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December 02, 2022

Innovating in the UK's credit information market - how Open Banking can help and why it matters

Kimberley Moran

The short read:

  • Open Banking is one of the main drivers of innovation in the credit information market, according to the Financial Conduct Authority (FCA).

  • Twenty million people in the UK may be classed as financially underserved. These are people with thin credit files, minor issues on their credit information, and/or volatile incomes.

  • Open Banking is already helping consumers build up their credit file with supplementary data sources, while lenders benefit from new, real-time insights into prospective borrowers - including on the affordability of loans.

  • The FCA should explore incentives for CRAs and lenders to incorporate Open Banking data into lending decisions, while also driving for Open Finance to give a fuller picture of borrowers’ financial situation.

The long read:

Open Banking is one of the main drivers of innovation in the credit information market in the UK, according to an interim report published by the FCA. In particular, Open Banking-based services could improve consumer outcomes for two of the four areas of concern highlighted in the report:

  1. There are significant differences in the credit information held on individuals across the three Credit Reference Agencies (CRAs).

  2. There is limited consumer understanding of credit information and how they can dispute this information.

How are lending decisions made?

Consumer lending in the UK encompasses mortgages, credit cards, car financing, and other personal loans, including deferred payment credit (DPC) such as Buy-Now-Pay-Later (BNPL). Any lending segment typically follows the same three steps to disbursing a loan:

  1. Onboarding: How do lenders quickly identify more desirable borrowers, while separating out those who are too risky?

  2. Underwriting: How do lenders assess the risks posed by lending to potential borrowers?

  3. Decisioning: How do lenders make a final decision on whether or not to lend to a potential borrower?

What role does credit information play in lending decision-making?

A consumer’s credit information helps lenders determine whether they could potentially lend to that consumer (onboarding) as well as understand how the risk profile of their loan portfolio might change (underwriting) from doing so. Credit information can also help determine if a lender should charge a higher interest rate or offer a smaller credit limit if the borrower is potentially higher risk. Ultimately, the lender will shoulder the cost of the loan if a borrower defaults, even if the borrower is still liable for repaying the loan.

The data sources included in a borrower’s credit report includes: personal information, such as a their name and address; whether they are on the electoral register at their address; amounts owed to current lenders; late and missed payments; county court judgements (CCJs); home repossessions or a borrower moving away while owing money; and bankruptcies or Individual Voluntary Arrangements (IVAs). Credit information does not include information such as the amount of money in a borrower’s current or savings accounts or their salary. 

What are the limitations with using credit information in lending decision-making?

Traditional approaches to credit information assess consumers’ historical ability to manage their credit. There are four limitations with this approach:

  1. There is no forward-looking view of a consumer’s ability to repay a loan or the affordability of a loan for the consumer. As a result, lenders tend to incorporate information on a consumer’s income and their fixed expenses and liabilities, particularly for larger loans like mortgages.

  2. Past behaviour or circumstances may lock consumers out of a loan long after their financial circumstances have changed. Information such as CCJs or missed payments can stay on a customer’s credit report for six years or more.

  3. Consumers that have never taken out credit are penalised for not doing so. Consumers with a thin credit file are viewed as “risky” because there is limited information on their creditworthiness, which can prevent them from accessing credit in the future. This affects five million consumers in the UK, particularly young consumers or immigrants.

  4. Credit information is slow to update and, in some cases, the information has little relevance to a consumer’s creditworthiness, such as whether they are on the electoral register. This also affects many people in the UK who are not eligible to vote, and therefore cannot be listed on the electoral register.

How can Open Banking improve outcomes for consumers in the credit information market?

In 2022, 21% of UK consumers reported using fintech for lending services, up from 16% last year, according to Plaid’s Fintech Effect. Consumers have also reported switching to using fintech to check or improve their credit score (31%) or to secure or refinance a loan (24%). Lenders and challenger CRAs are already adopting Open Banking-based solutions to support lending decisions on smaller loans, primarily through:

  • Providing supplementary data sources that support a customer’s creditworthiness. For example, third party-providers (TPPs), such as Canopy, enable consumers to incorporate data on their regular rent payments and their subscriptions to build up their credit file.

  • Offering lenders more visibility on the affordability of a loan for a borrower in real-time. For example, TPPs are using consumers’ open banking data to offer more personalised lending decisions, rather than relying on credit scores alone. This includes developing insights that flag risks for lenders or identify borrowers that are locked out of traditional lending sources.

The provision of Credit Information Services (CIS) or Credit References are regulated activities in the UK, which require appropriate licenses from the FCA. Given the opportunity for Open Banking to support such regulated activity, clarity around primary and secondary use cases for such Open Banking data would be welcomed to ensure the best outcomes for consumers.

Why does this matter for consumers and lenders?

Access to credit plays an important role in helping consumers weather unexpected financial shocks. This is all the more important now, with the cost-of-living crisis affecting consumers’ financial stability. However, over 20 million adults in the UK are classed as “financially under-served” meaning that 1 in 3 struggle to access credit from mainstream lenders. 

These figures do not include the unbanked or sub-prime populations. These are adults who may be prevented from accessing credit because they have a thin credit file, minor issues in their credit information that may prevent them from accessing a loan, or untraditional incomes that may affect their affordability assessments. Consumers who are locked out of mainstream credit sources may turn to alternative sources to meet shortfalls in their incomes, which typically charge higher interest rates because the borrower is perceived as riskier, further stretching their financial resources. 

Lenders are also missing out on opportunities to extend credit to potential borrowers, without raising the overall risk profile of their loan book. However, in order to do so, lenders need more data sources and more insights about potential borrowers. Higher quality, more comprehensive credit information has been flagged as an area of exploration for future FCA work. Preliminary suggestions include requiring BNPL firms to provide data to CRAs once these firms are brought within the FCA’s regulatory perimeter. The FCA will also need to explore how to uphold Open Banking’s consumer-driven consent processes, while also ensuring that credit information is consistent and widely available across CRAs.

What’s the call to action for the FCA?

We propose three actions the FCA could take to further support Open Banking-based services in this space:

  1. Create a “fairer lending pledge” by incentivising CRAs and lenders to incorporate Open Banking data into lending decisions to improve access to credit. 

  2. Explore opportunities to include Open Banking data into larger-scale loan decisions, such as mortgages, through regulatory sandboxes.

  3. Push for Open Finance, which will enable lenders and consumers to get a 360-degree view of their finances, including their credit information, affordability, savings opportunities, as well as assets and liabilities.