What Open Finance And The Digitisation of tax records mean for you

When a group of Redditors challenged the financial market hegemony in 2021, by trading stocks of the stuggeling company GameStop, the world took notice. Aided by stock trading software and Apps that made it easier for people to access the global financial markets, a small group of people shocked Wall Street. Not just since the Financial Crisis in 2008 are people questioning the role of established institutions and calling for Open Finance. If finance doesn’t work to enable the economy, businesses or individuals, then who is it for?

What is Open Finance?

In short, Open Finance is the opening up of your financial data (mortgages, pensions, savings, ect.) to 3rd parties of your choosing.This will enable you to gain access to a wider range of financial products and services, have greater control over your data and empowers you to make better financial decissions.    

Before the digital revolution, financial experts were seen as a necessity. They knew how things worked, what everything meant, could provide good advice and were employed to sit at the heart of the action. Now, trading can be done by anyone online through established platforms, with a wealth of information available to hand.

Yet, as the 2008 financial crisis proved, established financial institutions have made themselves too big to fail. Simply tearing down the existing financial system would leave many ordinary people, along with businesses and government treasuries, in ruin.

However, as legendary futurologist, Buckminster Fuller, once said: “You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.”

But to truly understand Open Finance, you need to understand Open Banking.

What is the connection between Open Finance and Open Banking?

Open Finance is the next step from Open Banking. While Open Banking allows 3rd parties of your choosing to access transaction data from bank accounts and payment services, Open Finance expands on this. 

Traditional banking models are already being upended by technology. Through Open Banking, challenger banks are able to connect services digitally, cutting inefficiencies and costs while speeding up transactions. Now, Open Finance is seeking to build on this model to connect financial services via technology, potentially making the existing financial model obsolete. 

Just as Open Banking led to greater democratisation of money, Open Finance has the potential to transfer power back to individuals. Not only would this benefit society as a whole, but it would help minimise the boom-bust cycles that cripple entire economies. No individual would be too big to fail, and bailing people out would cost far less, having minimal impact on the economy overall.

With more information available to them, Open Finance businesses will be able to use technology to make better decisions instantly. Many people struggle to get onto the housing ladder due to a poor credit score, for example, yet they have been paying rent every month of their adult lives. Why, then, can they not access mortgages? A company called Credit Ladder is addressing this through Open Banking, reporting rent payments via challenger banks like Starling to credit agencies, helping good renters to access mortgages.

While it is still very early days for Open Finance, there seems to be an endless raft of possibilities to benefit individuals, businesses and national economies. Faster, more secure, and less risky access to credit can help grow the economy, transforming finance from something that benefits a few wealthy capitalists to something that enables growth in the real economy.

So how else could Open Finance benefit society?

What are the benefits of Open Finance?

As with any new development and every new technical achievement, there is always the question of what the pros and cons of such development really are. Well, there are certainly some in the case of Open Finances! 

Open Finance improves the use of tax information 

Every working adult pays income tax. Some of us via self-assessment while others are enrolled in PAYE. Regardless, we all have tax records with a wealth of financial information that has been verified, at least in part, by HMRC.

The centralised approach by Open Finance could turn this financial information to better use. With the help of Open Finance, credit reference agencies could be allowed to better understand a person's risk profile or help to prove income as part of a mortgage application.  Right now HMRC is like a black hole of information ‒ its sheer size and power sucks information in, but nothing comes back out again.

However, by Making Tax Digital (MTD), HMRC are effectively allowing individuals to keep validated tax records on the software of their choice. Software providers may then be able to use this information to enable certain aspects of Open Finance. The information doesn’t need to be protected by HMRC, it is the individual’s choice and responsibility over how to use their own information.

As MTD software develops, we will see it connected to Open Banking, allowing self-assessment taxpayers to connect their business account directly to the software, effectively getting their tax return completed for them by an AI program. They will simply check the details, add any adjustments, and click submit. HMRC can then validate the records, providing assurance for any financial institutions using that financial information.

