Financial inclusion refers to access to useful and affordable financial products and services that meet the needs of vulnerable groups, such as low-income groups, rural populations, and women. It is a key enabler of reducing poverty and boosting prosperity. However, today, nearly 1.4 billion adults globally remain outside the formal financial system, with no basic access to a bank account.

Open banking is a powerful emerging tool for financial inclusion worldwide. Open banking solutions software allows third-party financial providers to access consumer financial data through application programming interfaces (APIs). This technology has the potential to spur innovation, grant customers more control over their data, promote access for underserved groups, and enhance competition in the financial services industry.

This discussion can be leveraged in the financial article on how banking beige drives inclusion through new financial products, alternate data for credit scoring, and competition promotion. The article also analyzes key challenges in scaling open banking and provides recommendations for stakeholders to maximize the benefits of this technology.

The Need for Financial Inclusion

Formal financial services can give people access to things that can really improve lives and livelihoods. It helps people start and grow businesses, invest in education and health, deal with financial emergencies and weather income shocks. It also means jobs, growth, and income, as well as reduced vulnerability to poverty.

Heavy reliance on cash leaves people vulnerable to theft and unable to leverage credit and insurance instruments for resilience. Financial exclusion constrains equitable economic growth and poverty alleviation worldwide. Universal financial access is now a policy priority under the UN Sustainable Development Goals 2030.

The Promise of Open Banking

Open banking refers to emerging frameworks for secure third-party access to consumer banking data through APIs. Under open banking, banks allow vetted financial technology (fintech) companies to directly access customer transaction data and initiate payments with prior user consent.

This enables fintechs to provide enhanced financial services by leveraging user data. Open banking started with the European Union’s Revised Payment Services Directive or PSD2. Countries such as the UK, Japan, Canada, Singapore, Australia and Mexico are now implementing open banking frameworks.

Open banking has the potential to spur innovation, expand consumer choice, promote financial inclusion and increase industry competition. By granting access to data, open banking allows fintechs to create affordable products tailored for unserved groups rapidly. Fintechs are leveraging this to drive inclusion in three key ways:

1. New financial products for excluded groups. Data sharing enables fintechs to analyze cash flows to design suitable savings, credit and insurance products for low-income individuals and micro-enterprises.
2. Alternate data for credit scoring. Open banking allows underwriting with transaction history data, unlocking finance for thin-file groups with limited documentation.
3. Promoting competition and efficiency. Open banking catalyzes the market entry of fintech companies focused on inclusion and increasing the availability of customized products.

Key Use Cases Driving Inclusion

Many fintech innovators are leveraging open banking to promote financial inclusion globally:

Microlending Based on Cash Flow Data

Open banking allows fintech lenders to analyze transactions to produce cash flow-based scores for thin-file consumers and micro-enterprises. This unlocks unsecured, short-term loans at lower interest rates.

For instance, UK fintech Wagestream provides earned wage access products to over one million workers. In Mexico, fintechs like Minu and Jefa offer micro-loans based on open banking data.

In India, Open taps user account data through India Stack to provide microcredit products to the unbanked. Luxoft from Ukraine, with its data analytics solutions, partners with fintech globally to optimize loan origination and scoring models, further enabling more inclusive access to financial services for underserved communities.

Savings and Wealth Management

Analytics on transactions can enable personalized savings and wealth products for mass consumers.

Sweden’s Minna Technologies automatically categorizes user expenses and provides recommendations for savings goals, budgeting and retirement planning. Nigeria’s PiggyVest, another example, allows micro-savings and investments through automated debits linked to bank accounts.

Gig Economy Worker Support

Open banking enables fintech platforms to better support gig workers with income smoothing, early wage access and financial advice.

For instance, Australia’s Lalo provides gig workers with early access to earned wages, while UK fintech Wagestream lets workers draw a percentage of their paycheck before payday. These services reduce income volatility for flexible workers.

Inclusive Insurance

Insurtechs leverage open banking data for customized products, including usage-based insurance, microinsurance pay-as-you-go models, and parametric insurance to cover climate risks.

