The federal banking agencies have issued a joint statement on the use of alternative data in underwriting by banks. The statement notes the benefits that using alternative data may provide to consumers, such as expanding access to credit and enabling consumers to obtain additional products and more favorable pricing and terms. The statement explains that a well-designed compliance management program provides for a thorough analysis of relevant consumer protection laws and regulations to ensure firms understand the opportunities, risks, and compliance requirements before using alternative data.
As with prior developments in the evolution of credit underwriting, including the advent of credit scoring, the use of alternative data and analytical methods also raises questions regarding how to effectively leverage new technological developments that are consistent with applicable consumer protection laws. Applicable consumer protection laws, include, as appropriate, fair lending laws, prohibitions against unfair, deceptive, or abusive acts or practices, and the Fair Credit Reporting Act.
The agencies recognize alternative data’s potential to expand access to credit and produce benefits for consumers. To the extent firms are using or contemplating using alternative data, the agencies encourage responsible use of such data. In addition, the agencies are aware that the use of certain alternative data may present no greater risks than data traditionally used in the credit evaluation process. For example, the agencies are aware that some firms are automating the use of cash flow data to better evaluate borrowers’ ability to repay loans. While this is a rapidly developing area of innovation, analysis of cash flow data generally focuses on assessing whether a borrower is able to meet new or existing recurring obligations by evaluating income and expense activity over time. The evaluation of a borrower’s income and expenses to help determine repayment capacity is a well-established part of the underwriting process. Improving the measurement of income and expenses through cash flow evaluation may be particularly beneficial for consumers who demonstrate reliable income patterns over time from a variety of sources rather than a single job. Cash flow data are specific to the borrower and generally derived from reliable sources, such as bank account records, which may help ensure the data’s accuracy. Consumers can expressly permit access to their cash flow data, which enhances transparency and consumers’ control over the data. Additionally, creditors’ use of cash flow data can generally be explained and disclosed to the borrower, as may be required under the Equal Credit Opportunity Act and the Fair Credit Reporting Act.
The manner in which alternative data is used in relation to traditional data also can provide benefits. For example, some firms may choose to use alternative data only for those applicants who would otherwise be denied credit, often called a “Second Look” program. Used in this fashion, Second Look programs may improve credit opportunities. Second Look approaches must also comply with applicable consumer protection laws.
Many factors associated with the use of alternative data, including those discussed for cash flow data, may increase or decrease consumer protection risks. For example, using alternative data, such as cash flow data, that are directly related to consumers’ finances and how consumers manage their financial commitments may present lower risks than other data.
A well-designed compliance management program provides for a thorough analysis of relevant consumer protection laws and regulations to ensure firms understand the opportunities, risks and compliance requirements before using alternative data. Based on that analysis, data that present greater consumer protection risks warrant more robust compliance management. Robust compliance management includes appropriate testing, monitoring and controls to ensure consumer protection risks are understood and addressed.
Alternative data include information not typically found in consumers’ credit reports or customarily provided by consumers when applying for credit. Alternative data include cash flow data derived from consumers’ bank account records. The agencies recognize that use of alternative data in a manner consistent with applicable consumer protection laws may improve the speed and accuracy of credit decisions and may help firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system.