If you’ve struggled to break down the API banking meaning, you’re one among many with a similar problem. API banking (Application Programming Interface banking) is a technology that enables a direct connection between the banking system and external applications or companies. This allows seamless communication, data exchange, and secured integration between parties.
Customers can execute banking transactions online through API banking without navigating the Enterprise Planning system (ERP). The technology eliminates the need for an intermediary between banks and corporates, simplifying transactions and communication.
So, how does API Banking work?
This post will explain APIs in banking, how they work, their applications, and their benefits in the financial sector. Read on to learn more.
What is an API?
An application programming interface (API) is a set of defined rules and protocols that allow two systems to communicate with each other. The software acts as an intermediary that processes data between a company and other external third-party service providers, therefore connecting the business with the different applications it uses in its daily operations.
APIs save employees time, break barriers to collaboration, and promote innovation. The technology is used in many industries, including transportation through Uber and accommodation bookings like Airbnb. The most common use is in financial institutions like Banks. Note that APIs can also be used between departments in the same company.
How Does API Banking Work?
First, the bank must publish its API specification to establish a direct connection with external third parties like fintech companies. This document details how clients can send a request to the bank API and receive a response.
The next step is giving third parties access to the API developer portal. Banks that use APIs have a developer portal. The portal lists the bank APIs available for the third party and offers instructions on how the third parties can use the API specification data to build an app that can integrate with their API of choice.
The third-party can choose an API they like and test it on the developer portals.
Once satisfied with the result, they will sign an NDA to ensure the safety of the customer’s information and the integration of the bank and the company.
Once the setup is complete and functional, here’s how API banking works:
- When purchasing products from an e-commerce platform, you are prompted to pay. It could be “Pay with Paypal” or any other third-party application. In this case, we will use PayPal.
- When you click on the payment button, an API sends the information (request) to the web server through the API URL (Uniform Resource Identifier)
- The web server then retrieves the requests or data, interprets it, and executes the needed action. It sends the response to the API with the requested information.
- The API interprets the sent response and transfers it to your mobile phone in a readable format.
Therefore, paying relies on an API connecting your bank account and PayPal. PayPal has your bank information, which it securely sends to the e-commerce platform to complete your transaction.
Uses of API in Banking
API banking is currently being used in Banking as a Service (Baas) and Embedded Finance
Baas
Banking as a Service (BaaS) is a business model that uses API technology to allow non-banking companies, such as FinTech, to offer banking services and products.
Baas has been instrumental in digitizing banking by facilitating mobile and online banking services. In 2019, a Federal Deposit Insurance Corporation (FDIC) survey revealed that only one in five households accessed their bank through tellers. The survey also found that more people preferred online and mobile banking. The COVID-19 pandemic has further aggravated the demand for digital banking.
API banking allows banks to integrate with trusted fintech companies that provide mobile and online banking to customers. Thus, banks can offer these innovations at a lower price than if they had to build the infrastructure in-house.
Since fintech is primarily tech-oriented, it provides a good customer experience that promotes digital banking. Customer experience matters a lot in the digital space since it is the only point of contact between you and your customers.
Banks can also use APIs to link their services to the fintech company. This allows services like opening a savings account or a debit and credit account through the FinTech app, reducing the need to go to the bank physically. Baas makes all these possible.
Embedded Finance
Embedded finance is another application of API banking meaning in real life. It is the technology of adding financial tools to non-financial applications. It allows the following:
- Embedded payment: Customers can make payments in an app without leaving it. For example, you can pay for your trip via Uber or Lyft.
- Embedded lending: Retail platforms like Afterpay and Klarna allow customers to pay for their purchases in installments.
Benefits of API Banking to Fintechs
Now that we have seen how APIs are used and benefit banking, here’s how corporates benefit from API Banking:
It Promotes Data Sharing
Previously, banks were reluctant to share their customers’ data, and when they did, it was limited. However, with the collaboration of third parties with the banking system, a fintech company can now easily access data with the customer’s permission. For example, if you have already filled out a Know Your Customer form with the bank, a fintech company can access the information through APIs.
They can use this data for cash management, reconciliation, forecasting, and to inform decisions for efficient business management.
Allows FDIC Insurance
Most fintechs are neobanks, likely not chattered, and cannot insure their deposits. However, through API banking, fintechs can now connect with established banks that can hold their deposits and back their services by providing FDIC insurance.
Summary
API banking is the backbone behind many everyday transactions and business operations. This technology is revolutionizing the finance sector, and more should be expected. A report shows that the global API Banking market is estimated to reach USD 17.5 billion by 2032, a 23% increase from the current estimation of USD 3.5 billion as of 2023.
With that much growth potential, it is essential to educate yourself on API banking, how it works, and the opportunities it offers. You want to participate in profitable innovations in a technological and digital advancement world.