A Tough Summer For Open Banking Powered Lenders

In the world of finance, where innovation is rapidly reshaping traditional models, two notable UK fintech players, Koyo and Fronted, have recently shuttered their doors. These closures signal a challenging summer for lenders using alternative data to underwrite, ultimately impacting the underbanked population in the UK. Despite these ventures offering solutions to the financial woes of those less economically secure, their demise comes at a critical juncture of rising interest rates and a mounting cost of living crisis.

Why Alternative Data Matters

Koyo provided personal loans to individuals who found it difficult to access credit via traditional means by using open banking and AI to create a more holistic picture of a user’s creditworthiness. Koyo encouraged users to link their bank account via open banking to receive a decision beyond the traditional credit score in less than 3 minutes. Applying for a Koyo loan did not impact the customer’s credit score. The fintech, founded in 2020, succumbed due to an inability to raise fresh capital. This is despite a Series A Extension in 2022 that says GBP 100 million in debt and GBP 5 million in equity.

Fronted addressed a niche market, particularly renters needing a short-term loan to fund a rental deposit. Like Koyo, it used alternative data to assess the individual’s creditworthiness, and the application did not impact the credit score. Interestingly, Fronted was looking to solve a more significant pain point in the rental market but developing a deposit scheme that “moved with customers.”

Using alternative data, specifically, Open Banking has immense potential to lower credit decision costs. A 2021 report by Credit Kudos found that 47% of lenders believe Open Banking can lower the cost of making credit decisions. In addition to reducing costs, it can also improve decision-making accuracy, with 43% of lenders agreeing that Open Banking can improve the accuracy of credit decisions. These benefits impact those most in need of credit by providing them with a higher chance of receiving a life-changing lifeline and ensuring that credit is as affordable as possible.

What Went Wrong?

One could make the case that we are seeing a case of shuttering doors via LIFO, last-in-first-out, with fintechs born in 2019-2021 beginning to wind down operations. Several factors are creating a perfect storm threatening several early-stage UK fintechs;

1. Scarcity of new capital: newly published figures from Innovate Finance, the UK fintech industry body, have revealed that the sector raised $2.9bn (£2.3bn) in the first half of 2023, representing a 37% drop from the last half of 2022.
2. An increasing cost of capital: On Thursday, 3 August 2023, The Bank of England raised the interest rate (Bank Rate) by 0.25 percentage points to 5.25%
3. An inability of users who want to or can pay for such services: Fronted CEO Jamie Cambell stated: “We knew that we had good results when customers were paying around about £50 for it, but the shift in the market meant we couldn’t offer it for less than £100, and the price elasticity for our customers just wasn’t there.”
4. A highly competitive market: the UK, in particular, has an incredibly saturated fintech scene using open banking technologies. According to The Open Banking Impact Report, released in March of this year, there are 159 fully-regulated firms offering live-to-market Open Banking-enabled products and services in the UK in December 2022, and 17% of these fall under the “better borrowing” outcome area.
5. Product-market fit: achieving product-market-fit tends to take about 18-24 months, proving unlucky timing for fintechs who began operations during 2019-2021.

The Focus Must Stay On The Underbanked

The closure of Koyo and Fronted is a massive loss for the underbanked. A 2020 report by CGAP found that “those ‘on the margins’ of financial inclusion (with no account or only a basic account) are likely to pay less in fees with open banking—saving the equivalent of 0.8 percent of their income. Open banking would save those who are “overstretched” (with account(s) and heavily indebted) the equivalent of 2.5 percent of their income.” Open Banking Excellence found that “between five and seven million individuals in the UK are now at risk of financial exclusion due to limitations in the information used to make important decisions which shape their lives.”

As the fintech landscape evolves, these departures underline the challenges of serving underserved segments amidst economic uncertainty and fierce competition. While these setbacks impact open banking’s potential to empower the financially marginalized, they also emphasize the need for continued innovation and support to ensure financial inclusion for all.