Recent estimates put the number of people without access to mainstream credit at around nine million in the UK [1]. The net effect is more and more people turning to high-cost loans from payday and doorstep lenders. Whilst the barriers to mainstream credit are varied, this article will set out to define four major categories, or as I’m calling them, “fallacies of consumer credit”.
Attainability
Perhaps the most obvious barrier to mainstream credit is a lack of attainability. The age-old “chicken and egg” problem still plagues first time borrowers. Credit Reference Agencies (CRA) consider a variety of factors when evaluating potential risk. Chief among these is historical repayment data, be it for a mortgage, loan, mobile phone contract or other forms of credit. No matter how much of a “good risk” you may be, lack of historical data very often works against you when applying for a credit product. This is compounded if you have borrowed from a high-cost lender as outcome data from doorstep/payday lenders is rarely considered by the CRAs, and carries far less significance.
Suitability
If it’s not attainability preventing borrowers from successfully applying for credit, often the suitability of product offerings can be the limiting factor. Alongside credit history, CRAs also consider “account turnover” data collected from partner financial institutions. This usually means an applicant's bank account balance for a given time period. Whilst this can provide insight, it can also be misleading if the applicant does not receive income at regular intervals (think zero-hours contracts, freelancers and contractors, for example). At best this misjudgement may lead to applications being wrongly declined (false-negatives), or far worse, wrongly accepted (false-positive). This might happen if an applicant shows a “healthy” financial state during application but whatever reason is unable to maintain sufficient income required to meet the repayments. The latter example is further compounded by the inherent delay in data reaching the CRAs (records are often a month or more behind).
Transparency
“Credit scores aren’t a problem until they’re a problem,” a senior director at a large lender once told me. He was referring to the fact that most people don’t think about their credit profile until they get rejected for a loan. The “spot-check” model employed by CRAs is completely opaque. Few of us know what our credit score is, and fewer still actually understand the factors that come together to calculate it, not to mention the adverse effects of simply having the calculation performed. Whilst improvements in financial education will certainly help the situation, I believe a move to a participatory form of credit scoring is necessary if we are to buck the “head in the sand” attitude that is prevalent today.
Portability
Perhaps the elephant in the room, or, more precisely, the elephant in the head offices of most CRA’s, is portability. That is, the lack of a formal credit paper trail that crosses borders. I recently moved back to the UK having spent the first two years of my working life based in San Francisco. Despite having been in full time employment for the entirety of my absence I still struggled to pass CRA checks when signing tenancy agreements or applying for a mobile phone contract. This seems like such low hanging fruit, and yet there’s still no widely accepted solution. There’s no reason for my financial history in a given locale to be siloed.
So what is being done to address these major failings of the current system?
The Financial Inclusion Commission made a number of key recommendations in their March 2015 report [2]. Firstly, the Government should “enable the use of public sector and non-traditional data in credit scoring, with safeguards, to make access to financial services easier for excluded groups”. As well as this, the Government should “lead a collective effort with retail banks and others to promote wider data disclosure and to fill the low income credit gap which has been widened by departing payday lenders”. Both recommendations point to the need for innovation and change in the sector.
A number of new entrants are working to develop scoring products that leverage a much wider “non-traditional” dataset. Aire’s platform (currently in closed beta) will enable borrowers to contribute their own information in order to build a score through means of a mobile application. Self Lender (currently US only) helps borrowers build credibility with the existing CRA’s through a series of “credit builder loans”. Tools like ClearScore add transparency, giving users access to their Equifax score and providing advice on how to improve it.
There’s still much change yet to come, with many services still relying on CRA’s and borrowers playing second fiddle to obsolete algorithms when it comes to building credibility. The end of 2015 saw the Open Banking Working Group deliver their report to HM Treasury [3], laying the foundations for an open API standard in UK banking. Programmatic banking could provide the key to far richer analysis and scoring. Research has already shown the efficacy of using account transaction data to predict delinquency [4]. Pairing such methods with an appropriate permissions model to alleviate consumer anxiety is important. Trust will be required to invite borrower participation and provide a much needed change of course to address these four failings going forward.
[1] New Economics Foundation, 2009. Doorstep Robbery: Why the UK needs a fair lending law, London: New Economics Foundation.
[2] Financial Inclusion Commission, 2015. Improving the Financial Health of the Nation.
[3] https://theodi.org/news/open-banking-working-group-roster-report-announced
[4] Amir E. Khandani et al, 2010. Consumer Credit Risk Models via Machine-Learning Algorithms.
