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FROM UNDER BANKED presented by TO UNDER STOOD It’s time to rethink credit decisioning 1
FROM UNDER BANKED presented by TO UNDER STOOD It’s time to rethink credit decisioning 1

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It’s time to rethink credit decisioning

It’s Time to Change How We Think About Credit

The modern credit score is a powerful number. It’s the number that defines each individual’s “financial identity” 1 and the number that determines where people live and work and how much they’ll pay for access to things like insurance. 2

The credit scoring model we know today was born in 1989, although legal standards have governed credit scoring practices since the passage of the Fair Credit Reporting Act in 1970. 3 Despite the nearly 30 year tenure of the modern credit score, it seems the market is still searching for an ideal solution to properly identifying risk in lending.

Since it was first introduced, the modern credit score has been far from perfect. People who start out with low credit scores or minimal credit history often see “larger down payments and higher interest rates on purchases – terms that place an undue strain on household budgets and that often result in high rates of bankruptcy and default, which in turn lower credit scores even more.” 4 Additionally, the credit score we know today can be slow to reflect changes in financial behavior, making it difficult for consumers to first build credit and/or turn their credit around.

The Limitations of the FICO Score

While the introduction of the FICO score helped standardize credit scoring and simplify decision making for lenders, it has its limitations. Additionally, as the American population shifts, its ability to simplify decision making for lenders has diminished.

One of the biggest limitations to the FICO credit score today is the potential

to discriminate against many different groups of Americans. Specifically,

those with lower incomes often receive higher interest loans, regardless

of their demonstrated ability to make on-time payments. The Consumer

Financial Protection Bureau finds that this practice often discriminates against minorities, immigrants and younger adults, and that a short credit history can negatively impact many of the same groups. 5

Perhaps most importantly, the unbanked and underbanked population is increasing, which leaves millions of Americans credit invisible or unscorable.

A recent survey from the FDIC finds that among the 32.6 million unbanked

and underbanked US households, many choose to retain this status due to privacy concerns, a lack of trust in banks and high or unpredictable bank account fees. 6 These reasons resonated particularly with younger adults in

the Millennial generation who came of age during the Great Recession 7 , and often see “checking” as antiquated and are far more comfortable with online-only options. 8

As the Consumer Financial Protection Bureau sums it up: “The use of traditional data and modeling techniques has left some important gaps in access to mainstream credit for certain consumer groups and segments. The Bureau estimates that 26 million Americans are credit invisible, while another 19 million are unscorable. Most of these nearly 45 million Americans are underserved by the mainstream credit system, and they are disproportionately Black and Hispanic, low income or young adults. Some populations, like those recently widowed or divorced or recent immigrants, have difficulty accessing the mainstream credit system because they have not established a long enough credit history on their own or in this country. Some underserved consumers instead resort to high-cost products that may not help them build credit history.” 9

It is not only consumers who fall into this category of unbanked and underbanked. According to Global Findex, 160 million small businesses lack banking access in the U.S. Without a business credit score, they have little hope of getting off the ground and building a competitive niche in the marketplace. 10

45 million

Americans are credit invisible or unscorable

25 %

of Americans are unbanked or underbanked

Unbanked

Households where no one has a checking or savings account.

Underbanked

Households that have an account at an insured institution, but also go outside of the banking system to alternative financial providers for services and products like money orders, payday loans, auto title loans, and more.

Who Are the Underbanked?

Currently, the Federal Deposit Insurance Corporation (FDIC) reports that 25.2 percent, or 32.6 million, of U.S. households are unbanked or underbanked, and a growing number of individuals who fall into this group do so by choice. As a result, more and more Americans are now credit invisible or unscorable, meaning they don’t have a credit score. 11

The problem grows even more pressing when we look at it from an international perspective. There are more than four billion people globally who have no financial history and must conduct all of their transactions with cash. As a result, they have no way to access the resources they need to start a business or build a life for their families. 12

Against this backdrop, it’s clear that the time has come for a new credit scoring model that improves access to credit for the millions of unbanked and underbanked Americans.

Who are the underbanked? They’re more than just numbers; they might be a student who just graduated from college, an immigrant with a positive credit history in her home country but no visibility in the U.S., or a newly divorced single parent with no independent credit history.

Often, it’s not that these unbanked and underbanked populations have never tried to build their credit files. They may have lacked access to traditional banking services. They may have had a mortgage for 30 years, but never opened other credit accounts. Now, not only are they restricted from access to credit, but financial services companies are also missing out on valuable business opportunities.

The Market Impact of a New Approach

If the industry can solve this lack of visibility, the worldwide impact will be monumental. According to the World Bank, taking advantage of existing digital technology could expand formal financial services to up to 100 million more adults globally. 13 These new transactions translate to approximately $380 billion in new revenues for banks and lenders alone. 14 Thus, the power of financial inclusion can extend its reach to benefit both consumers and their financial services providers.

