What is Open Finance?

Traditional banks are facing growing competition from financial technology (fintech) companies. By improving the accessibility and convenience of financial services, fintech is exploiting the shortcomings of traditional financial institutions, and consumers are taking notice. Industry data highlights this rapidly expanding demand. The fintech market was worth $127.66 billion in 2018 and is forecasted to reach a global value of $309.98 billion by 2022. While this growth is promising for fintech companies, consumers aren’t ready to desert banks altogether.

As third parties continue to develop better personal financial management (PFM) applications, competition is forcing incumbent financial institutions to develop both infrastructure and products. Through the use of integrative protocols, banks can provide fintech companies with secure access to financial data. In turn, both parties can collaborate to bring new products and services to consumers. The result of this cooperative relationship is known as open finance.

Open Finance and Data Collection

The sharing of information requires seamless integrations between banks and third-party fintech companies. Fortunately, the technology to facilitate this process already exists in the form of application programming interfaces (APIs). An API is a set of codes and protocols that determine how different software platforms communicate and interact. To enable open finance, an API acts as a secure conduit between bank systems and third-party solutions.

Despite the infancy of open finance, several reputable traditional financial institutions  have begun to implement APIs to provide end-to-end Banking as a Service (BaaS), a subset of open finance. Some examples include:

• BBVA: BBVA’s Open Platform utilizes APIs that enable third parties to offer financial products without a full suite of services.

• HSBC: HSBC’s Connected Money app was introduced in 2018 and allows consumers to view loans, bank accounts, and credit cards in one place.

• Barclays: This UK-based bank claims to be the first to offer account aggregation within a mobile banking app.

Opportunities in Open Finance

By forming a robust network of banks and third parties, both financial service providers and consumers benefit from greater transparency and convenience.

Transparency for Lenders: Currently, third-party lenders must complete an exhaustive audit of each consumer's finances to assess their creditworthiness. However, without the ability to access the data held by different banks, this process is time-consuming and vulnerable to human error.

In an open finance ecosystem, lenders can get a better understanding of a consumer’s financial situation. By aggregating consumer data securely and efficiently, lenders can select suitable credit products for potential borrowers, audit documentation, and offer customized solutions. Raw data can also be fed through machine learning algorithms to extract more in-depth insights.

Transparency for Consumers: Just as open finance provides a clearer picture to lenders, it also provides transparency for consumers. By bringing together data from banks and third parties, a complete picture of personal finances is possible. The resulting findings allow consumers to optimize their financial position using personal finance management (PFM) tools, which is incredibly valuable for those with less financial literacy.

Open Finance Challenges

Despite the many benefits of open finance, some challenges remain to ensure successful implementation.

Cross-Platform Friction: Open finance is an ecosystem that includes several stakeholders, including consumers, regulators, governments, data providers, and third-party providers. Because there are so many participants, friction between each of these parties remains a considerable hurdle. Although APIs can establish connections, the number of integrations necessary can lead to data asymmetry where not everyone has access to the same information.

Determining whether interoperability and cohesion between all platforms is possible remains crucial when pursuing cross-platform integrations.

Data Security: Understandably, banks and other financial service providers remain prime targets for hackers and open finance may exacerbate this problem. With open finance, consumer data is held amongst multiple institutions with varying security measures, which might give hackers more incentive and opportunity to launch attacks. As a result, open finance requires robust cybersecurity solutions to combat incoming threats.

It’s also possible that the level of security necessary to secure individual or unique,  multi-platform configurations is out of reach. The cost of securing data and the lack of adequate technology are both potential hurdles to making open finance a full-fledged reality.

Bank Compliance: Government agencies and financial regulatory bodies are already imposing existing standards, governance, and compliance requirements on open banking, putting pressure on fintech companies to comply with fast-developing regulations. If any stakeholder fails to uphold these regulations and others like them, the open banking ecosystem may expose all members to the risk of financial or reputational harm.

The Future of Financial Services

The integration of traditional banking and fintech is an ambitious undertaking. However, the resulting benefits for consumers and financial service providers are undeniable. Building on this momentum, the decentralized finance (DeFi) market is introducing solutions that rely on blockchain technology to deliver the most autonomous financial services to date. 

Through the use of blockchain-based digital currency, smart contracts can enable trustless transactions that further empower consumers. Platforms like Aave, Compound, and Maker have already made their mark. Despite the benefits of both fintech and DeFi, there are inherent challenges that must be overcome. But if emerging projects work collaboratively with incumbent financial institutions, open finance has the potential to transform the delivery of financial services around the world.