American Banker: Alternative Data Can Help Eliminate Credit's Catch-22

Alternative Data Can Help Eliminate Credit's Catch-22

The Catch-22 of credit — that you need it to get it — should not exist in this day and age when data galore is at our fingertips.

By Rachel Schneider and Rob Levy

The use of alternative data, like rent and utility payments in credit decisioning –  which industry professionals have been prophesizing about for years – should be more prevalent. Yet, millions of Americans continue to go without access to affordable, high-quality credit products, in part, because they lack a long credit history or do not have a credit history at all. This quandary could be at least partially resolved by the use of alternative data.

Some rental, utility and telecom companies report payment data, but not enough do. And the information that gets reported is usually negative, alerting the big three credit bureaus (Equifax, Experian and TransUnion) only when a consumer has been delinquent in paying a bill. Conversely, those consumers who pay their bills in full and on time every month are often unable to prove their creditworthiness since this positive financial behavior goes unreported. As a result, they may receive higher-priced credit or be denied credit by traditional lenders.

The Center for Financial Services Innovation has been studying the potential benefits of alternative credit data for several years. It is our belief that the use of alternative credit data has the potential to responsibly increase underserved consumers' access to high-quality credit products they can afford.

One of the reasons utility and telecom companies fail to report positive payment data to the credit bureaus is because many state regulators discourage it, leery of unclear federal regulations about the permissibility of doing so. Recently, two legislators have taken up this cause, introducing a bill to clarify that, under the federal Fair Credit Reporting Act, utility and telecom companies are permitted to report on the timely payment behavior of their customers to credit reporting agencies.

In September, the House Committee on Financial Services held a hearing to consider the merits of the proposed, bipartisan bill (H.R. 6363), known as The Credit Access and Inclusion Act. Introduced by Representatives Jim Renacci (R-Ohio) and Keith Ellison (D-Minn.), the bill is just one of the many ways to encourage more widespread use of alternative data and improve underserved consumers' access to high-quality credit products.

But this proposed legislation isn't just good for consumers. It has benefits for the financial industry, too. By having more rich data on consumers' payment history, financial institutions can better understand consumers' likelihood to repay. But, even more importantly, financial institutions can better reach the underserved market — which is a significant opportunity, considering there are 68 million financially underserved adults living in the U. S. today.

Many individuals without a lengthy credit history or credit score are creditworthy individuals. The Policy and Economic Research Council , a Durham, N.C. think tank, estimates that about 50 million consumers have credit scores that could be higher if utility and other alternative payment data was included in their files. PERC and the Brookings Institution also contend that including alternative data in consumer credit reports could place 40% of the currently unscoreable consumers into the prime category.

We recognize that not everyone shares our perspective on this issue. Some believe that full-file credit reporting is potentially harmful to consumers, because, in addition to the positive information utilities would report, a lot of new negative information could get reported. While we share some of these concerns, overall we believe this bill will have a positive impact on consumer access to high-quality credit.

H.R. 6363 is expressly not a mandate. It would simply clarify the landscape, thereby encouraging utility companies to report positive payment data. The need remains for a variety of affordable, high-quality credit options that meet the diverse needs of underserved consumers. After all, it may actually be in the best interests of lenders and consumers alike for financial institutions to provide some consumers a more limited credit offering because of full-file reporting.. 

Finally, credit reporting agencies are now, for the first time, being fully supervised and regulated by the Consumer Financial Protection Bureau, which gives us confidence that the consequences for consumers associated with adding nontraditional data will not go unnoticed.

Now is an opportune time to talk seriously about alternative data, considering how consumers' credit histories have suffered since the financial crisis. CFSI believes more research is warranted to show that alternative data can help a lender determine which consumers show positive credit behavior today, even though their traditional credit reports do not reflect as much. This would help both consumers and lenders, who can improve their bottom line with increased predictive ability.

H.R. 6363 advances the conversation about the power of alternative credit data — one of the many keys to increasing consumers' access to high-quality credit. The more the financial services industry and those who regulate it understand the potential positive ramifications of including alternative data in credit reports, the sooner we can eliminate the Catch-22 of credit.

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A Complex Portrait- An Examination of Small-Dollar Credit Consumers

Every year, millions of American consumers use small-dollar credit (SDC) products for quick access to cash. Yet, these products—payday loans, pawn loans, direct deposit advance loans, auto title loans, and non-bank installment loans—often come with high fees or interest rates and can lead consumers into a cycle of repeat usage and mounting debt. This study seeks to elucidate the reasons why so many consumers rely upon these potentially dangerous products and to glean what can be learned from their experiences to promote the development of high-quality credit solutions.

This study covers the following angles of the SDC Consumer: who they are, how they decide to use a SDC product, how they fare once they have used a product, and what they think about the products they use. 

Some key findings from the research:

• An estimated 15 million consumers used at least one SDC product in the past year
• The average household income for an SDC consumer was $32,000 compared to $40,000 for non-SDC consumers, although 20% of SDC consumers had an average household income between $50,000 and $75,000
• Only 27% of SDC consumers had a credit card, compared to 61% of non-SDC consumers
• The top 3 reasons for funds shortage included:
  • living expenses consistently more than income
  • bill or payment due before paycheck, and
  • unexpected events such as emergency expenses or income drops 
• While 66% of SDC consumers had no savings, more than half of those that did have savings chose not to use it all and relied on credit instead
• The top 3 loan attributes that mattered most to SDC consumers were:
  • quick access to money
  • ability to qualify, and
  • clear terms
• Although experiences varied significantly, many SDC consumers struggled with repeat usage, particularly users of payday and pawn loans who were often in debt for a considerable part of the year due to high levels of repeat borrowing.
  • When looking across the entire year, payday borrowers took out an average of 11 payday loans or extensions, remaining in debt for approximately 150 days out of the year; pawn loan borrowers took out an average of 7 pawn loans, remaining in debt for approximately 200 days out of the year
• While a slight majority of SDC customers reported a satisfactory experience, a significant number reported quite negative experiences.
  • Within the products considered, payday loans and auto title loans received the lowest ratings and deposit advance received the highest.
  • 30% of SDC consumers reported the loan costing more than expected

Download the full paper "A Complex Portrait: An Examination of Small-Dollar Credit Consumers below. 

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