Is the Open Banking System a Reliable Alternative to Credit Scores?

The last decade has witnessed notable changes in the fintech sector, driven by AI, advanced data analytics, and decentralised technologies such as blockchain. It has spurred changes in how financial institutions operate, as automation has enabled quicker decision-making, allowing lenders to improve their affordability assessments.

This has been made possible mainly by the country’s Open Banking system, introduced in 2018. Not only has this allowed lenders to offer borrowers a more personalised experience, but it has strengthened the cause of financial inclusion. As a result, borrowers with poor credit scores or a thin credit file can find a loan that’s suitable for them.

For example, Salad’s lending algorithms were shaped by Open Banking, as it was one of the first lenders in the UK to receive an Open Banking license. This has allowed them to help over 156,141 borrowers across the country access fairer loans backed by thorough affordability checks.

In this article, we examine the impact of Open Banking systems and how they support financial inclusion.

What is Open Banking

Before the introduction of Open Banking, borrowers, especially those with less-than-ideal credit scores, had limited loan options. This was primarily due to the emphasis placed on credit scores during the loan application process. As a result, many borrowers had to resort to high-cost payday loans to bridge short-term funding needs, exposing themselves to increased debt risks.

The UK government took cognisance of this and paved the way for the Open Banking system to make the lending market more competitive, inclusive and accessible. Open Banking is a secure system that uses application programming interfaces (APIs) and allows borrowers to share bank data with authorised third-party companies.

If you consent to Open Banking permissions, you can aggregate all your accounts in a straightforward app. You’ll benefit from streamlined services, faster payments, and insights for smart budgeting. Most importantly, it enables you to prove your creditworthiness with real-time financial data, improving your chances of finding the right credit product.

Why is Open Banking Better Than Credit Scores

Following the pandemic, the UK has seen a surge in fintech startups and lending solutions, all of which are fueled by Open Banking. If you’re wondering why, it’s because Open Banking uses real-time data to assess a borrower’s financial health. This is a game-changer as it allows lenders to form a more holistic picture rather than relying on historically siloed data used for credit scores.

Real-time data enables a more accurate and thorough affordability check, accounting for nuances in borrower behaviour. Credit scores provide a backwards snapshot of financial patterns, which may fail to capture a borrower’s current ability to manage credit.

While credit scores still form the backbone of credit assessments, relying solely on them can present a significant barrier to financial inclusion. Borrowers who in the past had thin credit files or poor credit standing and have since stabilised will still be judged by their old financial mistakes.

Open Banking, on the other hand, promotes responsible lending practices by focusing on a borrower’s current ability to manage credit. It helps borrowers access fairer credit, enabling them to benefit from financially inclusive products.

Here are some of the key advantages of the Open Banking system in the UK

•     Customer control
•     Strong regulatory protections
•     Reduced fraud risks
•     Enables switching to better value providers
•     All financial products and services in one place
•     Greater transparency
•     Personalised insights for efficient budgeting
•     Faster payments
•     Lower transaction costs
•     Improved decision-making on borrowing
•     Investment tools
•     Access to better financial products and services

Open Banking’s Impact on Lending

Credit scores will continue to play a role in loan assessments, but Open Banking is changing the way lenders gauge borrower creditworthiness. While it brings several benefits to borrowers, lenders aren’t far behind. Open Banking systems have enabled lenders to significantly improve their risk assessments by leveraging up-to-date transaction data.

Aside from enabling lenders to conduct robust affordability checks, including analysing disposable income, Open Banking is also helping lenders reduce loan delinquency and default rates.

Lenders who rely on machine learning models to improve their lending algorithms also benefit from granular behavioural data through Open Banking. This helps them improve their predictive power, which leads to a visible reduction in credit losses.

Building Financial Inclusion Through Open Banking

Open Banking is paving the way for a financially inclusive lending ecosystem that helps borrowers with varying credit profiles access fairer, more affordable credit through real-time affordability assessments. This is particularly helpful for students, those newly arrived in the UK, and young adults.

It also encourages disruption in the fintech sector as lenders continue to innovate and offer more personalised financial products and services. This keeps the lending market healthy and competitive while allowing borrowers to benefit from solutions that align with their financial goals and needs.

We hope this article has been helpful and insightful about the benefits of Open Banking and its transformative influence on the lending industry.