International Finance
Banking and Finance Magazine

Revolution called Open Finance

IFM_ Open FInance
Open finance gives consumers more access to and control over their financial data, encouraging more competition and innovation in the industry

The concept of open banking has transformed the way individuals and businesses interact with their financial data. Now, another era of financial innovation is on the horizon with the emergence of open finance.

Open finance builds upon the foundation of open banking, extending its principles to a wider range of financial products and services. This development aims to empower consumers and businesses by providing greater control and visibility over their financial lives while fostering competition and innovation.

Conversations over the future of open finance are already in progress in Europe. The public consultation on open finance has now ended at the European Commission level. The European Union has realized that a person’s financial life extends beyond their payment account. By end of 2023, a legislative initiative might follow.

Although open banking will be the foundation for open finance, the two concepts sometimes have different meanings. The two conceptions are different in a few significant regulatory and commercial ways.

What is open finance?

Like open banking, open finance aims to restore client control over financial data. According to both theories, account holders should control who has access to their information and can make payments on their behalf.

On the other hand, open finance dramatically broadens the scope of open banking. More specifically, it might provide third parties access to a broader range of client data, including insurance, mortgages, investments, pensions, and savings accounts. The result will be the development of more personalized and user-friendly financial products using that data.

Open finance can help open banking reach its full potential. Combining a customer’s current set of financial information into a single interface might make account aggregation far more thorough. Automatic transfers between savings and investment accounts could be possible with open finance.

Application Programming Interfaces (APIs) will be essential for this to happen. They enable regulated third parties to establish risk-free connections with financial institutions. Since APIs are the foundation of open banking in Europe, a robust framework for open finance should also rely on them.

Open banking vs open finance

Despite open banking and open finance having similarities, there are a few variations which separate them.

In Europe, the PSD2 (Revised Payment Services Directive) included open banking as one of its legal provisions. PSD2 requires financial institutions in EU member states to grant third-party providers (TPPs) access to a customer’s account data and the ability to initiate payments in exchange for the customer’s agreement.

The foundation of Europe’s open banking environment is PSD2. Though it only covers payment accounts, it has a narrow reach. Its restrictions do not apply to savings, investments, mortgages, or pensions. Therefore, banks and service providers are not compelled to grant TPPs access to data about these goods.

The application of open banking is constrained without this data. Open finance can apply open banking ideas to a wider range of financial products to provide value for consumers and businesses.

Open finance gives consumers more access to and control over their financial data, encouraging more competition and innovation in the industry.

The future of open finance

Open finance may arrive sooner than you would expect by building on PSD2 and applying open banking ideas to new financial goods.

Europe is already making efforts. While the European Commission just closed a call for comments on making open finance a reality, the United Kingdom government is putting together a smart data program to serve as the foundation for open finance. In the first half of 2023, an open finance framework for Europe is anticipated.

These programs should expand upon the groundwork that PSD2 and open banking have already established. This would entail codifying customers’ rights to utilize third parties to access their accounts, enabling TPPs to read data and start payments, and requiring APIs to speed up data retrieval and payments.

Effect of open finance on markets

The life cycle of financial services involves creating or using financial data. They are utilized by financial institutions in all of their interactions with clients and go along with every step of the customer journey. A McKinsey analysis shows seven major ways open financial data might generate profit.

Increased access to financial services, enhanced product selections, and increased user convenience are three things that directly benefit private individuals and MSME clients. The other four mechanisms, better fraud protection, better personnel allocation, enhanced operational effectiveness, and decreased friction in data intermediation, all directly benefit financial institutions.

Benefits for customers throughout the financial services life cycle are numerous. For example, it increases the availability of financial services. Thanks to data sharing, customers can purchase and use financial services they might not otherwise have access to.

For instance, open financial data can assist in assessing borrowers’ creditworthiness by sourcing rent, phone, and utility bills, where insufficient data from traditional documentation sources may prevent customers from getting loans. People and MSMEs with shaky credit histories or no formal credit history can access formal credit for the first time.

