Small businesses drive the US economy. They number more than 33 million and employ 46.4% of the private workforce, according to a Federal Reserve Banks (FRB) survey. They also create 1.5 million jobs annually and represent 64% of new jobs, according to the US Small Business Administration.

The capacity of small and medium-sized businesses (SMBs) for job creation underscores their importance in economic vitality. Yet despite their economic contribution, small-business owners consistently struggle to access capital.

Almost half (46%) of owners express concerns about how a limited credit history adversely affects loan opportunities, according to market research by J.D. Power. Almost two thirds (65%) of SMBs report that inflation is resulting in increased operating costs and unstable pricing strategies, according to the same research. And fully approved loan applicants decreased by 9% between 2019 and 2022, according to the FRB survey.

Corporate cards and somewhat limited access to small-business loans are helping tide things over for now. But when a Mastercard study finds that 55% of US consumers are willing to share secure access to their financial account data in exchange for the potential benefit of obtaining a better loan or interest rate, SMB borrowers will likely share that willingness too.

On the other side, SMB lenders grapple with many challenges when striving to profitably and efficiently meet the needs of their SMB borrowers. One hurdle is a lack of data to accurately assess risk; only slightly better is incomplete data that still cannot support complete assessments. And regardless of credit history, many traditional risk assessment models are designed for the needs of larger rather than smaller businesses.

Open banking offers an alternative by letting financial institutions gain real-time insights into an SMB's transactions and performance. Tailored financial products result.

Open banking is revolutionizing financial services from lending to payments, and it is even enabling better financial decisions for all types of audiences such as consumers, SMBs and large corporations. Open banking can be transformative for SMB lenders through enhanced access to SMB-permissioned financial data that sheds light on account transaction data and credit card receipts.

In turn, enhanced access allows enhanced analytics. Detailed SMB-permissioned data on inflows, outflows, non-sufficient funds and account balances allows financial institutions to assess risk more comprehensively. In particular, credit card data unveils a deeper understanding of vendor payment details for predictive analysis of credit risk exposure.

In essence, open banking not only provides more complete financial pictures of borrowers but also empowers lenders to make more informed decisions. Some advantages of open banking for SMB lending include:

• Enhanced risk management by supplementing credit bureau information with SMB-permissioned data on cashflow management and deposit-account balances.
• Confident approvals of loan and card applications from no-file and thin-file customers as well as “on margin” customers that may lack the minimum requirements for a traditional credit score.
• Reduced costs by streamlining document collection and increasing automation for loan underwriting.
• Smoother application processes to reduce customer drop-off rates.

Open banking offers an array of cash-flow insights that can enrich lending assessments. These insights encompass a wide range of data, including debit and credit summaries, average transaction values, estimated revenue figures, instances of non-sufficient funds, deposit and withdrawal histories, and net cash-flow calculations. These details of financial operations give lenders a deeper understanding of an SMB’s financial health, cash-flow stability and ability to meet loan obligations.

In addition, open banking can identify possible cases of loan stacking by recognizing new inflows into deposit accounts and new outflows that are designated as payments to financial institutions. This cash-flow data includes parameters such as minimum and maximum cash balances, averages of cash balances, occurrences of negative balances, and the number of days an account maintains a negative balance during a given period.

Such insights help lenders gauge the financial strain a business may be under and overall cash balance health. This proactive approach allows lenders to mitigate risks associated with loan stacking and offer more responsible and sustainable financing solutions.

Open banking and machine learning can combine to facilitate loan underwriting by allowing for accurate and data-driven lending decisions. This expedites approvals while also enhancing precision to ultimately benefit borrowers and lenders.

Open banking is reshaping credit to the benefit of SMBs and the financial institutions that serve them. SMBs benefit from a streamlined application process and solutions tailored to their needs. Financial institutions benefit from improved risk-adjusted revenue through a more comprehensive view of their borrowers.

Clear lending objectives and strategies start with defining and assessing use cases, such as supporting SMBs without established credit histories that have been denied loans in the past. Prototype development, UI/UX testing for seamless experiences, and risk-management integration should be supported by a three-step process:

1. Understand the existing lending ecosystem: Review and evaluate the current underwriting process to develop a comprehensive understanding of the factors that lead to supporting and making credit risk decisions.
2. Select the right partners: Consider partnering with open banking service providers who can enhance capabilities and expedite implementation by accelerating deployment and delivering customer value across entire customer journeys — from launch to ongoing monitoring.
3. Enhance analytics and overall engagement: Use open banking insights to personalize user experiences and engage SMBs with tailored credit products that solidify the customer relationships and lead to higher satisfaction and loyalty.

This three-step process helps unlock the potential of open banking by prioritizing innovation.

Open banking gives businesses control by letting them grant secure access to their financial data for better financial relationships. But it is lending where SMBs will gain through improved access to loans via seamless integrations, streamlined and secure processes, and personalized solutions.

Nowadays, opening an account or applying for a loan online is standard practice and comes with expectations around speed and funding. Know your customer (KYC) checks, external account verification and fraud protection can be part of a single process through secure connections between application programming interfaces (APIs) that enable competitive tailored loans. Moreover, financial institutions can better understand an SMB’s current and projected financial health by linking its accounting software to digital banking solutions, which helps them manage portfolio risk.

Nonetheless, challenges remain: ongoing regulatory evolution, challenges with identity verification, non-standard API connections, and the need for heightened privacy and data security protocols and secure customer authentication.

Report contributors:

Abhishek Roy, Aishwarya Aishwarya, Franciso Bustillos, Ritika Tiwari