. However, following regulations such as PSD2 may decrease the risks significantly.
As open finance keeps evolving, we can expect innovation in financial services that aims at enhancing customer experience while keeping operations secure.
