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Open Banking: Credit Market Competition When Borrowers Own the Data

Journal: Journal of Financial Economics

Date: 20230201

Author: He, Zhiguo; Huang, Jing; Zhou, Jidong

Abstract:
Open banking facilitates data sharing consented to by customers who generate the data, with the regulatory goal of promoting competition between traditional banks and challenger fintech entrants. We study lending market competition when sharing banks' customer transaction data enables better borrower screening for fintechs. Open banking promotes competition if it helps level the playing field for all lenders in screening borrowers; however, if it over-empowers fintechs, it can also hinder competition and leave all borrowers worse off. Due to the credit quality inference from borrowers' sign-up decisions, this remains true even if borrowers have the control of whether to share their banking data. We also study extensions with fintech affinities and data sharing on borrower preferences.

Link: Google Scholar

Background and Context

Open Banking Movement

Open banking requires banks to share customer data with third parties when customers consent, aiming to promote competition between traditional banks and fintech challengers.

Research Focus

This study examines how open banking affects credit market competition when borrowers control their own banking data, particularly focusing on lending decisions and borrower welfare.

Methodology

The research develops a theoretical model comparing lending market competition between a traditional bank and a fintech lender before and after open banking implementation.

Impact of Open Banking on Screening Abilities

  • Traditional banks initially have superior screening ability (0.4) due to existing customer data
  • Fintech lenders start with lower screening ability (0.35) due to limited data access
  • After open banking, fintech screening ability significantly improves (0.8) when customers share their data

Borrower Sign-up Decisions in Semi-Separating Equilibrium

  • 30% of borrowers are privacy-conscious and never sign up
  • All non-privacy-conscious high-type borrowers (35%) choose to sign up
  • Low-type borrowers split between signing up (15%) and not signing up (20%)

Lending Competition Outcomes

  • Traditional bank dominates lending market before open banking (65% share)
  • Market share shifts significantly to fintech lenders after open banking (65% share)
  • Overall market structure becomes more competitive but can potentially hurt borrowers

Interest Rate Changes Under Open Banking

  • Interest rates generally increase across all borrower types after open banking
  • Rate increase is most pronounced for low-quality borrowers
  • Even high-quality borrowers may face higher rates due to market power effects

Welfare Impact of Open Banking

  • All borrower types can potentially suffer welfare losses under open banking
  • Industry profits increase significantly due to enhanced screening abilities
  • Privacy-conscious borrowers face negative externalities from others' sign-up decisions

Contribution and Implications

  • First theoretical framework analyzing how open banking affects credit market competition when borrowers control their data
  • Reveals potential perverse effects where enhanced screening abilities can harm borrowers despite voluntary data sharing
  • Provides policy insights for regulators implementing open banking initiatives

Data Sources

  • Screening ability visualization based on model parameters in Section 2.3
  • Sign-up decision chart based on equilibrium analysis in Section 4.2
  • Competition outcomes derived from theoretical model results in Section 4
  • Interest rate changes based on numerical analysis in Section 4.2.3
  • Welfare impact visualization based on Proposition 5 results