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Combating The Lack of Financial Inclusion in Canada - A Case for Open Banking

Financial inclusion is a serious problem globally, and in Canada is no different. Financial inclusion can be measured in three dimensions:

(i) access to financial services; (ii) usage of financial services; and (iii) the quality of the products and the service delivered.

The lack of financial inclusion in Canada is a problem that cannot be solved by just one party but requires all stakeholders within the financial services ecosystem in Canada to come together and collaborate. Along with such a collaboration, the implementation of an Open Banking framework within Canada will also be an important tool to help ensure financial inclusion across Canada.

Meet Lily*, a 28-year-old waitress who has only had access to a chequing and savings account with one of the big-5 financial institutions in Canada. She only uses her chequing account to deposit her paycheque and pay bills and tries to save, but usually has so little left at the end of the month that the low savings interest rates offered by her banks are not enough of an incentive. She has given upon ever being able to afford a house or own a business and her lack of access to credit via traditional institutions means that when she has financial emergencies, she will need to go to a payday lender despite their shocking interest rates.

According to ACORN Canada, Lily is one of 5 million Canadians or about 15% of the population, deemed underbanked.Underbanked can be defined as those who do have a traditional bank account of some kind but are unable to qualify for any kind of credit through a traditional bank, leaving these individuals to turn to alternative sources for their credit needs.

Looking at the same data, 3% or 1 million of Canadians are considered unbanked, or in other words people who have no bank accounts or access to banking services. For a country that prides itself on inclusion, this is a worrying statistic that requires attention. Over the past few years, these statistics have risen across Canada due to wage stagnation, a rise in the cost of living, and the impact of the COVID-19 pandemic on the Canadian economy.

Most of the people who are likely to be underbanked or unbanked fall in the category of Low-Income earners or a household or individual earning below 50% of the median household income, which for 2018 is less than $18,380. In 2018, about 7 million Canadians fall into the category of low-income earners. Common reasons why low-income individuals are excluded from financial services as identified by ACORN include:

  1. Perception that these individuals are too risky to be provided basic credit products, such as lines of credit, overdraft protection, credit cards, no holds on cheques/accounts.

  2. Conditions and rules, such as minimum balances for basic credit products like overdraft protection.

  3. NSF fees of $48 at most major banks which are not affordable for most of these people.

  4. Targeted marketing and sales by traditional banks that do not seek to gain business from certain subgroups, often called red-lining.

  5. Geographic exclusion: Between 2001 and 2003, 700 bank branches in Canada closed. These closures were mostly concentrated in lower income neighborhoods, while research has shown that payday lenders moved aggressively to fill the vacuum left by the banks.

What is Open Banking?

Per the Open Banking Initiative Canada (OBIC), “Open banking is a global movement to help consumers be the owners of their own financial transaction data. This ownership gives them the freedom to share their data with third-party companies that can then use it to provide alternative financial services that make it easier for consumers to move, manage and control their money. Open banking also stimulates and strengthens the banking sector.It increases competition and encourages innovation and product development, all of which come back to consumers in the form of greater choice, control and personalized services”.

Open Banking will help those who are underbanked or unbanked have greater access to financial products and services that they need, expand usage of those products and services, as well as improve the quality and introduce innovative solutions to all consumers. The Department of Finance report on the 2019 consultation highlights the following:

  • Financial health is a significant source of concern for all Canadians. One in six Canadians struggle with their finances and would benefit from new tools that would help them manage their finances more efficiently.

  • Open banking could deliver tools that would supportCanadians in improving their financial outcomes by enabling them to use their information to secure better rates or products, manage their small businesses more easily, and access new tools that would help improve their financial health. It has the potential to be particularly beneficial to small business owners, consumers facing challenges in managing their finances, and those with limited or non-traditional credit histories

    • A consumer could use their financial transaction data to secure an online loan to refinance their credit card debt or to shop around more easily and receive recommendations for products that would provide them with better rates, thereby saving money

    • A person with a limited credit history, such as a newCanadian, someone working in the gig economy, or a person deemed low-income, could use their financial transaction data as a more comprehensive demonstration of their creditworthiness and secure financial products that are previously unavailable to them. This could enable them to start businesses, buy financial products and services and participate more fully in Canada's economic life

    • Tools for micro-lending and peer-to-peer lending can be developed as fintechs can get access to more consumer data to enable them to build more robust credit risk models

    • A key risk with data sharing is ensuring that the data is accessed, transmitted, and stored securely. The existing practice of “screen scraping”, which is currently used by some 3.5 to 4 million Canadians who use data-driven services that offer them convenient ways to manage their finances and their businesses, is not very secure. Screen scraping is a process of automated data gathering. It occurs when a customer discloses their Internet Banking Access ID and Password to a third party, which enables the third party to use scraping technology to log in to their customer’s Internet Banking and copy transactional information to support their service. Third parties that use this technology include online lenders, financial management/investment app providers or accounting package providers. Today, this is the only way clients can share their data with fintechs and other financial service providers to get services. Open banking would introduce a better alternative, which is the use of APIs for data sharing, and ensure that customers do not unknowingly break their electronic access agreements with their banks and are left unprotected while also providing fintechs and financial service providers with a better tool to service their customers.

