How APIs are shaping the future of financial services

Financial APIs enable consumers to quickly share their financial data with third-party services and financial institutions. Here’s how it works.

August 12, 2021

Katie Randolph
Katie Randolph

At Plaid, Katie partners with banks and payroll providers to enable users to have secure and seamless access to their financial data.

Introduction

Building new financial products is, to say the least, a complex process. It often depends on gaining access to your customers’ permissioned financial data: things like bank transactions, account balances, investments, and credit cards.

In recent years, financial APIs have become a best practice for connecting third-party services  with financial institutions for the purpose of exchanging financial data. They allow consumers to quickly and securely share their financial data, leading to entirely new financial tools that offer a better user experience. 

The ongoing shift toward digital solutions continues to transform the financial ecosystem. Financial institutions that can meet changing consumer behaviors and provide an API-based approach are well-positioned to build and define the financial services of the future. In this article, we’ll explore:

  • What open banking APIs are and how they’re used

  • How financial APIs work

  • The future of banking and financial transactions

What is a financial API?

API stands for Application Programming Interface. An API is a software application that allows two different digital systems to interact with one another. Think of APIs as an intermediary that ensures the direct exchange of data.

In the financial services industry, APIs act as an intermediary between institutions that hold consumer data (for example, banks and credit unions) and entities that need to access that information (for example, PayPal and TurboTax). Financial APIs allow developers to programmatically access a financial institution’s data without having to interact directly with their back-end systems. 

By leveraging APIs, financial institutions can more easily collaborate with third-party services like Marcus and LendingTree. In some instances, that enables them to connect their customers with products they otherwise couldn’t or wouldn’t offer. For example, rather than attempting to build its own automated savings product, a mid-size credit union might opt to connect its users with Digit, a savings app, via a financial API.

In general, APIs provide a faster, more secure, and cost-effective way to share financial data. When financial institutions grant third-party platforms access to their data via API, customers have access to a wider range of services to meet their financial needs. 

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How do financial APIs work?

Financial APIs enable third-party applications (for example, Venmo and Cash App) to interact with certain kinds of data held at a given financial institution. That could include things like account-holder information (name, address, phone), transaction history, current account balances, and more. 

For illustration purposes, let’s say you want to pay your friend using Venmo. Before Venmo can begin processing your payments, they need the account and routing numbers associated with the checking account you’ve decided to use.

  1. First, Venmo asks for your permission to access your bank account.

  2. Once you give your permission, the financial API goes to work.

  3. You are prompted to authenticate yourself, usually by entering the username and password associated with the account.

  4. Once you’ve logged in, the financial API sends an automated request to your bank, asking for the data Venmo needs (in this case, your account and routing numbers).

  5. Your bank returns the requested data via API to Plaid, which passes it along to Venmo.

  6. Once Venmo gets your account and routing numbers, they can proceed with requesting funds from your bank account.

In general, all financial APIs proceed along these same lines: permission, request, receive, and transmit.

What are the three main types of APIs in the financial services industry?

Three main types of APIs operate in the financial services space today:

Private APIs

These APIs are accessible only internally, within the different business units of a single financial institution. They are used primarily to improve internal processes, either by automating repetitive tasks or by boosting operational efficiency. For example, the Lending department of a large bank may wish to check on a customer’s cash flow with their Retail Deposits unit when underwriting a personal loan. 

Partner APIs

More open than private APIs, partner APIs can be accessed by a financial institution’s preferred third-party partners. For example, a bank could use a partner API to send permissioned data from its customers to a company that automatically generates loan-closing documents, enhancing the bank’s lending solution. 

Open APIs

These APIs make certain kinds of financial data held at a given institution available to third-parties, allowing them to develop new apps and services. Open APIs offer third-party services the opportunity to partner with them, instead of competing or recreating a full suite of banking features from scratch.

What are Open Banking APIs? What are they used for?

Open Banking refers to the practice of providing open, consumer-permissioned access to financial data held at financial institutions through the use of standardized APIs. Different countries have approached open banking in different ways. Broadly speaking, these approaches tend to fall into two main categories: government-driven and market-driven.

