By Ishant Gupta
Open banking is the most recent innovation in the field of financial instruments. Open banking can be best understood as the use of an Application Programming Interface (API) in the field of financial services, which allows third-party developers to build an application around the financial institutes. To understand the crux of open banking we need to understand the engine under the hood, that is API.
API: The centre of the innovation
In the modern world, we all enjoy instant connectivity. We all are connected on various fronts. We can book movie tickets, shop online and order food at the click of a button. However, the unsung hero here is the Application Programming Interface (API). The technical definition of API is a set of function and procedures that allow the creation of applications which access the features or data of an operating system, application, or another service. It is a messenger which takes a request and sends the response.
Suppose you are booking flight ticket online from Air India. From a list, you will select the destination, the date and time and at last the class. As soon as you confirm the entered details the request will be taken by the company which will access the Database of Air India to provide an estimated cost. Now, instead of booking your flight from Air India suppose you book it via Make my trip, which will showcase results from different platforms such as Deccan, Emirates, and so on. What essentially happens, in this case, is that this third party use API to access the database of the various service provider and provide the response to the request made by you.
Earlier API was not secured to handle crucial resources such as money, but it is now. The blend of API and banking is what we call as open banking.
Open banking and India
Demonetisation played a major role in promoting open banking in India. This was partly due to the cash withdrawal limit and partly due to increased awareness of populace on the matter of banking. To understand it factually, transactions via debit card rose from 817 million in the year 2016 to over a billion in just January 2017. The main driver of this transaction was the point of sale machines that various merchants used, as ATM transactions remained constant around 700 million. The government further took advantage of the situation to launch the BHIM application, which was run with the help of UPI. The transactions via UPI and BHIM tripled and quadrupled from mere 1 Lac in October 2016 to 6.4 Million in March 2017.
UPI is the best example of open banking in India. UPI, or Unified Payment Interface, is like an email address for money. It provides a unique identity to every bank account and enables faster transactions. IMPS (Immediate Payment Service) earlier required a lot of details like account number, IFSC code, and the name of the beneficiary. Doing all this on a smartphone was rather a tedious task, but with the help of UPI, this system became easier. One can transfer the money to a third party or a merchant just by knowing their unique identity. BHIM app further aided it by linking it to Adhaar and enabling transactions by just entering a Unique ID and a simple biometric scan at various points of sale across India.
The government was not the only one to exploit the opportunity. Various start-ups like Mobikwik emerged during this time period. Even Google soon came up with an application called Tez based on UPI. Some of the biggest beneficiaries of the system are the e-commerce industry. Giants like Uber, Ola, Zomato, and Food panda could link themselves as an identity under UPI and can undertake transactions easily.
Open banking has changed the retail industry down to the hilt. The two major benefits to the retailer are the reduction of cost due to frauds and payment processing fees and generations of revenue by providing a platform for coupon-based discounts. The cost incurred by retailers due to the payment processing fees is regarded as the second-highest expense after labour cost and Mobile wallets help in reducing that. Secondly, these platforms act as sales promotion techniques. So in totality, more revenues and less cost, which equates to higher profits. The only cause of the problem has been the security issue on these platforms, but UPI is getting more secure day by day.
Key takeaways the from European Union
The European Union has been a pioneer in the field of open banking model. EU was the first to pressurise upon open banking, dating back to 2008-09. EU in the past came up with various innovative open banking models such as Fidor and N26. The seven-day account switch service was one of the innovative models which allowed the consumer to evaluate various services provided by the financial institutes and enabled them to switch their service provider within seven days. However, the most important learning from the European Union is the written set of guidelines for API called as Payment Service Directive; to be precise PSD 2 which was passed in November 2015.
PSD2 aims at securing e-payments and expanding the financial service ecosystem. It covers most of the payment service providers, demands strong authentication for every financial transaction and opens data to third parties. PSD2 solves some major problems faced by open banking such as Security, accountability, and reluctance from existing player.
By including most of the payment service provider it enables wide-scale acceptability and dependency of open banking. To overcome fraud and hijacking, it follows strong authentication such biometric scans. This helps in protecting the consumer against hackers. A lot of existing giants are reluctant to share their data with third parties due to which these parties were not able to develop the application for all, but PSD2 overcame this by legalising the need to share information, thereby levelling the playing field. Further, it ensured that in case of a fraud, the service provider is responsible to collect evidence and securing the confidentiality of users security credentials thereby boosting the reliability.
Future of open banking
Open banking offers various advantages to the customer. It shifts the control from banks to the consumer. Individuals can have their own personalised interface with the help of third-party developers under one head. It will enable them to manage multiple accounts under one window. The feature that one can retain the account number even after changing the provider will be beneficial for them as they can switch to the more beneficial provider without incurring the cost. It will also enable free movement of money. Third parties will provide the platform to overcome the use of cards to make payments. However, banks will be at a great disadvantage. Given the reluctance of consumers these days to pay banking charges and these third parties enabling all things such as loans at a tap of a button, banks will need to rethink their revenue model. They will be forced to come up with far better services aimed at customer satisfaction to regain the trust of the consumer. They will need to develop their own digital services, which is the case with various banks entering the UPI market in India. Banks are going to face the situation where third party competitors will take away a chunk of their consumers and revenues. Hence, a sea level change in the banking sector will also help in adopting open banking in future.
However, thats not it. Open banking will lead to far better digital footprints as well as the formalisation of the whole payment process. This will have a lot of positive economic externalities. First of all, credit creation will boost the supply of loans. Combined with better digital footprints of the user, this will lead to lower interest rate and lower risk of default. In an economy like India, open banking will enable financial inclusion of the populace as it is not technical in nature and even elderly or less educated will be able to perform banking services easily.
Open banking lays the foundation for the increased role of technology in financial services. Ensuring a level field for competitors, secured sharing of data and increased control by the consumer when it concern their money is the future of banking sector. As Bill Gates said back in 1994, Banking is necessary, banks are not.
Featured image source: Pixabay