FIs are warming up to alternative data and 93% think it will have a positive impact on their bottom lines

While the adoption of alternative data in lending is far from widespread, a new study has found that lenders are gradually moving to incorporate these data sources in their lending decisions. For lenders, alternative data presents an opportunity in the face of rising concerns around the efficacy of credit scores as a good depicter of credit worthiness.

For example, in 2017 the CFPB found that alternative data from unconventional sources may help consumers who are stuck outside the system build a credit history to access mainstream credit sources. Others have stated that credit scores leave out whole segments of potential consumers like young adults or those who rely more on cash. 

Take up of alternative data by traditional FIs have been slow, while fintechs like TomoCredit have captured some of this market by building products that underwrite based on cash flow.

But recent data shows that FIs are warming up to the possibilities alternative data presents, albeit slowly. 31% of FIs now believe that credit scores are not a sufficient indicator of credit worthiness compared to last year where only 17% believed the same, according to a recent study by Nova Credit. 

Currently 43% of FIs use alternative data to gain a better understanding of their consumers’ finances. And among the types of alternative data they utilize, income verification and employment verification are the most commonly used data points.

Although research in the past has found that  consumers who had their rent data reported noticed a 60 point jump in their credit score, less than half of FIs report using rent payments data in their lending depictor. Previous research also reports that younger consumers (18-25) stand to benefit the most from the use of this kind of data. 

If FIs can better determine who is a good credit risk, it’s good for consumers as well as lenders’ own bottom lines. Most executives surveyed believe that using alt data will reduce fraud risk for their FI and 90% of them think it would help them approve consumers more confidently. This is also shown by the fact that 93% of those who do use alternative data have felt a positive impact on intended KPIs. 

Among FIs, credit unions feel the least prepared to leverage such data sources, while digitally native fintechs and banks seem to be the best positioned. But even for them, there are risks involved in taking on such a strategy. 

44% of FIs think using alternative data may increase regulatory oversight or introduce compliance issues, and 43% think that reliability of the data and stability are roadblocks as well. 

As firms try to balance the challenges and opportunities alternative data presents, they may be helped along the way by supporting regulations as well as third-party vendors. Currently, 75% of FIs think that the CFPB’s proposed rule on Open Banking will ease the process of providing data to FIs for consumers. There also seems to be an emerging bipartisan agreement in the Senate Banking Committee to encourage the use of this kind of data amongst lenders.  

71% also think that third-party vendors will help them navigate the adoption of Open Banking practices.This is because to use this form of data, lenders have to go through a multi-step process of data collection, analysis, and predictive modeling – the load of which can be lightened by technology providers. 

“To use alternative credit data, lenders must first obtain it, and then incorporate it into their models and loan-approval decision process. It’s possible to use a “ready-made” score that incorporates all alternative credit data sources rather than using multiple scores or sets of attributes that can be cost inefficient and/or difficult to use,” wrote Dave Sojka, a risk advisor at Equifax.