Open banking frameworks

Even though Britain, EU and Australia have already adopted open banking frameworks, Canada seems to be lagging behind in setting up their own open banking systems framework. The senate committee on Banking Trade and Commerce called for a decisive action from the federal government to move forward with an Open Banking framework based on a study conducted by them. The Cabinet, however, had a lukewarm response to the committee’s recommendation and in its turn set up an advisory committee in 2018 which is yet to recommend any course of action.

On the other hand, innovative fintechs have already allowed Canadians to borrow at lower rates, invest better and get competitive rates on currency exchange. Fintechs have the ability to improve financial services for customers and businesses, increase competition, and to be an engine of growth for Canada’s technology sector in the near future with the help of Open Banking systems.

While there are definitely risks associated with Open Banking systems, not having an Open Banking system infrastructure only increases the risks since data sharing activities continue to happen with outdated methods like screen scraping. This exposes end customers to privacy and security risks that can be easily reduced with APIs securely interacting with the Banking systems to share customer data with third party service providers with the consent of the customers. All this requires the open banking system framework. Open banking systems then look largely beneficial and even imperative. In this scenario it is alarming that in Canada’s largely concentrated banking industry this change is being led by the Banks themselves in a bid to stay updated with the global market. This in the absence of a open banking system framework can be dangerous for Canadian customers and the security and privacy of their data.

What is Open Banking?

With the rise of technology and data sharing across all industries, it was imperative that the need for data sharing would arise for Banks and Financial institutions at some point. In fact since customer spending is the best indicator of customer behavior, the data from Banks and financial institutions are the biggest predictors of customer spending, saving and investment. As a result we have seen technologies cropping up around smart fintech that work with APIs and provide smart suggestions to customers based on their transaction and interaction histories. This kind of evolution of technology requires a banking framework around data sharing and data privacy that can allay customer fears and yet allows space for innovation. This entire infrastructure is what has come to be known as Open Banking system.

Benefits of Open Banking Systems

Benefits to customers:

At the basic level open banking systems allow customers to take control of their data and share the same with third party providers to receive customized value propositions. As a result more differentiated and specific but wider choice of financial service and products become available to customers. Specifically customers might benefit in the following ways from an open banking system:

• Data aggregation: An aggregated view of their financial position across bank accounts, loans, credit cards, investments and insurance will provide a detailed level of insight to customers, leading to better financial decisions and easier tax reporting. Currently data aggregators are using screen scraping but are slowly moving towards APIs.
• Personalization: Greater personalization of services across industries including banks, real estate brokers, lawyers and home inspectors, all integrated into a single seamless service.
• Customer access to better technology and innovation: greater competition among service providers to provide better technology, innovation and access to customers. Customers will also be allowed to choose how they want to engage with open banking and what data they consent to be shared with whom. This will in turn lead to high customer sentiment because of high levels of innovation like in the U.S.
• Better pricing for products and services: Third party service providers and challenger banks will be empowered to offer better priced products to customers based on their data that was earlier guarded by the established banks.

Benefits to financial institutions

• Better understanding of the customer’s risk profile: Financial institutions will get a holistic understanding of their customer’s risk profile because of data sharing across financial institutions instead of a piece meal view.
• More accurate pricing: They will be able to price products more accurately in sync with the customer’s risk profile.
• Holistic view of the customer: A holistic approach to the customer will ensure that banks and financial institutions can offer the customer the exact product that the customer might need.
• Expand market share: Expansion of the market share is possible through innovation in product and customization.
• Reduce time to market: This will serve as a push to other institutions to undergo core modernization and in turn reduce the time taken to market new products and services.
• Enhanced fraud prevention: Ensure enhanced fraud prevention (e.g., anti-money laundering and counter-terrorist financing) and better customer identity management (e.g., KYC/KYB). Credit risk profiling for loan requirement verification can be performed by application programming interfaces (APIs) much more easily.

Benefits to the economy

At a macro-economic level, due to the increase in commercial and customer activities, open banking is likely to have a positive impact on the financial services industry and overall GDP. According to a study by the Centre of Economics and Business Research in the UK, open banking can contribute more than£1b annually to the UK economy and support the creation of 17,000 jobs.

Potential risks and mitigation strategies for open banking

While open banking brings many benefits to customers, financial institutions and the economy there are associated risks that need to be mitigated as the journey towards open banking continues. Let us take a look at the areas of risk for both the customers and the financial institutions.

Risks for Customer

Security

Security is the first obvious concern in open banking systems. With a growing number of cyber attacks, financial loss, identity theft becomes more probable as data is shared more widely. Even cyber bullying and ransomware, which have already emerged as cyber terrorism tools, can become more effective with open banking.

To mitigate these risks, controls and protocols including authentication and verification protocols need to be established. Additionally, educating and training employees and customers on leading practices to follow and steps to respond to cyberattacks, will be imperative to protecting both customers and financial institutions.

Fraud

As the number of participants in the financial ecosystem increases, the risk of fraudulent vendors with fake product offerings and services is expected to go up. This could also increase the risk of financial crimes, including money laundering and terrorism financing.

Potential tools to increase trust in the system need to be implemented to mitigate these risks. This can include verification protocol and authentication mechanisms. Technology enablers such as artificial intelligence and machine learning algorithms can help by learning vendor and customer patterns and flagging any irregularities investigation before a transaction is allowed.

Privacy

As the number of parties among which the customer data is shared increases the chances of the customer data being misused in a way not authorized by the customer thus exposing the customer information.

A robust data privacy policy along with educating participants to increase awareness on how they can protect their information could reduce the risks.

Digital and financial exclusion

Some customers who are less technologically inclined get left out of the open banking system. The same could be true for some vendors and customers will little or no digital presence. This presents a challenge for regulators around inclusivity.

Risks for Financial institutions

Disintermediation

Owing to the increasing involvement of third parties in the relationship between banks and their customers banks will face a risk of disintermediation. It is imperative then that they evolve and adapt their relationship with their customers to the new scenario. Open banking might lead to changes in liquidity concentration risks for financial institutions too. While infrastructure costs might continue to stay with incumbents, the benefits may shift to other players in the ecosystem.

Additional costs due to regulatory requirements

Banks may have to invest and incur costs to replace legacy systems, establish core banking platforms, digitize offerings, and re-engineer new processes to make regulatory and compliance shifts. It might also increase regulatory oversight across the ecosystem.

About Incepta

Incepta Solutions is an emerging tech consulting company focusing on API led integration services in the area of banking and automation.

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