Bringing unbanked adults and businesses into the formal banking sector could generate about

$380

billion

In new revenues. 14

Bridging the Gap:

Models for Alternative Credit Scoring

As the limitations of the traditional FICO score become increasingly glaring, more and more institutions have come out in favor of alternative credit scoring. While there is currently no standard model for alternative credit scoring, proponents of this new approach hope to expand the types of data that go into credit scoring in order to improve access to credit for the millions of unbanked and underbanked Americans and others who are underserved by the traditional model.

The Alternative Credit Scoring Landscape Today

Even though credit scoring has traditionally centered around the FICO score, other scoring models have been developed. Still, all of these mod- els use the same five data points as the FICO model.

In the world of alternative credit scoring, the same can’t be said. The Consumer Financial Protection Bureau reports that it is aware of “a broad range of alternative data and modeling techniques that firms are either using or contemplating.” 15 These models range from platforms that have been developed by data aggregators and licensed to vendors to those that lenders have developed for their own proprietary use.

According to the Consumer Financial Protection Bureau, these models typically look at some combination of the following activities to deter- mine creditworthiness: 16

Traditional loan repayment behavior

Non-loan payment data (e.g. utility or rent payments)

Cash flow information

Home, job, and lifestyle stability information

Education and employment data

Online behaviors

Personal and professional connections

Across the board, some of the most common variables used in alternative credit scoring models to understand these points of interest include:

Checking and saving account transactions: Checking and saving account transactions can provide concrete information on cash flow by looking at Checking and saving account transactions can provide concrete information on cash flow by looking at deposits (income), spending habits (bill payments) and typical account balances.

Utility bill, rent, cable and/or mobile phone payments: An individual’s history of utility bill, rent, cable and/or mobile phone payments can help establish non-loan payment patterns (e.g. early, on-time, late or missed payments) and intent to make payments. In fact, FICO has a new program called FICO Score XD that uses telecom and utility bills from Equifax and property and public re- cords from LexisNexis to expand access to credit to those who are traditionally credit invisible or unscorable. Utility bill, rent, cable and/or mobile phone payments: 1 7 17

who are traditionally credit invisible or unscorable. 1 7 Mobile phone location: Some experts have also

Mobile phone location: Some experts have also proposed using mobile phone data to capture an individual’s location as a way to verify their home and work addresses, which can help determine stability. 18

Social media activity: Experts have also proposed using so- cial media data to help gather information around home, job and lifestyle stability, education and occupational attainment, online behaviors and personal and professional connections. For exam- ple, lenders can review employment history on LinkedIn and look across other social media channels to assess connections and understand lifestyle choices and spending habits. Social media activity: 1 9 19

Alternative credit scoring could help approximately 7.6 million consumers that are currently unscorable to earn a credit score of 620 or higher. 21

The Goal of Alternative Credit Scoring Models

The alternative credit scoring models in place currently are still very young, but they are already making headway toward their goal of increasing access to credit for consumers who are traditionally credit invisible or unscorable, and improving credit scores for those who are unfairly discriminated against by the traditional FICO model.

For example, TransUnion has introduced an alternative credit scoring model known as CreditVision Link that relies on proper- ty, tax and deed records as well as checking, debit or payday lending information, among other points. Spokesman David Blumberg shares that the firm has collected over three billion non-traditional data points on over 260 million American adults and that “these alternative data sources have proven to accu- rately score more than 90 percent of applicants who otherwise would be returned as no-hit or thin-file by traditional models.” 20

Similarly, VantageScore Solutions estimates that alternative credit scoring could help approximately 7.6 million consumers that are currently unscorable to earn a credit score of 620 or higher. 21

By improving access to credit and helping consumers earn higher credit scores, alternative credit scoring can help mil- lions of Americans do things like purchase a house, get better insurance rates and even get better jobs, as many employers now look at credit history as a way to gauge responsibility. In turn, alternative credit scoring can help improve economic and social mobility.

