Risk assessment and the open banking revolution

| Article by: Abilio RodriguesProfile Image Abilio Rodrigues 4 min

One of the most common procedures in the loaning industry is the assessment of an applicant’s risk profile, in order to determine whether a credit should be approved or denied. 

The TL;DR definition of risk assessment refers to the process of identifying elements that can have a negative impact on one’s assets. This (ideally) careful evaluation will then translate to the decision-making process. 

Why is this done? Well, first of all, to ensure that lenders are protected from customers who won’t be able to pay back. But also to provide solid options for clients from a wide variety of socio-economic backgrounds. 

But things are a little bit different now, with open banking’s technology pioneering new ways of ensuring that everyone benefits from modern finance.

The past

Loans were a thing long before computers and the internet. The thing is, back then, people didn’t really have a reliable source of financial information.

Lenders had to take a lot of risks, since they couldn’t really evaluate if someone had the necessary means not to default on payments. They mainly checked if a client had a job, trusting that no one would want to have his name besmirched, or a “bad credit score”.

Another way to go about loans was having someone pose as a guarantor, who should be responsible for a percentage of the credit. This legal figure was secondarily liable for an hypothetical debt, guaranteeing that the lender would at least get some money back. 

Of course, if someone had a bad reputation for not paying his debts, lenders would refrain from serving them, at least until some sort of collateral, like a property, was offered. 

Things have come a long way since then, mainly because the world became a lot more connected. Bank accounts became mainstream, and online financial data streams added a decent layer of protection for all parties involved.

The present

In the European Union, risk assessment takes many different forms, varying from country to country. Some of the more advanced countries are still highly dependent on credit bureaus that act on wider markets, while other countries rely on data available through traditional banks. 

To evaluate someone’s credit worthiness, lenders often request relevant information from external credit bureaus. Even worse, some demand that applicants submit financial statements (like payslips or proof of expenses) that are then reviewed and serve as a baseline for decision making. 

This data will later be used to fuel financial models that should be able to precisely estimate if someone who borrows money will default. 

One of the main drawbacks of this method is the bureaucracy associated with application forms. But there are a lot more challenges with the current modus operandi. 

Risk assessment: obsolete and expensive, or simply outdated?

Having a good grasp of someone’s risk profile has always been a challenge, mainly because today’s evaluations are built over outdated data sources

Not only that, but these sources are also very expensive, especially if we factor in that the data is not particularly thorough. This might seem like a simple oversight, but it means that decision-makers don’t always have the necessary information to estimate an applicant’s risk value

As if this wasn’t enough, these processes can be very lengthy and require a lot of effort from the customer. They do not, for this reason, meet modern expectations about financial products and services, and therefore have a high abandonment rate. 

The future: how can open banking help?

Well, it’s actually quite simple! Open bankinggives your business access to not only more refined data points, but also to more relevant information to support your decisions

This alone will help reduce your exposure to risk, while improving acceptance rates and customer satisfaction. 

It can also solve the friction issue that stems from the lengthy and cumbersome application flow. Faster decisions translate to less frustration, meaning that applicants won’t have to think about maybe taking their business elsewhere. 

Open banking takes convenience and runs away with it. We live in a time when everyone wants everything, and wants it now! A rapid digital application process is paramount nowadays, as it takes us from spending days to submit documents to a few clicks until submission

Companies also add the benefit of streamlined operations, which has a severe positive impact on business efficiency

Modern financial technology is also reliable, guaranteeing that all necessary information is verifiable, up-to-date and, more importantly, secure. Gone are the days where risk decisions were based on old data.

Here is the gist of it all: the labour market has changed, and assessing someone’s financial profile demands more granular information. There is no “too much data” on risk assessment based on open banking. 

Risk assessment and open banking: how does it work?

  1. Lender asks applicant to share open banking data (clear consent process, according to the PSD2);
  2. Open banking data is gathered by a Third-Party Provider (TPP);
  3. Data is categorised (indicating potential risks);
  4. Lender accesses categorised data and determines applicant’s ability to pay;
  5. Lender determines whether to allow or deny application for loan (or automates this process based on certain parameters);

The application process is also simplified for the applicant: it’s as simple as accessing the form and being redirected to a simple interface, where he selects his bank, logs in and consents to sharing his banking data. It’s that simple.

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