The role of financial APIs in open banking

Fintech has reached mass adoption. According to Fintech Effect 2021, a research report published by Plaid and The Harris Poll, nearly 90% of Americans rely on digital solutions to manage their money, and they typically have three or more fintech apps on their mobile phone. 

As consumers increasingly rely on fintech, they’ll demand new types of services as their financial needs evolve over time. These demands are driving innovation and creating the next generation of fintech apps and services. 

Financial APIs are critical to the continued growth of open banking. They allow consumers to seamlessly access and share financial data with the fintech apps and services they love and improve the security and reliability of digital financial solutions. Most importantly, financial APIs allow open banking to scale, keeping pace with growing consumer demands.

What is open banking?

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.  

The role of APIs in open banking

In open banking, open access to financial accounts is provided through APIs. These financial APIs make it easier for people to securely connect their financial accounts to the apps and services they choose. In turn, this allows consumers to more easily share financial data to obtain the products and services they want and to better manage their money.

API stands for application programming interface. It’s a software that allows two or more applications to communicate with each other. APIs provide a common language and structure for how data will be shared. When APIs are used for data access, it’s called API-driven connectivity. 

Financial APIs make it simple for banks, consumers, and fintechs to communicate and conduct financial transactions. They connect an entity that needs consumer data (for example, Venmo or Acorns) with an entity that holds consumer data (for example, a community bank or investment firm). Without an API, these entities don’t have an easy way to securely send a request or receive data. 

Most fintechs can’t deliver their services without access to consumer account data. Without API-driven connectivity, fintechs have less reliable access to financial institutions, which can lead to service disruptions. An app can’t create a budget without access to a user’s spending data.

→ Need a financial API solution? Core Exchange enables financial institutions to quickly execute Financial Data Exchange (FDX) APIs they can use to connect with Plaid, other aggregators, and organizations.

How an app uses APIs to connect to a customer account

Let’s examine how Venmo, a digital wallet, uses an API to connect to a customer account. 

1. A new customer downloads the Venmo app and creates an account.

2. The customer requests access to their existing bank account from within the app so they can use it to fund their new Venmo account.

3. Venmo sends an API request to the bank to:

• Verify (authenticate) that the customer owns the account.

• Validate that the available balance in the customer's account is more than the amount being requested.

• Execute a transfer of funds between accounts. 

4. The customer’s financial institution sends codes and tokens via the API to first authenticate the customer and then authorize the funds transfer. 

5. Venmo then exchanges a token for data access and transfers the funds into the customer’s Venmo account.

→ Need a faster account opening and onboarding flow? Plaid Auth provides instant bank account authentication when users connect with their bank account credentials. 

The acceleration of open banking has made APIs even more critical 

The increased adoption of APIs has been dramatic. Plaid-connected financial apps saw a 300% increase in new users between March and May, 2021. More users means more data sent between financial institutions and fintech apps and services. As data traffic increases, API-driven connectivity becomes even more critical. 

The acceleration of open banking was partly driven by changing consumer habits during Covid. When consumers were in lockdown, they conducted more of their financial management with digital tools, more often. The number of US fintech users jumped to 88% in 2021 up from 58% in 2020; and daily fintech users rose from 37% pre-pandemic to 48%.

Increased regulatory attention is also placing pressure on financial institutions to integrate APIs into their open banking solutions. In 2020, the Consumer Financial Protection Bureau (CFPB) requested that new rules be proposed around consumer access to financial data. In addition, President Biden’s 2021 executive order on promoting competition in the American economy “encourages the CFPB to issue rules allowing customers to download their banking data and take it with them.” 

Given this regulatory attention, financial institutions are seeking an easy way to provide connectivity to consumers. APIs are the best solution because they deliver direct data access to consumers who can then seamlessly connect to the thousands of apps and services they want to use.

How do consumers benefit from financial APIs?

Consumers who use fintech (which is mostly powered by APIs) have more control of their financial data, while saving time and money. They can see which third-party apps have access to their data and easily turn permissions on and off. Over half of fintech users report saving at least $50 a month. They also save time and 73% of these users believe that technology helps them make smarter financial decisions. 

