Power of Open Finance to Deepen Financial Inclusion

Data can transform financial inclusion, and open finance can be the key to unlocking it.

Financial services have expanded over the last few decades with the penetration of mobile phones, especially mobile wallets and G2P payment platforms in emerging markets like India, Brazil, and parts of Africa. Yet the depth of financial services has remained limited. Only 31% of adults have saved formally; worse, only 29% have access to formal credit.

Open Finance and Open Data based on non-financial data sources can be a transformational enabler to increase the breadth as well as the depth and utility of financial inclusion

Data-driven financial services can help close inclusion gaps. Data trails of individuals have been growing exponentially and will continue to grow, despite income and gender-based differences, more low-income people (especially women) are generating digital data trails than ever before. This is expected to multiply, driven by increased smartphone penetration as a result of which the depth and amount of data generated will also grow.

The growth of data trails presents an enormous opportunity to increase financial inclusion and enhance the value of financial services for the poor. Data-driven financial services enable the provision of more varied and better-tailored financial solutions, including to the previously unbanked, or underbanked customers, and to more effectively serve the needs of these customers.

Globally, 67% of low-income individuals who are digitally included have an account. Bringing the remaining 33% of digitally included poor people ( approx. 600 million) into the financial system would reduce financial exclusion by nearly 50% from the current 1.4 billion to 800 million people. Furthermore, only 12% of the digitally-included poor have borrowed from a financial institution so far, providing an even greater opportunity to deepen the financial services they have access to.

In credit, data trails – particularly transactional data trails – help facilitate customer segmentation and risk assessment, which enables data can transform financial inclusion, and open finance can be the key to unlocking it.

Financial services have expanded over the last few decades with the penetration of mobile phones, especially mobile wallets and G2P payment platforms in emerging markets like India, Brazil, and parts of Africa. Yet the depth of financial services has remained limited. Only 31% of adults have saved formally; worse, only 29% have access to formal credit.

Open Finance and Open Data based on non-financial data sources can be a transformational enabler to increase the breadth as well as the depth and utility of financial inclusion

Data-driven financial services can help close inclusion gaps. Data trails of individuals have been growing exponentially and will continue to grow, despite income and gender-based differences, more low-income people (especially women) are generating digital data trails than ever before. This is expected to multiply, driven by increased smartphone penetration as a result of which the depth and amount of data generated will also grow.

The growth of data trails presents an enormous opportunity to increase financial inclusion and enhance the value of financial services for the poor. Data-driven financial services enable the provision of more varied and better-tailored financial solutions, including to the previously unbanked, or underbanked customers, and to more effectively serve the needs of these customers.

Globally, 67% of low-income individuals who are digitally included have an account. Bringing the remaining 33% of digitally included poor people ( approx. 600 million) into the financial system would reduce financial exclusion by nearly 50% from the current 1.4 billion to 800 million people. Furthermore, only 12% of the digitally-included poor have borrowed from a financial institution so far, providing an even greater opportunity to deepen the financial services they have access to.

In credit, data trails – particularly transactional data trails – help facilitate customer segmentation and risk assessment, which enables better underwriting and hence better pricing, and tailored products to meet the needs of individuals. The informal sector accounts for the largest chunk of the population in emerging markets and data can help tailor products based on their cash flow patterns some of which could be seasonal.

Similarly, transactional data can effectively be used to offer credit to those who don’t have a credit history. A very large percentage of financially excluded in emerging markets are in the informal sector - transactional data of these small retailers, banking agents, and platform workers showed similar predictive power of credit losses when using transactional data or credit history data and combining the two sources can be a very powerful credit source. This means that FSPs can effectively lend to these MSMEs and individuals, many of whom haven’t had access to formal credit before, by using their transactional data (e.g., sales, purchases, restocking) without taking on additional risk.

Data-driven approaches can also be used to support women’s financial inclusion. Women typically face greater financial exclusion than men; there is indeed a six-percentage point gender gap in financial inclusion globally. Under certain conditions, the use of gender-disaggregated data in credit scoring can be used to increase credit for women without increasing credit risk for providers. Traditionally women are a better credit risk and contribute substantially more to financial inclusion compared to men

The promise of data is not limited to credit. While most novel data-driven products currently revolve around credit, there is an opportunity for data to enable a more diverse set of financial services that further deepen inclusion. Data can support the expansion of inclusive insurance, including a better understanding of customer behavior, designing and pricing more responsive products, providing a smoother customer acquisition and onboarding, and building efficiency in claims management and fraud detection.