In response to the Consumer Financial Protection Bureau’s Request for Information on alternative credit scoring, a California-based property manager writes:

“We don’t accept applicants with no credit history as we have no way to gauge their creditworthiness. I’m sure we have turned down many good qualified applicants [because of that], but we will never know. Adding payment history for rent, utilities and cell phones would be a valuable addition for individuals who don’t buy on credit.” 22

Alternative credit scoring could bring formal financial services to up to

100

million

more adults globally. 13

“Contrary to common perception, tests indicate that many underserved consumers represent prime or near- prime credit risk to lenders.” 25

The Consumer Financial Protection Bureau has also identified several ways in which alternative credit scoring can improve on the limitations of the tradi- tional credit scoring model, including: 23

Greater credit access: The unbanked and underbanked who are currently credit invisible or unscorable could finally become scorable using data like utility bill and rent payment history, which would increase their access to credit. When alternative credit data was added to consumer credit files, Expe- rian saw a 60 percent lift in approvals for near-prime consumers. 24

Enhanced creditworthiness predictions: In addition to discriminating against the unbanked and underbanked, the traditional credit scoring model also often inaccurately portrays creditworthiness (for example by looking at the length of time accounts have been open). As a result, many people who could very well be good candidates to receive – and repay – credit have arti- ficially low scores that hurt their ability to obtain credit or obtain it at a lower interest rate. Alternative data points can help generate more accurate credit scores.

More timely information: Some data used in traditional credit scoring often lags, as it can take months from the time an account is opened until it’s included in the consumer’s credit report. Alternative data points typically don’t include this time lag (especially since many of these data points can be collected via automation), which could contribute to greater accuracy, make it easier for consumers to first build credit and help identify those who have overcome financial challenges.

Lower costs: Alternative data and modeling techniques can lower costs for lenders (e.g. by allowing for less expensive data sources and collection meth- ods thanks to data automation), which lenders can then pass on to consumers by lowering prices and/or making smaller loans.

Better service and convenience: In addition to lowering costs, alternative data and modeling techniques can also improve service and convenience by making the approval process faster and decreasing reliance on discretionary decisions that might lead to discrimination.

In general, recent research from the Center for Financial Services Innovation finds that, “contrary to common perception, tests indicate that many under- served consumers represent prime or near-prime credit risk to lenders. Most importantly, unlike traditional credit scores, alternative credit scores can be generated for most adults in the United States, which means that widespread use of alternative data could dramatically broaden the reach of mainstream financial services companies.” 25

9

Making Change a Reality:

How to Develop Alternative Credit Scoring Models

Change can take place slowly in the lending space. As Steve Ely, CEO of eCredable said: “The credit reporting industry hasn’t fundamentally changed in more than a century.” 26 Still, the tables are beginning to turn in credit decisioning. For example, long-time players like FICO and TransUnion have started to experiment with alternative credit scoring models, while new players like eCredable are penetrating the market with new sources of credit data.

For financial technology organizations, a lot of value lies in investing in data to create propri- etary scoring models. First, proprietary models provide complete control over both the data and the calculations, which can help ensure timeliness and accuracy, both of which can make a big difference to lenders. Second, proprietary models that include timely and accurate data and prove reliable when it comes to predicting risk provide a competitive advantage when it comes to which scoring models lenders choose to use in their decision making process.

Tapping the Right Alternative Data

Alternative credit scoring is more viable now than ever before, as alternative data becomes widely available. Experian’s 2018 report found that 70 percent of con- sumers are willing to provide additional financial information to a lender. 27

However, it can’t be stated enough that the value of alternative credit scoring is only as good as its ability to accurately predict risk for lenders. If alternative mod- els can’t accurately predict risk, then they prove dangerous to lenders and, down the line, the U.S. economy. As a result, any firms developing proprietary scoring models need to put careful thought into the type of data points used and where that data comes from.

It is also important to note that alternative data is not a standalone solution. As Liz Pagel, VP of Consumer Lending Market Strategy at TransUnion, said: “Alternative credit data alone does not provide a comprehensive view of subprime consumers or tell their whole story, but when combined with traditional, particularly trended data, it can yield powerful results.” 28

Beyond accuracy in predicting risk, the Center for Financial Services Innovation points out that the ease of access to alternative data is another important con- sideration for anyone developing new credit scoring models. This is because the easier it is to integrate this data into marketing and decision making efforts, the easier it will be for lenders (and therefore consumers) to reap the benefits that alternative scoring models can provide. 29

Fortunately, utility bill payment is data that satisfies both predictive accuracy (the Center for Financial Services Innovation finds that utility bill payments are among the most reliable data points used in alternative credit scoring models 30 ) and ease of access and integration.

Specifically, a solution like Urjanet can provide accurate and timely access to util- ity bill data by automating the data collection process, standardizing data across multiple providers and seamlessly delivering the data in any number of formats. This type of automation makes it easy to integrate reliable and timely utility data into alternative credit scoring models.

Utility bill data opens up a promising opportunity for expanding financial inclusion. An Experian study on the impact of energy-utility reporting on credit decisioning found 97 percent of the population to see an increase or neutral impact to their credit score. 31

70 %

of consumers are willing to provide additional financial information to a lender. 27

Urjanet Utility Data enables access to consumer and business payment history that is:

retrieved and verified directly from the source

consumer-permissioned to meet privacy and regulatory requirements

available on-demand for timely credit decisioning

Bringing Credit Scoring Into the 21 st Century

When the FICO credit score first hit the market in the 1980s, it brought standard-

ization to the credit scoring process and made decision making easier for lenders. But a lot has changed since the 1980s. And many of those changes have made the traditional FICO credit score outdated. Today, nearly 50 million consumers and 160 million small businesses are credit invisible or unscorable, which makes

it nearly impossible for them to obtain the type of loans needed to buy a house or

a car and creating other barriers to economic and social mobility along the way.

