In the olden days before credit reports and credit scores, financial institutions extended credit based on personal relationships between the borrower and the lender. Bankers knew who in their communities were creditworthy and who were not. Now with the development of credit reports and credit scores, extensions of credit are more dependent on a person's credit score than his or her reputation in the community and relationship with the lender. The circular problem is that if a person has no outstanding credit, he or she probably does not have a meaningful credit score and without a meaningful credit score the person cannot get credit. According to the Consumer Financial Protection Bureau (CFPB), 46 million Americans are credit invisible, which is they have no credit score or their credit score is so outdated it is meaningless. Also according to the CFPB, most of the people affected are African-American, Hispanic or low-income persons.
Just because a person does not have a meaningful credit score does not mean that the person is not creditworthy. He or she pays rent, utility bills, medical bills and other charges timely. But none of that is reported to a credit bureau unless it is delinquent.
The credit bureau unreported obligations are now being referred to in the credit process as "alternative data". Apparently, some lenders on occasion use alternative data in their credit underwriting. In an effort to make credit available to all credit worthy consumers, the CFPB has recently issued a "Request for Information Regarding Use of Alternative Data and Modeling Techniques in the Credit Process". It will be interesting to see how this process plays out. My hope is that facilities will be developed whereby alternative data becomes more available to the lending industry. My fear is that the CFPB will someday take the position that lenders who do not use alternative data are illegally discriminating.
One of the good things about credit scores is that they have been around long enough that the score developers have decades of experience in developing the modeling techniques and algorithms that they use in score development. You can be confident that a person with a credit score of 840 will pay his or her loan and that a person with a score of 320 will not. In my view, the biggest problem with using alternative data is that there is insufficient experience to create models that have the same accuracy as credit scores. In any event, if you are a lender, be aware that this is one of the new hot topics on the CFPB agenda and be on the lookout for future developments.
Cellphones and Access Devices
On a totally different subject, we had an interesting customer question recently. A customer of a bank loaded all of his debit and credit cards into an app on his cell phone. He also disabled the security code on the phone. He lost the phone and the finder used it to make several purchases. The bank wondered first whether the phone was an access device for which it was responsible and second whether the customer's negligence in not protecting the phone got the financial institution off of the hook. First, technically the mobile phone is not an access device but the information that is on it is. Whether a physical card is presented to a merchant or just the card information, that is an access device and the issuing institution is responsible for unauthorized use. Second, consumer negligence has never been a defense to unauthorized use of a card. We recommend that financial institutions provide their account holders with literature, encouraging the protection of their cards and card information. Also my guess is that the technology is already out there where a crook can hack your mobile phone as easily as your computer.