Data can also be a very powerful tool for financial literacy at the bottom of the pyramid where it is most needed. Data can help FSP design products based on regional/sectoral needs including products for the agricultural sectors and farm workers

The challenge with data is it is most often inaccessible to the FSPs that can innovate with it. Data is often held in siloes, making it costly for innovators to access. Large incumbent players have a competitive advantage and dominant position since they hold the largest pools of data, which gives them limited incentives to go down the market, as a result, they tend to cater to customers who provide them with higher margins, which is one of the key hindrances to financial inclusion in emerging markets. When data is shared through bilateral agreements with third parties, as is often the case, customers have limited knowledge and control over how their data is used. In addition, data analytics capabilities are not equally spread among providers, and smaller fintechs, who may have higher digital capabilities, may not have access to sufficient data pools.

Open finance can lead to a pivotal shift in the trajectory of financial markets, thriving and driving competition and innovation

Open finance can address some of the most fundamental obstacles that inhibit the access to and use of data in financial services by reducing two types of information asymmetry that exist in many markets: between FSPs and customers, and between different types of FSPs. By empowering customers to access their data, and by creating a level playing field among providers to access and use customer data, open finance reduces these two types of information asymmetry, which in turn creates a more competitive market that can drive innovation in the products and services offered.

There is an information asymmetry between FSPs and customers, as FSPs typically only see part of a customer’s data, and this may inhibit the FSPs’ ability to serve a customer. Open finance opens up the full transaction information of a customer (not just transactions with a given partner), including payment transactions, making data trails richer. This is potentially transformational for informal MSMEs because transactional data offers the most value for those without a traditional credit history. This is already happening in markets like Brazil and India where FSPs participating in open finance ecosystems can view the full transaction history of individuals and MSMEs and use this data to expand credit to new borrowers or to improve loan terms. The potential to improve inclusion can be further expanded by adding “alternative” data from non-financial providers such as telcos and utility companies (a concept called “open data”).eg If a merchant or a manufacturer is using a POS machine the data sitting on his machine is a golden opportunity to lend to him and help him expand/grow as his receivables are protected.

There is also an information asymmetry between different types of FSPs as older, larger financial institutions – especially banks – typically hold the largest pool of client data. Open finance eliminates the need to set up bilateral partnerships between those who hold the data and those who want to use it. While bilateral partnerships also make it possible for a fintech to gather data from a bank (through bespoke APIs) and develop new financial products, such approaches limit competition (fintechs are much smaller than banks and thus, at a disadvantage) and generate higher fixed costs related to the cost of bespoke APIs and potentially lengthy negotiations processes. By facilitating data sharing, open finance levels the playing field for collaboration among all FPSs, including banks and non-banks, and lowers the cost of innovation.

Early evidence supports the promise that open finance helps FSPs to better serve customers in emerging markets. Open finance is still in its early days, so the use cases that have been implemented remain limited. However, the potential can be inferred from existing successes, powered by similar (but more limited) data sets than a full-fledge open finance scheme would allow. There is indeed evidence emerging from the implementation of open finance in Brazil and India. Banco do Brasil, for example, has reported using open finance data to better score customers, which enabled it to raise credit limits by more than BRL 700 million for their customers who were early adopters. Similarly in India, the implementation of the Account Aggregator (AA) framework (India’s version of open finance) points to positive results.

The development of artificial intelligence (AI) tools will undoubtedly unlock open finance's potential even further. Because open finance leads to an increase in the amount of data being shared, there will be more value in the adoption of more sophisticated data analytics techniques, including those using AI, which creates both opportunities and risks. Open finance enhances the volume and quality of datasets that are available to FSPs for developing financial services targeted at excluded individuals and MSEs. AI can leverage the same datasets to further enhance opportunities for FSPs to serve these customers. It could for instance automate and improve the accuracy of crucial processes such as know-your-customer (KYC), client data analysis, fraud analysis, document authentication, credit scoring, product personalization, and customer service. This in turn could significantly decrease the cost and improve the efficiency of FSPs in acquiring clients and managing small-value accounts.

The journey to open finance has many steps :

Despite the positive evidence that is emerging, if the correct enabling environment is not in place, the impact of open finance on financial inclusion will be limited. Open finance’s contribution to increasing financial inclusion relies on a multifaceted effort where other enablers are put in place too.