Startups like Singapore’s PolicyPal and India’s InsuredMine allow transaction analysis for affordable insurance targeted at low and moderate-income segments. Others, like Etherisc, offer crop insurance products paid out based on weather data triggers.

Digital Identity and eKYC

Open banking allows fast, bank-grade digital identity verification critical for onboarding excluded groups.

Initiatives like India Stack’s eKYC and Malaysia’s eKYC framework integrate national ID systems with bank APIs, enabling remote authentication for account opening. This curbs costs and fraud for providers while improving customer experience.

Enhanced Credit Scoring

Fintechs leverage open banking transaction data to create alternate credit scores for thin-file consumers.

For example, Lenddo underwrites loans via transaction patterns provided by OakNorth, which has developed a methodology to score small business loan applicants based on open banking data. New credit scoring models can open up affordable credit to excluded groups.

Key Challenges in Scaling Open Banking

While open banking innovation shows promise, scaling adoption faces critical challenges:

Slow Consumer Adoption

Customer adoption of open banking is low globally because of data privacy, security and lack of awareness of use cases despite potential benefits. Adoption will only happen if we ensure that consumers get informed consent and build trust around data sharing.

Reluctance Among Incumbents

Opening up data to fintech rivals who eat into their customer base may be resisted by large banks. Industry collaboration can be held back by conflicting commercial incentives which can stifle innovation. Here, regulators are a key part in making sure ecosystem participation is balanced.

Implementation Complexities

Technical complexity around APIs, data standards and integrations poses challenges for rapidly innovating solutions at scale. Suboptimal user experience due to multi-step redirects between bank and fintech apps also contributes to sluggish adoption. Smoothening integration and minimizing redirection overload are critical to drive usage.

Cybersecurity Risks

Third-party data access also heightens data privacy and creates fraud risks from potential attacks. To build trust, robust governance frameworks for authorization, encryption, audit trails and breach disclosure need to be instituted. Most early open banking implementations struggle with cybersecurity.

Investment Shortfalls

To build open banking capabilities, financial institutions and fintechs have to invest significantly upfront. Market entry barriers may prevent many startups working to include vulnerable groups from mobilizing large investments, stifling innovation aimed at these groups.

Recommendations for Scaling Open Banking

To maximize the promise of open banking, policymakers and regulators should promote:

Gradual Adoption Mandates

Progressive policies that require financial institutions to open up access in phases, prioritizing use cases that enable inclusion and competition. Gradual adoption allows the development of open banking infrastructure while building ecosystem trust.

Usage Incentives and Subsidies

Incentives for fintech and consumer adoption until open banking gains traction and clear benefits emerge. Subsidies for vulnerable groups, small businesses and micro-entrepreneurs using open banking-based financial products can also boost usage.

Interoperability Standards

Common technical standards for APIs, data structures, security protocols and customer redressal mechanisms allow interoperable solutions to emerge across providers. System compatibility enables convenient products that leverage multiple data sources.

Robust Cybersecurity Frameworks

Storage, access authorization and encryption that limits risks of third-party data sharing and engenders trust, through comprehensive cybersecurity and data privacy regulations. Responsible disclosure should also be mandated around them.

Investment in Awareness

Educating consumers about the new era of public awareness campaigns, which amplify the benefits of open banking, while clarifying the data sharing options consent. Cases of financial inclusion can highlight the use case and overcome the early distrust and inertia of customers.

Research on Adoption Barriers

Adoption barriers across customer segments are continuously researched to continually refine policies and standards. It’s crucial to study the challenges vulnerable groups and SMEs face when adopting.

The Road Ahead

Open banking has immense potential to enable access to affordable, customized financial solutions for the unserved and drive competition across banking. However, concerted efforts across policy, regulation, industry collaboration and public engagement are vital to unlock its benefits.

While still early, initiatives across developed and emerging economies show promise in leveraging open banking APIs and data for inclusion. Research shows that innovations in financial access can cause leapfrog improvements, starting small but scaling rapidly across communities. Open banking could, therefore, trigger an inclusion tipping point, transforming how low-income groups access finance worldwide.

Open banking has the potential to usher in a new, personalized, seamless and inclusive era of financial services worldwide with collaborative action. The road ahead is hard, but the promise is real and important.