Patrick Brusnahan investigates the current credit scoring scene. Is the sector developing as quickly as the rest of financial services? With certain scandals drawing unwanted attention to the field, are consumers finally getting the long-awaited fairness when it comes to credit? Or is the reputation unwarranted?
The rate of development in the retail banking sector is astonishing. It seems that rarely a day goes by without some new form of innovation emerging in the sector. However, one faction attracting less attention is credit scoring.
Is this field developing as well or is it being left behind?
At first glance, consumer credit is in a good place. Consumer confidence recorded its first positive index, since the 2008 global financial crisis, in August 2014 and it has been positive ever since.
According to Timetric, total outstanding lending fell from £172.5bn ($267.8bn) between 2010 and 2014.
In addition, Timetric’s report, Consumer Credit in the UK: Key Trends and Opportunities, highlighted that the demand for, and availability of, credit has risen since the second quarter of 2014. This included a huge spike in the fourth quarter of 2014 as payday lenders began to pull back from the market due to a slew of new regulation.
As a result, mainstream banks loosed their lending criteria to compete. HSBC became the first lender to break the 5% interest rate barrier for its £7,500-15,000 personal loan at the end of 2014. This triggered a price war between all mainstream providers as banks and building societies tried to come top in the comparison tables. This competition does not seem to be slowing down as Sainsbury’s recently offered a rate as low as 3.5% in August 2015.
The Bank of England recorded similar trends in its Credit Conditions Survey which stated that the final quarter of 2014 marked the highest level of consumer lending since before the financial crash. Lending is cheaper than ever for consumers and financial institutions have much cheaper access to credit.
For the consumersWhile the market is growing, the question remains if it’s advancing or developing in terms of credit scoring for consumers.
Paul Thomas, managing director of Provenir, a provider of risk decisioning solutions, believes the market needs a change. Speaking to RBI, he says: "We certainly see our customers looking at new models. It’s a model that has been developed for a different time in history, a different place and a different demographic."
Andrew Jennings, FICO’s chief analytics officer, believes that the current system could be more inclusive to unrepresented markets.He says: "Where we are in mainstream credit scoring today is that most techniques still exist to some degree. Credit bureau scores are the ones predominant across most countries in the world. A central bank established bureau or a private sector bureau collates very similar information and that is used to make credit scores. That’s the state of play at the moment.
"What’s beginning to happen is that if you’re on the credit bureau, that’s great, but what happens to the people not on it? Lenders and providers have been looking at ways to try and tap into alternative sources of information on people that would allow us to provide a consistent and reliable credit rating."
Professor Jonathan Crook, director of the Credit Research Centre at the University of Edinburgh, says: "I think there’s a move to answer more revealing and helpful questions. Traditionally, what lenders do is they estimate an equation which basically predicts the chance someone will repay as agreed usually within the first 12-18 months of the life of the loan.
"Now, lenders are beginning to experiment with trying to predict the chance that someone will pay a particular payment in a particular month or the chance they will default in a particular month. They are exploring these sorts of methodologies. They are also exploring more sophisticated affordability models. These are general trends."
No matter the solution picked, it needs to have two key factors: consistency and reliability.
Jennings adds: "Lenders are going to make decisions about people’s lives, for example, if they get a mortgage or not. It can’t be something that is cooked up off of a small amount of data that you manage to find. It needs to be useful to the industry. Where we are now is finding these sources of other data that will help solve that problem."
New sources of dataSo where are these new forms of data going to come from? Companies such as Provenir have been looking at social media as a form of data for an ‘add-on’ to its approval process. If a loan application is undecided, social media analytics are utilised to try and get approval ratings up.
If there is nothing in the person’s activity to suggest an irresponsible or dubious lifestyle, then the referral is more likely to be approved.
Another option is utility bills. A company in Chile, Destacame, takes individuals’ utilities and cell phone data to create and manage alternative credit scores and influence current credit scoring models. The start-up won the BBVA Open Talent 2015 Special Financial Inclusion Award this year.
Thomas says: "If you look at consumer finance initiatives, organisations have looked to attract different demographics of clients and score those people in very different ways. We’ve heard all about financial inclusion. This could apply to anybody new to a country that doesn’t have a credit history or has had credit problems.
"Traditional models might prevent them from accessing financial services. Our customers are saying the historical models, whilst they might function, they might not provide enough service."
On this topic, Jennings adds: "In many countries, broad base credit scoring models are not some fly-by-night thing, they are highly regulated. That leads you back into what types of data are available. It needs to be data that is collected with some degree of reliability and consistency because you can’t have a situation where a consumer is disputing the information.
"Usually, this becomes other financial obligations. The typical place to go is somewhere that doesn’t go through the credit bureau and these tend to be utility bills or mobile phone activity. This is interesting as the amount you pay per month can go up and down. The variety of information you can get is much richer there."
With regards to social media being utilised in credit, he adds: "The consumer lets the lender use whatever they like as they haven’t been able to get a loan via conventional means. This is a difficult thing to pull off en masse. People will not do this if they don’t need to do it.
"The second point is that most high street lenders won’t go near this stuff as the regulatory picture around it is undefined and most of the lenders doing this are not regulated in the same way that, say, Barclays or Wells Fargo is. There would be sensitivity in saying ‘Wells Fargo turned me down because something was written on my Facebook page’. I wouldn’t say it has no future, but it’s not without its challenges and it is not without its issues."
Fair scoreWith the developments in the credit industry happening now, speculation has arisen that the market might become fairer and more inclusive in the near future.
Dr Crook takes a different view. He says: "There’s no such thing as fairness as far as the [credit] models are concerned. What models do is treat people who look the same in the same way. That’s one of the arguments for using a model as they cannot be influenced by any personal prejudices. The models are completely neutral."
However, Thomas disagrees and believes that the market has been ‘harsh for some time’. He says: "We’ve seen a lot of publicity around how difficult it is in the UK, even if you’re a white collar worker, to get a mortgage today."
On whether the market is getting fairer, he concludes: "I would hope that that is the case. I would hope that it gives consumers that have struggled, whether it’s through traditional financial institutions or not, to access credit markets and a fairer shot at accessing these markets."