  • Government-driven. Europe has followed a government-driven approach by creating a prescriptive regulatory framework. In 2018, the EU introduced the revised Payment Services Directive (PSD2), which established measures to open up Europe’s financial services industry, drive innovation, increase competition, and protect consumers. In practice, it means licensed apps and services now have access to the same permissioned consumer financial data as the financial institutions where the data was generated.

  • Market-driven. Meanwhile, the U.S. has followed a market-driven approach. In October 2020 in the U.S, the Consumer Financial Protection Bureau (CFPB) released their Advanced Notice of Proposed Rulemaking (ANPR) on Dodd-Frank Section 1033. In the ANPR, the CFPB restates that consumers have a right to access their own data under Section 1033, but the agency has not taken affirmative steps toward how best to enable access to this data. In our view, the best practice is to leverage Open Banking APIs, and various bodies exist, such as the Financial Data Exchange, to converge on a standard.

Generally, customers grant consent to companies that wish to access their data. At Plaid, that’s certainly our philosophy of financial data-sharing, and we plan to continue advocating for and building a financial services ecosystem centered on consumer choice and control.  

How are APIs changing financial products and services for consumers?

In the past, because sharing financial data between institutions was difficult, providers often aimed to provide comprehensive product suites, everything from mortgages to savings accounts to financial planning. But financial APIs have changed that. The result has been more financial products and services, and thus, increased competition, which has tended to benefit consumers. 

Because money and financial data are more portable, people generally opt for the best rates, the lowest fees, the most impressive features, and the best user experience. Below are just a few examples of this new generation of financial products:

  • The American Express Gold card offers benefits and ongoing rewards for dining and supermarkets, as well as an annual dining credit

  • Chime provides fee-free mobile-first banking and accelerated access to direct deposits

  • US Bank offers a small-dollar loan product to help customers with unexpected or short-term cash needs

  • Betterment provides diversified investing with ETFs, automated investing, and transparent pricing

  • Robinhood, the popular trading app, offers no-fee stock, ETFs, and options trading

  • Ellevest members receive targeted financial education and investing advice, in addition to portfolio and retirement management tools

It has also enabled the creation of a new class of products and services built entirely on the kind of permissioned consumer financial data that APIs provide.

  • Make P2P payments with your bank account (Venmo, Zelle, CashApp)

  • Earn rewards on debit card purchases (Point)

  • Instantly build a personalized budget using your bank transactions (YNAB, EveryDollar)

  • Prevent overdraft fees and predatory loans (Brigit, Dave, Earnin’)

  • Buy, sell, and send cryptocurrency (Coinbase, Gemini)

  • Get automated investment advice (Atom Finance)

  • Round up your purchases for spare-change investing (Acorns, Qapital)

  • Get personalized recommendations based on your financial situation (Credit Karma)

Learn more about open finance for financial institutions and their customers.

Do financial institutions offer APIs?

While some financial institutions do offer APIs, their APIs have typically been private; that is, they integrate only with other products or services from the same financial institution, primarily to enhance operational efficiency.

Today, consumer expectations are changing—and so are the banks. People expect their money and financial data to be available instantly, wherever they want it. Regulations like Dodd Frank 1033 have further solidified the ability for consumers to take these steps to access their data. As a result, banks have begun building partner APIs for preferred third-party partners. An example would be the April 2020 Data Access Agreement (DAA) between Charles Schwab and Yodlee, or a similar one between Plaid and US Bank

By the same token, it’s not feasible for some financial institutions to build and maintain their own APIs. For example, smaller community banks and credit unions may not have the engineering resources or budget to develop an open API, or they may simply prefer to prioritize other initiatives. Some of these institutions have enlisted third-party providers to help build APIs, or have adopted simpler connectivity methods to enable data-sharing. Plaid has attempted to solve this problem by developing Plaid Exchange, an Open Finance spec. 

How is the relationship between financial institutions and financial technology companies evolving?

Financial services is changing. To cite just a few examples, Americans now manage more than half of their money using digital tools. Most say they can do their finances entirely without visiting a bank branch. Fintech is here to stay

Navigating a changing industry landscape is never easy, especially for incumbents. Initially, many established firms viewed fintechs (financial technology companies) as a competitive threat, and many did not see the value of innovating their offerings. By the same token, many fintechs gained access to permissioned consumer financial data using screen scraping, a method that many incumbents disliked.

