In the fall of 2023, the Consumer Financial Protection Bureau (CFPB) presented its plan to implement a new section of the Consumer Financial Protection Act of 2010. It aims to make Open Banking mandatory for all financial institutions in the US. 

A technological transition necessitated by this legislation will require major efforts from traditional banks. As the regulatory framework is being developed, banks have a choice to take a proactive position: not only to comply with the upcoming regulations but also to take advantage of the opportunities presented by this change. 

N-iX is a long-term strategic technology partner for financial organizations in Europe, the UK, and North America. Our team has comprehensive experience in financial services software development, including API development and implementation, cybersecurity, data engineering, and financial data governance. This uniquely positions us to address the next wave of financial technology advancements. Let's discuss the implications of Open Banking implementation and identify the most effective Open Banking strategy for US and Canadian banks to lead in this industry transformation.

Open Banking essentials

Open Banking is the practice of securely sharing customer financial data with trusted third parties (TTPs) through APIs. This contrasts with the status quo, where banks hold this access exclusively. Now, individuals can share their information with multiple financial providers, paving the way for a more interconnected financial system. This shift also fosters the creation of new applications and services that enhance customer experiences and deliver innovative solutions.

The transformation of the financial system by Open Banking

What does the legislation require banks to implement? 

Section 1033 of the Consumer Financial Protection Act will require the implementation of Open Banking APIs by all financial institutions. An API is a tool that allows entities to “make available to consumers and authorized TTPs certain data relating to consumers’ transactions and accounts; establish obligations for third parties accessing a consumer’s data, including important privacy protections for that data; provide basic standards for data access; and promote fair, open, and inclusive industry standards” [2].

How is customer data shared now?

Currently, customers in the US have limited options for sharing their financial data with TTPs. One common method is screen scraping, which automatically extracts data from a user's online banking interface. Alternatively, some services allow customers to manually share their data with third-party applications using a username and password provided by the customer.

Neither of these methods adheres to proper security protocols, thus creating significant risks.

Open Banking in other countries

Open Banking has gained traction globally, driven by regulatory initiatives and the desire to create a more dynamic and competitive financial ecosystem. Europe has pioneered Open Banking adoption, particularly due to the implementation of PSD2 in 2018. The demand for easy access to consumer data has been growing since the rise of fintechs and third-party financial software solutions; however, recent years saw a surge in its growth. In 2022, Forrester projected Open Banking usage to double by 2027. 

Asia has also experienced a rise in Open Banking, particularly in India and Singapore. In South America, Brazil and Mexico are currently developing their Open Banking frameworks.

By unrolling Open Banking, North America is catching up with the global technological and organizational trends. 

Open Banking implementation map

Benefits of Open Banking to industry players

Secure and streamlined sharing of user data is an opportunity for strategic collaboration rather than a threat. Both fintech companies and traditional banks hold unique assets that are mutually desirable. Fintechs offer innovative technologies and agile approaches to financial services, while traditional banks bring established customer trust and a broad client base. This complementary dynamic presents significant opportunities for strategic partnerships and collaborative growth in the financial sector. Let’s look at how Open Banking benefits each of the market’s stakeholders:

Traditional banks

The evolving preferences of the new generation of customers have generated a substantial demand for innovative financial services. This led to the fintech boom and is now spearheading the implementation of Open Banking. Recognizing the importance of customer-centric services, many banks are rapidly integrating an Open Banking strategy into their business models to enhance user experience and foster innovation in financial services. Outsourcing to specialized technology providers can help effectively meet the ever-changing market demands and benefit from the expertise of top providers in their respective fields. 

  • Satisfied customers. Offering a range of new financial services (such as digital wallets, BNPL, insurtech, and more), more secure transactions, and various payment options significantly enhances the user experience, thus retaining and expanding the existing customer base.
  • Security. At a basic practical level, Open Banking eliminates the need for consumers to extract their data unsafely when using a third-party app. By enabling secure data sharing with TTPs through direct connectivity, banks can ensure that sensitive customer information is handled safely and complies with strict security protocols. This strengthens the banks' defense against potential cyber threats and allows them to utilize the latest cybersecurity technologies developed by these TTPs.
  • Payment type diversification. Traditionally, banks have focused primarily on credit card transactions. However, Open Banking paves the way for a broader array of payment options. The demand for cardless, direct, and cross-border payments are big trends. This diversification not only caters to the evolving preferences of customers but also positions the bank as a more versatile player in the financial market. 

