Federal banking regulators support using alternative methods to assess creditworthiness to help high-risk people get loans, The Wall Street Journal (WSJ) reported on Tuesday (Dec. 3).
Instead of using traditional credit scores, lenders can look at alternative data like borrowers’ cash flow. This approach “may help firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system,” the regulators said in a joint statement.
The regulators added that agencies choosing to tap into alternative data should do so judiciously.
According to the nonprofit research firm FinRegLab, approximately 45-60 million people lack the payments history to generate reliable credit scores. Using income and spending data can open up access to credit, a September FinRegLab study indicated. The study analyzed information from FinTechs like LendUp Global and Petal Card that extend loans based on alternative data.
“It’s helpful to have the agencies weigh-in,” Kelly Cochran, deputy director of FinRegLab, told WSJ. “It’s particularly useful for banks, but also nonbanks, who have been thinking about these data.”
Lawmakers are working on ways to overhaul the current credit-scoring system and held hearings to address the use of alternative data. In order to help FinTechs adhere to fair-lending laws, the Government Accountability Office wants regulators to explain their position on applying alternative data.
Consumer advocates have raised concerns that assessing alternative data could lead to discrimination and widen the credit gap. For example, some lenders use employment and education history to evaluate creditworthiness. Others have tapped into data generated from social media, a practice that is widely criticized.
The Federal Reserve and the Consumer Finance Protection Bureau said in a joint statement that lenders using alternative data must certify that consumer-protection pitfalls “are understood and addressed.”
The lending space is prone to financial frictions that can arise if a borrower’s credit score is either unavailable or insufficient to issue a loan from a bank. The trouble with relying on credit scores, however, is they do not always present a complete picture of a borrower’s financial health.