Open banking is the practice of sharing financial data between banks, financial institutions, and third-party service providers through standardized application programming interfaces (APIs). Through open banking, customers can grant access to their financial data to third-party developers, who can then create new financial products and services. The practice of open banking encourages competition and innovation in the banking industry.

Open banking services and payments are increasing in many countries. In the United Kingdom, for example, 11% of consumers and 17% of small businesses used open banking services in 2023. And open banking payment volume in the UK increased by 88% from June 2022 to June 2023.

This guide will cover how open banking works, how it’s changing financial services, and the most common use cases you should know.

What’s in this article?

• How open banking works
  
• Open banking use cases
  
• How open banking is changing financial services
  

How open banking works

Open banking was made possible by regulations such as the European Union’s revised Payment Services Directive (PSD2) and governmental bodies such as the United Kingdom’s Open Banking Implementation Entity (OBIE). They created a framework for legal and secure data sharing such that third-party developers could use that data to innovate in the financial services industry.

Open banking is based on the idea that consumers should be able to control their financial data and decide who can access it. Consumer consent is central to open banking, and customers must explicitly grant permission for third parties to access their financial data. With access to customer data, third-party providers can develop innovative financial products and services, creating a competitive business environment that improves customer experiences, reduces costs, and encourages new business models.

Application programming interfaces (APIs)

APIs are the technical backbone of open banking. They enable standardized and secure data exchange between financial institutions and third-party providers (TPPs).

Different types of APIs have different functions. Account information services (AIS) are APIs that provide access to account data such as transactions and balances. Payment initiation services (PIS) are APIs that enable third-party providers to initiate payments on behalf of customers. Other types of APIs used in open banking support identity verification, authentication, credit scoring, and more.

Security measures

• Secure APIs: APIs must have strong encryption, authentication, and authorization mechanisms to prevent unauthorized access and data breaches.

• Data privacy: Open banking must comply with data protection laws such as the EU’s General Data Protection Regulation (GDPR), ensuring that customer data is used only for the intended purposes and with customer consent.

• Third-party oversight: Regulatory bodies oversee third-party providers, requiring them to meet specific standards and obtain accreditation before accessing customer data.

The open banking process

Customer consent

The customer initiates the open banking process by granting consent for a third party to access their financial data. They typically provide consent through an online platform or a mobile app, where the customer can select the specific data they want to share and the purpose of sharing.

Secure data exchange

Once the customer has consented, the third party uses APIs to access the customer’s financial data from their bank. APIs use security protocols such as OAuth 2.0 and OpenID Connect to ensure secure authentication and authorization.

Data processing and analysis

Third-party providers use the accessed data to offer a wide range of services. For example, an account aggregation app can consolidate multiple bank accounts, a budgeting app can analyze spending patterns, or a payment app can initiate transactions on behalf of customers.

Open banking use cases

Third-party providers, financial institutions, and businesses have implemented open banking in a variety of ways. Here’s an overview of common use cases.

Identity authentication

Ecommerce businesses use open banking to authenticate customer identities by verifying their banking credentials, reducing identity theft and fraud in online transactions. Financial institutions and third-party providers can access identity-related information to confirm that a person is who they claim to be.

Financial management

Open banking has enabled the creation of third-party financial management applications for budgeting, expense tracking, and personalized financial advice such as savings plans. These applications display a consolidated view of financial accounts across multiple banks and help users better understand their finances.

Payment reconciliation

Open banking has simplified payment reconciliation for businesses and accounting firms. With access to transaction data, third-party software can automatically match incoming payments with invoices or accounting records, reducing administrative effort and manual errors.

Income verification

Open banking has enabled third-party providers to verify a person’s income by accessing bank statements and transaction histories—speeding up the process of loan applications, rental agreements, and other situations where income verification is required.

Credit checks

Open banking can help lenders evaluate credit by providing a detailed view of a customer’s financial history. Lenders can access bank account data to assess spending habits, account balances, and income patterns for a more holistic understanding of credit risk.

Overdraft solutions

Open banking allows banks to develop personalized overdraft protection solutions such as automatic transfers from savings by analyzing a customer’s transaction patterns and account balances. These solutions can reduce overdraft fees and improve customer satisfaction.

Peer-to-peer transfers

Open banking has enabled the creation of third-party applications for faster, simpler peer-to-peer transactions—reducing the need for cash or checks.

Integration of multiple banking services

Third-party applications use open banking to integrate multiple banking services into a single platform, allowing users to manage various accounts, conduct transactions, and access additional financial services through one application.

Debt recovery

Open banking has made it possible for collection agencies or financial institutions to access customer transaction data, identify payment sources, and assess overall financial health. This improves recovery processes and allows these entities to create customized repayment plans.

Customized insurance offerings

With open banking, insurance companies can customize their offerings by accessing customer financial data and analyzing risk profiles, life stages, and financial circumstances. Insurers use this information to offer personalized policies and premiums that better align costs and coverage with individual requirements.

Loyalty programs

Open banking can improve loyalty programs. Businesses can design personalized rewards by analyzing transaction data and customer spending patterns to identify qualifying purchases. This creates more engaging and customized loyalty programs.

New payment technologies

New payment technologies such as contactless payments and digital wallets rely on open banking and the ability of third-party applications to access customer bank accounts.

How open banking is changing financial services

Open banking has transformed banking and financial services by promoting competition, innovation, and customer-centricity—creating a new framework for how customers interact with financial institutions. By providing developers with access to a rich pool of financial data, open banking has driven a new wave of fintech business models and services including budgeting apps, robo-advisors, and automated savings tools. This increased competition in the financial sector has led to more customized solutions and a better customer experience, as traditional banks adapt and improve their offerings to keep up with new competitors.

Democratization of financial services

Open banking has democratized access to financial services, breaking the monopoly of traditional banks and making it easier for fintech startups and smaller financial institutions to enter the industry.

Improved customer experience

Open banking has generated financial tools that provide a unified view of accounts, give personalized advice, and offer various products without requiring customers to switch between different platforms. This convenience has improved customer satisfaction and encouraged consumers to engage more frequently with financial services.

Better payment options

With open banking, third-party applications can initiate payments on behalf of customers rather than relying on slower methods such as checks and cash.

More financial inclusion

Open banking can improve financial inclusion by providing access to financial services for underserved or unbanked populations. Fintech companies can use open banking data to offer microloans, peer-to-peer lending, and other financial products to individuals with limited access to traditional banking.

Stronger financial security

While open banking raises concerns about security and privacy, it also drives improvements in these areas. Regulations governing open banking mandate protecting customer data using encryption, secure authentication, and strict oversight of third-party providers.

Financial collaboration

Open banking promotes collaboration between traditional banks, fintech companies, and other third-party providers—allowing institutions to rely on each other’s strengths. Banks can integrate fintech solutions into their services, while fintech companies can access a broader customer base through these partnerships.

More transparency and data portability

Open banking increases transparency by allowing customers to more easily access and control their financial data. Customers can transfer their data when switching between financial institutions, reducing the barriers to changing banks. This empowers customers and encourages financial institutions to compete on the quality of their services.