A report from LexisNexis Risk Solutions finds that lenders’ desire for increased financial inclusion is a driver behind the increased use of alternative data.
LexisNexis Risk Solutions’ Alternative Credit Data Impact Report is a nationwide survey assessing alternative credit data’s adoption, utilization, and impact on credit portfolio growth and management in consumer and SMB lending. New updates of the report will be released annually.
VP of Credit Risk and Marketing Strategy Kevin King defines alternative data as any information not included in traditional credit reports. But its use must be more than adding data for data’s sake – it has to bring clear value. That data must also meet all regulatory requirements for inclusion. That is when it can get tricky, especially when credit decisions are involved.
Three reasons behind alternative data surge
King sees three factors behind the increased use of alternative data. The first is the democratization of data science and AI. Fifteen years ago, he saw folks excited about the importance of alternative data in underwriting, but they had no means of tapping into it if they weren’t a large company. Now, even the smallest companies have someone who can work with data.
The second reason is a shift in the mindset around financial inclusion. In the search for growth opportunities, companies hate turning them down due to an absence of information.
“We’ve seen a shift in the last decade around inclusion from being something that was done from a values-based perspective to a growth-based perspective,” King said. It shifted from a side initiative that perhaps felt right to do but wasn’t going to deliver value to one that pulled insights on new groups.
“Now when I talk to financial institutions, from fintechs to the largest in the country, they know there is real growth to be had here, in building those relationships with the young customers and immigrants early on,” he added.
Increasing consumer choice in competition forces companies to look at alternative data so they keep up with the Joneses. Thanks mainly to fintech disruptors, consumers can easily shop for the best offers. Financial institutions need to be more aggressive and precise in their lending techniques.
Why lenders are prioritizing financial inclusion
Why are lenders prioritizing financial inclusion? There are several reasons, King said. Regulators are paying more attention to financial inclusion, including the OCC with Project REACh. During audits, lenders will be asked how they foster inclusion.
King added that increased competition for prime consumers, especially from fintechs, also helps. The most successful ones focus on the quality of their underwriting, which happens through a combination of data science and using data sources that large institutions often ignore. That blend sees success with immigrants and young consumers, two groups that entice lenders.
Alternative data usage provides clear value, the report finds. Nearly all institutions using it say it has increased revenue growth by at least 15% while improving CX.
No surprise that institutions are diving deep into alternative data usage. More than 80% typically use more than 10 different sources. King said part of that explosion could be explained by defining alternative data as anything that doesn’t appear in a FICO. That widens the net a bit.
King cautioned that some companies might have a narrow vision of deploying alternative data. Their idea may be limited to using cash flow data on existing customers to conduct portfolio assessments or cross-sell. That’s not consumer-consented information where the more pioneering firms produce their advantage. Those initiatives are only beginning.
The call comes from inside the house, as two of the top three data types are often sourced from within the lender’s institution. That’s one of the simplest yet most profound benefits of improved technology – making better use of the data your company already generates.
More than 60% of financial institutions leverage alternative credit data on 75% or more of their applications. But there is room for growth there, too, as adoption still heavily focuses on deep subprime to near-prime applicants.
Risks posed by alternative data
Recent developments should have everyone considering the value they get from what they thought were reliable sources. While credit-seeking behavior has long been a staple, many fintechs do not report it to bureaus. LexisNexis Risk Solutions considers it to provide a more realistic view of an applicant.
Credit reporting agencies must reevaluate the weight they place on issuer reports.
“What we are seeing is these large credit reporting agencies saying a large credit card issuer will plus stop posting hard inquiries entirely,” King said. “In five years, we will look at our credit reports and see far fewer credit applications being listed there. We’ve been trained to think that’s good.
“I’m not sure it is. I think it challenges consumers on how they become credit visible and gets a profile opened up with the bureaus.”
Evolving consumer behavior has companies considering new data types in their search for inclusion and profit. Carefully consider the limits of each one, King advised. Evidence of consistent rental payments is a good sign of a person’s ability to maintain a financial relationship, but many landlords, especially the small ones, don’t report activity.
Utility payment history is more prominent too. Decades ago, bureaus couldn’t imagine a time when households would have telecommunication bills as high as their credit card or auto loan payments. Even smaller, regular bills like Netflix subscriptions that are regularly paid off provide evidence of consistent payment activity. It is especially valuable for younger consumers, King said.
More data types will become available, especially as open data principles are widely adopted. That raises a huge red flag for King.
How are agencies obtaining it? Most often, it is because the consumer allows it to be reported. If I often forget to pay my Netflix tab, and I can have it excluded from my credit file, what do you think I will do?
“Some of us love that notion of consumers having more control, right?” King asked. “But I think we also have to recognize the loss of integrity. If I can choose what bills to show you and what ones not to show you, I only let you see one portion of myself.
“I know of several top 10 financial institutions which specifically linked to those credit bureaus and said to take that data out because it’s so often hitting a misleading picture of overall credit risk. It’s our job to hold a mirror up to the consumer and provide the clearest, sharpest picture of who they are and their ability to manage a financial obligation. And so, with every new data insight, that’s the question I’m asking my team, are we getting a better picture?”
How the current market may affect alternative data usage
How will the banking crisis affect lending and the use of alternative data? Will more prominent institutions curtail lending and open up an opportunity for fintechs?
There’s always a use for alternative data, King argues. When things are booming and regulators are a soft touch, alternative data can provide a competitive edge. When times are tight, lenders must try harder to understand their clientele. Alternative data can help provide that insight.
“Can I better understand this individual’s ability to manage a credit relationship than my competitor?” King asks. “That’s where alternative data provides the answer, and in the world of lending, giving a better answer than they have a better algorithm.
“Regulators have their radar up on who’s getting their competitive advantages through innovations in machine learning. But I’m just opening the aperture to understand better how this consumer manages their financial life. That’s a tougher thing to argue with.”