There has been much chatter about open banking over the last couple of years, and for a good reason. If it stays on its current growth trajectory, it could revolutionize the financial services sector worldwide, forcing changes to existing business models.
At this stage, many business bankers, and the small commercial clients they serve, are not ready to move to an open banking system. Banks have traditionally enjoyed a monopoly on their consumers’ financial data — and they do not want to lose it. Small business owners might worry that their data is shared with financial services providers other than their banks.
Open banking can seem risky, but it offers benefits to both lenders and borrowers. 2022 could be an excellent opportunity for this perception to catch up to reality and make open banking the norm in the business lending space.
Open banking is a banking practice that uses application programming interfaces (APIs) to give third-party providers access to consumer financial data. This access allows financial institutions to offer products that are tailor-made to consumers’ needs. This approach is more attractive than other ways that consumers have traditionally aggregated their financial data. For instance, screen scraping transfers screen display data from one application to another but can pose security risks. Optical character recognition (OCR) technology requires substantial human resources to read PDF documents to extract information. And data entry is both time-consuming and has a high likelihood of errors.
Using APIs addresses many of the problems that exist with other data aggregation methods. The data is transmitted directly — no need to share account credentials — eliminating the security risk inherent with screen scraping. And since there is no PDFs or data entry involved, bankers do not need to use many resources to check the accuracy of the data.
Still, bankers may wonder: Why do we need to move to an open banking system?
Business lending works today, but there is significant room for improvement. The main issue is the lack of centralized data. Lenders do not have enough data to approve loans to creditworthy borrowers or identify other products the client could receive. On the other side, small business owners endure a slow and cumbersome process because they must provide their data to each lender, one by one. An open banking system allows lenders to offer borrowers better terms and creates an easier application process for borrowers.
Misconceptions could complicate adoption. In an Axway survey, half of the respondents did not think that open banking was a positive development. They had concerns about the constant monitoring of financial activity (33%), losing control over access to their financial data (47%) and financial institutions using their data against their interests (27%).
But open banking gives consumers more control over their financial data, not less. Since open banking is a new concept, there is a significant gap between perception and reality. There is, understandably, a hesitancy among the public to share their data, which emerges when consumers are directly asked about it. But as services like Personal Capital and Credit Karma clearly show, consumers will overwhelmingly opt for open banking services because they can use their financial data to gain via more straightforward analysis or track their spending.
This is the promise of open banking in the business finance space. Small business owners want to focus their attention on non-administrative tasks and connecting their financial data to services that bring them faster access to capital with less paperwork is a clear benefit they are excited to get.
Services like Plaid and Envestnet Yodlee connect customer data directly with financial institutions and are widespread in the small business lending market. More than half of small business owners already choose to use these services when applying for financing, according to direct data reported by business lending companies.
Banks, on the other hand, will need to make a couple of adjustments to thrive in an open banking ecosystem. They will need to leverage the bevy of consumer financial data they have to offer more customizable financial products, as the system’s open nature will lead to more competition. To analyze all that data and provide those customer-centric products, banks should consider using a digital lending platform, if they aren’t already. Open banking is set to disrupt the financial services sector. Financial institutions can set themselves up for sustainable success by embracing the movement.