According to a study by Experian, 20% of consumers with little supporting evidence for their credit applications could proceed and become “thick-file” customers by incorporating utility data. When scaling up these advantages to the level of the entire economy in the United States and the EU, greater access to credit using alternative data may enhance the credit-to-GDP ratio by 20 basis points. By 2030, the increase in GDP in India might be as much as 130 basis points or roughly $80 to $90 billion.

It also provides greater user comfort. Data sharing lets customers communicate more quickly and efficiently with their financial services provider. MSMEs, for instance, can deliver documentation more quickly during customer onboarding. Consumers can apply for loans without using mortgage brokers thanks to open access to data on available mortgage products and applications already filled out.

Customers can also take advantage of the best prices while simplifying the procedure. In contrast to traditional mortgage brokers who charge arrangement fees, start-ups in the United Kingdom, which implemented its Open Banking system in 2018, leverage data to enable quick and straightforward mortgage applications to all participating providers for free.

Open financial data allows customers to save money by accessing various products. An open-data environment, for instance, simplifies swapping accounts between institutions, assisting retail and MSME clients in getting the best yield.

Open financing has many benefits, including increasing operational effectiveness. Open financial data could reduce costs and make it simpler to incorporate automation technology, which would increase efficiency because the majority of data is still contained in physical papers or scattered digitized sources. This can enhance the consumer experience by encouraging quicker and more open communication with service providers. According to reports, the cost for financial institutions to “know your customer” (KYC) verify retail consumers in India decreased from approximately $5 per client to $0.70 using the national digital identification system, Aadhaar.

Sharing borrower data enables automated underwriting for typical mortgages in the mortgage industry. Sharing financial data also reduces the number of manual data transfers that can result in mistakes, more work, and less effective results. It greatly lowers the expenses incurred in correcting inaccurate customer relationship management data, which now account for 20% of the revenue of the average financial institution.

Fraud prevention and many more

Open financing will also be better at predicting fraud. The Association of Certified Fraud Examiners calculates the annual cost of all fraud (including but not limited to financial services) at more than $4.5 trillion, or around 5% of worldwide corporate earnings. Financial services fraud can take many forms, such as fake and real ID fraud, payment fraud, and credit application fraud.

Access to real-time consumer data can assist cutting-edge methods for detecting and lowering the costs associated with these and other types of fraud. Data sharing increases the information and hints available to detect suspicious conduct. This aids organizations in expanding their predictive fraud modelling and identifying situations earlier.

The UK’s non-profit Cifas group claims its members reported more than 350,000 fraud instances in 2019, avoiding fraud worth £1.5 billion.

Employers may also better target and distribute their workers using open data by putting employees in charge of the most valuable tasks. They may concentrate their calls on high-risk clients more effectively, spend less time checking the credit of low-risk clients, and eventually recover more debt.

Moreover, to obtain and use data from third-party suppliers, this approach is especially pertinent to financial institutions that still need to gain direct knowledge of a potential customer, such as lead generation or loan origination. The missing information can be anything from more detailed behavioural information to simple identity data.

By employing application programming interfaces (APIs) for data intermediation, which lowers friction, open data platforms offer direct access to data. For instance, over half of all mortgage servicers in the United States use third-party data for mortgage origination, including credit, KYC, and property appraisal information. Although these data can cost up to $80 per mortgage application, more and more of this information is becoming available to the general public thanks to open data for finance.

The key objective of open finance is to give individuals more personalized and user-friendly financial products by leveraging data from various financial sources. Open finance enables more thorough account aggregation by combining a customer’s current account, savings account, and investment information into a single interface. It also allows for automatic transfers between savings and investment accounts, making it easier for individuals to manage their finances.

While open banking focuses primarily on payment accounts, open finance extends the principles of open banking to a broader range of financial products. By doing so, open finance gives consumers more access to and control over their financial data, thus fostering competition and encouraging innovation in the financial industry. It offers benefits such as increased access to financial services, enhanced product selections, improved user convenience, better fraud protection, enhanced operational effectiveness, and decreased friction in data intermediation.

Open finance extends open banking to more products, empowering users with data control and personalized financial services through APIs and innovation, benefiting customers and companies alike. The future of open banking is well on its way, thanks to open finance.

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