Open Banking
Improving Financial Inclusion: Alternative Credit Scoring and Access to Financial Services
According to FICO, “79 million people in the U.S. have [credit] scores below 680, a common lender threshold of acceptable credit.” And “53 million people in the U.S. do not have enough data in their credit files to generate a FICO® Score.” With low scores or no scores, these tens of millions of Americans don’t have access to loans to help them take the next step in their financial journey. Additionally, many Americans don’t have access to other financial products and services that could help them be more financially stable.
These consumers aren’t seeing the benefits of financial inclusion or, as the World Bank puts it, “access to useful and affordable financial products and services that meet their needs—transactions, payments, savings, credit and insurance—delivered in a responsible and sustainable way.”
While these consumers may not have credit in the traditional sense or access to financial services, many have money flowing in and out of their accounts and may be perfectly capable of repaying their debts. So how can financial inclusion improve to include those who would be excellent candidates for financial products and services, even if their credit scores are low or nonexistent? Here are two crucial ways to improve financial inclusion:
- Financial institutions need to look at the whole picture of financial health—not just the traditional measures of creditworthiness or simply the propensity to repay.
- Consumers need to have access to financial services and products in place of high-risk, nontraditional lenders or accounts.
Keep reading to learn why these are important and how to make them happen.
A Holistic Picture of Financial Health
Currently, lenders gauge creditworthiness by looking at the five Cs of credit:
- Character. What is reflected in the applicant’s credit history?
- Capacity. What is the applicant’s debt-to-income ratio?
- Capital. How much money does the applicant have?
- Collateral. Does the applicant own an asset that can back the loan?
- Conditions. What is the purpose of the loan? What is the amount involved? And what are interest rates like?
While these five Cs are definitely good indicators to take into account, financial institutions miss out on lending opportunities when these are the only criteria they look at. Lenders should look at the whole picture of financial health, which includes indicators besides good credit. These can include bank account health, responsible spending behavior, and bill payment history.
Bank account health is a great indicator that consumers are responsible with their finances:
- They are prepared for financial crises. They don’t overspend and they have started a retirement account.
- They have both a savings account and an emergency savings account.
- They stay above the minimum balance requirement for checking accounts.
When consumers demonstrate responsible spending behavior, they avoid lifestyle inflation and stick to a budget. Their expenses do not exceed their income.
Bill payment history not related to credit may include utilities, internet and phone, and subscriptions. If consumers are paying all their bills and paying on time, they’re likely a good candidate for financial services.
Financial inclusion improves when financial institutions look at the whole picture of financial health and not just the traditional measures of creditworthiness or simply the propensity to repay.
High-Risk Loans
Currently, consumers with low or no credit typically have access only to high-risk loans. These loans often charge high fees and interest rates, may require big-ticket items for collateral, and may put a cosigner on the hook if the loans are not repaid. Payday lenders, for example, can legally charge annual interest rates of up to 400 percent. Clearly, high-risk loans are not a responsible or sustainable way for consumers to improve their financial situation.
On the other hand, the best loans out there are typically available only to people with high credit. While interest rates are currently very low, “borrowers will likely face stricter lending standards as lenders try to protect against the coronavirus downturn,” writes Zina Kumok for U.S. News. While these loans are great options for those who qualify, standards for qualification are high and unattainable for many borrowers.
Financial inclusion improves when borrowers have access to financial services and products in place of high-risk, nontraditional lenders or accounts.
Bridging the Gap between Financial Exclusion and Financial Inclusion
To bridge the gap between what is currently available and what could be available, consumers and lenders need to have access to alternative data. This data can be provided through transactions and account details via open banking connections.
Two examples of this solution are Experian Boost and UltraFICO.
Experian Boost is a service that can do the following:
- Raise FICO® Scores quickly
- Give credit for paying non-credit-related bills
- Give consumers free access to their Experian credit report and FICO® Score
- Provide Experian credit monitoring and alerts
An UltraFICO™ Score aims to enhance consumers’ FICO® Scores by taking sound financial behavior into account. If consumers consistently have cash on hand and their accounts maintain a positive balance, their UltraFICO Score may actually be higher than their FICO Score. According to UltraFICO, there are “15 million people in the U.S. who can receive an UltraFICO™ Score, even if [they] don’t have enough credit history to generate a FICO™ Score.”
An UltraFICO Score is generated instantly, giving you access to good credit decisioning as soon as you need it. With the ability to improve or create traditional credit scores, consumers have greater access to traditional loans and lower interest rates, giving them a boost towards their financial goals.
Our Finicity Lend™ data services are another resource to improve financial inclusion. Made possible by our open banking platform, Finicity Lend gives consumers the power to permission data access and gives lenders access to the data they need to make credit decisions. With Finicity Lend, lenders can make decisions that benefit them and consumers, and consumers are empowered to be fully involved in the process.
Millions of Americans are currently financially excluded, so improving financial inclusion is crucial to help them reach their financial goals. When financial institutions look at the whole picture of financial health, and when consumers have access to responsible financial services and products, financial inclusion improves and everyone benefits.