The full potential of open finance depends indeed on some key enabling elements in the financial ecosystem. As things currently stand, the first step for a customer to participate actively in open finance is to have an account. The full impact of open finance cannot be materialized without widespread account ownership. That said, as open finance ecosystems mature and expand to open data, financial institutions will be able to leverage alternative data such as telco data or utility bill payment data to develop new use cases and bring on more people, including previously unbanked people. Secondly, the data shared from those accounts is most valuable if it contains rich transactional data trails. As a result, open finance builds on payment system reforms – i.e., it works better if there is a robust digital payment system, interoperable, offers instant settlement, and allows for third-party payment initiation. Such a robust digital payments infrastructure creates an environment that attracts fintechs and other innovators, which are essential to driving better use cases for inclusive finance. Finally, the adoption of open finance depends on customer trust that, at a minimum, gets promoted through and is underpinned by a strong data protection framework.

Brazil and India, both early adopters of open finance, had widespread adoption of instant payment systems, as well as thriving fintech ecosystems before they implemented open finance. This has created a clear opportunity to improve financial inclusion by incorporating rich transaction data trails. Further progress could be achieved by expanding the range of datasets available on those who are currently excluded or underserved in these countries, such as utility payment information.

Consumer protection and regulatory frameworks need to evolve at every step. As the use of digital data and digital processes increases, so can consumer risks and cyberattacks. Regulators will have a major role to play in this regard.

Implementing open finance comes with risks and challenges

Despite the myriad benefits that open finance can offer, some risks and challenges need to be appropriately considered.

Customer participation, awareness, and trust. One of the most important enablers of an effective open finance system and the responsible use of data is a strong data privacy foundation.

Underdeveloped business models and misalignment of incentives for providers

Global experience shows that the incentives for FSPs to participate differ greatly by their size, market share, and capabilities. Large incumbent banks that hold large quantities of data and have more complex IT systems can be more reluctant to participate in the open finance ecosystem than smaller more nimble players, such as fintechs. While the evidence is still nascent, there can be significant benefits for players of all sizes to participate in open finance. In an open finance regime, the existing market share is not split among more actors, but rather, the whole market grows to include more clients and more products with reduced costs and new revenue streams.

Capacity to implement

The successful implementation of an open finance regime requires investing in technology and strengthening technical capabilities – both by regulators and providers. Initial investments in developing the API architecture, as well as the associated IT developments to comply, are fundamental building blocks for successful open finance regimes. For FSPs and regulators, these ICT investments can benefit the entire business beyond the open finance application. Beyond ICT, it is also critical for regulators to develop an oversight mechanism for open finance regimes and to ramp up their supervision and enforcement capabilities.

The journey to open finance must be taken together

We believe there is potential for data-sharing regimes like open finance to lead to significant progress in the breadth, depth, and utility of financial inclusion. Open finance can serve as the next wave of financial inclusion if we are intentional about designing ecosystems and services that consider low-income and vulnerable customers’ needs. Overall, stakeholders need to recognize the new paradigm and embrace the concept of inclusive data ecosystems. They can facilitate this in a variety of ways:

• Policymakers and regulators: by building the foundations of an inclusive payment and data ecosystem, including by putting in place an effective open finance legal and regulatory framework, and strengthening their data protection regimes. Governments can also actively participate by sharing relevant public datasets.
• Financial service providers: by sharing and using data to expand their reach down the market and develop products to deliver value to unserved or underserved segments.
• Non-financial service providers (e.g., big tech): by embedding financial services in their value proposition and, in time, participating in wider open data regimes.
• Customers and those representing their interests: by demanding more control over their data and more benefits from the data they share with others.
• International standard setters: by helping with the harmonization of data sharing standards.

As the development and adoption of open finance as a central element in modern and digital financial ecosystems are just beginning to take off, we have the unique opportunity to shape open finance regimes in a way that works for everyone. This underscores the need to act now to design open finance regimes that are inclusive.

Open finance could lead to the development of a financial sector in which the modularization of the supply chain of financial services becomes a reality and where fintech, mobile money operators, banks, and other players work together to leverage each other’s strengths and offer an efficient combination of services that are more inclusive and best suited for clients. In other words, successful implementation of open finance should lead to a financial sector in which a range of FSPs can serve any individual or enterprise, regardless of size, income, location, or gender, with affordable, responsible, and effective financial services tailored to their needs.