Introduction to API banking: How APIs enable embedded finance and banking-as-a-service


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  1. Introduction
  2. What is API banking?
  3. How does API banking work?
  4. Examples of API banking
    1. Embedded payments
    2. Banking-as-a-service (BaaS)
  5. Benefits of API banking

Banking APIs are part of the tech-powered sea change that is reshaping the way in which customers and businesses interact with money. Not only has technology changed the way in which financial institutions do business (e.g. online banking), but it has also completely changed the types of institutions that are able to provide financial services to customers. This new way of offering and accessing financial services owes a lot to API banking. A report from Cornerstone Advisors found that between 2019 and 2021, 65% of banks and credit unions entered into at least one partnership with a fintech company – many of which rely on banking APIs to provide their services.

Below, we'll talk about what API banking is, how it works and how it's being used in two key categories – embedded payments and banking-as-a-service (BaaS) – as well as the many benefits it can offer businesses in both spaces.

What's in this article?

  • What is API banking?
  • How does API banking work?
  • Examples of API banking
  • Benefits of API banking

What is API banking?

Application programming interfaces (APIs) are communicative protocols – essentially, sets of rules and tools – that enable different software components to communicate and share information with one another. These protocols define the methods and data structures that developers can use to communicate with the software component – whether that's operating systems, libraries or different services.

In API banking, developers use APIs to create a more open architecture within financial institutions. This allows the interaction between a bank's core services and third-party developers (or other banks) to be modular and flexible. This setup decouples different banking functions, such as payments, identity verification and data sharing, making them accessible through well-defined APIs.

By leveraging API banking, a financial institution can create an interoperable system that can communicate directly with external platforms and applications – rather than a closed-off entity with proprietary systems. This design facilitates specialised financial services that can be rapidly developed, tested and deployed.

How does API banking work?

Banks can move away from a monolithic architecture and adopt a more adaptive approach through API banking, which involves isolating, updating or extending specific features without affecting the overall system. API banking breaks apart the structural frameworks that have, historically, housed the operability of financial services, allowing institutions to be more flexible while rethinking how their services can be accessed and offered.

Let's take a closer look:

API banking uses a layered architecture in which each layer serves a distinct function, and all layers interact with each other through well-defined APIs. The primary features that a bank offers – account management, payments, data analytics etc. – are abstracted and exposed through APIs for third-party consumption. In other words, they're simplified to be easy enough for third parties to use and they're opened up to allow that to happen.

Starting with the core services layer, each banking function – whether that's payments, Know Your Customer (KYC) verifications or transaction history – is encapsulated into distinct modules, each with its own API. These APIs adhere to specific protocols and use standardised data formats, such as JSON or XML, which provide a consistent way for third-party developers to interact with the bank's services.

The API gateway authenticates and routes incoming API calls from external services, acting as a protective layer that guards the core services. When a third-party application wants to initiate a payment or access account data, it sends a request to the API gateway. The gateway identifies the incoming request, performs any required security checks, such as token validation or OAuth authentication, and routes the request to the appropriate service module.

This modular system allows for faster and more targeted innovation within financial services. Developers can access specific banking functions without having to interact with or understand the entire system. For example, a fintech startup can build a specialised payment service using just the payment API – without having to integrate all other banking services.

This layered setup allows businesses to update or replace each part independently of the others, providing flexibility and easing the burden of maintenance. Businesses can also implement security measures at the API gateway level to ward off unauthorised or malicious access to core banking systems. Often, monitoring and analytics layers are built on top of these APIs, and they track API usage, latency and other performance metrics. These analytics allow businesses to spot trends, anticipate bottlenecks and maintain optimal performance.

Examples of API banking

Both embedded payments and banking-as-a-service (BaaS) represent the evolving nature of financial services, which API banking enables. These models allow for rapid development and increased accessibility, as well as a range of financial products that are tailored to specific customer needs.

Embedded payments

Embedded payments result from the direct integration of payment processing into third-party platforms or applications. This approach eliminates the need for customers to leave an app to complete transactions, improving the customer experience.

