The fintech sector has been hugely successful (and hugely profitable) for much of the last decade, and even more so during the pandemic. But it might come as a surprise to learn that many in the industry believe that the story is just beginning and the sector is poised to achieve much more, with fintech’s next decade expected to be radically different from the last 10 years.
Long before the pandemic, the way in which banks were regulated was changing. Initiatives like Open Banking and the Revised Payment Services Directive (PSD2) were being proposed as a way to promote competition in the banking industry — allowing smaller challenger firms to break into a market that has long been dominated by corporate titans.
Now that these initiatives are in place, however, we’re seeing that their effect goes way beyond opening up a gap for challenger banks. Since open banking requires that banks make valuable data available via APIs, it is leading to a revolution in the way that small and mid-size enterprises (SMEs) are funded — one in which data, and not hard capital, is the most important factor driving fintech success.
Open banking and data freedom
In order to understand the changes that are sweeping fintech and reconfiguring the way that the industry works with small businesses, it’s important to understand open banking. This is a concept that has really taken hold among governmental and supranational banking regulators over the past decade, and we are now beginning to see its impact across the banking sector.
Allowing third parties access to the data held at banks will allow the true financial position of SMEs to be assessed, many for the first time.
At its most fundamental level, open banking refers to the process of using APIs to open up consumers’ financial data to third parties. This allows these third parties to design, build and distribute their own financial products. The utility (and, ultimately, the profitability) of these products doesn’t rely on them holding huge amounts of capital — rather, it is the data they harvest and contain that endows them with value.
Open-banking models raise a number of challenges. One is that the banking industry will need to develop much more rigorous systems to continually seek consumer consent for data to be shared in this way. Though the early years of fintech have taught us that consumers are pretty relaxed when it comes to giving up their data — with some studies indicating that almost 60% of Americans choose fintech over privacy — the type and volume shared through open-banking frameworks is much more extensive than the products we have seen up until now.
Despite these concerns, the push toward open banking is progressing around the world. In Europe, the PSD2 (the Payment Services Directive) requires large banks to share financial information with third parties, and in Asia services like Alipay and WeChat in China, and Tez and PayTM in India are already altering the financial services market. The extra capabilities available through these services are already leading to calls for the U.S. banking system to embrace open banking to the same degree.
If the U.S. banking industry can be convinced of the utility of open banking, or if it is forced to do so via legislation, several groups are likely to benefit:
Consumers will be offered novel banking and investment products based on far more detailed data analysis than exists at present.
The fintech companies who design and build these products will also see the use of their products increase, and their profit margins alongside this.
Arguably, even banks will benefit, because even in the most open models it is banks who still act as the gatekeepers, deciding which third parties have access to consumer data, and what they need to do to access.
By far the biggest beneficiary of open banking, however, will be SMEs. This is not necessarily because open-banking frameworks offer specific new functionality that will be useful to small and medium-sized businesses. Instead, it is a reflection of the fact that SMEs have historically been so poorly served by traditional banks.
SMEs are underserved in a number of ways. Traditional banks have an extremely limited ability to view the aggregate financial position of an SME that holds capital across multiple institutions and in multiple instruments, which makes securing finance very difficult.
In addition, SMEs often have to deal with dated and time-consuming manual interfaces to upload data to their bank. And (perhaps worst of all) the B2B payment systems in use at most banks provide very limited feedback to the businesses that use them — a lack of information that can cost businesses dearly.
Given these deficiencies, it’s not surprising that fintech startups are keen to lend to small businesses, and that SMEs are actively looking for novel banking products and services. There have, of course, already been some success stories in this space, and the kinds of banking systems available to SMEs today (especially in Europe) are leagues ahead of the services available even 10 years ago.
However, open banking promises to accelerate this transformation and dramatically improve the financial services available to the average SME. It will do this in several ways. Allowing third parties access to the data held at banks will allow the true financial position of SMEs to be assessed, many for the first time.
Via APIs, fintech companies will be able to access information on different types of accounts, insurance, card accounts and leases, and consolidate data from multiple countries into one overall picture.
This, in turn, will have major effects on the way that credit-worthiness is assessed for SMEs. At the moment, there is a funding gap facing many SMEs, largely because banks have been hesitant to move away from the "balance sheet" model of assessing credit risk. By using real-time analytics on an SME’s current business activities, banks will be able to more accurately assess this risk and lend to more businesses.
In fact, this is already happening in countries where open banking is well advanced – in the U.K., Lloyds’ Business ToolBox offers unlimited credit checks on companies and directors in addition to account transaction data.
Open banking will also allow peer comparison analytics far ahead of what we have seen until now. APIs can be used to provide SMEs real-time feedback on how they are performing within their market sector. Again, this ability is already available in the U.K., with Barclays’ SmartBusiness Dashboard offering marketing effectiveness tools as part of a customizable business dashboard.
These capabilities will be so useful to SMEs that they are likely to drive the popularity of any fintech product that offers them. For SMEs, this value will lie mainly in intelligent data-analytics-based insights, recommendations and automatic prompts that can be built on top of account aggregation.
Then, additional insights generated from these same monitoring tools could enable banks and alternative lenders to be more proactive with their lending — offering preapproved lines of credit, in a timely manner, to SMEs that would have previously found it difficult to access funding.
The bottom line
Crucially for the fintech sector, it’s almost a certainty that SMEs will be willing to pay fees for data-analytics-based value-added services that help them grow. This is why some startups in this space are already attracting huge levels of funding, and why open banking is at the heart of the relationship between tech and the economy.
So if fintech has had a good year, this is likely to be just the start of the story. Backed by open-banking initiatives, the sector is now at the forefront of a banking revolution that will finally give SMEs the level of service they deserve and unleash their true potential across the economy at large.