Interoperability among financial institutions is their ability to work harmoniously to achieve their common goals. Specifically, it is a mechanism that increases the efficiency of the financial ecosystem, including reducing the cost and time taken in transactions, as well as improving security in transactions.
The concept of interoperability is about removing the barriers that previously existed among institutions with regards to the transfer of money among them. The idea is to make it convenient for customers to transfer their funds, pay their bills, make withdrawals, among other transactions.
This enables more transactions per hour and increased income generation by financial institutions. Interoperability has made financial transactions easier for fintech companies, banks, businesses, educational institutions, and other entities.
One of the breakthrough benefits of interoperability has been the resultant improvement of access to financial services for millions of unbanked people. For instance, mobile money transfer platforms have made it easier for millions of people in East Africa to access loans, pay for services, among other benefits.
Businesses have also benefited from seamless compatibility between payment wallets, branchless banking, among other things. For regulators, interoperability means putting in the necessary regulations to level the playing field for all the entities involved.
Key entities involved in interoperability
Regulators: Interoperability has relatively liberalized the financial ecosystem. This has necessitated the need for regulatory authorities to expand their scope of regulations to ensure that all institutions involved in financial services adhere to the rules of financial discipline. Their involvement also sets in place an appropriate environment that ensures some parties don’t have an undue advantage.
Banks and other financial services providers: These are the biggest stakeholders in the financial system. These institutions hold the largest liquidity in the financial ecosystem. Therefore, not only are they among the biggest beneficiaries of interoperability, but they also stand to lose the most in case the system’s security is compromised.
This also means that they have the biggest burden in setting up the required infrastructure and setting up the necessary working framework agreeable amongst all of them.
Mobile network firms: Mobile telephony companies have emerged as major players in the financial services sector. In some countries, they have mobile money transfer subsidiaries that have millions of people access financial services.
In addition, they also provide part of the essential infrastructure needed by the wider market to facilitate the various financial transactions. In some countries, the majority of the population is unbanked, and mobile money platforms provide greater access to financial services than banks.
Factors defining interoperability
- It is a process and not a one-off event: The concept is largely a work in progress, with new improvements being made to it from time to time.
Even in instances where different firms have agreed to integrate their platforms, it takes time to actualize the new functionalities, with test runs, research, and periodic improvements being made. Such improvements vary and can include tweaks geared towards improving efficiency, introducing new functions, improving platform security, among other things.
- Interoperability is based on three key pillars. They include a common working framework, technical infrastructure, and a business model for each of the participants.
- Interoperability is continuously being improved and has reached different milestones in different countries. In the financial sector, there are different levels of development for mainstream finance, including the latest efforts to integrate blockchain technology into banking services. In addition, some central banks have been working on developing central bank digital currencies compatible with several banks.
Levels of interoperability
There are four main levels of interoperability. These are:
- Peer-to-peer interoperability: connections between an institution and another.
- Agent interoperability: connections between one agent offering a service and another.
- Merchant interoperability: a type of interoperability enabling integration of payment systems among merchants. This lets them process payments among themselves.
- Full system interoperability: a multi-purpose integrated platform capable of supporting different entities such as banks, fintech companies, institutions, and other entities. The system supports different services in the financial sector. Such services are common to the needs of the incorporated entities.
Benefits of interoperability
- Increased interoperability is beneficial to financial institutions because of increased volumes of transactions, which translates to higher revenue and increased profits.
- Interoperability enhances efficiency in financial transactions, such as through the elimination of duplicity and reduction of transaction and operation costs.
- By having many people and institutions transacting financial services, governments get more tax sources.
Financial services providers are increasingly adopting interoperability as a way of enhancing the efficiency of financial services and increasing their profits. Consumers, on the other hand, are enjoying the convenience that comes with better access to financial services such as loans and easy payments solutions.
In the coming years, the rate of adoption of interoperability is likely to grow exponentially out of necessity. Regulators also have an essential role to play in creating an enabling environment for the growth of the sector. The future of finance will, therefore, be greatly dependent on interoperability.