With market shocks and new regulations in place, the business of lending has become riskier. Outdated models and bureaucratic processes can’t keep up with the pace of change, but open banking might! Read on, and find out about the opportunities open banking can offer.
It is no secret that lenders need to embrace alternative data to thrive in such a tumultuous and competitive market. The consumers’ financial picture and expectations have evolved from what it used to be 15 years ago, requiring lenders to adapt. For example, an individual career path nowadays may include various type of employments combinations, mixing gigs and full-time employment which complicates cash flow appreciation for lenders. Additionally, the rise of neo-banks shows that customers desire more personalised experiences.
Open banking enables lenders to understand their customers at the individual level and provide targeted offers leading to better customer outcomes. Here, we share some of the results we have seen when integrating open banking data into credit decisioning and outline how it can give lenders the edge they need to grow their market share and therefore their profitability.
Current limits that traditional lenders are experiencing when broadening their customer base
Updating your credit decisioning process is not trivial. It requires significant operational, tech, and cultural hurdles. We have seen this first hand while helping banks improving their customers’ understanding. Usual challenges include:
Outdated data sources
Credit reports are often caught lagging. Financial improvement, new loans, and even missed payments can take weeks to appear. On the other side, thin or no file customers are simply excluded by many lenders because they do not have enough information to decide their case.
Likewise, Office of National Statistics (ONS) based models are right on average, but wrong in every individual case. This is especially true in the context of high inflation. When looking at the distribution of utilities spend per month, ONS’ average may disadvantage cost-conscious customers or the ones living in a well-insulated property. On the other hand, it may be potentially missing customers living in poorly insulated homes or working from home and consuming more than the average.
Heavy manual processes do not scale
A considerable number of lenders still rely on extensive and unwieldy paperwork, requiring customers to provide PDFs of their bank statements, account balances, transaction records, and proof of identity and address to fuel their models. This adds unnecessary friction for users (increasing their likelihood of dropping out of the process) and takes more time and operational resources, especially when the importance given to the detail is stronger, as for customers with limited credit history. It is also prone to human error and bias.
Enabling a better understanding with open banking
Open banking improves data accuracy by providing instant access to categorised customer spending, unveiling their spending habits, recurring expenses, frequency of transactions, and hidden loans that may not appear on the credit file. Lenders no longer need to rely on ONS averages or client provided data. This allows for a much more refined approach and provides a targeted view of affordability and customer vulnerability. This makes lending decisions more defensible, especially in light of the new FCA Consumer Duty regulations. For example, a recent study conducted by our team revealed that financial institutions in the UK may be lending more than £174m a week to people who are using a risky proportion of their income on gambling.
Increasing loan volumes can also mean taking on riskier customers. However, companies using Render's comprehensive affordability assessments, rather than just credit scores, have seen huge drops in default rates. For example, Abound has reduced its default rate by 70% compared to market averages. Better understanding your customers' financial health can also help you choose those able to withstand economic shocks, like the current inflation.
Conclusion
It is crucial that lenders continually evolve their decisioning process in line with an ever-changing consumer, regulatory, and economic environment. The value of utilising open banking in decisioning is clear. Increasing your comprehension of your customer is key to expanding your reach. If you found this topic interesting, reach out to us. We are excited about helping an increasing number of lenders strengthen their credit decisioning capability with Render.
