How Open Banking Can Revolutionize Dated Banking Systems in the US

Open banking is on everyone's minds now – and for a good reason. In Latin America, open banking is bringing society together to achieve greater social inclusion.

In Africa, fintech companies are engineering a new hub for economic activity, and the latest EU regulations on open banking are provoking an inevitable face-off between challenger banks and traditional financial institutions.

Compared to the world's emerging open API-fintech landscape, the US banking system is falling behind its more glorious opponent: the world's emerging open banks. While lawmakers have taken an important step to overhaul the current data privacy law and roll the dice for an open banking system, the biggest resistance so far has come from the banking sector itself – due to high investment costs, lack of IT staff to implement open API technology, and a lack of regulation.

The reluctance of traditional financial institutions is a stumbling block to innovation. Here’s what they are blindly missing.

Forget utopian novels – open banking simply refers to sharing consumer data and exchanging that data smoothly with third-party services via open Application Programming Interface (API) technology. 

A good prototype is the iPhone and its Apple Store. The apps you download to monitor your sleep in your health application or get automatic calendar entries about upcoming flights to work because of open APIs – a technical medium that allows various programs to access, read and process data. 

The Payment Services Directive (PSD2), a European regulation, applies to banks and e-money providers. It facilitates access for third parties to both transactional data and payment operations. This allows EU businesses like the Tikkie app to evolve. Via Tikkie, you can quickly ask friends who owe you their part of dinner out to transfer you that cash in real-time.

But while the EU is moving at a rapid pace towards favorable regulation, the scenario in the US is quite different. 

The US banking sector is traditionally much more monopolistic. Few banks attract consumer attention and manage the market. However, this is why open banking is even more critical – instead of concentrating data within the existing big financial institutions, financial data must turn into accessible, democratized goods for all players in the economy.

Additionally, the data infrastructure of these banks is ancient, often leading to problems and faulty data connectivity. Customers experience connectivity failure rates of between 47.39% and 40.16% when they first attempt to link their accounts to third-party tools, depending on the type of financial institution they use. Without improving connectivity and renovating their data infrastructure, businesses will face bugs installing open APIs and continue handling disorganized and unreliable data.

At the same time, the US is fertile ground for open APIs – but not only because of the reining inequality. Roughly 7% of American households lack access to a bank account, and around 20% do have a bank account but still require financial help with services like payday loans. If you look at the country’s statistics almost no financial services exist for low-income households, and the racial wealth gap, it’s all rather gloomy.

Open APIs are the key to overhauling the financial system and elevating social equity – but are also crucial to generating new revenue for the banks. For example, financial institutions could realize approximately $2 billion in incremental, additional annual revenue if black Americans had the same access to financial products as white Americans.

When it comes to the financial health of the US population, the Center for Financial Services Innovation (CFSI) finds that 57% of American adults are struggling financially – with either large sums of debt, irregular income flows, or sporadic savings patterns. Additionally, approximately 91 million US adults today are credit-challenged.

Until now, bank loans have worked like this: After you apply, the bank checks variables like your credit score, background, and income to determine how much money it can lend you and what annual percentage rate (APR) you qualify for. On paper, this looks pretty straightforward, but in reality, the credit check is an extreme hurdle millions of US citizens face every day. Many of them fail to meet the predefined credit score indicators.

About 26 million American adults have no histories with national credit reporting agencies such as Equifax, Experian, and TransUnion. An extra 19 million have credit reports that are so limited or out of date that they are unscorable. All these people are living without credit scores – so they have no chance to access traditional forms of payment support, including college loans and money for healthcare.

After all, a person’s life is neither stable nor predictable, which means that the question of creditworthiness is a complex one. Circumstances can change dramatically within a few days. Nevertheless, traditional lending is usually based on financial records dating back months, if not years.

A reliable credit risk analysis based on an individual’s financial data, rather than opaque documents and intransparent variables, will help many Americans finally earn the deserved right to apply for a credit card or get a loan. Our analysis, for instance, looks at things like liquid cash flow, debt to income, bank service fees, and utility payments rather than just credit history.

