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The emergence of alternative data as a key enabler in expanding credit delivery and financial inclusion is unmistakable.
The saying that the only thing that is constant is change, is attributed to Heraclitus, the Greek Philosopher. This is so very relevant today in the way lenders use technology and scoring solutions to understand the credit worthiness of applicants. Credit Risk Management has come a long way from the days when banks used just one credit score cut off to decision loan applications. Risk managers now have a plethora of solution options to enable them to craft the right risk reward balance when they design a credit policy that would suit them.
It is common knowledge that large volumes of data are being constantly generated and a good portion of this can be used to better understand a potential borrower. This profusion of data has only provided greater depth and reach to lenders.
The emergence of alternative data as a key enabler in expanding credit delivery and financial inclusion is unmistakable. It not only expands the scorable population, but also deepens the understanding of their payment behavior. The three credit bureaus, realizing the value of this data asset have embarked on an acquisition spree.
A basic definition of traditional data as well as alternative data will help understand the scenario better.
Traditional data typically refers to data that credit bureaus maintain on their files. This includes data provided by the customer in the loan applications, data on credit lines, loan repayment history, credit enquiries as well as public information like bankruptcies. Traditional data is FCRA compliant and the acid test is that it must be verifiable and disputable by the customer.
Industry research has shown that scoring solutions that use traditional data cannot score a significant section of the population. According to the Consumer Financial Protection Bureau (CFPB), these ‘credit invisibles’ number over 45 million people. It further points out that although this segment of the population may not have a regular loan payment track record, they may still be paying their other bills regularly. It is thus very important to track this payment history – e.g. utility payments – to estimate their credit risk.
Definitions of alternative data may vary, depending on where you choose to look them up. But in a broad sense it pertains to data that includes, but limited to rent payments, mobile phone payments, Cable TV payments as well as bank account information, such as deposits, withdrawals or transfers.
While alternative data has a very important role in financial inclusion, it also has other important benefits. In addition to improving the assessment of the risk of the customer, it can provide timely information to lenders on activities that may not be reflected on bureau data. Further it enables lenders to provide enhanced customer experience. For example, when they share online bank account, the loan application processing may be faster.
Like traditional data, alternative data to is susceptible to inaccuracies. Consumers may not be able to readily review and correct alternative data although the standards governing it are constantly changing and evolving to meet customer and regulatory expectations.