How alternative credit data can help enterprises achieve fair lending
Jan 30, 2017 Walt Wojciechowski
The 2008 recession put financial institutions under the microscope. Consumers are quick to judge FIs for both real and perceived transgressions, and organizations such as the Consumer Financial Protection Bureau aren't afraid to pursue companies accused of violating fair lending laws.
While fair lending legislation has good intentions, it introduces risks to businesses that provide forms of credit to consumers. At times, determining which consumers are risky is impossible because some applicants don't have traditional credit reports. With respect to this issue, CFOs in charge of leading fair lending initiatives may find a friend in alternative credit data.
"15% of Blacks and Hispanics are credit invisible."
Solving the fair lending puzzle
Loan officers shoulder the responsibility of ensuring the companies for which they work adhere to the Equal Credit Opportunity Act, Community Reinvestment Act, and so forth. The weight of this burden grows given the lack of information lenders have at their disposal.
For example, the ECOA mandates that lenders cannot deny applications to potential borrowers based on their race. While designed to help Blacks, Hispanics and other minorities, the effects of the law reach a dead-end when lenders review applications. The CFPB found that Blacks and Hispanics are more likely to be credit invisible or have unscored credit records than Asians or Whites. Specifically, about 15 percent of Blacks and Hispanics are credit invisible, while only 9 percent of Asians and Whites fall in this category.
Based on the CFPB's data, it's clear that, as a group, Blacks and Hispanics are less likely to receive loans than Whites or Asians. If a lender can't tell whether a Black or Hispanic applicant is creditworthy, then he won't extend credit to that customer. Doing so would put the company (and possibly his job) at financial risk.
Failing to extend credit to minorities, however, introduces a couple of problems. First, it's easy for the average consumer to interpret situations such as those described above as discriminatory. This assumption leads to bad press, and possibly lost business. Second, lenders fail to establish long-lasting relationships with these communities.
"Alternative credit data consists of information regarding a person's monthly financial habits."
Alternative credit data provides context
Alternative credit data consists of information regarding a person's monthly financial habits. Loan officers, underwriters and other parties across the transaction can see how often a person paid his utilities, rent, phone and insurance bills over time. In addition, some reports also detail whether an individual has outstanding liens, judgments or evictions in his name, but this depends on the alternative credit data partner.
The benefits of alternative credit reports work two ways: Minorities with thin-file or no-file credit reports receive access to credit products while lenders can reference accurate, detailed information when assessing the creditworthiness of Black and Hispanic applicants. With respect to regulatory pressure, integrating alternative credit data into the loan approval process enables FIs to demonstrate their commitment to reaching minority communities.
Lenders aren't making much progress with traditional credit products. While this information is adequate when available, it's absence puts minority applicants at a disadvantage. There's a case to be made for alternative credit data, FIs just need to find the right providers.