What is open banking? Inside this key innovation in the financial sector

A relatively new way of sharing financial data, open banking is a major transformation in the financial sector. This development lets banking data be shared with third parties easily and efficiently, paving the way for new, innovative and personalized financial services. 

It's a revolution in the banking landscape that promises to have as much impact on users' lives as the Internet, smartphones and electronic payments. In fact, it’s well on its way to doing so already.

Let’s unpack this concept a little further and explore what open banking means for businesses, banks, and their customers. 

What is open banking?

In practical terms, open banking refers to the process by which banks and financial institutions open up their data, letting the right people access, use and share it. This free flow of information then lets financial service providers, fintechs, and banks create more integrated products. 

But don't panic: information sharing only takes place with the explicit agreement of customers as to what information is shared and with whom, and does not compromise data security. It’s governed by strict measures and rigorous regulations such as PSD2 in Europe, which imposes robust security measures to protect customer data. 

Transactions and data sharing are subject to authentication and encryption protocols, ensuring that financial information is protected against unauthorized access and cyber attacks.

Open banking APIs

The key to this process is open banking APIs, which enable software to communicate and exchange data securely. Standardized APIs allow specific information, such as account or product data, to be shared with authorized third parties. 

The system is designed to be transparent and secure, giving customers control over what information is shared and with whom.

What data is involved?

Open banking services provide access to three main categories of data: account data, product data and payment initiation.

• Account data concerns information relating to a bank account, such as:some text
  • The name of the account holder
  • Type of account
  • Currency
  • Account opening date
  • Information on transactions (amounts, companies, etc.)
    
    
• Product data refers to the products and services offered by a financial institution. There is no longer any need to visit a bank branch to obtain this information; it is now available online.
  
  
• Payment initiation allows you to transfer funds from one bank account to another. Instead of contacting your bank to carry out each transaction manually, open banking lets you initiate this process via another software application or website, and to speed it up.

Again, no stress: you have total control over what information is shared and with whom. No data about you can be shared without your consent.

The benefits of open banking

The aim of open banking is to stimulate innovation and improve the financial services offered to users. Thanks to open banking, integrated services and APIs, banks can now integrate new services faster than ever before. 

This even includes offerings traditionally considered less profitable, such as loans and small business financing. But they offer other benefits:

1. Improved financial services

For banks

Open banking encourages financial institutions to innovate, developing products and services that are more tailored to the needs of businesses and individuals. Machines can already perform many time-consuming, low-value-added tasks, such as credit and customer checks, risk assessments, document authentication and analysis, and internal controls, more accurately and almost instantaneously. 

It also enables banks to offer new financial services and stimulate the creation of new offerings. This open banking approach is pushing banks towards extra-financial services, a concept known as ‘beyond banking’. The idea is not just to intervene when an individual needs a financial service, but to position themselves upstream and downstream of that need to offer real advice, support and decision-making assistance. 

By freeing banks from operational tasks, AI enables them to get back to the heart of the business.

For businesses

Financial tools become more efficient and cost-effective, thanks to increased automation and reduced costs. This technological improvement offers small businesses fast, flexible banking services tailored to their specific needs, reducing the usual delays and complications.

For individuals

Open banking offers better solutions to manage consumer accounts, savings, borrowing and investing in a more informed and personalized way. The data analysis made possible by open banking means, for example, that premiums can be reduced. 

Neo-banks have already redefined standards: today, it is no longer acceptable to take weeks or months to open an account, send and receive money or obtain a line of credit. Everything has to be accessible online, via your phone, instantly.

2. Improved access to financial products

This flow of bank data across software improves access to financial products. This is true even for individuals and businesses traditionally excluded from the banking system.

In fact, some of the fastest changes have occurred in emerging markets. Relatively poorer countries with less established banking systems have developed new ways to send and receive funds, including internationally. This is built on the back of open banking APIs and technologies. 

3. Automation and efficiency

Standardized data makes it easier to automate manual financial tasks, such as initiating payments, credit checks and internal controls, and making transactions faster, more accurate and more secure. 

4. Faster, fairer risk assessments

Advances in technology enable almost instantaneous risk assessments, making it easier for businesses to access capital quickly. At Defacto, we are able to carry out credit checks and assess a customer's risk profile in just 27 seconds. These features reduce the administrative burden traditionally associated with these tasks, and are continually improved with each new integration. 

We also use algorithms that establish an initial credit limit based on the information provided. This limit is then dynamically increased as the business grows or proves its reliability.

A few concrete examples

Open banking has revolutionized the market. Fintechs such as Lydia (payment service) and Bankin' (multi-account management) are enjoying great success, while banks are offering applications for monitoring stock portfolios (LCL) or managing employee savings (BNP Paribas). 

By drawing on the possibilities offered by open banking, Defacto is also able to offer companies fast, customized financing that would simply have been impossible before.

Open banking has also led to the development of new financing methods such as RBF (Revenue Based Financing), which offers an interesting alternative to traditional financing solutions because it is based on anticipated business revenues.

What impact will open banking have on the financial sector?

By making banking services more customer-centric, competitive and inclusive, open banking has the potential to radically transform the financial landscape. 

Emerging technologies such as artificial intelligence (AI) and automation are playing a key role in this transformation. For example AI is already used in lending to improve risk assessments and credit checks, enabling faster and more accurate financing decisions. 

As mentioned above, at Defacto we use AI to perform credit checks in seconds, to dynamically assess customer risk profiles. This is a fundamental transformation of the banking business model. What used to be a heavy operational burden is now inexpensive and fast.

Finally, open banking represents a significant step towards greater transparency, improved customer experience and greater innovation in the financial sector. By enabling the secure and controlled sharing of financial data, it offers consumers and businesses more personalized and efficient services, while increasing competition and innovation in the financial services market.

By embracing open banking, financial institutions can not only enhance their current offerings but also explore new avenues for growth and collaboration, making the financial sector more dynamic and responsive to society's changing needs.

To stay at the forefront of change, banks must embrace these innovations and continue to explore what is possible in this vital sector. At Defacto, we’re committed to offering modern and efficient financial solutions tailored to the needs of SMBs, to help them grow at their own pace.