Open banking also supports financial inclusion for underserved groups. Black, Indigenous, and People of Color (BIPOC) use fintech more than white people to address their biggest financial challenges.

How do financial institutions benefit from APIs? 

Financial institutions can leverage API integration to improve data control and transparency. They can see how their customers are using fintech to manage their finances, leading to a better understanding of evolving financial needs. Institutions can use this insight to create innovative, customized products and services. 

Engagement also increases when customers are digitally connected to their financial institution. When a consumer links their primary account to a fintech app using Plaid, transaction frequency within that account increases by an average of 7%. This increased use of connected accounts shows that financial institutions that support API integrations and the apps they power can maintain account primacy and gain greater profits.

Additionally, APIs give financial institutions better data management. They are managing huge amounts of data as they receive API requests and send information to fintechs. When this data traffic isn’t well managed, it can cause delays and a poor customer experience. 

The best API programs only send the data that is absolutely necessary for a given transaction. APIs that support this “data minimization” are easier and cheaper to build and maintain—and lighten the load on a financial institution’s servers. 

How do fintechs benefit from financial APIs? 

Fintechs can deliver a better user experience when they leverage financial APIs, as they receive only the data they need for each transaction. This streamlines data management and ensures seamless, reliable connectivity for consumers. Without efficient API-connectivity, customers and fintechs face service delays and miss opportunities.

• Someone using a lending app to apply for a personal loan could face delays if the app can’t access bank data for its underwriting process. 

• A person using a trading app might miss out on a stock if they can’t fund their trading account. Without instant access, they may use a competing trading firm.

How do APIs improve data security?

APIs improve open banking data security primarily by removing credentials from the open banking ecosystem. Historically, consumers entered their online banking credentials (username and password) directly into a fintech app to request data access. The app would often store their credentials for future use. 

A consumer’s private information could be held by multiple fintechs. This created a security risk for the consumer and the financial institution. If there was a data breach at one of these fintechs, a bad actor could obtain the credentials and access a customer account.

APIs support the use of tokens instead of credentials to access consumer data. So consumers never need to share their username and password with a third-party. With API connectivity, customers can be routed by the app to their financial institution’s domain to enter their credentials. After the credentials are verified, they’re routed back to the app. Instead of sharing the credentials, the financial institution sends an API token that approves data access. The app uses this token to securely access customer financial data without storing credentials.

How are APIs fueling new business models? 

APIs fuel new business models by making it easier for partnerships to develop between financial institutions, fintechs, and non-financial businesses. When two parties can seamlessly and securely transmit account data, they can refer customers, cross-sell their services, and rely on data networks for open banking implementation. 

Recent key partnerships include:

• Monzo offers banking services through its mobile banking app in partnership with Sutton Bank.  

• Wells Fargo has partnered with AutoFi, a platform for digital automotive sales and financing. Consumers seeking a car loan can use the platform to obtain real-time credit decisioning from Wells Fargo Auto.

• Upgrade offers no-fee rewards checking accounts fulfilled by Cross River Bank.

Many financial institutions that want to build an open banking solution face resource and time constraints. That’s why many partner with Plaid to create a compliant, secure solution more easily and more quickly than building in-house. This partnership delivers API-based access to 5,500+ fintech applications.

Consumers are driving fintech innovation by demanding more complex digital financial products and services. Some recent public examples of consumer-driven fintech innovations that use APIs include: 

• BlockFI, a crypto wealth manager, offers accounts where customers can earn cryptocurrency interest on their holdings. 

• Clair offers consumers free payday loans, along with checking and savings accounts. It integrates directly into an employer's workforce management software. 

Investment platform Round offers small investors access to a wide range of institution-grade investments including asset-backed securities, hedge funds, and real estate.

How will APIs impact the future of open banking? 

APIs are fueling the growing consumer adoption of open banking. They drive innovation as fintechs develop the next generation of products and services. API-connectivity ensures secure, reliable, and seamless data access. This expanded access and the partnership opportunities it creates benefits consumers, financial institutions, fintechs, and the entire open banking ecosystem. 

Open banking supports Plaid’s mission of unlocking financial freedom for everyone by empowering innovators to create new solutions with secure, API-based access to the financial system.