Proportion of financial industry executives who anticipate that over half of payment transactions will originate from non-bank channels

  • Entering new markets. The connectivity that Open Banking provides enables banks to extend their services to previously untapped regions or demographics. This expansion is not just geographical; it also encompasses reaching out to different sectors and consumer segments, thus broadening the bank's market reach and potential for growth. 

Neobanks and fintechs

Open Banking presents a significant opportunity for neobanks and fintechs by providing access to the extensive client bases of traditional banks. This access enables them to offer an array of financial services that are in high demand, such as Account-to-Account (A2A) payments, advanced ecommerce payment solutions, and efficient cross-country payment systems. 

Additionally, Open Banking allows fintechs to cater to niche markets, including small business management and improved crediting options. This broadens their market reach and allows them to innovate and develop new financial products tailored to these needs. 

Customers

Around 50% of people aged 18 to 21 consider Open Banking highly important, with the same sentiment shared by about 40% of those in the 22 to 36 age group [3]. According to a survey conducted by Deloitte, customers consider convenience to be the most important benefit of Open Banking. This includes easy access to their accounts, the ability to perform transactions, and a unified interface for all accounts and loyalty programs.

Ecommerce

Ecommerce platforms can integrate with Open Banking APIs to offer customers a broader array of secure and convenient payment methods and a streamlined checkout process. Additionally, Open Banking transactions often have lower fees compared to traditional payment methods like credit cards. Ecommerce businesses can benefit from cost savings when processing payments, ultimately improving their profit margins.

Barriers to Open Banking implementation

If Open Banking presents so many benefits, why isn’t it an industry-wide practice? One side to it is the lack of awareness about Open Banking. The other side is explained by challenges and unexpected expenses, which make implementing Open Banking difficult in the short term. With new regulations on the horizon, financial institutions will inevitably need to overcome these challenges to remain a part of the industry landscape. Let’s look at the biggest challenges in implementing Open Banking:

Lack of data management strategy

Open Banking expands the pathways for data transfers, putting pressure on the data management system it has not experienced before. For banks that have not developed modern data management strategies, implementing Open Banking will involve bringing their other systems up to date. It is important to address data quality, security, and interoperability and align them with the Open Banking framework. In doing this, institutions can strengthen their solutions to handle future challenges with resilience and sophistication.

Open Banking and legacy systems 

Legacy systems are consistently named as one of the biggest factors hindering digital transformation in finance. Implementing an Open Banking strategy while maintaining legacy core banking systems is theoretically possible. However, the premium on developing such a solution might exceed that of abandoning the legacy system for good. It might be more sound to start transitioning to a modern system in parallel and implement API into it. Whatever the choice, adhering to the Open Banking legislation will require investment in IT systems. 

Integration with international legislation and standards

The fintechs and software development companies implementing the API for banks often do not have experience with simultaneous compliance with multiple legislations and industry standards. Several studies [4] on the difficulties in Open Banking implementation have pointed out that smaller fintechs do not have the legal capacity to meet the needs of traditional banks. European experience shows that developing the solution takes little time compared to establishing the proper legal framework. 

Furthermore, Open Banking APIs are currently not standardized in the US, which means they do not comply with regulations to the same extent. Properly integrating diverse services with banking systems requires a significant amount of work. Banks will likely need to invest in custom Open Banking solutions to ensure seamless integration and meet their standards.

