24 June 2017
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Open APIs to shake up small business banking market

23 March 2017  |  6895 views  |  0 Chris Gorst, Nesta

Chris Gorst, Challenge Prize Lead at Nesta, explains the motivations and ambitions behind the innovation agency's £5 million prize Open API fund, which opens for applications today.

The global fintech industry, with an estimated 12,000 fintechs and counting, has changed the way small businesses can manage their money in all kinds of ways.

A small business in Huddersfield or Cardiff can manage online payments with Stripe, take card payments with iZettle, borrow peer-to-peer via Funding Circle, raise equity via Crowdcube, discount outstanding payments via Market Invoice, manage expenses with Xero, send money abroad via TransferWise, and do much more.

The promise of fintech is so great that $36 billion of venture capital and growth equity has been invested in the sector globally in 2016 alone, representing exponential growth since 2010. Alibaba, PayPal and Amazon have all entered the market for lending to small businesses. There are now two fintech “unicorns” in London, with valuations of more than $1 billion, both serving small businesses.

But despite the recent boom in fintech - with the UK a global leader - and the rise of challenger banks and alternative finance, most small businesses in the UK largely haven’t changed how they bank, or who they bank with.

Right now, for the 5 million small businesses in the UK, most core business banking services - the provision of current accounts, almost all lending, and other finance services - are still provided by just a handful of banks. The market is recognizably the same as 40 years ago. And it is a big market - 5.5 million business current accounts generated approximately £2.5 billion in revenues for banks in 2014 and the total stock of outstanding bank lending to small businesses at the end of 2016 in the UK was £164 billion. Bank lending flows to small businesses of £54 billion in 2016 compared with P2P lending of just £1.3 billion.

Amidst an explosion of choice in the market, 80% of UK small businesses still hold a current account with four major banks. Some banks are gaining market share among small businesses despite appearing to offer a combination of below-average quality and above-average prices. Although there are big differences between small business banks and loans in costs and quality (with some banks charging twice what others do for monthly bank account fees, for example), 28% of UK start-ups don’t look into the lifetime costs of a bank account when they open one, and only 4% of businesses switch bank accounts each year. And 35% of businesses who think their banking service to be poor are still not considering switching.

How best to explain this combination of growing choice, customer dissatisfaction and customer inertia to date? A compelling explanation is that the small business banking relationship still centres around the business current account, with a fortress around it preventing third parties from offering better value to customers. This is set to change with open banking. From January 2018, small businesses in the UK will for the first time be able to share their bank account and transaction data securely with third parties via APIs, and allow payments to be initiated directly from their accounts on their behalf. This creates unprecedented opportunities for new players and innovative services that create value for small business customers. It is the most ambitious scheme of its kind anywhere in the world, and other countries are expected to implement similar initiatives.

To align with the Open Banking agenda, Nesta's Challenge Prize Centre has launched the ‘Open Up Challenge’, a new £5m prize fund to inspire the creation of next-generation services, apps and tools designed for the UK’s 5 million small businesses. The Challenge is looking for 20 winning entries from anywhere in the world that will use the UK’s open banking APIs - newly available from early 2018 - to transform the way small businesses discover, access and use core financial products. This challenge prize was created by the order of the Competition and Markets Authority as one of a package of remedies aimed at shaking up retail banking , and its winners will be at the forefront of the UK’s open banking API reforms that will come into force in 2018.

It will reward teams that plan to use the new APIs to create ground-breaking value for the UK’s small businesses, including helping them to compare current accounts and loans. All this means small businesses might anticipate risks better, make more informed decisions, manage cash flow better, grow more easily, and spend more time running their businesses rather than on admin. And if the world follows the UK on open banking, it just might mean this is where we’ll see the next fintech unicorn.

The Challenge opens for applications today and talented developer teams, start-ups, or established companies from anywhere in the world have until 31st May to apply. Their concepts may be at idea stage or could be more advanced.

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