Could Open Accounting transform SME lending?

What is Open Accounting and what does it mean for SMEs? Mahmed Najem, Technology Analyst at Recognise Bank, explains the technology and how it could transform small business lending

Open Accounting is a promising development that has the potential to transform the way financial services are provided to small and medium-sized enterprises (SMEs). While the technology is still relatively new, its benefits are already starting to be realised by forward-thinking financial institutions like Recognise Bank.

Open Accounting evolved from the development of Open Banking in the UK, a concept designed to give banking customers greater choice of products and services by allowing their bank account data to be securely shared with third party providers. Following recommendations from the Financial Conduct Authority (FCA) and the Competition and Markets Authority (CMA) to help increase competition in the banking sector, Open Banking got government backing and was launched for retail customers in 2018.

While Open Banking has had its uses in retail banking, its benefits have not been fully realised by small businesses because they do not manage their finances via their bank account in the way that many personal banking customers do. And for a lender making a decision about a business loan, for example, assessing banking data alone would not be sufficient to understand a business’s financial health.

What is Opening Account and is it safe?

This is where Open Accounting comes in, because it allows organisations, such as banks and lenders, access to a greater amount of up-to-date financial data about a small business, enabling them to better understand an SME’s needs and provide business customers with tailored products and services, especially commercial loans. Lenders use an Open Accounting gateway API (Application Programming Interface) to access rich data such as balance sheet, profit and loss, and cash flow information from small business accounting systems like Xero, QuickBooks and Sage.

This data is only accessed with the customer’s permission and is considered “contributed” accounting data, as the customer voluntarily shares their data with a specific third-party organisation. Open Accounting is extremely secure because it uses APIs to act as a bridge between the accounting system and the third party, such as the bank or lender, to protect customers’ financial data. These APIs use measures such as encryption and authentication to protect against unauthorised access.

It is important to note that customers must provide consent before any of their financial data can be accessed by third parties via Open Accounting. This consent is typically granted through an authorisation process that requires the customer to explicitly agree to share their data with a specific third party. Customers have the right to revoke this consent at any time, and financial institutions are required to respect the customer’s wishes and stop sharing the data upon request.

Open Accounting also includes a number of other safeguards to protect the privacy of customers. For example, financial institutions are required to implement strict security measures to protect the data that is shared and to follow best practices for data protection. Customers also have the right to access their own financial data and request that any inaccuracies be corrected.

The adoption of accountancy software, and therefore the ability to support Open Accounting services, has increased in recent years following the launch of HMRC’s Making Tax Digital initiative which encourages SMEs to go digital with their own accounting data.

In fact more than half of the UK SMEs have adopted accounting software to meet their bookkeeping and reporting needs, according to research by Open Accounting pioneer Codat. As a result, a growing number of financial institutions are also embracing Open Accounting to provide enhanced services for their customers. This trend is more established in the US, where Codat’s research shows that as a company grows beyond ten employees, the need for specialised software for accounting, payments processing and other related business tasks increases. This is reinforced by the fact that financial software is most widely used among SMEs, with 75% of them deploying accounting software. It is likely that similar trends will be seen in the UK in the future as companies look to expand and streamline their operations.

What are the benefits of Open Accounting?

The benefits of Open Accounting for both the lender and the borrower fall into four main categories:

Efficiency: The process of accessing accounting data is extremely fast and straightforward. Customers simply need to click on a link and provide consent, after which all the relevant accounting data is transmitted to the lending institution. This streamlined process can greatly accelerate the underwriting process and help borrowers receive decisions more quickly. In addition, the instant availability of accounting data allows underwriters to perform various ratios and metrics calculations as soon as the data is received by having pre-existing calculations in place that are populated by the API data, saving hours of time that would otherwise be spent on loan origination and underwriting.

Accuracy: Because the data is transmitted directly from a small business’s accounting system, it is presented exactly as it is recorded for reporting purposes. This ensures that the data is highly accurate and up to date, providing lenders with a comprehensive and reliable picture of the SME’s financial operations. This can be especially useful for small businesses that may not have the resources to manually compile and transmit financial data to lenders. By using Open Accounting, small businesses can trust that lenders are considering their full financial picture and do not need to worry about gathering and transmitting the right data themselves.

Risk Mitigation and Know Your Customer: By analysing data directly from a small business’s accounting system, financial institutions are able to identify unusual patterns or anomalies that may indicate fraudulent activity. This helps to protect both the lender and the borrower by ensuring that the lending process is based on accurate and reliable data.

Product offerings and development: Accounting data from a wide range of customers is anonymously aggregated to help devise new solutions and better optimise existing product offerings. This means that lenders can tailor-make and offer customised products to customers based on patterns identified in the loan book. Lenders also use the data to segment their customers based on a range of variables using Machine Learning and Artificial intelligencemodels. This can help lenders to better understand the needs and preferences of different customer segments and tailor their products and services accordingly. For example, providers might look at the types of products and services that are most popular among certain customer groups, or the financial challenges that small businesses are facing, in order to develop solutions to meet those needs.

How is Recognise using Open Accounting?

At Recognise Bank we have partnered with Codat, a leading provider of Open Accounting technology, to bring these benefits to our SME customers. By integrating Codat with our Customer Relationship Management (CRM) system, nCino, we are able to leverage the power of Open Accounting to improve the efficiency and accuracy of our own lending and underwriting processes, ultimately benefiting our small business customers.

Our roadmap paves the way for us to automate a significant portion of our underwriting process for most of our products through the development of a powerful credit decisioning engine. This technology will allow us to make more accurate and efficient lending decisions. As a result, we expect to see customers receiving decisions at a significantly faster pace, improving the overall customer experience and their access to the funds they need to help grow their businesses.

Existing borrowers will also benefit from the Open Accounting via the automatic testing of financial covenants they committed to when they agreed to their loan facility. This makes the in-life management process vastly more efficient.

Open Accounting, along with the benefits of Open Banking we covered in a recent blog, will continue to improve the service SMEs get from their banks, a crucial factor at a time when small businesses need all the support they can get.

This kind of technology and innovation will be a major differentiator in the business finance marketplace, and our understanding of Open Accounting and the benefits it brings SMEs demonstrates Recognise Bank’s commitment to staying at the forefront of innovation and meeting the evolving needs of the UK’s growing businesses.