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Lending Briefing: Lenders are adopting alternative data, but find it challenging

  • An increasing number of lenders have started to incorporate alternative data sources into their risk modeling, but many find this initiative challenging.
  • Data reliability and the costs associated with alternative data sources represent the top barriers for lenders to start using alternative data.

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Lending Briefing: Lenders are adopting alternative data, but find it challenging

Over the past few years, lenders have increasingly turned to alternative data sources — such as income verification, payday loans, bank transaction data, and cash flow underwriting — in order to gain a clearer picture of a consumer’s true creditworthiness beyond credit reports. 

Traditional data is a relic of past underwriting methodologies, and lenders know this. The vast majority believe that traditional lending data doesn't give them a complete picture of a consumer's creditworthiness, a new report by Nova Credit found. 

Nowadays, an increasing number of lenders have started to incorporate alternative data sources into their risk modeling, as they provide valuable insights into a consumer's trustworthiness in paying important expenses. 

What lenders look for are solid indicators of risk in order to assess if the consumer will pay back the loan. Alternative data is a perfect candidate for this, but there are still many knowledge gaps to fill in terms of how to make the most use of this data. 

When asked about their perception of where the industry is today, half of the lenders surveyed said they are ready to adopt alternative consumer data into their credit risk assessments and nearly 40% are in the early stages of adoption.

However, not everyone is on board with using alternative data today. The vast majority (83%) of those who aren't ready to incorporate alternative data sources into their credit risk assessment said they would change their mind if the industry could better validate its impact of predictability. 

Data reliability and the costs associated with alternative data sources represent the top barriers for lenders to start using alternative data. 

This is likely a sign of this market segment's maturity, which is still in its early stages of adoption. 

The use of different types of alternative data is still quite recent. Around 50% of lenders have only started looking into cash flow and bank transaction data over the past one or two years, and a third began 3-5 years ago.

Adoption is driven mostly by midsized lenders (those with 500-1000 employees), which were found to have a stronger focus on innovation and expansion through the use of alternative data, much more than larger organizations (1000+ employees) – 80% versus 39%. 

And even for those that have gotten on the alternative train, similar challenges surface. The cost of data is a deterrent, as well as understanding how to incorporate that data into existing frameworks. 

The study also noted how lenders are not fully taking advantage of alternative data to reach new market segments that would be traditionally hard to underwrite. Only 27% of lenders said they were motivated by a desire to reach new audiences through the adoption of alternative data. 

This contrasts the fact that lenders consider the expansion to new geographic markets as their greatest strategic initiative for their company. Lenders know there is untapped potential in many customer segments, and they could benefit from having more visibility into alternative financial data points. 

Quote of the week 

"Lending is a learning business. Sustainably successful lending requires striking the right balance between the amount of money lent and the level of assurance that the customer is required to provide."

- Alex Johnson, Fintech Takes Newsletter

What we’re reading 

Digital lending platform Lendsmart goes live at First Community Bank and Trust

SBA wants to add fintechs to its biggest lending program

What fintech forgets about consumer lending 

Buy now, pay later delinquencies could get 'dangerously' high. What will companies do about it?

Fintech could soon get a bigger piece of government-backed loans

Chart of the week 

Source: CB Insights

What we're writing

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Wells Fargo is launching a new virtual assistant named "Fargo", powered by Google Cloud AI, to keep up with the digital transformation trend driving evolution of financial services.

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In this Q&A, CMO Aaron Wollner talks about what’s new in the digital bank’s campaign work and how it’s been shifting its messaging to fit the current financial climate.

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