# Open Banking: Definition, How It Works, and Risks

![Open Banking](https://www.investopedia.com/thmb/ugVQXA4soSqjukmcj_lCqbL2zWc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/open_banking-final-8af075f74bb54196bbbd342f717e7716.jpg)

*— Investopedia / Sydney Burns*

## What Is Open Banking?

Open Banking, often referred to as "open bank data," is revolutionizing the banking sector by allowing third-party financial service providers access to consumer financial data through [application programming interfaces (APIs)](https://www.investopedia.com/terms/a/application-programming-interface.asp). This practice facilitates the networking of accounts and data across various [financial institutions](https://www.investopedia.com/terms/f/financialinstitution.asp), fostering innovation poised to reshape the industry's landscape. While Open Banking presents opportunities for enhanced financial management and innovation, it also introduces potential risks concerning data privacy and financial security. Below, we delve into the intricacies of Open Banking, examining its promises and pitfalls.

### Key Takeaways

*   Open banking allows third-party financial service providers to access consumer financial data, enabling innovation and enhanced financial services through the use of secure application programming interfaces (APIs).
*   Through open banking, consumers can benefit from more personalized financial services, such as finding better financial products, improving loan terms, and accessing features tailored to specific needs like budgeting or fraud detection.
*   While open banking offers convenience and competition, it also poses privacy and security risks, including data breaches and misuse of financial data by third parties.
*   The open banking system could drive established banks to innovate and improve customer service as they compete with agile, tech-savvy newcomers, ideally lowering costs for consumers.
*   Despite its potential benefits, open banking may lead to market consolidation, raising concerns about the misuse of consumer data and increased pricing power by larger institutions.

## How Open Banking Operates

Open banking lets banks permit third-party providers, often tech startups or online financial services, to access and control customers' personal and financial data. Customers typically give consent, like checking a box on a terms-of-service screen, to allow banks to provide such access. Third-party APIs can use the customer's shared data and information about their financial counterparties. Uses might include comparing the customer's accounts and transaction history to a range of financial service options, aggregating data across participating financial institutions and customers to create marketing profiles, or making new transactions and account changes on the customer's behalf.

## Benefits and Innovations of Open Banking

Open banking is a major source of innovation in the banking industry. By relying on networks instead of centralization, open banking can help financial services customers to securely share their financial data with other financial institutions. For example, open banking APIs can facilitate the sometimes onerous process of switching from using one bank's [checking account](https://www.investopedia.com/terms/c/checkingaccount.asp) service to another bank's. The API can also look at consumers' transaction data to identify the best financial products and services for them, such as a new [savings account](https://www.investopedia.com/terms/s/savingsaccount.asp) that would earn a higher interest rate than the current savings account or a different credit card with a lower interest rate.

Open banking, through networked accounts, could give lenders a clearer view of a consumer's finances and risk, allowing for more advantageous loan terms. It could help consumers better understand their finances before taking on debt. An open banking app for customers who want to buy a home could automatically calculate what customers can afford based on all the information in their accounts, perhaps providing a more reliable picture than mortgage lending guidelines currently provide. Another app might help visually impaired customers better understand their finances through voice commands. Open banking can also help small businesses save time through online accounting and help fraud detection companies better monitor customer accounts and identify problems sooner.

Open banking will push large banks to compete more with smaller banks, potentially lowering costs and improving technology and customer service. Established banks will have to do things in new ways that they are not currently set up to handle and spend money to adopt new technology. However, banks can take advantage of this new technology to strengthen customer relationships and customer retention by better helping customers to manage their finances instead of simply facilitating transactions.

Before banks offered open banking, the closest thing available were aggregation sites like Mint or [Personal Capital](https://www.investopedia.com/empower-review-4587916) that combine users' account information from all their financial institutions so they can see it in one place. These services require users to provide usernames and passwords, then scrape data from account screens. This practice has security risks, and screen scraping often leads to inaccuracies, making transaction identification difficult. In addition, users may find that not all of their financial accounts are compatible with account aggregation services, preventing them from getting a true or complete picture of their finances. APIs are considered a more secure option because they enable applications to share data directly without sharing account credentials.

## Navigating the Risks of Open Banking

Open banking can provide convenient access to financial data for consumers and reduce costs for financial institutions. However, it also poses significant risks to financial privacy and consumer account security, potentially leading to liabilities for financial institutions. Open banking APIs are not without security risks, such as the potential for a malicious [third-party](https://www.investopedia.com/terms/t/third-party.asp) app to clean out a customer's account. This would be an extreme (and less likely) threat. Much broader concerns would simply be data breaches due to poor security, hacking, or insider threats that have become relatively widespread in the modern era, including at financial institutions, and will likely remain commonplace as more data becomes interconnected in more ways.

Open banking is likely to alter the competitive landscape of the financial services industry, which could benefit consumers by increasing competition as described above, but could also have the reverse effect and increase consumer costs if it leads to [consolidation](https://www.investopedia.com/terms/c/consolidation.asp) in financial services, due to the natural [economies of scale](https://www.investopedia.com/terms/e/economiesofscale.asp) from big data and [network effects](https://www.investopedia.com/terms/n/network-effect.asp). Resulting market concentration and associate [pricing power](https://www.investopedia.com/terms/m/market-power.asp) could more than offset any cost advantages to consumers. Such market consolidation has already been seen and widely criticized in other internet-based services, such as online shopping, search engines, and social media, in that it is widely believed by consumers and regulators to result in misuse of customers' data by tech giants for their own benefit. Beyond the direct costs of [market concentration](https://www.investopedia.com/terms/h/hhi.asp), similar misuse of customers' private financial data could ultimately raise even greater concerns.

> **Article Sources**
>
> 1.  Open Bank Project. "[Open Banking API Platform](https://www.openbankproject.com/openbankingmiddleware/)."
>     
> 2.  Visa. "[The Future of Banking Is Open](https://usa.visa.com/dam/VCOM/global/partner-with-us/documents/visa-open-banking-whitepaper.pdf)," Pages 2-14.
>     
> 3.  Congressional Research Service. "[Open Banking, Data Sharing, and the CFPB’s 1033 Rulemaking](https://crsreports.congress.gov/product/pdf/IN/IN11745)."