America’s credit system fails to serve a large portion of the population. Approximately 25 million Americans have no credit profile whatsoever, and an additional 28 million lack sufficient information to generate a reliable credit score. That’s more than 50 million individuals who can’t access safe credit products and are vulnerable to financial shocks.*
A new innovation aims to include more people in the financial system: consumer-contributed data. Consumers grant underwriters permission to use their personal financial data.
At a recent event hosted by the Urban Institute, experts described how access to broader financial data could build more accurate and inclusive credit files. Using data from financial statements (such as bank accounts) compiled using new data aggregation tools will give lenders access to more information on consumers and allow for quick verification of employment, income, and assets.
Nick Thomas, president and cofounder of Finicity, a financial technology (or “fintech”) firm specializing in data aggregation, explained that the aggregation and secure transfer of consumer-contributed data allows borrowers to make smarter financial decisions and reduces the cost and time it takes for lenders to close a loan.
How consumer-contributed data can help borrowers and lenders
Models that use consumer-contributed data can more accurately gauge a borrower’s ability to repay debts. By including information from an applicant’s bank account, it is possible to look directly at cash flows: how much money is coming in versus how much money is being spent.
For consumers with little prior credit experience, this cash flow measure may be more predictive of their ability to repay a loan than a score based upon stale or thin data. Cash flow data may demonstrate that they are a good credit risk. This would benefit consumers who have sufficient income but lack previous experience with credit products.
Lauren Saunders from the National Consumer Law Center reminded the group that “credit scores are a crude tool” and that data from bank accounts can measure residual income, which better assesses whether borrowers can repay what they borrow.
Privacy concerns are a top priority
Saunders also warned that it is important to look out for disparate impacts and that there are significant privacy issues involved if lenders, credit reporting agencies, or data aggregators gain access to consumers’ bank accounts on an ongoing basis or for broader purposes than consumers understand.
Also, what is “consumer permissioned” today might soon become no more voluntary than clicking “I agree” to a lot of fine print as a requirement for access to a product or service.
According to David Shellenberger from FICO, preliminary research based on 35 million consumer credit records has shown promising results. Using transaction data—which includes the amount of experience a consumer has managing checking and savings accounts, capacity (the account balance over the past six months), and the presence of information such as negative balances—researchers could build out credit scores for consumers who were previously unscored and adjust FICO scores for consumers with previous scores.
Mike Pecen from Experian reported that in an empirical study, cash flows recorded in financial accounts were highly correlated to loan payment performance. Including comprehensive consumer financial data allows models to analyze borrowers in a more holistic way, without simply relying on prior credit performance.
A borrower’s demonstrated history of on-time payments, regardless of the total balance in their accounts, is highly predictive of their ability to handle new debt.
What needs to happen for innovation to take hold?
For this innovation to benefit consumers, companies need to abide by consumer privacy protocols. This includes making sure consumers understand what they are consenting to and are informed about how these data are being stored and used by data aggregation companies and credit bureaus.
As with any new tool that becomes popular in our financial system, industry leaders, researchers, and policymakers must understand the risks and put consumer protections in the forefront of design to ensure inclusive benefits.