Financial institutions are facing fundamental changes, a new era is dawning in the financial world and banking is facing a radical change of direction – there really is no shortage of superlatives when it comes to outlining the effects of PSD2 on the banking industry.
The EU Payment Services Directive undoubtedly gives impetus to the debate on what the future of banking will look like. In this context, one term comes up again and again: Open Banking. For some, Open Banking is an empty phrase past its sell-by date, whilst others see it as signalling a promising future for the financial world.
So what’s behind Open Banking? What is the definition of the term? And what impact does Open Banking have on the financial world? In this blog post we will try to provide answers to these questions step by step.
Open Banking – All a Question of Definition
Strictly speaking, Open Banking refers to the opening of banks to third-party providers. On 13 January 2018, the EU Payment Services Directive (PSD2) was transposed into national law. PSD2 provides the legal framework for the market opening for third parties.
These third parties are now authorised both to access the account information stored at financial institutions via a banking API and to initiate transactions. There are two categories of providers:
- Account Information Service Providers (AISP): These providers access account information stored at the account-holding bank on behalf of the customer. Depending on the provider, the information is aggregated and analysed and, for example, further processed within the framework of loan application processes.
- Payment Initiation Service Providers (PISP): These providers also receive access to accounts on behalf of the customer. However, unlike Account Information Service Providers, they are authorised to initiate transactions on the account.
After receiving approval from the account owner, account-holding financial institutions grant third-party providers access to the account via a banking API. These banks open up, participate in Open Banking and are actually one of the most important players throughout.
In a broader sense, Open Banking describes a movement that has almost turned into a philosophical question regarding the future of banking. In this respect, PSD2 is the last step to ensure an opening that has been long overdue. For many decades, the banking world has been reluctant to cooperate with third parties, even though there has always been a demand for innovative banking services.
From PayPal’s success since the late 1990s to the impressive development of Challenger banks such as N26, customers have always been open to new approaches that enhance the banking experience. The reason that success stories like PayPal were so rare during the nineties and noughties was mainly due to the closed nature of banks back then.
However, as the revised Payment Services Directive began to emerge, it became apparent that the financial sector would finally succeed in opening up – quickly and with great dynamism. Whereas banks have had sovereignty over account information to date, innovative FinTechs can now also access such information and develop new offers that supplement classic banking services.
Since then, investments in FinTech companies have rocketed. In 2018 alone, FinTech investments of more than 30 billion euros are forecast. Newcomers to the industry have become a symbol for the Open Banking movement on a large scale.Open Banking is no stranger to investment: 30 billion euros will be invested in FinTechs in 2018 and investment growth continues unabated. Click To Tweet
Three Major Use Cases: Finance, Loans, Payment Transactions
In the end, one of the main beneficiaries of Open Banking will be its customers. New apps and services are already improving the banking experience and one of the main goals of the European Union has become a reality. PSD2 is intended to create more competition and thus a wider range of products and services.
Many FinTechs are working with established financial institutions to further improve the customer experience. Three main areas are likely to benefit from Open Banking:
1. Personal Financial Management
It has long been the norm that customers have two or more accounts. Since banking systems were previously incompatible with each other, customers had no choice but to log into each account separately. Open Banking now makes it possible to manage your personal finances in a more convenient manner. Numerous app providers aggregate different bank accounts under one user interface and provide customers with a neatly sorted overview of their finances.
2. Online Lending
Customers who apply for a loan are familiar with the time-consuming procedure: the lending financial institution wants to see lots of paperwork such as salary statements, bank statements and rental contracts. From the customer’s point of view, this is a complicated and tedious experience.
Thanks to Open Banking, credit checks can be carried out online and without media discontinuity. The lending bank accesses the relevant account information via a banking API and can make a precise loan decision within a few minutes.
3. Payment Transactions
Very few customers who shop online and pay by credit card at the checkout realise how complicated it is to process payments in the background. Online retailers work with payment service providers, which in turn cooperate with credit card companies.
It can be days or weeks until the paid amount actually arrives into the shop operator’s bank account, not to mention the expensive processing costs. Open Banking makes it possible to initiate a payment directly from a customer’s account.
Open Banking Is a Healthy Development
Regardless of whether you regard Open Banking as a technical process or as a major movement, it is a topic that will definitely have a long-term impact on the financial world. But like most sustainable changes, we will experience Open Banking as an organic process rather than a blatant disruption to our banking experience.
This gives everyone involved the opportunity to prepare themselves and to find a place in this newly forming value chain in the banking sector. Only one thing will ensure your lack of success: not to participate. By the way, our colleagues from Innopay operate the Open Banking Monitor with exciting information and analyses about the Open Banking market – it’s worth taking a look.