Lenders have traditionally relied upon a limited set of data to make lending decisions. Typically a credit file contains information relating to a person’s financial history. It gives detailed information in relation to how people have historically handled their credit responsibilities and this has been used as a way for lenders to mitigate any risk to them.
The information in a file is used to produce credit scores for those looking to borrow. The higher the credit score, the less the perceived risk that someone will default on any payments. While this approach may have served lenders well to some extent, it has also led to a swathe of people being financially excluded. By using alternative data to assess risk and a willingness to repay, these people can be brought into the mainstream.
If lenders are able to look beyond traditional credit scores and, instead, start to consider personality and behaviour, they will find that there is a market that is virtually untapped and one where they can be at the forefront.
When looking at those who are financially excluded, we are considering those who don’t comply with what is needed in terms of credit scores. We are looking at those who have little or no credit history and have a credit file that is extremely thin or even non-existent. In countries such as the UK, which is the 6th most affluent country in the world, there are some 5.8 million people who are classed as being financially excluded. Given that there are also approximately 1.7 billion people around the world with no bank account, it becomes clear that the market size here is considerable.
Typically, those who are financially excluded fall into set groups. These include:
There are people who have only just reached the age where credit is a possibility. They will have no credit score or history that a lender can use to mitigate their risk.
It is possible that many in this category have cleared their mortgage and because they have never used the likes of credit cards their credit file becomes non-existent.
Without a bank account, people are often all but invisible in terms of the ability to apply for credit.
As people arrive and settle in a new country they often leave their credit scores behind. This can see them starting from scratch and, for a time, being completely excluded from the ability to acquire credit.
There are still considerable areas of society that rely on cash transactions as they struggle to make ends meet. This means that there tends to be little or no records of payments being made/commitments being honoured.
When assessing someone’s ability and willingness to repay, lenders have, in some areas, started to make a shift. It has been recognised that, perhaps, those who rent are not afforded the same treatment as those who hold mortgages. In these instances, it has become possible to have rental payments included on a credit file and so boost credit scores.
There is also the potential to utilise Open Banking. By opting into this, potential borrowers are able to share their financial information and, assuming that they hold a bank account, they can share exact details of their behaviours and how they manage their account.
Although such moves are welcomed, these still don’t address all of the issues faced by those who are financially excluded. In order to become fully inclusive, lenders need to look beyond repayment history and instead start to look at personalities and character as part of any risk assessment.
Whereas there are billions of people without a bank account and as many again who are financially invisible, one thing that we all have is a personality. By considering personality and character everyone can be given a credit score without the need to have a comprehensive credit history.
Examples of personality types that are significant when it comes to assessing risk include:
Acting on impulse without thinking of potential outcomes is not an attractive personality trait when it comes to assessing risk. Those who show high levels of impulsiveness are more likely to default on loan repayments. This is perhaps down to a lack of thought that goes into the borrowing decision.
Where we are often told that we live in a society where instant gratification is sought, an ability to measure this personality trait can be useful to lenders. Some who displays the ability to act in a certain way to achieve rewards at a later time is far more likely to honour their credit commitments.
If lenders are purely using credit scores as a measure of someone’s willingness to repay, then they are excluding a significant proportion of society. The implications of this are twofold in terms of the impact upon the lender itself and the longer-term impact on society:
A lenders business model must, of course, mitigate risk. Credit scores are used to ensure that the risk of default is minimal. When customers successfully repay a loan or credit card debt, the lender of course stands to profit. The exclusion of billions of people means that lenders are leaving profit on the table.
Lenders who move first in terms of using alternative data stand to profit the most. By being seen as a leader they will become the go-to institution.
Where lenders are prepared to consider alternative data they are having a positive impact on wider society. Those who are financially excluded have had little choice other than to turn to the likes of payday loans where interest rates are excessive and a cycle of debt is created.
Bringing these people towards mainstream lending gives them the opportunity to improve their lives and their position within society.