    • Open banking must be viewed in a broader context as it is not merely a natural progression in the provision of financial services, but rather a fundamental part of a much broader transformation. Through this lens, it has an integral role to play not only in ensuring the financial sector's continued global competitiveness but also in strengthening Canada's innovation agenda and supporting Canada's successful transition to a data-driven economy.

Open banking is not a particularly novel idea globally. While Europe may claim the title of the “birthplace of open banking” as PSD2 and the UK’s Open Banking standard pioneered the framework, the Open Banking Report of 2019 shows that more than 87% of countries around the world have some form of open APIs in place, reaching over 10,000 institutions. According to the report, the pioneers in the world include the United Kingdom, Australia, and the European Union. Follower countries are Japan, Hong Kong, South Korea, and Brazil. Mexico, Singapore, Malaysia, and Canada are identified as converts. Some of the risers are Switzerland, India, and China. Beginners include the United States, New Zealand, and Chile, among others. The United Kingdom is leading the way in Open Banking with the rise of UK challenger banks and Fintechs, such as Revolut, Monzo, Starling, and Curve who are thriving in the banking sector.

In the UK, open banking regulations have enabled:

  • The development of a true culture of innovation and partnerships as banks partner with fintechs. An example is HSBC as a frontrunner via its Connected Money app, which was launched in May 2018. The bank then picked the best features available via fintechs and other third-party service providers and added them to their core online banking app in June 2019. The great thing was the bank's ability to leverage the speed and cost effectiveness of their fintech partners as very little of the build was done within HSBC.

  • The use of open banking data to underwrite customers for credit products. HSBC has been using open banking data for this purpose and believe this is the clearest business case so far and one of the few monetizable ones. HSBC has seen their acceptance rates materially increase as customers in the UK who are creditworthy, but on whom the credit bureau has limited data and who the banks would typically have said no to, now have more data points to show creditworthiness and access credit.

  • Traditional banks to modernize their systems and enable APIs to make innovation more seamless due to open banking regulations.

No system is perfect and some of the challenges of open banking adoption include:

  • Increased data security and fraud risks which are still concerning, and in some ways overshadow innovation. Finding a good balance between safety and innovation is still a work in progress.

  • A need for a robust digital identification and authentication services that are easily accessible, easy to use and provide consumers with flexibility on which identity attributes they would like to share depending on the transaction.

  • Lack of consumer knowledge on what open banking is and what their role is, especially with providing and removing consent to service providers.

  • Introduction of regulations for fintechs and big tech companies to ensure accountability while not stifling innovation.

So where do we go from here?

To become a truly inclusive economy, be able to compete with its peers globally, and retain its position as a truly innovative country, Canada in collaboration with all stakeholders must:

  1. Get moving. The Government of Canada must prioritize open banking and put in place the necessary policies and standards to create a sandbox of sorts where all accredited third-party providers have equal access.

  2. Efforts to educate consumers must start as soon as possible, with all stakeholders aligned on the definition of open banking and how it will impact Canadians. Banks, fintechs, schools, the business community and the government will need to come together to spread the word and prepare consumers for the upcoming changes.

  3. Provide a coherent framework on what types of data will be shared, on authentication and data governance, on how liability will work, and on how the relationship between data generators and data consumers should be structured.

  4. Provide standardized APIs that can be used by all participants and what the accreditation framework will look like.

For Canada to have true financial inclusion, all stakeholders must come together to ensure that we use the tools at our disposal, like Open Banking, to empower all Canadians to live their best lives. Imagine a world where Lily has access toa chequing account, a savings account, a credit card, an interest-free overdraft with a limit of $1000, all from various financial service providers. She has flexibility to pick from a wide range of product offerings in the marketplace and is not “stuck” with a few. She earns an interest on both her checking and savings accounts and has access to micro-lenders in case of emergencies.

She has a personalized financial aggregator that helps her to plan her liquidity and ensures that she always knows how much she has at every point in time. Her aggregator app provides her with financial literacy information and advice to help her make more informed decisions. She is happier now that she can fulfil her dream of partnering with a friend to open her own restaurant someday. That is the Canada that I would love to see. What about you?

If you’d like to know more about Open Banking Initiative Canada or feel aligned with our purpose, we’d love to chat. Become a member of OBIC, connect with us, or follow us @OBIcanada on Twitter!

Article written by OBIC Member Mo Banjoko MBA, Senior Manager, BusinessConsulting EPAM Systems

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