If you’ve read my recent blogs, you’ve likely noticed a theme—the world of banking and financial services is changing radically; this includes the growing adoption of digital payments and, most recently, the arrival of decentralized finance.
Now it’s time for yet another chapter in this evolution, open finance. If decentralized finance is the wild wild west of banking, where the “red tape” rules and administrators have run for the hills, open finance is the slightly more traditional entity. The formal structure, in place for decades, is changing for a new set of players.
It’s no secret that the banking and financial sector has been slow to evolve, but formidable external elements have forced its hands. These include threats from FinTechs and other businesses, an urgency to outperform new competition, and lastly, a desire to help those without access to banking services.
Today the epicenter of open finance is the U.K. Its roots date back to 2016 when the Competition and Markets Authority (CMA) did a study around the region’s nine biggest banks. Through these efforts they identified two areas that needed to be addressed:
- These nine companies were exceedingly comfortable, which ultimately meant they didn’t have to compete hard enough to gain customers.
- The smaller and newer banks outside the nine-company circle were struggling to grow and access the market.
With that, the CMA took action, requiring these banks to give licensed banking and financial startups access to their data. The decision created more competition and a renewed focus on innovation; this became known as open banking and was focused exclusively on the financial element.
Evolution of open finance
The system then evolved further into open finance, expanding this ecosystem to include entities outside the financial realm— insurance companies, utility providers, retailers, and more. People without access to banks, the unbanked, were the driving force behind this expansion. If you’re not familiar with this term, it refers to people who don’t have an account at a financial institution or through a mobile money provider— according to World Bank, approximately 1.7 billion adults remain unbanked.
Open finance also aims help the gig economy, where the number of workers is growing— according to Upwork by 2027, the U.S. will have 86.5 million independent gig workers. While this model is ideal for many, the lack of a stable income can hamper the ability to gain access to critical financial services such as loans.
Open finance – connecting the unbanked and gig workers to financial services
Leveraging application programming interfaces (APIs), open finance securely connects these institutions to other banks, and most importantly, third parties, from FinTech services such as digital wallets to insurance companies and others I referenced earlier.
Through this connectivity, businesses, with the consumer’s consent, gain access to customer data, including mortgages, savings accounts, retirement accounts, bills, payroll data, and more. With this information, they have a single snapshot into an entirely new set of people, their current financial footprint, preferences, and more. They can offer critical new and personalized products and services while the consumer retains ownership of their data, including the unbanked and gig workers.
As you can imagine in the data-driven model, security is vital. Open banking security standards such as mutual authentication over transport layer security (mTLS), eIDAS (electronic IDentification, authentication and trust services), OAuth 2.0, OpenID Connect, and financial-grade API (FAPI) are being used to guarantee security. Other security measures include polymorphic encryption and Zero Knowledge Proof. The latter is a set of tools that allow information to be validated, such as a birthday, without exposing the data that proves it. As a result, it delivers an extra layer of security.
Adopting open finance around the world
Today in the U.K., open finance continues to evolve as the government along with help from groups such as the Financial Conduct Authority (FCA) work to plot its future. In fact, the FCA recently released its feedback statement, a report which summarizes feedback it received to its Call for Input that was issued in 2019 to explore the opportunities and risks from open finance and how to ensure it develops in consumers’ interests and the role [the FCA] could play. Looking forward, the FCA will work with the government to develop common standards and roadmaps to open finance.
As the U.K. continues its efforts, other countries are beginning their journeys. In Australia, the Consumer Data Right (CDR) was created to address a scenario like that in the U.K. where a few big banks were holding all the cards. In Europe, the Payment Services Directive (PSD2) along with open banking are laying the groundwork for a possible of open finance in the region.
Putting consumers first - the open finance way
Clearly open finance will benefit consumers with virtually anyone gaining access to financial resources they need. On the flip side, businesses also benefit by reduced operational costs as well as by gaining access to a larger ecosystem of businesses where they can compete for new opportunities that previously were not readily available.
Based on my last two blogs, it’s abundantly clear that the financial services sector as we know it is undergoing a radical change where the old meets the new. The latest example, open finance, aims to create a middle ground where old meets new, and the winners are consumers who further grow their financial footprint, all while retaining ownership of their data.
Previous blogs:
Sailing through the turbulence
Explainable AI: shining a light on the future of AI