Expanding beyond traditional credit-based underwriting

More than 60 million Americans are credit-excluded because they don’t use credit in conventional ways. As a result, these consumers struggle to access basic financial services that require credit checks, such as obtaining a student loan, mortgage or even a phone plan.

The reality behind this issue is that credit scoring is not inadequate for today’s priorities. For example, when a consumer does not have enough historical data, their risk is simply categorized as unknown in our current system, which translates to high risk. So even if they have high potential, there is no way for evaluators to determine that. That’s why traditional credit-based underwriting practices miss key variables when assessing a consumer’s ability to pay and the cycle of consumers being locked out of financial services continues.

Credit scoring has evolved over the years to introduce alternative forms of data with the goal of bridging gaps in the system. According to a recent report by Nova Credit, more than half of lenders are already tapping some of these sources such as non-transaction checking account data, employment/income verification data and cash flow or bank transaction data to help complete their view of a consumer’s financial picture.

Part of this push has been driven by the current economic environment as lenders look for growth opportunities by considering consumers that may have been left behind and finding ways to reach them. Additional data from the report shows that 56% of lenders anticipate changes to their credit-risk policies in the next 12 months in preparation for a possible recession. We expect more conversations about alternative data to emerge as lenders look to “recession-proof” their underwriting.

Recent tech advancements have accelerated the discussions behind how the industry can leverage different forms of data to adopt more inclusive practices. From a pure credit-risk standpoint, it’s clear we need more flexibility and consumers are ready for change, starting with taking back some control over their finances through alternative data.

Lenders are on board with welcoming this next chapter of lending. When asked about their perception of where the industry is today when it comes to integrating alternative data into risk assessments, 50% of lenders say the industry is ready to adopt, with 39% saying they are already in the early stages. However, it’s clear there are still some barriers that remain.

Like any new technology, alternative data brings new questions to the table. For example, when asked about concerns impacting alternative data adoption, reliability and/or stability of alternative data sources and associated costs were the top responses. While these are valid concerns, lenders need to get aligned with where the industry is heading, or run the risk of missing out on potential growth opportunities with previously locked-out audience segments.

Lenders also benefit from different forms of data that help paint the bigger picture. Cash flow underwriting, one form of alternative data, stands out for its ability to provide direct insight into what’s in a consumer’s bank account. In addition to showing the availability of funds for paying any future responsibilities, cash flow underwriting provides ample opportunities for lenders to engage previously overlooked consumers — according to the FDIC, nearly 95% of U.S. households have a checking or savings account.

The strength of new data and analytics methods has been proven to be accurate and more research is coming out to support this thesis. As a result, we’re seeing more lenders opening their arms to supplemental data sources and ushering in this next wave of lending. Additionally, consumers are ready for change.

The pandemic accelerated a behavioral shift in the way they access their financial services, and they want more control over their financial narrative. With digital and online banking services becoming the primary channel for managing their finances, consumers have become increasingly comfortable with digitally connecting their information to their online profiles to control their data and oversee their access to different products and services.

With these advancements, the industry is finally in a position to solve the challenges facing credit excluded consumers, while also finding new growth opportunities amidst this recessionary backdrop. It’s time we invite consumers to the table and start these conversations that are long overdue.

Sarah Davies is chief data and analytics officer at Nova Credit.