The OCC, Federal Reserve Board, FDIC, NCUA and CFPB have issued an “Interagency Statement on the Use of Alternative Data in Credit Underwriting.”
The statement sets forth the agencies’ recognition of the benefits of using alternative data (AD) in credit decisions. For purposes of the statement, AD means “information not typically found in the consumer’s credit files of the nationwide consumer reporting agencies or customarily provided by consumers as part of applications for credit.” The benefits cited by the agencies include improving the speed and accuracy of credit decisions (including in connection with small business underwriting), helping firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system (sometimes called “credit invisibles”) or would otherwise be denied credit (such as in “Second Look” programs), and enabling consumers to obtain additional products and/or more favorable pricing/terms based on enhanced assessments of repayment capacity.
The agencies specifically discuss the automated use of cash flow data to evaluate a borrower’s ability to repay as an example of how the use of AD “may present no greater risks than data traditionally used in the credit evaluation process.” The agencies indicate that such data “may include a range of metrics that examine categories of income and expenses (e.g. fixed expenses such as housing, amount of variable expenses, etc.) and how a consumer or small business has managed an account over time (e.g. residual balances).” Noting the traditional use of a borrower’s income and expenses to determine the borrower’s repayment ability, the agencies state that “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.” The agencies also comment that the cash flow data used “are specific to the borrower and generally derived from reliable sources, such as bank account records, which may help ensure the data’s accuracy.” Significantly, they observe that the use of cash flow data and other AD that are directly related to a consumers’ finances and how consumers manage their financial commitments may present lower risks than other data. (Presumably such AD present lower risks because of their greater accuracy and direct relationship to credit underwriting.)
While recognizing the benefits of AD, the agencies also highlight the need for the use of AD to be consistent with applicable consumer protection laws, citing fair lending laws, UDAAP prohibitions and the FCRA as examples. They comment that a well-designed compliance program would provide “for a thorough analysis of relevant consumer protection laws and regulations to ensue firms understand the opportunities, risks and compliance requirements before using [AD]” and that based on such analysis, AD “that present greater consumer protection risk warrants more robust compliance management” such as appropriate testing, monitoring and controls to understand and address consumer protection risks.
AD is often used in conjunction with artificial intelligence (AI) models. Our weekly podcasts include an episode released in June 2019 titled, “Using artificial intelligence for consumer finance: a look at the opportunities and challenges.” In the episode, we discussed the opportunities and challenges created by the use of AI models in consumer financial services, including the benefits of explainable AI and its implications for the consumer financial services industry, especially for applications where understanding the model’s reasons for returning a score or decision are necessary. Click here to listen to the podcast.