Technology predictions are difficult. From the assertion that New York City would be drowning in horse manure in the early 1900’s to Steve Ballmer’s infamous dismissal of the iPhone, folks have been making incorrect predictions for centuries.
Compared to transportation or mobile adoption, however, predicting the future of personal finance looks easier. Wariness around finances and the concentrated power of a few large banks means both customers and companies tend to be slow to adopt innovative products and services.
That’s not to say that consumers aren’t demanding more, and voting with their feet and wallets for companies who can innovate while building trust in the personal finance space. A big barrier to faster change has been the dominance of a handful of banks over the cash and account data of most Britons.
In 2016, a Competition & Markets Authority (CMA) report found that the largest four banks control 73 per cent of all personal accounts in the UK. The report led to the government making a strong push for open banking, a regulatory achievement now poised to radically change the way we manage our finances over the next decade.
What is open banking?
Starting January 13 2018, the largest UK banks began the process of allowing their customers to request transaction data be shared with third parties. Barclays, HSBC, Lloyds, Bank of Scotland, Halifax, Nationwide, RBS, NatWest, Santander, Danske, AIB, First Trust, and Bank of Ireland now make their customers’ current account transaction data available to third parties through two dozen Financial Conduct Authority (FCA)-regulated technology providers.
Open banking allows individuals to share their complete online banking transaction history, including every payment made in and out of their account.
FCA-regulated open banking providers (called account information service providers, or AISPs) aggregate banks’ APIs, providing a customer interface through which third parties such as online lenders, deal aggregation websites, and budgeting apps can request access to an individual’s transaction data.
For example, online lenders use an AISP, to request customers link their accounts through open banking as part of a loan application process.
Credit Kudos’ online process prompts a borrower to select their bank, then securely transfers the borrower to that bank, where they can authorise open banking access by completing a two-factor authentication.
The bank then issues a digital token, which grants the AISP access to the borrower’s transaction history. The AISP then consolidates the borrower’s transaction information into a form lenders can easily use to check if the borrower can afford the loan.
Credit scoring and lending
The current system of selling data to lenders with little input or interaction from borrowers is antiquated. Fair Isaacs Corporation (FICO), the original credit scoring company, first developed its modern scoring system in 1989. It has retained the basic structure since then. The traditional system has created a large swath of underserved Britons who are shuffled into higher interest credit products or who are excluded from the borrowing market altogether.
The current components of a credit score in the UK include:
- History of payments, including delinquencies
- How much you owe across accounts
- Length of credit history
- Types of credit you’ve used before
- Number of recently opened accounts and new credit inquiries
- Electoral roll data
Open banking has unlocked a new data source that is already transforming the way lenders evaluate individuals. By providing a verified spending history alongside personal identity decoupled from residential addresses, bank account data provides a secure source of personal financial history.
The digitised version of bank transaction data, crunched by algorithms developed by fintechs like Credit Kudos for personal accounts and iwoca for business loans, can provide alternative measures of creditworthiness driven by clear metrics rather than obscure ‘black box’ credit scores.
In addition to helping individuals prove their creditworthiness, open banking allows lenders to gain insight into affordability, or someone’s ability to repay a loan.
A financial behaviour score derived from bank account data retains the ease of use of traditional credit scores but has a broader scope to help the tens of millions left behind by near-prime and sub-prime scores.
For borrowers that lack credit history or struggle to prove income to lenders, using their transaction data in place of a traditional credit score opens up lenders who would have otherwise turned them away.
With open banking, this is a transaction-based score that can be updated dynamically beyond credit applications or events, which can improve customer access to revolving credit and can take into account changes in consumer circumstances.
In the coming decade, credit will likely become a consumer-held passport that can give power back to individuals to use to shop around for better deals. Less friction in the lending process would mean you can better compare rates across lenders, without having to request a credit check that then impacts your score negatively.
Customised loan offers, based on a portable passport, open up new avenues for lenders to engage and retain customers.
Want to make a budget, and stick to it? Apps like HSBC’s Connected Money, Yolt, Plum, and Cleo already help users track and manage spending through open banking. Their offering is simple: use open banking to authorise a connection to your bank, and the app can show you how you spend your money, and give you nudges to stick to a budget or provide alerts when you are running low on cash.
All of these apps currently struggle when it comes to multiple purchases in a single shop or restaurant and are unable to report if the £15 you spent at a local pub was spent on a round of drinks or on a roast dinner.
Understanding how much you spend on types of food at the grocery store can be helpful for family budgeting and is valuable to targeting promotions to specific individuals. Just as open banking has opened up bank transaction data, digital receipts, opening up major retailer’s data or innovating product scanning and tracking are just some of the means of upending budgeting in the coming years.
Account switching and overdrafts
The impetus for open banking was to break up the stranglehold banks have on customers and their data. Opening a new bank account, for the most part, can be a manual and time-consuming process.
According to the CMA, only three per cent of customers move bank accounts each year. It’s often easier to make payments, spend cash abroad and borrow money from the bank where you opened your first account. This behaviour, repeated on a national level, means that a few large banks have an effective monopoly on money-related services, even if their user experience and customer service are lacking.
With the data available through open banking, tasks that are particularly time consuming, like shopping around for the best overdraft rates and switching bank accounts, will be quicker and easier. Now that customers can port their data from one bank to another, there is less of a reason to stay with a particular bank for ancillary services if you can conveniently go elsewhere for a lower fee.
The old system of credit scoring is ripe to be replaced by new technology built from new data sets available through open banking. Credit will become increasingly decentralised, as small businesses and even individuals can use technology to increase peer-to-peer lending and trust.
You would be more willing to lend money or even your possessions to your neighbour if you had a trusted third party verify her credit using her verified bank data.
Just as the development of Google Maps enabled Uber drivers to find customers in real time, the financial data released through open banking enables new technology to find ways to improve the efficiency of consumer lending. The digitisation of banking is coming, and it’s up to the new guard of financial technology companies to make the most of it.