Open Finance can lead to more growth and lower risk

This might sound a bit scratchy but hear me out. Opening up your financial data to other providers can indeed help your business or financial investments grow while at the same time reducing the risks of bad decisions.

Let’s just say you want to apply for a mortgage:  With access to complete and validated financial information, lenders would be able to more quickly and accurately assess individual risk when considering your application. This would greatly speed up the process of applying for a loan, whether for a business venture or property purchase.

Do you want another example? Let’s say you are a residential landlord: You might own a few properties already but are on the lookout to acquire some more. But to obtain another property, you would need to get your accountant to assemble your financial information, complete a SA302, and send everything off to your mortgage advisors who would then validate the information before submitting the mortgage application. 

This might take months to approve, slowing down the process and potentially leading to missed opportunities. As property sales usually occur in a chain (the owner of the property you are purchasing is usually purchasing another property, and so on), these inefficiencies slow the process down for everyone and can have major impacts.

If, however, mortgage applicants could simply share validated financial/tax records, mortgage providers could use that information to make quick decisions with reduced risk. What’s more, applicants could share only relevant, high-level information, rather than expose their entire financial history. 

Open Finance benefits your individual risk management

Currently, individuals can manage their credit score/risk profile via third party providers like Experian, Equifax and TransUnion. These credit reporting agencies use limited information, such as credit cards, store cards and loans to assess risk. Individuals need to understand what factors each agency uses in order to ‘game’ the system.

For example, someone who has always been careful with their money, kept to a strict budget and never taken out a loan or credit card will have a far worse credit rating than someone who regularly uses debt to finance their lifestyle. So, even though they may have amassed a good deal of savings, they cannot get a good deal on a loan or mortgage.With Open Finance, these individuals would be able to quickly prove their earnings, spending, and savings, decreasing their risk profile in line with reality. 

Rather than crude measures of creditworthiness, financial institutions would be able to use accurate and validated information to make quick decisions based on realistic risk. This both transfers more power to individuals and contributes to faster growth while reducing overall risk.

As a centralised repository for validated financial information, MTD providers will be in a unique position to develop a two-sided marketplace for finance, allowing credit providers to match products to individuals’ risk profiles. When a customer needs a loan, credit card or mortgage, they can simply browse products for which they have already been approved, applying and receiving finance instantly.

Open Finance is Empowering PAYE Taxpayers

Currently, PAYE taxpayers have little, if any, visibility or control over their tax contributions. They will see the amount paid in tax and national insurance, but to claim any allowances requires them to submit a self-assessment tax return. For most PAYE taxpayers, this simply doesn’t seem worthwhile.

Yet, self-employed taxpayers can claim for things like travel to their place of work, a proportion of living expenses when working from home, even their lunch. These things are necessary for productive work yet, for PAYE taxpayers, come out of their already taxed income. Meanwhile, businesses tend to make use of every tax allowance available to them.

This imbalance could be rectified with Open Finance connected to tax software. As MTD becomes a validated system for self-assessed taxpayers, a new version could be developed for PAYE taxpayers, putting them in control of their tax and finances. Not only would they be able to benefit from Open Finance in the same way as self-assessed taxpayers, but they will also be able to claim for reasonable allowances. What’s more, HMRC would be able to hold employers accountable for pay disparities and unreasonable tax avoidance.

Open Finance, then, has the power to speed up and reduce the cost of obtaining and providing finance. It would make the finance system fairer and more transparent while distributing financial power, and help to avoid the creation of too big to fail financial institutions and the boom-bust cycle that has become unfortunate features of modern capitalism.

Ultimately, Open Finance has the potential to help the UK and other nations recover from the seemingly unending series of crises that have plagued the early 21st century by allowing people to access finance quicker in order to grow their business and personal finances while reducing risk, inefficiencies, and costs.

Want to know more about Self-Assessment? We created the Ultimate Guide to Self-Assessment Tax Returns for YOU!