Can Open Banking replace credit cards?

As Open Banking gradually becomes an indispensable part of the global payment landscape, its comparison with credit cards is inevitable. Can Open Banking truly replace credit cards in the future of payment transactions?

What is Open Banking

Open Banking, also known as “open bank data,” is a system that allows third-party access to consumers’ financial data from banks, providing this information to non-bank financial institutions through APIs (Application Programming Interfaces). Open Banking is a novel concept in the field of financial technology. It breaks the traditional closed nature of the banking system by leveraging the power of information technology to open up financial information to third-party service providers.

This emerging financial model has sparked discussions about the possibility of Open Banking replacing credit cards and becoming the future mainstream payment method.

Typical credit card payment model - the four-party model

Let’s first examine the four-party model of traditional credit card payments. Credit card payments were historically dominated by card organizations such as Visa and Mastercard, managing transaction processes for issuing banks, acquiring banks, and customers. The typical flow of payment information involves:

1. Merchants choosing a payment acquiring bank or a third-party payment service provider.
2. Card organizations verifying customer card information and authorizing the transaction.
3. The network routing the transaction to the cardholder’s bank (issuing bank) for approval.
4. The network performing similar actions for the merchant’s bank (acquiring institution or acquiring bank).
5. After approval, the acquiring service provider confirms the transaction.
6. The merchant’s bank settles with the card organization, and the payment amount is completed by the cardholder’s bank.

For these intermediaries, card organizations define transaction fees (through their network routing costs related to payments) and interchange fees paid by merchants to issuing institutions.

PISP payment flow

However, the rules of the game in Open Banking have changed this information flow, as it directly connects merchants with consumers without the need for layers of intermediaries: payments are initiated directly from the consumer’s bank account.

There are three arguments supporting Open Banking payment:

1. Payment Initiation Service (PIS) transactions are not only a small part of the cost of credit card payments. Through PISPs (Payment Initiation Service Providers), they offer higher security, a better user experience, and immediate completion of payments.

2. Due to the increase in competition and the decline in profit margins, merchants now have more incentive than ever to accept cheaper payment and transfer methods.

3. The innovative applications of Open Banking also expose users to more possibilities in financial services. Compared to credit cards, Open Banking is more easily integrated with other industries, such as e-commerce, social media, health tech, etc. This collaborative model not only expands payment usage but also enhances the integration of financial services, allowing users to enjoy a comprehensive suite of financial life services on one platform. This holistic experience may, to some extent, replace traditional credit card payment methods.

The challenges for Open Banking

Does this mean that Open Banking will replace credit cards? In fact, for Open Banking to replace credit cards, it needs to overcome some challenges.

Firstly, user’ concerns on data privacy and security are significant obstacles. Open Banking needs to establish a robust data security system to ensure that users’ personal and financial information is not subject to unauthorized access. While credit cards also pose some risks, the relatively closed systems make the risk of data leakage comparatively smaller.

Secondly, the level of global adoption of Open Banking is also a factor to consider. Currently, the development of Open Banking varies from country to country, and users in some regions may not have fully experienced the convenience of Open Banking. In contrast, credit cards have a higher global prevalence, and users are more familiar with paying with credit cards.

Regulation is also a significant factor in the development of Open Banking. Regulations regarding the management and use of financial data vary across different countries, and Open Banking needs to expand while adhering to the compliance framework established by these regulations. This regulatory uncertainty could become a limiting factor for Open Banking replacing credit cards.

Finally, credit cards have established a stable credit system where consumers’ credit records and scores are closely tied to the use of credit cards. This makes credit cards not only a payment tool but also a basis for credit evaluation. Open Banking needs a robust risk control system and innovative credit evaluation mechanisms for long-term operation under a structured framework to have the opportunity to gain consumers’ trust in payment security and credit reliability.

The opportunities of Open Banking

Open Banking may surpass the limitations of credit cards in some aspects. For instance, the data analysis and artificial intelligence technologies of Open Banking can better understand consumer spending habits, providing more personalized financial services. This personalized service might attract a portion of consumers to shift towards Open Banking, especially those seeking a more intelligent and convenient payment experience.

Conclusion

Overall, as an emerging financial model, Open Banking does exhibit significant potential in the payment domain and holds potential advantages and opportunities for businesses. However, overcoming challenges such as data privacy, global adoption, and various regulations is necessary for it to fully replace credit cards. The future of payment methods will be an incremental process, with Open Banking and credit cards coexisting in a new, more complex, diverse environment, each leveraging its strengths to offer users a richer, more convenient financial services experience.