Fed Governor Points Lenders Toward Second-Chance Borrowers

Federal Reserve Gov. Michael Barr is urging lenders to look beyond conventional credit histories when evaluating consumers and entrepreneurs with criminal records, pointing to cash-flow underwriting, alternative financial data and artificial intelligence (AI) as tools that could identify borrowers whose current finances are stronger than their credit files suggest.

Speaking Tuesday (Sep. 1) at the Second-Chance Lending Forum in Washington, Barr said people who have experienced incarceration face significant barriers to mainstream credit despite showing a strong demand for financing. Federal Reserve data show they are 16 percentage points less confident that a credit application will be approved but 10 percentage points more likely to have applied for credit in the past year than people without that experience.

“This tells us they face substantial barriers to the mainstream credit that they need,” Barr said, adding that cash-flow-based underwriting and alternative financial data could help expand access for borrowers with thin or poor credit histories.

The approach could give lenders a way to distinguish historical credit damage from a borrower’s current ability to repay. Bank-account data can provide a more recent view of income, recurring expenses, payment behavior and balances, giving lenders information that a traditional credit score may not capture.

Federal banking regulators have previously identified so-called “second look” programs as one potential use of alternative data. Under such programs, lenders can use additional financial information to reevaluate applicants who would otherwise be declined.

Barr also highlighted a potentially significant small-business opportunity. Research he cited estimates that about 1.1 million U.S. small-business owners, or nearly 4% of the national total, have criminal records. People with records may also be disproportionately inclined toward entrepreneurship, creating a potential pool of business customers for banks, community development financial institutions and alternative lenders.

Barr said more data is needed to measure the creditworthiness of these borrowers and determine which lending and entrepreneurship programs can scale. AI-powered underwriting, he said, could provide another tool for expanding access while giving lenders more information with which to assess risk.