The crusade to begin using newer credit scoring models that consider factors such as a person’s bank account history, work history, or utility payments as part of the credit underwriting process may have just gotten a big push in the right direction.
On Tuesday, the nation’s biggest banking regulators issued a
joint statement that expressed cautious optimism on the use of alternative
credit models in underwriting.
In the announcement, the Consumer Financial Protection Bureau, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency,
and the National Credit Union
Administration state that using alternative data may expand access to
credit and enable consumers to obtain additional products and more favorable
pricing and terms.
But the agencies caution that expansion from traditional
underwriting methods should be done in a compliant and safe manner.
“The agencies recognize that the use of alternative data in a manner consistent with applicable consumer protection laws may improve the speed and accuracy of credit decisions and may help firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system,” the agencies state.
“The agencies recognize alternative data’s potential to
expand access to credit and produce benefits for consumers,” the agencies
continue. “To the extent firms are using or contemplating using alternative
data, the agencies encourage responsible use of such data.”
The announcement comes just a few months after the CFPB released a study that showed that using alternative credit models will not only lead to more borrowers getting loans, the loans they get will be cheaper too.
That study suggested that one alternative credit
underwriting system, which considered traditional underwriting methods along
with information related to borrowers’ education and employment history, could
lead to 27% more loan applicants being approved.
The model also yielded 16% lower average annual percentage
rates for approved loans.
While the use of alternative credit data may become more
commonplace among certain credit products, mortgage lending is a different
story.
The two main sources of mortgage credit, Fannie Mae and Freddie Mac, still utilize a FICO credit scoring model
that’s several models old in their underwriting process.
But, there may be some light at the end of that tunnel.
In August, the Federal Housing Finance Agency announced that it will allow Fannie Mae and Freddie Mac to consider using VantageScore as an alternative to their currentFICO model, a reversal from a proposed rule issued late last year.
Last December, the FHFA issued a proposed set of rules surrounding the adoption of alternative credit scoring rules, including a provision that would have prohibited the government-sponsored enterprises from using the VantageScore model because of conflicts of interest with the company’s backers.
VantageScore Solutions, the developer of the VantageScore model, is a joint venture between the nation’s three largest credit bureaus, Equifax, Experian, and Transunion.
But earlier this year, the FHFA released its final rule on
the matter, and missing from the rule was any mention of conflicts of interest
or “credit score model developer independence,” meaning VantageScore is no
longer subject to any potential blacklist and is back on the table for the
GSEs.
Even with that change, the timeline for implementing an
alternative to the classic FICO model at Fannie and Freddie is lengthy, likely
at least four years, so alternative data use probably isn’t coming to Fannie
and Freddie until the middle of the next decade.
As for the rest of the financial services industry, the
banking regulators state that changes could be coming, as long as they’re done
responsibly.
“Many factors associated with the use of alternative data,
including those discussed for cash flow data, may increase or decrease consumer
protection risks. For example, using alternative data, such as cash flow data,
that are directly related to consumers’ finances and how consumers manage their
financial commitments may present lower risks than other data,” the regulators
state.
“A well-designed compliance management program provides for
a thorough analysis of relevant consumer protection laws and regulations to
ensure firms understand the opportunities, risks and compliance requirements
before using alternative data,” they continue. “Based on that analysis, data
that present greater consumer protection risks warrant more robust compliance
management. Robust compliance management includes appropriate testing,
monitoring and controls to ensure consumer protection risks are understood and
addressed.”
To read the regulators’ full statement, click here.
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