In the long term, though, both established players and new entrants are united in a common goal: they aim to meet the needs of consumers and offer them the best possible experience. Increasingly, that has led some traditional institutions to see fintechs as potential partners. Some of these partnerships have allowed incumbents to swiftly gain new business, launch new products and services, and migrate away from legacy systems. 

Many fintechs also view banks as important customers, sources of capital, and data-access partners. By working together with established institutions, fintechs benefit from increased traffic, greater trust, and faster growth.

In the United States, this move toward partnership and collaboration has generally been supported by regulators and policymakers, most notably the Consumer Financial Protection Bureau (CFPB). The CFPB’s Advanced Notice of Proposed Rulemaking (ANPR) on Dodd-Frank Section 1033 reiterated in 2020 that consumer control is central to a data sharing ecosystem. As they work more closely together, fintechs and established financial institutions can build jointly-designed solutions that take into consideration each of their specific perspectives and needs, while ensuring that these solutions and standards are good for consumers.

For example, the Financial Data Exchange (FDX) is dedicated to unifying the financial industry around a common interoperable data standard. Plaid serves on the FDX board with financial institutions, data aggregators, permissioned parties, and industry groups to ensure that APIs protect the data and provide the reliability our customers need. 

What will the future of banking and financial transactions look like?

In the wake of the COVID-19 pandemic, consumer behavior has shifted dramatically. Plaid recently partnered with The Harris Poll to survey 2000+ American adults about their attitudes toward finances and technology, and the results surprised even us.

We learned that Americans now manage more than half of their money using digital financial tools like online banking and investing apps. 73% say that using digital tools to manage their finances is the “new normal,” and 82% report that they get better results when they use technology.

This shift toward digital will continue to transform the financial services industry. Those financial institutions that can meet consumer expectations and provide an API-based approach are well-positioned to continue to define the financial solutions of the future.

Traditional financial institutions aren’t the only ones who will feel pressure to pursue an API-based, Open Finance approach. As newer financial technology companies (e.g. Acorns, Robinhood) continue to grow, many are becoming data sources themselves. After all, wouldn’t you like to be able to connect your Robinhood account to your primary checking account? Or your Varo account to your budgeting app?

Financial accounts are only the first type of data that has transitioned to an API-based approach. In coming years, data from the fields of healthcare, insurance, payroll, and utilities are likely to follow suit, and some early adopters have already started. The result will be an increasingly interconnected financial ecosystem, with the difference between incumbent firms and newer entrants increasingly blurred. Meanwhile, consumers will enjoy increased competition (read: more competitive rates) among providers and newer, more consumer-friendly financial products and services.

Building a consumer-oriented ecosystem, powered by APIs

Today’s established financial institutions are the result of many years of evolution in the absence of APIs. They were built as one-stop shops for their customers: a single place to get every kind of financial product, from credit cards to checking accounts to home loans. If there happened to be better rates at other banks, that wasn’t such a big deal; the pain of moving money between financial institutions was simply too great for most consumers.

Open Banking is changing this all. They allow consumers to swiftly and securely transmit their financial data between providers. That, in turn, has enabled innovators to build a whole new class of financial tools. Personalized budgets are generated instantly; international money transfers are processed for pennies; and loans are increasingly underwritten with cash-flow data—all of which would have been impossible ten years ago, without the permissioned consumer financial data that flows through APIs.

This has enabled the flourishing of a new and interconnected financial services ecosystem. Today, it’s normal for consumers to have credit cards from Chase, a home loan from Capital One, and a primary checking account at Chime—as well as a handful of financial apps that pull data from all of the above accounts. Increasingly, financial institutions are prioritizing a digital-first customer experience—including connectivity between their accounts. Institutions that fail to adapt do so at their peril.

Generally speaking, regulators and policymakers have supported the consumer’s right to their financial data, as well as the move toward an Open Finance ecosystem powered by APIs. The shift toward digital money management is here to stay. The more interesting question is the future: what kinds of financial tools, inconceivable today, will be widespread in ten years? And which firms will most successfully navigate the changing landscape?

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