Customers can expose their data for consumer lending or other financial services with an open API. Fintech companies (like Klarna or Afterpay) or merchants who allow for credit payments grant access to affordable financial products, so-called nano-loans, or even micro-insurance – and banks should offer the same services to stay in the market.

Banks have traditionally served as financial service providers, but thanks to open banking, they are now able to provide a wide range of consumer-lifestyle products – whether it’s concert tickets, dining reservations, or promotions and loyalty points on their purchases.

A good example is the Apple Titanium Credit Card, allowing consumers several benefits when buying products via the card and mobile applications. It is important to note that it isn’t Apple that provides all the additional lifestyle services. Instead, third-party providers offer their products via open API payment, resulting in a broader and more consumer-friendly user experience.

API integrations allow for a faster and more seamless shopping experience. As a user, you are just a click away from paying any potential service and receiving an additional loyalty bonus such as cashback without having to type in any account details or logging in to a user account. 

And with an open API, there’s also a much brighter future for larger investments, like housing. A customer potentially interested in an asset can use their banking application to access relevant financial documents, area real estate information, and current mortgage or rent details all on the spot.

We need a human-centered approach that brings buyers back in control of their own data, lifestyle decisions, and financial wellness. Open APIs are a great asset for encouraging informed financial behaviors and improving people’s monetary health.

For example, the average 25- to 34-year-old spends more than $2,000 a year at coffee shops – some of these might be interested in tools that could help them save their money for investing in a coffee machine. By accessing financial data, technology can analyze customers’ individual situations and opportunities for improvement. Often, people pay too much for a service, either because they don’t know the alternatives, or because they don’t even know how much money they are spending in the first place. 

Assessing financial data, service providers can help customers look for more suitable alternatives for loans or credits for lifestyle products, cars, and education loans. Smart data analysis can further guide important decisions like saving up for a down payment or when to buy or choose a financing option.

If you empower clients to improve their financial health and navigate their finances along their life stages (and with more predictive insights), the result is a much more personalized and sustainable customer approach.

Cornerstone Advisors’ research suggests that only 11% of US adults held their primary checking account at a digital bank in December 2020. Undoubtedly, there is a lot of growth potential for banks and fintech to build on the needs of today’s customers. Banks are basically sitting on a gold mine, but have yet to exploit it.

Let’s check what steps are necessary for moving towards a digital banking strategy and an open system.

Security requirements

One key factor for safe data transfer across applications is cybersecurity. There are several vulnerability points: attacks on third-party services, on the API itself, the application you use, or against the whole company. To regulate and secure the transfer, authentication, authorization, and delegation of credentials, it is advisable to implement security standards like HTTPS, mTLS, OAuth 2.0, OpenID Connect, FAPI. For better access security of customers, you can use multi-factor authentication methods, including identification factors like biometrics (as they are unique to each user and difficult to imitate or copy). In this process, the user will always be asked whether a third-party service can get access to their data with an authenticator app, a pop-up, or a web page verifying their identity.

Privacy statements

Getting privacy statements is one thing – getting active content of your customers is where it gets tricky. Since, as a bank, you're hosting the data of users, you're just giving their data back to them. Customers must have the technical ability to decide on variables such as the extent of sharing, the time period, and the purpose behind giving active consent. 

Customer buy-in

When transitioning to an open banking model, it’s key to get the customer's buy-in. That’s where marketing is helpful: Use your social media channels, email newsletters, and FAQ page to point out the benefits you're creating. The only details transmitted with open banking payments are payment instructions sent securely to the customer’s bank rather than the merchant making online payments much safer. So, you can't go wrong with a campaign about the new opportunities and services you can now offer – while stimulating a discussion on privacy and financial inclusion. 

Another crucial action is building customer support systems for when payments go wrong, technical difficulties arise, or customers need support with third-party service transactions. Open banking providers must have procedures in place in case a customer is not happy with their payment management or order. The key is to build an unbiased dispute settlement mechanism that decides customers’ rights and obligations case-by-case.

Due to new regulatory winds, 2021 was a historic year for open banking – and 2022 will bring an implementation tornado for banks and financial service providers to implement customer-centric services. Just ask yourself this: Why would a customer switch services when they can get everything they want, regardless of who they are from one institution, and one single platform?