Insight: Why Open Banking data heralds a new era of credit decisioning

The regulatory clampdown on high-cost short-term lending over recent years could arguably be seen as a positive thing for UK consumers, but in reality, it has left large swathes of society with no access to mainstream credit at all.

When combined with a period of rapidly rising living costs, the result is a ‘perfect storm’ whereby many people have no option but to turn to illegal, and/or unregulated lending, to get by.

At the same time, lending businesses face multiple pressures. These organisations have shareholders to appease, profit margins to achieve, staff to pay – as well as regulators to satisfy. Therefore, against an increasingly challenging macroeconomic backdrop (with soaring interest rates and sparse funding), lenders cannot simply elect to ‘loosen up’ – that’s just not how the world works.

So, it begs the question, what could the UK lending industry do to solve this issue? How does it dig itself out of this apparent perpetuity?

The lending equation

Well, part of the problem stems from the ‘broad-brush’ methods lenders typically use to decide who they are prepared to lend to, and who they are not. At the risk of stating the obvious, the basic lending equation is constructed from two core factors:

1. How likely is the borrower to pay me back?
2. Can the borrower actually afford to pay me back?

… where the answers to these respective questions can be mutually exclusive, but are always derived from – and inherently limited to – how much the lender really knows about the borrower.

In the UK credit industry, such information on borrowers remains predominantly sourced from the three credit reference agencies (CRAs): Experian, Equifax, and TransUnion. The data these companies hold has long proven to be effective at predicting repayment risk on a collective level – but is it still fit for purpose in modern times? And besides, has it ever been truly fair?

The fact is that hyper-dependence on CRA data as the sole or primary determinant of a lending decision involves accepting some fairly fundamental flaws. Whichever way you view it, the CRA approach usually means neglecting an individual’s financial circumstances at a personal level, and/or excluding some groups entirely due to a lack of visible credit history.

It also means relying on data that can be weeks or months out of date, and/or data that is simply incomplete due to the lottery of which organisations report to whom.

The value of Open Banking data

In today’s world of personal data ubiquity this status quo is increasingly hard to accept. Open Banking has been around for some years now, and while it inevitably comes with its own hurdles in terms of its efficacy for lending decisions, the barrier to adoption has been predominantly inertia.

Or, in other words, the main reason most lenders have failed to realise the true value of Open Banking data is that they simply haven’t tried.

Some seven million UK adults have no credit history, for example, yet over 97% of UK adults have at least one bank account. Therefore, just for starters, that’s a lot of people who could be considered for mainstream credit if lenders were just willing to decision on cashflow data rather than CRA data alone.

But that’s not all. It’s now empirically proven that cashflow data and transaction profiling can offer a materially contrasting (and/or ancillary) perspective on a consumer’s risk level versus that indicated by CRA data – meaning there’s an opportunity for lenders to make better and more personalised risk decisions right across the credit spectrum, even in the traditional ‘prime’ segments.

In fact, data scientists here at D•One have been able to demonstrate the ‘risk-splitting’ power of Open Banking data across the respective portfolios of its lender clients – finding incremental unserved segments that can be lent to at no greater risk, and accurately identifying non-paying customers who probably shouldn’t have been lent to in the first place.

As a result, early adopters of Open Banking data have been quietly enjoying their first mover advantage – safely expanding their lending appetite into otherwise credit invisible populations at minimal incremental risk. At the same time, they have also been skimming the best quality customers from existing served segments through favourable pricing, and increasing their portfolio profitability due to reduced credit losses.

Change is afoot

The upshot is that through Open Banking, society’s unserved are finally getting a fair deal, where they were previously financially excluded. While there will always be sub-groups who cannot be lent to responsibly and need a different type of help, the introduction of Open Banking into mainstream lending is at last starting to level the playing field.

We’re about to see a sea-change in the world of credit decisioning and it will be here to stay.

Consumers are becoming increasingly aware of the opportunity to share their own financial data in order to get a better deal – one in three of all ClearScore marketplace viewers already have Open Banking data connected, for example. Now it’s just a question of how long it takes the UK lending market to fully embrace it.

Tim Kelleway is general manager at D•One, by the ClearScore Group