N-iX’s experience with implementing Open Banking

At N-iX, we have helped European banks develop an Open Banking strategy, comply with regulations, and ensure the highest level of security for their services. One of our clients is a British bank processing billions in payments and looking to be a part of the digital transformation of the industry. Our engineers have delivered: 

  • An Open Banking API seamlessly integrated with existing systems, aligning new components smoothly with the current technology architecture;
  • A regular system monitoring and reporting to the Financial Conduct Authority (FCA) for compliance and operational efficiency.
  • Strong Customer Authentication (SCA) introduced an extra layer of security before payment authorization to prevent fraud. Customers verify payments through bank prompts, adding a layer of protection.
  • Two-factor authentication with Identity Guard; 
  • Strengthened login security by requiring a verification code alongside standard credentials.
  • Integration with Snowdrop 2.0, which provided users with detailed merchant information for transactions, improving transparency and tracking.

N-iX has experience in handling the challenges of the highly regulated financial software industry, combined with advanced expertise in cybersecurity. Our collaboration has contributed to simplifying and securing financial services for customers while also making innovative technology easy for the bank.

Read more: Facilitating secure neobank transformation

Open Banking strategies

In formulating their Open Banking strategy, traditional banks make two critical choices: first, determining whether to outsource their products; and second, deciding whether to externalize the ownership of customer relationships. Let’s examine the matrix of Open Banking strategies these decisions create:

Open Banking strategies matrix

Minimal efforts

Open Banking is primarily adopted to comply with regulatory requirements, and this approach does not necessarily entail significant alterations in the bank's operational processes.

While this strategy may appear to present the least risk, banks that choose to stay behind the trends may lose customers to more innovative institutions. 

Expanded traditional banking 

It combines the strengths of traditional banks, such as their established customer base and trust, with the innovative and specialized capabilities of fintechs. 

Traditional banks can expand their services and products by partnering with TPPs. This can include advanced digital payment solutions, personalized financial management tools, or investment services not previously offered by the bank. By integrating these services, banks can improve their value proposition and remain competitive in the digital financial landscape. 

Banking-as-a-service (BaaS)

BaaS, or Banking as a Service, refers to the practice of banks offering their core banking infrastructure as a service to external customers. Traditional banks can focus on the technologies they already know: managing accounts, processing payments, and providing credit facilities. BaaS is also a valuable tool for banks in the role of customers of other banks, allowing them to replace outdated legacy systems quickly. Fintechs benefit from this cooperation because their business model does not imply a banking license, which forces them to rely on an external core banking system.

64% of American banks have made an effort to improve their BaaS capabilities in 2023 and state that further development is a priority for them [5]. They explain their decision to invest in Banking as a Service (BaaS) with its capability to accelerate time-to-market and eliminate the necessity of developing all new products in-house. This, in turn, allows banks to diversify their product offering and revenue streams. 

Banking-as-a-platform (BaaP)

BaaP is the most innovative strategy out of the four. Neither the customer base nor the services belong to the bank. Instead, the bank's product is the platform that matches the services of different providers with customers. When various financial institutions join a BaaP platform, they essentially blend their customer bases. This is akin to the way online marketplaces work, where different sellers offer their products to buyers through a joint platform. Banks that adopt the BaaP model can expand their reach beyond traditional banking services. They can tap into new markets and customer segments by offering various financial products, including those not typically associated with traditional banking. 

Develop an Open Banking strategy with N-iX experts

Wrapping up

Overall, Open Banking offers opportunities for collaboration and growth in the financial sector. With the push for Open Banking legislation, banks must embrace this transformation and develop effective strategies to stay competitive in the changing industry landscape. Embracing Open Banking can challenge many institutions, especially those with outdated systems. However, this shift also provides a crucial opportunity to modernize their technological infrastructure. By investing in this transition, these institutions can not only meet current industry standards but also position themselves at the forefront of financial innovation.

References: 

  1. Required Rulemaking on Personal Financial Data Rights, CFPB
  2. Notice of Proposed Rulemaking for the Required Rulemaking on Personal Financial Data Rights, CFPB
  3. Executing the Open Banking strategy in the United States, Deloitte
  4. Barriers to Open Banking, Janina Haapanen 2022
  5. Financial Services State of the Nation Survey, Finastra 2023

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N-iX Staff
Yuriy Voloshynskyy
VP Delivery

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