DEFINITION of 'Open Banking'

A system that provides a user with a network of financial institutions’ data through the use of application programming interfaces, better known as APIs. The Open Banking Standard defines how financial data should be created, shared and accessed. By relying on networks instead of centralization, open banking helps financial services customers to securely share their financial data with other financial institutions. Benefits include more easily transferring funds and comparing product offerings to create a banking experience that best meets each user’s needs in the most cost effective way.

Also known as Open Bank Data.

BREAKING DOWN 'Open Banking'

Open banking is meant to improve customers’ banking experience in several ways. It forces large, established banks to be more competitive with smaller and newer banks, ideally resulting in lower costs, better technology, and better customer service. Open banking regulations require banks to publish, both online and inside their branches, accurate and unbiased information that lets consumers evaluate their service quality, a move towards transparency designed to motivate banks to provide the best possible customer experience. Banks also have to notify customers about unforeseen overdrafts and give them a grace period to correct the problem and avoid overdraft charges.

Open banking is a major source of innovation in the banking industry. For example, open banking APIs can facilitate the sometimes onerous process of switching from using one bank’s checking account service to another bank’s. The API can also look at consumers’ transaction data to identify the best financial products and services for them, such as a new savings account that would earn a higher interest rate than the current savings account or a different credit card with a lower interest rate.

Through the use of networked accounts, open banking could also help lenders get a more accurate picture of a consumer’s financial situation and risk level in order to offer more appropriate loan terms. It could also help consumers get a more accurate picture of their own finances before taking on debt. An open banking app for customers who want to buy a home could automatically calculate what customers can afford based on all the information in their accounts, perhaps providing a more reliable picture than mortgage lending guidelines currently provide. Another app might help visually impaired customers better understand their finances through voice commands. Open banking can also help small businesses save time through online accounting and help fraud detection companies better monitor customer accounts and identify problems sooner.

Open banking threatens long-established banks by increasing competition, requiring older banks to do things in new ways that they are not currently set up to handle and requiring that these banks spend money to adopt new technology. However, banks can take advantage of this new technology to strengthen customer relationships and customer retention by better helping customers to manage their finances instead of simply facilitating transactions.

Before banks offered open banking, the closest thing available was an aggregation site like Mint or Personal Capital that combines users’ account information from all their financial institutions so they can see it in one place. Such services accomplish this by requiring users to hand over their usernames and passwords for each account, then scraping the data off the screens of those accounts. This practice has security risks and the results of screen scraping are not always entirely accurate, making it difficult at times for users to identify transactions. In addition, users may find that not all of their financial accounts are compatible with account aggregation services, preventing them from getting a true or complete picture of their finances. APIs are considered a more secure option because they enable applications to share data without sharing account credentials.

That being said, open banking APIs also have security risks, such as the potential for a malicious third-party app to clean out a customer’s account.

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