In today’s hyperconnected world, several new methods of evaluating an individual’s creditworthiness are emerging. Influenced by the vast amounts of consumer data available, creditors are exploring new credit scoring models. In this article, we take a look into what alternative credit scoring is and the role it plays in today’s society. We’ll also discuss in which markets it can have the most impact, and how it can ultimately benefit credit companies.
What Is Alternative Credit Scoring?
Credit scores are traditionally based on consumer credit reports information, available from bureaus such as Equifax or FICO. Any credit scoring method that does not use conventional credit history information such as past banking financial transactions, falls under the broad spectrum of alternative credit scoring. New-age credit scoring companies are utilizing data coming from various alternative sources. To determine a person’s creditworthiness, they analyze information from their daily activities, behavioral patterns, and digital footprint.
Where Does Alternative Credit Scoring Come From?
Vast Amounts of Underbanked Populations
Over 30% of the world’s population, along with a large number of micro and small businesses, lack access to formal financing systems or other banking services. And this starts to make sense once you consider the vast unbanked populations in developing countries, as well as consumers that are new to the financing and credit ecosystem.
Alternative credit scoring stems from the problem that for such marginalized groups, centralized credit data is either insufficient or unavailable. By looking into criteria other than traditional credit history, companies are able to profitably serve customers that are otherwise financially active, providing a great way for these populations to be introduced into the financing and credit landscape.
Key Information & Resources Becoming Available
Credit scoring agencies continually improve and update their scoring models, as part of their internal process. From scanning mobile phone logs to analyzing online social behavior, creditors are making lending decisions based on data coming from novel sources. However, basing a creditworthiness assessment to data disconnected from traditional credit and economic activity has only recently become sustainable. This is due to cost-efficient access in three key resources: availability of vast amounts of consumer data; computing power becoming more affordable; and AI advancements.
The Top Relevant Models of Alternative Credit Scoring
Alternative credit scoring companies are tasked with converting overwhelming amounts of data, into credit risk insights. In achieving this goal, a variety of models of alternative credit scoring have been developed, based on different types of analyses of consumer data.
Cell Phone Usage
This model considers the information coming directly from cell phone usages, such as GPS data, contact lists, and SMS & call logs. Companies are using AI to develop scoring models by identifying relevant data patterns. These include how much a person is organized, utilizes contacts, has a regular income, or engages in transactions outside of the banking system, and the locations in which they spend more time.
Daily Expenses Payment History
The calculation of an alternative credit score, in this case, takes into account an individual’s payment history for reoccurring expenses. Things like utilities, internet, phone bills, and even subscriptions to online services. The idea in this model is that a responsible payment history of your everyday expenses or monthly bills should grant you a good credit score.
Social Behavior Credit Rating
Social behavior is at the heart of this alternative credit rating system. Factors such as social media footprint, career experience, education, and monthly salary, are taken into consideration. Using AI, predictive tools, and big data analytics, this system provides a method of assessing credit risk based on one’s overall social standing.
Sectors Affected by Alternative Credit Scoring
Any sector engaged in providing credit to its customers, will be affected by this novel credit scoring paradigm. And even though this applies to many secondary sectors, such as car leasing companies, for example, the ones most affected are the finance and technology sectors.
The first major area to be affected will be FinTech companies, which have already adopted a modern tech-driven outlook on business. Alternative credit scoring can provide them with a way to reach large audiences that share a similar mindset. Another sector affected will be more traditional banking institutions. With alternative credit scoring opening up new lending options for wider audiences, it could provide a basis for people to request lower interest rates for their existing bank loans. Moreover, banks are bound to utilize alternative credit scoring in combination with traditional credit scoring, to assess a person’s creditworthiness; or even provide borrowing products based exclusively on the customer’s alternative credit score.
The acquisition of customer information by creditors is a challenge in and of itself, as they include user consent and legal implications, according to regional jurisdictions and regulations. For this reason, technology providers such as mobile phone manufacturers, mobile phone application developers, internet service providers, and social media companies, are directly affected. By providing alternative credit score evaluations, these companies with raw user data open up new modes of income. Tech companies could engage in defining and calculating specific indicators for their users, in cooperation with alternative credit scoring companies. The latter can use such indicators from multiple services in aggregate, to assess a person’s alternative credit score.
How Companies Can Use Alternative Credit Scoring to Their Benefit
Lenders can use alternative credit scoring to boost their reach in underserved geographical areas while minimizing their risk. These rural and outer urban areas of developing economies can be accessed without the need for infrastructure, through the utilization of mobile technologies.
Adapt Credit Scoring Systems
Alternative credit scoring might be relatively new now, but once it has matured, certain elements will inevitably become part of traditional credit scoring. This helps banks and mortgage companies to innovate and update their old school credit scoring systems.
Real-Time Credit Assessment
The real-time nature of the data upon which alternative credit scoring is based, provides creditors with a dual advantage. This data will help to maximize profit with a faster turnaround. Companies won’t miss out on potential business with borrowers who might have a bad credit score due to past difficult circumstances but have now attained financial stability. This will also help to reduce risk and improve accuracy. A credit score will be based on an applicant’s current creditworthiness, rather than their overall past score.
Alternative credit scoring cannot replace traditional credit scoring altogether, but it will serve to complement the system. Even though it’s a fairly new concept and it could involve an increased risk for creditors, there is significant momentum in its adoption and it is expected to continue to take hold well into the future.