> Posted by Eric Zuehlke, Web and Communications Director, CFI
Imagine you’re a young immigrant in the U.S. who’s been working for a few years in a series of low-wage jobs. Through discipline and determination, you’ve saved up some money for a down payment on a used car and you want to apply for a loan. You haven’t made many large purchases, you don’t have a credit card, and have few assets to your name. Chances are, your credit report is nonexistent and you won’t be able to access the credit you need to buy a car that will get you to your new job everyday. Tough luck.
It’s a familiar story for the “credit invisible” – tens of millions of Americans (possibly as many as 1 in 4) – some young, some elderly, and across income levels. For people without a detailed credit report or credit score, high cost lenders such as pawn shops, pay-day lenders, and check cashing services fill the void. The resulting inability to build assets, buy a home or start a business doesn’t just have implications for individuals; the lack of a ladder for climbing up the economic ladder helps entrench economic inequality.
A new research report from the Policy & Economic Research Council (PERC) indicates that the use of alternative data is presenting an opportunity for financial inclusion. A growing number of companies are using non-financial services data such as energy utilities, telecoms and cable TV history, and rent to determine credit worthiness and reach clients that typically would be financially excluded.
Large and well-known credit bureaus are using alternative data. The report highlights findings on alternative data from credit scoring firms in the U.S. including LN, Equifax, Experian, TransUnion, and Fico. Another example of increasing uptake is First Access, an Accion Venture Lab investee. By using a platform that integrates alternative data that can predict credit risk, segment customers, and automate credit decisions, more people can access financial services at a lower cost while reducing the risk of lending and borrowing in informal markets.
The report argues that despite its relatively limited use so far, alternative data is poised for a breakthrough for two reasons:
“First, more data available to lenders improves lending…And with so much recent attention being paid to Big Data and the power of data in general, there are increased efforts to gather and bring to market useful datasets. And these efforts are being aided by IT advances that are improving on the ability to collect data. Second, some consumers may have many non-financial payment histories but very few or no financial payment histories (what we term “Credit Invisible”). For these consumers, the best indicator of their credit risk profiles is their non-financial or alternative data payment histories. It has been becoming increasingly clear that this non- negligible segment of consumers can represent new market opportunities for mainstream lenders.”
However, PERC points out, not all alternative data are created equal. According to the report, some datasets, including energy utility and cable TV/phone payments, have proven predictive and have been validated in credit markets around the world while the jury is still out on data from social media and other “fringe alternative data assets.”
The FI2020 Roadmap on Credit Reporting focuses on building and improving credit reporting systems worldwide, including the use of alternative data. One of the three recommendations in this Roadmap is to “enable alternative data to be collected and shared to build the financial histories of borrowers with thin files.” When writing the Roadmap, we found that interest in developing stable credit reporting systems is growing as the number of credit bureaus around the world between 1990 and 2011 is estimated to have tripled. However, reaching base of the pyramid with credit reporting still requires a lot of work.
“New market opportunities” is a theme we come across time and again in our work on Financial Inclusion 2020, whether we’re talking about the untapped opportunity in reaching the growing population of older people, persons with disabilities, or those without credit histories.
To read the PERC report Research Consensus Confirms Benefits of Alternative Data, click here.
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