If traditional CRAs were themselves fit to the task, would Chase be looking at its c. 4 million small business customers through the lens of OnDeck technology? Unlikely. Admittedly, CRA data is highly likely to serve as an important source of fuel for the OnDeck credit assessment machine. But it is by no means the only source, and one wonders if its importance is on the slide.
The high street banks do some things very well – but not everything. A myriad of fintech companies are now flourishing because they have split out and focused solely upon one of the many services offered by the banks – international money transfer, for example. Not to mention consumer loans, small business loans, credit facilities, invoice finance, trade finance, and so on. That un-packaging of the bank proposition is at heart of all things fintech.
To my mind, both the banks and the credit bureaus are experiencing a similar kind of squeeze. Though parts of the bank’s broader offering might be stolen away by cutting edge specialists, the vast majority of the bank package will remain relevant for the vast majority of the population. In much the same way, CRA data will remain crucial for the bulk of lenders – alternative or otherwise. It’s the single most predictive indicator of trustworthiness in the face of financial obligation – for most types of borrowers.
Never mind the fact that the CRAs enjoy a privileged position within the financial services ecosystem. There are just three credit bureaus in the UK that are licensed by the FCA, and hence just three that have access to a comprehensive set of historical consumer credit data: Equifax,Experian and Callcredit. While most of the information held by CRAs relates to how well a borrower has maintained his or her credit and service/utility accounts in the past, it also covers details of previous addresses, and information from public sources such as the electoral roll and public records, including county court judgments, as well as bankruptcy and insolvency data.
You can’t simply set up a new Credit Reference Agency. Nor can you lay hands upon the kind of historical data that they’re privy to via some other method. Bottom line? If a lender wants to understand a borrower’s past behaviour – they’re going to need to enlist the services of a licensed Credit Bureau.
What’s more, the indispensability of the CRA is all but assured by the fact that the vast majority of lenders report to them (indeed, they are the only companies to which lenders can report). As this quote from the Information Commissioner’s Office explains:
“It is easy to see why people assume the CRAs are responsible for all the information that appears on their credit file. However, in reality, the lenders and telecoms and utility companies who passed the information to the CRA in the first place also have responsibilities for the information that appears on your credit file.”
In the US, the FICO machine crunches through a heap of credit data before spitting out an end report and score. But crucially that score contains no information whatsoever about a borrower’s age, salary, occupation, title, address, employer, date employed or employment history.
Clearly that manner of marker is of little use to a company like SoFi, which specifically targets Millennials. The platform recently hit the $6 billion mark in cumulative lending, a total comprised of a mixture of student debt, first mortgages and consumer loans. A recent survey – commissioned by Bankrate and compiled by Princeton Survey Research Associates International – revealed that 63% of Millennials (18-29 year olds) do not own a credit card. What, then, can FICO tell SoFi about the majority of its prospective borrowers? Not much. Hence the divorce. The platform will henceforth focus on three core borrower criteria: employment history, track record of meeting financial obligations, and monthly cash flow minus expenses.
But for a company like Lending Club, where the target borrower is not quite so narrowly defined, the value of CRA data is plain as day. Renaud Laplanche said in an email to the Wall Street Journal that FICO scores remain the most useful resource for lenders that are targeting a broad base of borrowers – one which is representative of the entire U.S. population. The Lending Club boss added:
“Niche players focusing on narrower customer segments… would not find as much predictive power in FICO.”
Clearly this article has been a little consumer centric, but the debate is relevant to the small business lending sector too. John Davies, Director of Just Cash Flow PLC – self-styled as the “alternative bank overdraft” for small businesses – offered his take:
“Like most questions the answer is 'it depends'.
Lenders are obligated firstly in law to carry out full AML and KYC checks – and as we live in a world where the funding of terrorism becomes more of an issue for Governments, expect those obligations to become more burdensome.
Therefore you need to source this data from somewhere.
Next lenders have a responsibility to lend responsibly, whether that's to consumers or SME's – I'm not entirely sure how you would achieve that without evidencing what the current financial obligations that the applicant has or how they've managed such obligations in the past.
Building models – such as our own 'Propensity Model' – on top of the Credit Agencies 'big and analytical data' helps us to make better decisions and I'm sure that will be the same for many balance sheet lenders.
Investors have confidence in our business and this would be seriously undermined if we suddenly told them we no longer carry out any in depth credit reference checks on our borrowers, and that instead we rely upon some 'black box' software – the long term effectiveness of which cannot be proven.
I once heard someone say that the advent of the e-book spelt the end of books – right!!”