Expanding Credit through Alternative Credit Scores
As the election draws near, we must set aside time to not just think about the candidates, but also their policies. The economy may look good in the markets, but the New York Times noted the number of Americans living in poverty has risen by about six million, and the poverty rate has jumped from 9.3 per cent, in June, to 11.1 per cent, in September.
As a former regulator at the Department of Treasury there is one policy that remains important to me — the use of credit scores. While such scores cannot eradicate poverty, scores that more accurately reflect the financial capacity of a family can lead to greater access to credit and capital.
Your credit score is a number that represents the risk a lender takes when you borrow money. A FICO score is a well-known measure created by the Fair Isaac Corporation and used by credit agencies to indicate a borrower’s risk. In both cases, the higher the credit score, the perceived lower the risk to the lender.
Having joined the Office of Thrift Supervision (OTS) after the Savings & Loan Crisis (RTC) in 1995, where wealthy people were overleveraged, I saw first-hand that low income folks are not a threat to our financial systems, but wealthy people are.
Credit reporting is fewer than 200 years old. It was invented as part of America’s transition to a capitalist movement. Its history has proved both alarming and empowering, helping millions to realize the American Dream through access to credit, while causing irreparable harm for others that is hard to change and shake.
Credit scores have saddled the majority of Americans with a lifelong ‘financial identity’: an un-erasable mark that has an outsized impact on one’s financial future.
The biggest experiment of credit scores took place in 1841 with the creation of the Mercantile Agency. Merchants who were burned by the 1837 depression panicked due to the over-extension of credit. They set out to systematize the rumors regarding debtors’ character and assets. These early financial reports were incredibly subjective. They were filled with the opinions of predominantly white, male reporters, and provided clear evidence of their racial, class and gender biases. The subjectivity of these reports had two important consequences. First, it reinforced existing social hierarchies, serving as an early form of redlining. Second, the jumble of rumors contained in early reports proved difficult to translate into actionable lessons. This dilemma continues.
Credit scores are often one of the biggest challenges faced by entrepreneurs as they seek capital to support the scaling and sustaining of their businesses; modifying existing credit scoring guidelines will expand access to capital and create opportunities for entrepreneurs who are overlooked by the current system.
With limited access to friends and family funding, coupled with the higher cost of being Black, too often expenses outweigh income — personally and professionally. This causes cash flow issues which lead to lower credit scores. However, Black folks do pay their bills, such as cell phones, food, car insurance and the like. The prioritization is based on necessity, not availability. Therefore efforts should be taken to consider alternative inputs — that are more relevant to the daily survival of low income communities — to determine credit worthiness.
The Consumer Financial Protection Bureau found that only 54% of all adults in the U.S. have Superprime or Prime credit scores. This leaves a significant portion with a less than ideal credit score, and 22% have thin credit — or no credit at all.
Alternative credit scoring gives borrowers without a strong past of credit a chance to receive a loan by basing their score on different criteria. For example, to determine a borrower’s alternative credit score a lender could evaluate data such as:
• Rent, utility, cable and/or cell phones payments — does a borrower pay them on time and in full?
• Checking account data — does a borrower have sound financial backing?
• Shopping history — does a borrower make unnecessary/frivolous purchases without the financial means to back them up?
• Property records — has a borrower invested in their own property?
In addition to these factors, some alternative credit scoring models will also take a deeper look into a borrower’s education, occupation and even social media presence. With all of this information, lenders have a comprehensive profile of a potential borrower and can determine their risk level based on more information than just a traditional credit score.
It is time to enlist a newly created public scoring division within the Consumer Finance Protection Bureau (CFPB) to work with the three major credit bureaus to implement alternative credit scoring approaches. The goal would be to minimize bias and racism in scoring and algorithms.
In 2012, a rule was created that allowed the CFPB to supervise consumer reporting agencies. The three largest credit reporting companies issue more than 3 billion consumer reports a year and maintain files on more than 200 million Americans.
The division would create alternative credit scoring approaches to be implemented by the three major credit bureaus that reduce unnecessary barriers to capital for new majority entrepreneurs. The agencies would include non-traditional sources of data like rental history, utility bills, etc., in their scoring criteria.
CFPB should be charged with instituting an alternative credit scoring process — to be implemented by the three major credit bureaus — that includes:
• Driver’s license and driving records;
• Employment and income;
• Real estate ownership and liens;
• Bank accounts, bankruptcies;
• Utility payment records — electricity, gas, water, mobile phone; and
• Rental records — location, length of lease, payment history.
A pilot study amongst ride hailing service providers was conducted to create an alternative credit scoring model for drivers based on their behaviors, their ratings, and the comments customers leave. The new methodology enabled integration of drivers access to capital — one that did not have access to financial services — and, in turn, they had lower default rates than any other sub-segment in the current portfolio.
Alternative scores inclusive of employment, consistent or increasing income, address stability, and reliable payment history verified through alternative credit assessment models can provide opportunities to grow access to credit to historically marginalized communities.