  • Payment gateways and APIs
    Typically, APIs from payment processors serve as the lynchpin for embedded payments. Developers use these APIs to establish a connection between their application and payment networks. APIs process different kinds of transactions, including credit card payments, payments via digital wallets and bank transfers.

  • Real-time processing
    What sets embedded payments apart is their capability for real-time transaction processing. The moment a customer initiates a payment, the API calls are activated to process the transaction, validate customer credentials and update account balances – and often, this happens within milliseconds.

  • Use cases
    E-commerce platforms are a good example of embedded payments in action. Embedded payments allow customers to check out without needing to switch to another website, minimising the number of steps required and accelerating the purchasing process. In subscription services, embedded payments facilitate the automatic renewal of services without requiring customer intervention.

Banking-as-a-service (BaaS)

BaaS is an end-to-end process that allows third parties to access and use the core banking features via APIs. Often, BaaS providers are banks that offer a set of APIs to enable third-party platforms to launch their own branded financial products.

  • Functionality
    In a BaaS arrangement, the functionality can range from simple services – such as checking account balances and transaction histories – to more specialised services, such as credit scoring, loan origination and identity verification.

  • APIs and third parties
    In BaaS, the set of available APIs is comprehensive, allowing third-party platforms to access data, initiate transactions and develop new financial products. Financial institutions, fintech startups and even non-financial enterprises can use these APIs to build a variety of applications, such as personal finance managers or specialised lending platforms.

  • Use cases
    One example of BaaS is a retail business that wants to offer its customers financial products. BaaS allows the retail business to provide different options, such as branded credit cards or loyalty programmes, without having to build the financial infrastructure from scratch. Another example in which BaaS can be useful is for a fintech startup that offers specialised investment platforms. By tapping into the APIs that a BaaS setup provides, the fintech startup can gain access to banking features to develop its product.

Benefits of API banking

API banking has become an integral part of modern financial technology. As this development continues to shape the industry, several key benefits emerge. Below are some of those advantages.

  • Rapid development and deployment
    API banking enables quicker development cycles. With pre-defined sets of features available through APIs, developers can plug into banking services immediately. This rapid development cycle speeds up the time to market for new products and facilitates faster updates for existing ones.

  • Flexibility and modularity
    APIs offer developers the ability to select individual features and incorporate them into different applications. Financial institutions and third-party developers can pick and choose which services they want to include in financial products.

  • Strong security layers
    It's common for API banking architectures to include robust security features, such as authentication protocols, data encryption and other measures, designed to ward off unauthorised access. Often, these security features are built into the API layer itself, and they offer robust protection for both the bank and customers.

  • Scalability
    APIs are designed to handle varying degrees of demand. Whether the business in question is a small startup or a large enterprise, APIs can accommodate different scales of operation without requiring an overhaul of the entire system. This scalability is particularly advantageous for growing businesses.

  • Easier maintenance
    Modular API architectures allow developers to update or replace individual components without affecting the overall system. This localised updating capability makes it easier to maintain and improve the service without disrupting the customer experience.

  • Interoperability
    API banking allows for better interoperability between different systems and services. Financial institutions can interact easily with third-party services, and vice versa, to offer a broader range of capabilities. And interoperability extends beyond the financial sector to retail, health care and other industries.

  • Real-time analytics and monitoring
    APIs often come with built-in analytics features. These features allow businesses to track transactions, usage patterns and system performance. Such analytics can offer actionable insights for business strategy and operational improvements.

  • Revenue-generation opportunities
    API banking opens up new avenues for generating income. Financial institutions can monetise their APIs, enabling third-party developers to offer value-added services to their customers. Whether through a pay-per-use or subscription model, APIs offer additional revenue streams.

  • Improved customer experience
    API banking facilitates smoother and more convenient interactions for the customer. Whether it's faster payment processing or more intuitive financial management tools, these benefits elevate the overall customer experience.

These important benefits help to make API banking a transformative force in financial services.

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