On November 7, the Congressional Research Service updated its report on the use of alternative data in financial services. Credit rating agencies rely traditionally on standard data points such as repayment history on mortgages, student loans, credit cards, auto loans, credit applications, bankruptcies and debts in collection to determine credit scores. New technology, however, has enabled financial institutions to incorporate alternative data, including payment histories in telecommunications, rent, utilities, checking account transactions, educational or occupational attainment, and even social media information, to assess an individual’s creditworthiness.
The report noted that approximately 20 percent of the U.S. population remains unscored due to limited credit histories. This group is typically lower-income, younger and more likely to be nonwhite. The CFPB’s Section 1033 final rule aims to streamline and accelerate the use of alternative data in fintech underwriting, potentially allowing fintech lenders to make more informed credit decisions by accessing novel data through data brokers or prior relationships with borrowers. The Bureau’s final rule on personal financial data rights would mandate that financial institutions, credit card issuers, and other financial providers make covered data available to consumers and third parties in a standardized format. The final rule is currently under challenge in federal court.
The report noted that incorporating alternative data into credit scoring models has shown promise in scoring previously “unscorable” borrowers and improving existing scores. However, concerns over data security, privacy and fair lending remain as financial institutions must navigate the regulatory landscape to ensure compliance with the GLBA and the ECOA.