A UK SME’s Guide To Open Banking

• Open banking puts customers in control of their financial data, allowing secure third-party integrations for payments and account management
• PSD2 regulations fuel innovation by requiring UK/EU banks to share data with authorised fintechs, enabling real-time affordability checks and AI-driven lending
• SMEs gain fairer credit access as open banking assesses cash flow and transactions rather than relying solely on traditional credit scores
• Merchants enjoy lower costs and security with reduced processing fees, no chargebacks and instant payment settlements
• Open Finance goes beyond banking, incorporating pensions, tax and insurance data to give lenders a complete view of SME finances

What is Open Banking?

Open banking begins with a simple premise: financial data belongs to the customer, not the bank. Open banking is built upon open-source technology that allows financial service providers to deliver services by integrating directly with customers’ bank accounts and has transformed the digital payments sphere in recent months.

The concept of open banking has been around since 2018 and is a direct consequence of the European Union’s Payment Service Directive 2. The directive mandates the sharing of data between banks and technical providers. These providers fall into two categories: account information service providers (AISPs) and payment initiation service providers (PISPs). AISPs provide informational services, such as collating read-only financial information from multiple bank accounts or categorising expenses to help users monitor their outlays and budget accordingly. PISPs facilitate payments; with customers’ consent, they can initiate transfers between bank accounts. This provides users with a convenient means of making account to account payments without needing to repeatedly enter the same data.

The UK’s journey with open banking began with PSD2 (the Second Payment Services Directive), which mandated that banks open their data to authorised third-party providers. It paved the way for the speediest financial transactions, real-time affordability checks, and AI-led risk assessments.

Benefits of Open Banking

Possibility to Access Real-Time Financial Data

Traditional credit-scoring models often disadvantage newer businesses or those with a short credit history. Open banking provides lenders with ways to go beyond limited old credit reports to assess ongoing cash-flow trends in real time, recurring revenue, and transactions with suppliers.

Embedded Finance & Seamless SME Lending

Embedded finance is transforming SME lending by embedding financial services within platforms SMEs use. Rather than applying for commercial loans via a conventional bank, businesses can source financing via platforms such as Nucleus. Through Open banking APIs, lenders can evaluate financial information in real time, providing tailored loan opportunities within the applications SMEs already use daily.

Seamless Payment Experience

Customers do not need to provide much data and frictionless Strong Customer Authentication (SCA) lowers the risk of cart abandonment while improving the customer experience.

Financial Inclusion

Open banking is bridging the financial gap through favourable lending for SMEs as until recently they were quite unable to get a loan. Most SMEs, especially start-ups, are seen to have only thin credit files, a situation where their credit history fails to meet the required standards for traditional lenders. With open banking, lenders can assess financial activity like consistent flow of revenue, invoice payments and transactions done by customers for purposes of determining creditworthiness. This has opened the door for microloans, instant lines of credit, and innovative lending models targeting the gig economy and digital entrepreneurs.

Lower Processing Fees

Open banking is an account-to-account payment method, cutting out intermediaries. This means the cost of processing payments is reduced significantly and merchants avoid interchange fees.

AI-Powered Risk Assessment & Alternative Credit Scoring

ML plays a vital role in SME lending, particularly in risk assessment. Traditional credit scoring models often disadvantage newer businesses or those without an extensive credit history. Open banking allows lenders to go beyond outdated credit reports by evaluating real-time cash flow trends, recurring revenue streams, and supplier transactions.

Instant Settlements

Open banking payments can be instantaneous, depending on the region (e.g. the UK, SEPA Instant). This provides greater security for merchants, who do not have to wait for payments to be transferred and reduces the risk of false positives.

No Chargebacks

Open banking does not allow for chargebacks, which are a big risk to merchants and can heavily affect their bottom line. Payment processing is incredibly secure and the risk of fraud is minimal. This protects both the merchant and customer.

Challenges

While open banking offers significant benefits, its global rollout faces hurdles:

The lack of a unified global framework remains the core challenge. Without international standards, implementations vary sharply by region, forcing providers to adapt to local regulations and bank protocols. This fragmentation requires merchants to integrate multiple payment initiation service providers (PISPs) to operate across markets, increasing complexity and cost.

Regulatory patchworks exacerbate the issue. Jurisdictions like the UK and EU have robust open banking mandates under PSD2, while others rely on industry-led initiatives. Even within regulated markets, technical specifications (e.g., API standards) differ, hindering interoperability.

Security and privacy concerns persist, though strong safeguards like GDPR and FCA regulations mitigate risks in regulated regions.

The Future

The future of open banking lies in its expansion beyond bank accounts. Open Finance is set to integrate pensions, investments, tax records, and even insurance data into financial decision-making. This evolution will allow lenders to gain a 360-degree view of an SME’s financial standing, leading to even more precise lending solutions.

Open banking will continue to foster innovation, as service providers develop new services. While banks and financial institutions were initially wary of fintechs, transparency and open collaboration is now being seen as an opportunity for growth and diversification. Innovation is no longer the sole remit of banks; the fintech sector is now creating cutting-edge solutions that replace old-fashioned banking products. This delivers added value to consumers in the form of financial and payment services, without banks needing to implement their own solutions. We have only seen the tip of the iceberg and can expect more innovative solutions in the future. Traditional banks are also adopting OB innovations, collaborating with fintechs to offer faster and more flexible lending options. This hybrid approach will help SMEs access funding through both traditional and digital channels.

Channel’s Technology Integrates Open Banking

Channel is a technology-enabled asset manager, powered by Magic, our custom-built technology stack that combines off-the-shelf components with proprietary in-house solutions. Magic streamlines the investment process by automating data gathering, enrichment and analysis. It integrates open banking, real-time liquidity monitoring, reputational intelligence and ESG evaluation to deliver smarter, faster credit underwriting.