Access to credit is access to opportunity. For too long there has been a lack of access to both for millions of people. The traditional bureau credit score is based on limited data. The system advantages certain people, in turn discriminates against many others. The credit playing field is far from level today. It entrenches financial inequalities in the system.
The term ESG has been floated around since the 1960s, but has recently taken on increasing importance in business, and particularly for banks, financial institutions and lenders.
ESG stands for Environmental, Social, and Governance. When looking at banks and financial institutions, this is what we are looking at:
This looks at how an organisation manages their responsibilities towards the environment. This can relate directly to the organisation itself such as how much power it uses and how green its operation is. With financial institutions, this can also include where money is invested and the green credentials of countries and companies.
This focuses on social responsibility and inclusion. It considers how a company manages relationships both internally and externally. This may involve looking at working conditions of employees, having a diverse workforce, and ensuring that they also have a diverse customer base.
This is all about trust. Who leads an organisation and who are the investors behind it. The focus here is to show that there is a diverse board and that an organisation is free from corruption and bribery.
Many ESG strategies today fall down when it comes to the social aspect. Catering to a diverse customer base means the need to review credit inclusion. The traditional approach to offering credit leaves millions of people outside of a system.
Simultaneously, lenders need to protect themselves by carrying out appropriate risk assessment before offering credit. It is these checks that give the lender confidence that the borrower can repay what they need to.
An outdated credit system that excludes millions
The credit bureau score most people are familiar with today was introduced in 1989, this relatively modern tool is already outdated. Credit scores that only see part of the market also limit the business of lenders, cutting them off from many ‘good’ borrowers.While a financial institution may want to lend to those with little or no credit history, the incumbent legacy credit score system simply does not allow them to.
The legacy methods of assessing borrowers leads to millions of people being denied access to credit through no fault of their own. There are some 5.2 million people who are unable to access credit just because they have a thin credit file. These people haven’t defaulted on loans or shown that they are a risk. Quite the opposite – they have not been given the opportunity to demonstrate their creditworthiness in the first place.
For banks and financial institutions to show that they take the S aspect of ESG seriously, then there is a need for a change. Rather than relying upon outdated credit scores that penalise millions of people, the world of credit needs to rapidly become more inclusive.
The recently released World Bank Findex Report found that while digital payments climb worldwide and account ownership has reached new heights, challenges remain in many markets, with access to credit and savings still out of reach for too many.
A lack of access to fair, formal credit remains a sobering reality for most adults in developing countries. The report found 77% of adults in these regions did not access any formal form of credit in the reporting period.
The impact of excluding people from credit is significant. It drives people to seek unsafe alternatives such as payday loans. These payday loans create a vicious cycle of debt which leads to people being less and less likely to access mainstream credit facilities.
In terms of the economy, when people are unable to access credit they are unable to spend when they’d like or need to. Denying people access to credit stunts economic growth at a time when the world is seeking a financial bounce following months of lockdowns and restrictions.
Deteriorating economic conditions in many countries have prompted calls from regulators to lenders, encouraging fair lending practices. In the UK, the regulator, the FCA (Financial Conduct Authority) has written directly to more than 3,500 lenders in the UK to “remind them of the standards they should meet as consumers across the country are affected by the rising cost of living.”
The letter stresses the importance of lenders taking the time to understand their customers’ individual circumstances. The days of a ‘one-size-fits-all’ approach to lending are behind us, and with more data and resources at their fingertips than ever before, lenders can have more personalised conversations with their customers.
Credit inclusion needs to become the norm. There needs to be a new approach that doesn’t just rely on a single score determined from limited data:
For banks to offer true financial inclusion they need to consider alternative data rather than relying upon a traditional credit file and credit score. This can be achieved by incorporating alternative data such as device data, psychometric assessment, open banking or mobile money data.
A lack of credit history isn’t a sign of a potential borrower being irresponsible with money. It simply means that they have not accessed credit previously. Alternative data can allow them to demonstrate their creditworthiness by proving that they manage their money responsibly.
Lacking a substantial credit history should no longer be a sticking point when there is now the ability to look at character-based credit scores.
This sees potential borrowers accessing psychometric assessments or consenting to sharing device data. The results of these data sources allow a profile to be built that show someone’s willingness to repay, their personality traits, their cognitive abilities, and their attitude to risk.
Credit inclusion has been an ongoing challenge around the world. There is a need to make informed, and safe, lending decisions but when it comes to social responsibility there is a need to be more inclusive. Sticking by outdated assessment methods is depriving people of the opportunities that are open to others.
By using alternative data and a character-based credit scores as an assessment the world of credit is opened up. Those who have previously been locked out of obtaining credit are suddenly given the opportunity to do just that. These alternative methods are an important step towards credit inclusion and are a huge stride towards banks and other financial institutions taking the S is ESG seriously.
While there will always be a place for credit scores, there needs to be a willingness to allow people to build one in the first place. Alternative data allows lenders to look at people as a whole rather than just a number. This leads to a more rounded lending decision being made and allows someone access to credit for the first time.