The rise of open banking has revolutionized financial services, providing customers with enhanced money management tools and convenient banking options. However, open finance, the next phase of this evolution, promises to unlock even greater potential by allowing customers to securely share their financial information with trusted third-party providers (TPPs) or financial institutions.
By enabling access to digital banking, lending, payments, renting property, and investing, open finance seeks to empower consumers, promote financial inclusion, and address biases in credit evaluation systems.
The current credit system often excludes individuals from financial opportunities. A survey by TransUnion in 2022 revealed that a significant number of Americans and Canadians are either credit unserved or credit underserved. Moreover, credit evaluation systems are prone to bias and discrepancies, as highlighted by the UK Financial Conduct Authority (FCA), which identified substantial variations in credit information among credit reference agencies (CRAs).
These biases have particularly adverse effects on marginalized communities, with the Consumer Financial Protection Bureau (CFPB) finding that credit invisibles, those without a credit history, or with a short one, face disproportionate challenges in obtaining loans, particularly affecting Black and Hispanic consumers.
Open finance holds the potential to transform the financial landscape by addressing the shortcomings of the credit system and promoting financial inclusion. By leveraging the power of open banking and expanding it to encompass a wider range of financial activities, open finance empowers consumers to control and utilize their financial data to access innovative products, enhance safety and transparency, and exercise choice.
One of the key benefits of open finance lies in its ability to improve credit evaluation methods. Raja Chakravorti, Plaid's universal access lead, argues that open finance can enhance Fair Isaac Corporation (FICO) scores, which often fail to consider data from across borders.
By adopting open finance principles, financial services can overcome these limitations and tap into alternative data sources such as investments, loans, utility payments, and subscription payments. These alternative data points can provide a more comprehensive view of an individual's financial behavior and health, enabling fairer assessments of creditworthiness.
Open finance not only expands the range of data used for credit evaluation but also places greater emphasis on financial responsibility indicators. Timely and consistent bill payments, for example, can serve as reliable markers of an individual's financial responsibility.
By considering a broader range of financial behaviors, open finance can provide a more accurate representation of an individual's creditworthiness, reducing the reliance on traditional credit scores and expanding access to credit for those who have been historically underserved.
To ensure the success of open finance, robust cybersecurity measures, supportive legislation, and consumer education are essential. By embracing these principles, we can collectively work towards a more inclusive and equitable financial ecosystem that benefits all individuals, regardless of their background or credit history.