Fortunately, the remedy for this situation is well within reach, as we now have the technology to access mountains of data that can be used to create alternative credit scoring models that accurately predict risk for lending to unbanked and underbanked consumers (as well as others who are underserved by the tradition- al approach). Most often, these alternative models use data points like checking account information and rent and utility bill payment history to create a new kind of credit profile for consumers.

Ultimately, with the use of data automation technology that enables access to consumer-permissioned, on-demand alternative credit data, alternative credit scoring is poised to provide millions of consumers with access to credit without increasing risk for lenders, improve costs and efficiency for lenders and infuse the market with more consumer spending power as a result.

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2 Trainor, Sean. “The Long, Twisted History of Your Credit Score.” TIME. July 22, 2015.

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4 Trainor, Sean. “The Long, Twisted History of Your Credit Score.” TIME. July 22, 2015.

5 “Request for Information Regarding Use of Alternative Data and Modeling Techniques in the Credit Process.” Federal Register. February 21, 2017.

6 “2017 FDIC National Survey of Unbanked and Underbanked Households.” Federal Deposit Insurance Corporation. 2017.

7 Crichton, Danny. “Millennials Are Destroying Banks, and It’s the Banks’ Fault.” TechCrunch. May 30, 2015.

8 “Packaged Facts: Banking on Unbanked Millennials.” PR Newswire. April 7, 2016.

9 “Request for Information Regarding Use of Alternative Data and Modeling Techniques in the Credit Process.” Federal Register. February 21, 2017.

10 “Global Findex Database.” The World Bank. 2017.

11 “2017 FDIC National Survey of Unbanked and Underbanked Households.” Federal Deposit Insurance Corporation. 2017.

12 “Global Findex Database.” The World Bank. 2017.

13 “Financial Inclusion on the Rise, But Gaps Remain, Global Findex Database Shows.” The World Bank. April 2018.

14 “Within Reach: How Banks in Emerging Economies can Grow Profitably by Being More Inclusive.” Accenture. 2015.

15 “Request for Information Regarding Use of Alternative Data and Modeling Techniques in the Credit Process.” Federal Register. February 21, 2017.

16 “Request for Information Regarding Use of Alternative Data and Modeling Techniques in the Credit Process.” Federal Register. February 21, 2017.

17 Selyukh, Alina. “Could Your Social Media Footprint Step on Your Credit History?” NPR. November 4, 2015.

18 Raj, Rajiv. “Your Digital Behaviour Impacts Your Loans and Spends.” Livemint. April 7, 2017.

19 Selyukh, Alina. “Could Your Social Media Footprint Step on Your Credit History?” NPR. November 4, 2015.

20 Selyukh, Alina. “Could Your Social Media Footprint Step on Your Credit History?” NPR. November 4, 2015.

21 Seidman, Ellen. “Innovations in Credit Scoring Could Help More Families Become First-Time Home-Buyers.” Urban Institute. March 28, 2017.

22 Adams, Sandy. Comment on “Request for Information Regarding Use of Alternative Data and Modeling Techniques in the Credit Process.” April 17, 2017.

23 “Request for Information Regarding Use of Alternative Data and Modeling Techniques in the Credit Process.” Federal Register. February 21, 2017.

24 “The State of Alternative Credit Data.” Experian. 2018.

25 Schneider, Rachel and Arjan Schutte. “The Predictive Value of Alternative Credit Scores.” Center for Financial Services Innovation.

26 “eCredable and Urjanet Partner to Expand Financial Inclusion for Consumers and Small Businesses.” Urjanet. October 23, 2018.

27 “The State of Alternative Credit Data.” Experian. 2018.

28 Monfort, Francis. “TransUnion Launches Risk-Scoring Model for Alternative Lenders.” Mortgage Professional America. August 26, 2018.

29 Schneider, Rachel and Arjan Schutte. “The Predictive Value of Alternative Credit Scores.” Center for Financial Services Innovation.

30 Schneider, Rachel and Arjan Schutte. “The Predictive Value of Alternative Credit Scores.” Center for Financial Services Innovation.

31 “The Impact of Positive Data Reporting.” Experian. June 25, 2016.

Impact of Positive Data Reporting.” Experian. June 25, 2016. ©2018 Urjanet, Inc. All rights reserved. 0026/1.19

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All rights reserved.

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