To the average joe, the term Alternative Data may not make a lot of sense. But to those who are financially and technologically savvy, Alternative Data may be the thing that disrupts the world of money lending as we know it today.
Last year, the House Financial Services led by Congresswoman Maxine Waters (D-CA), sent a letter to the Government Accountability Office requesting information about the benefits and possible drawbacks of Alternative Data in mortgage lending.
The system is programmed in such a way that in order to get credit, you have to use credit. If you need to buy a house, you don’t just need a downpayment, you also need to have a good credit score. Despite the credit score and reports holding so much weight on the financial implication of the users, 35-54 million people in America have such limited credit history that their records are sparse, or totally nonexistent. The credit lenders and credit bureaus simply refer to these people as “thin file” consumers because their record lack sufficient data to support a reasonable credit score.
But the truth is, most “thin-filers” would be deemed as low-risk if the credit system in the country was able to evaluate them. But, the system has established these segregation criteria often leading these people to risks because they lack access to affordable credit. Even if they had savings, it still wouldn’t be enough to leverage for loans, if by any chance they do get a loan, they end up paying higher interest rates. These individuals in the eyes of the rest of the world are “risky” even getting employment or an apartment to rent might be difficult. Imagine they had an emergency requiring a significant amount of cash, what would happen then?
I wonder how the United States came to be known as the economy with the most advanced and competitive credit market in the world, yet, a significant number of people are misrepresented. While it is true that since the 2008-2009 financial crisis may have had a huge blow to the credit system in the country, the industry has had an incredible recovery; with $1.07 trillion in outstanding balances as of May 2019. Technology has been central to this growth, fintech lending has seen even greater growth accounting for 38% of the 138 billion unsecured personal loan market in 2018. But what these numbers fail to show is that the country has a huge challenge when it comes to financial inclusion. To be more accurate, about 45 million Americans do not have access to credit. These consumers tend to be disproportionately African American, Hispanic, and other minority groups in the country.
Luckily, there is a solution. Alternative Data. This is a low-cost way that would improve the system so that these 45+ Million Americans can be included in the system. Alternative Data refers to the financial information that’s usually included in credit reports such as rent, utilities, and phone bills. These payments are often reflected on the credit reports when a person pays late, but if the system was to include these payments when a person pays in time and late, the credit bureaus could bring in millions of “thin-file” consumers into the financial mainstream. The underwriting models that include alternative data can increase the lending volumes, lower the interest rates for the consumers and improve the accuracy of default predictions. Basically, alternative data would make the credit system sounder with historically underserved borrowers and communities reaping the most.
This new form of credit information will include anything that’s not included in the traditional credit score information. The data can range from cashflow underwriting, educational and occupational information, to social media use. But, there is a downside to this. The extent to which alternative data can go in so far as mining information about the consumer may bring about concerns of discrimination against protected classes or even threaten consumer’s privacy. But, let’s look at the bigger picture here, wouldn’t it be counterproductive to prevent or even constrain the use of alternative data in lending? Restricting this technology would inflict more harm than help marginalized borrowers. As a matter of fact, a recent study found a huge gap attributed to credit discrimination in traditional lenders than in fintech firms.
I support this idea because the majority of people not benefiting from credit access are the minority groups. The arguments against alternative data are legitimate, but in my experience, discouraging innovation out of the fear that potential discrimination may undermine financial inclusion is somewhat vague. The Policy and Economic Research Council (PERC) found that including the full utility bills in credit information led to a 21% increase in low-income households qualifying for access to mainstream credit.
It is rare that this single piece of the legislature could lead to such a large and meaningful impact on millions of American families. Incorporating alternative data in lending information will enhance the affordability of credit and make the credit system more inclusive and the fact that this technology requires no need for new laws or rules since the same laws that ensure fair credit access, privacy protections and transparency in underwriting decisions equally apply to lenders using alternative data, makes it even more appealing and achievable.
The system owes it to the 45 million underserved Americans to do better because credit in this country is so important. Every financial decision revolves around credit, but many people have not mastered the art of letting money and credit work for them.
