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Think tank
Sep 30, 20215 min read

How open banking can take consumer credit to the next level.

by Alex Marsh

This opinion piece was originally published on The Fintech Times.

There is much in the current system that has not kept pace with the way many consumers want to use credit. As new and innovative credit products gain ground, data sharing under open banking rules can help transform the way consumers are assessed offering better decisions and greater protections.

Whether dealing with an unexpected cost like replacing a broken washing machine, or simply wanting to ‘try before you buy’, there are plenty of times when people want or need to use credit. New options like buy now pay later (BNPL) are providing lower cost alternatives for consumers, who are increasingly turning their backs on traditional forms of credit.

Because Klarna’s Pay in 3 instalments and Pay in 30 days payment options charge no fees and no interest, the consumer only ever pays the price of the product. This is arguably a more sustainable way to use credit, helping consumers avoid becoming trapped in debt by late fees and punitive interest charges. However, providing a no-cost alternative does not on its own prevent consumers from getting into difficulty. One of the key challenges for all credit providers is ensuring their products and services are offered responsibly. This is where robust assessments of eligibility must come in.

In the UK, the cornerstone of solving this challenge is provided primarily by three ‘credit reference agencies’ (CRAs) which credit lenders use to assess eligibility for their products, from car loans to mortgages. At Klarna we use the CRAs as a key part of the eligibility assessments we perform on every transaction.

They have, broadly, served the industry well. However, changing consumer preferences, and the emergence of new credit providers and products, are quickly exposing opportunities to improve the way that consumers’ creditworthiness is evaluated. Launching a review of the sector, the The Financial Conduct Authority (FCA) said it had “identified concerns about the coverage and quality of credit information, the effectiveness of competition between credit reference agencies, and the extent of consumer engagement”.

Borrowers and credit products have changed.

In short, the current system serves consumers of traditional products well but does not capture users of alternative products such as short-term, low value credit. This creates an unconscious bias generally towards older, wealthier people who are homeowners. People who have no history using a credit card or paying off a mortgage; people who have recently moved to the country; and people who have, until recently, been dependent on others for their financial lives, don’t get as good of a deal.

Indeed, an increasing number of consumers are turning to new forms of credit which do not fit naturally into the CRAs’ way of compiling information and scoring borrowers. Barely half of millennials own a credit card, and of those 93 per cent don’t plan to get one. Instead, for an increasing number of people today, taking out credit means borrowing small sums for short periods using products like BNPL. Klarna’s latest research shows that about a quarter of UK adults have used BNPL at some point.

Updating the system.

Klarna has been working with the CRAs closely to help adapt to this new way of borrowing, and we are seeing progress. But we can go further. To do this, one of the most promising tools we have is ‘open banking’.

Open banking is mandated by both UK and EU regulators. It allows consumers to share their banking data instantly and securely with other financial services companies. With the right infrastructure in place, lenders can access consumers’ current account data to build a detailed and real-time profile of the applicant’s financial situation. This means even people with very limited credit history (‘thin files’) can access credit by demonstrating their financial health.

However, opening banking alone is not a panacea. One challenge is that people must opt-in to share their data – so the benefits must be made clear to them. When they do opt-in, consumers decide what accounts they share, meaning the lender might still not be getting the whole picture still. And current account data alone does not reveal the individual’s outstanding credit balances and whether or not they are keeping up with payments.

A hybrid solution.

The solution is to combine this data with CRA data, to build an in-depth and up-to-the-minute profile of an applicant’s whole financial situation. This hybrid solution can enable better, more responsible lending and borrowing.

Klarna is already using this approach in Germany to augment the information in credit checks so it can reassess applicants refused credit on the basis of their credit score. Something we are looking to introduce in other markets, including the United Kingdom.

This is just the beginning. By incorporating open banking data we have the opportunity to improve access to credit, enabling new products to be brought to market based on the customer insights gained. One of the most exciting prospects is providing understandable and actionable information about creditworthiness and financial health. Having built a comprehensive understanding of the consumer from open banking’s feed of real-time data, we can use this to show them where they stand, whether or not they can afford a purchase, and what practical steps they can take to improve their situation.

Being able to take greater care of consumers like this brings considerable benefits for consumers and would lead to a safer and healthier credit environment for everyone, whether they use traditional forms of credit or prefer newer alternatives.