What is an API in the context of open banking?

hat is API in the context of open banking

If you’ve heard of APIs (Application Programming Interfaces) but aren’t quite sure what their function is in the banking space, then you’re in the right place. 

As banking becomes more digitized and integrated, APIs play an increasingly important role in any financial institution or software provider’s tech stack. APIs are key to helping financial institutions modernise their business model, improve their customer experience, and stand out from the competition. 

In this guide we’ll be looking at what APIs are, how they work with Open Banking, and the benefits they offer banks and financial services companies.

What are API integrations?

APIs work as a bridge that transmits data from one place to another. They act like messengers, enabling two systems to speak to each other.

You’ll see APIs working in real-time when you head to Skyscanner or Kayak to compare flight prices. These sites use APIs to gather real-time information from various airlines, enabling you to find cheaper flights almost instantly without having to manually check each website. 

In the financial world, APIs enable financial institutions to communicate with each other, but they also allow third parties to build their own products and applications based on that API. For example, a financial management app will use APIs to connect with a bank, allowing all the customers from that bank to view and budget their finances on the third party app.

APIs are key to offering a better customer experience that is also digital-first. Without them, it’s impossible to be truly digital. 

There are usually three types of APIs:

  1. Internal: these are used within an organization and enable automation, collaboration as well as better security.
  2. Partner: these are APIs that are used for specific third parties. Usually a partner will pay a monthly fee to access the API and use it (such as the financial management app).
  3. Public: these are accessible to everyone and anyone who wants to use them, and anyone can build products on them.

When a bank develops its own API, it is essentially opening itself up to other products, industries, and partners. 

APIs also make it a lot easier for developers to build products. Applications such as payments, transportation, and maps usually take months to build. With APIs, developers can integrate with already-built applications and speed up the time to develop a product. More and more developers rely on APIs to build applications, which is why people say we now live in an “API economy”.

How APIs work with Open Banking

With Open Banking, financial institutions around the world are using APIs to share customer data securely. Open Banking helps set the standards of how banks and FIs should communicate: which language should be used, which regulations to adhere to, and what the experience should be like for the customer.

Before Open Banking, if a third party wanted access to a customer’s bank data they had to use a method called screen scraping, which involves gathering data by logging in as the user and storing their credentials. This method caused security issues and connections were highly unreliable as banks regularly update their apps. 

In the UK, the Open Banking movement was expedited by PSD2 in 2016, a European law that requires banks to share their customer’s financial information via APIs. Now, with Open Banking, third parties and banks can move away from screen scraping and transmit data securely, reliably, and quickly.

The law was put into place to encourage more competition in the financial sector, as well as improve the customer experience for the end consumer and business. The UK was one of the first countries to implement Open Banking, and now boasts more than 2.5 million users, with estimates saying that 71% of SMEs will be using Open Banking enabled products by 2022. 

For software providers and financial institutions, APIs help automate specific services, offer better products to customers, and enhance data analytics. Open Banking APIs can improve a wide variety of functions including decisioning, analytics, authentication, information, payment processing, loyalty programs, and finance management. 

Open Banking also offers an opportunity to build better products by enabling fintech companies to plug in directly to a customer’s bank account to help them with budgeting, lending, and investing. 

Let’s look at the benefits of Open Banking for both banks and fintech companies in more detail.

How Open Banking APIs benefit financial institutions

Offer a better experience to customers

The main benefit of Open Banking for financial institutions is that it allows them to offer a superior customer experience. 

What would a customer prefer: a financial product that integrates with other banks and allows them to see all their balances on one dashboard? Or a product that does not offer connectivity and instead requires manual login to each account separately? There is no denying that customers are less likely to look for alternatives if the product they use aggregates all their information on one app. 

But it’s not just about dashboards; Open Banking also improves the entire customer onboarding experience. With Open Banking, customers can apply for credit without having to upload Excel documents or several month’s worth of bank statements. Data is also pulled on an ongoing basis, so customers don’t have to keep uploading information, and financial institutions have access to the most up-to-date information on their customers’ financial health.

Banks and fintech companies can also use this as an opportunity to offer more tools and better value to customers. For example, by utilizing Codat’s digital lending offering, financial service companies can provide customers with intelligent and faster lending decisions. 

By offering a much better digital infrastructure and attending to customer needs securely, financial institutions are able to future-proof their business and increase the lifetime value of their customers.

Increase efficiency and lower costs

As mentioned above, Open Banking can also help automate and update specific processes. Instead of requesting manual bank statements or going to credit bureaus to gather more information, financial service and software providers can underwrite their customers by accessing data from their other financial platforms, such as accounting software. This is especially useful for smart lending solutions.

For example, many Codat clients have replaced collecting financial statements — which is time-consuming and manual — with automatic data processing via accounting tools such as Xero and QuickBooks, which SMEs use all the time. By integrating directly, financial institutions are able to save time, lower costs, eliminate human error, and improve the applicant’s experience.

Enable access to more data

By accessing banking via an API and allowing customers to integrate with other products, financial service providers have a much better overview of their customer’s spending habits and financial health. 

This can give companies and banks an incredible overview of how their customer interacts with competitors, what high engagement looks like, as well as their competitors’ weaknesses. This sets a precedent for understanding the competitive landscape a lot better and thereby offering more specific products to their customers.

The other benefit of accessing this type of data is increased personalization. Financial institutions can create new products that are not just useful, but also personalized. For example, these could be business financial management, or cash flow forecasting tools that would help an SME customer better understand and manage their business.

By offering more bespoke solutions to customers, banks and fintech companies are once again able to increase the lifetime value of their customers.

Improve the credit process

The traditional method of offering credit is highly manual and time-consuming: applicants need to submit PDFs, and fill in extensive forms, and lenders often need to head to credit bureaus for more information. Since this is not in real-time, information is often not up to date and can easily be tampered with. The low quality of data means lenders and fintech companies take longer to make a decision, and the time-to-cash can often be weeks, or even months. Even once the borrower receives the funds and starts repaying, collections are still very one-sided and time-intensive.

Open Banking aims to turn this process on its head, by providing lenders with access to several financial data points in real-time. The high quality of the data enables more accurate underwriting and loan decisions. Since the lender is already plugged into the customer’s bank account, they can release the funds in much shorter time frames. 

As for collections, financial institutions can automatically collect the repayments — with the customer’s consent — directly from their bank account, and personalize it to when it suits them best. For example, collecting a repayment right after a borrower receives their paycheck.

This is incredibly revolutionary for the end business, as well as for lenders: risks are lower, repayment rates are higher, and more customers that are traditionally underserved can now become a profitable customer segment. 

Don’t get left behind

APIs are the foundation of Open Banking and are key to connecting databases with anything digital — which will always include financial institutions and banks. Although Open Banking APIs were initially met with reluctance from some financial institutions, adoption is only increasing, and those that don’t innovate will risk being left behind. The good news is that for those who are ready to be digital-first, there are many benefits that come with embracing Open Banking.

To find out more about how Codat’s business data APIs could help your business, please contact us below.