Open Finance Can Reduce Financial Inclusion Gaps: Here’s How

Data has the potential to be transformational for financial inclusion and open finance can be the key to unlocking it. 

Over the last decade, there has been rapid growth in the ‘breadth’ of financial services (i.e., the number of people with access to accounts), largely fueled by the growth of mobile wallets and the digitization of G2P systems. Some 76% of people globally now have access to an account. During this period, the growth in the ‘depth’ of financial services (i.e., ensuring a wider range of relevant services are available to all) has been more limited globally –  only 31% of adults reported having saved formally and 29% having borrowed formally. While the world has made good progress, there is clearly more work to do.

CGAP has, in recent years, been demonstrating the potential for data not only to further expand the breadth but also the depth and the utility (i.e., the practical benefits) of financial services for low-income people. We see the ongoing development of open finance ecosystems – and, in the future, open data with non-financial data sources being included – as a truly transformational enabler that will unleash the power of data to increase financial inclusion. 

Data-driven financial services can help close inclusion gaps

Data trails of individuals have been growing exponentially and will continue to grow. CGAP’s research suggests that despite income and gender-based differences, more low-income people (including women) are generating digital data trails than ever before. We estimate that roughly two billion low-income individuals (earning under USD 5.50 per day) in low- and middle-income markets are currently digitally included, and as a result, are generating a digital data trail. This number is slated to grow thanks to advancements in digitization and digital inclusion, especially driven by increased smartphone ownership and the fact that the richness and amount of data generated by each individual are also expected to continue growing. 

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 previously unbanked, or poorly banked, customers, and to more effectively serve the needs of these customers. 

CGAP’s research over the last three years suggests that effective use of data trails enables financial service providers (FSPs) to cater to low-income and excluded individuals in a variety of ways: 

The use of digital data trails could reduce financial exclusion by nearly 50%.

Globally, 67% of digitally included poor people have an account. Bringing the remaining 33% of digitally included poor people (roughly 600 million individuals) into the financial system would reduce financial exclusion by nearly 50% from the current 1.4 billion people to 800 million. Furthermore, only 12% of the digitally-included poor have borrowed from a financial institution so far, providing an even greater opportunity to deepen the depth of 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, reduced pricing, and tailoring of products to meet the needs of individuals.

Transactional data can effectively be used to offer credit to those who don’t have a credit history. CGAP’s analysis of transactional data of small retailers, banking agents, and platform workers showed similar predictive power of credit losses when using transactional data or credit history data, with an upside when combining both sources of data. This means that FSPs can effectively lend to these MSEs 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. CGAP’s research using data from TymeBank and AB Bank Zambia shows that analyzing data trails with a gender lens can help lenders better understand how men and women differ in terms of credit risk, allowing lenders to carry out a more accurate risk assessment of each gender group that can benefit both women and providers. Our research showed how a gender-intentional approach can result in a larger total portfolio with a higher proportion of loans to women for a given level of risk.   

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. CGAP’s research has identified several ways in which data can support the expansion of inclusive insurance, including by better understanding customer behavior, designing and pricing more responsive products, providing a smoother customer acquisition and onboarding, and building efficiency in claims management and fraud detection. Personal financial management apps leverage the income and spending data of customers to give them a full view of their finances and make recommendations related to money management, supporting financial education, and facilitating switching to products that better suit individual needs. 

Data is most often inaccessible to the FSPs that can innovate with it

While our findings are promising, there are challenges that limit the access and use of data. 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 market, and, as a result, they tend to cater to customers who provide them higher margins. 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. As per the World Retail Banking Report, 70% of banking executives are concerned they lack sufficient data analysis capabilities, while 75% of customers are attracted to new, agile fintech competitors who offer easy-to-use products and superior customer experiences while remaining low in cost. However, fintechs that have advanced data analytics capabilities do not always have access to the large data pools that are held by incumbents. 

Open finance can lead to a pivotal shift in the trajectory of financial markets, 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”).

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. For example, after the implementation of the framework, a prominent private sector bank achieved a 25% reduction in credit application process costs, an investment advisor observed a ~60% increase in user engagement as individuals linked their financial accounts via AA, and lenders reported zero fraud rates on bank statements shared. 

In the United Kingdom, the Bank of England (BoE) reports that open banking (a more limited form of open finance limited to banking data) has unambiguously increased competition and innovative entry in the financial sector. They report that the number of fintechs backed by venture capital has increased by a third, and the amount of money invested has doubled following the adoption of open banking. Furthermore, fintech activity has increased across many financial products – including financial advice applications, credit, payments, and regtech – confirming that open banking data is useful for a wide range of financial products beyond credit underwriting. The BoE also found evidence that open banking improves consumer outcomes, with new open banking advice solutions being associated with greater financial knowledge and open banking-based credit being associated with greater access to credit products. They also found benefits for SME finance, as being eligible to share data has made SMEs more likely to form new lending relationships with non-bank lenders, including new fintechs, and those SMEs that formed new lending relationships with non-banks paid less interest.

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.  CGAP has developed a self-assessment tool to help regulators and policymakers identify and address areas of the enabling environment that they should strengthen before or during the early stages of implementing an open finance roadmap. 

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 payment system that is digital, interoperable, offers instant settlement, and allows for third-party payments 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 payments 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 payments information (i.e., by moving beyond open finance to open data). 

The figure below depicts the building blocks that support open finance. It is important to note, however, that the steps depicted in the figure are not necessarily sequential and that different layers can be implemented in parallel. 

It is also essential to build in consumer protection at every step. As the use of digital data and digital processes increases, so can consumer risks and cyberattacks. Clearly, regulators will have a major role to play in this regard, but all players involved need to incorporate consumer protection into their approach in order to build a responsible open finance system that establishes and maintains trust – and is therefore both good for consumers and sustainable over the long term.

Implementing open finance comes with important risks and challenges

Despite the myriad benefits that open finance can offer, there are risks and challenges that need to be appropriately considered. We've included some examples below. 

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. CGAP research has shown that low-income customers care deeply about their privacy and are willing to pay a premium for data protection, including paying higher interest rates or fees. CGAP’s recent research in Brazil has shown that awareness of and trust in open finance are lower among traditionally underserved groups like women and lower-income segments. While it can be expected for these groups to be underrepresented among the early adopters in view of their more limited prior access to the financial system and often more limited digital and financial capabilities, it is critical that, as the scheme matures, underserved groups are willing and able to participate.  

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, we believe that 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. We acknowledge, however, that open finance is a complex framework for regulators that requires not only regulating data sharing but also regulating a much larger and complex financial sector.
• Financial service providers: by sharing and using data to expand their reach down market and develop products to deliver value to unserved or underserved segments.
• Non-financial service providers (e.g., bigtech): 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 (including financial service providers, telcos, and governments).
• 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. Taking corrective measures to make systems inclusive ex-post can be more challenging and costly. This underscores the need to act now to design open finance regimes that are inclusive.

We are very optimistic about the potential. 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 fintechs, 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.