‘Alternative data’ can improve access to credit for millions of Americans. It can do this by overcoming two important limitations of today’s best practices in lending, which rely heavily on credit scores from the three major credit reporting agencies.
The two principal limitations of current best practices are that:
1. Many consumers remain ‘credit invisible’, meaning that no credit scores are available for them
2. The accuracy of scores today, while very good, is still sufficiently limited that many potentially good borrowers must necessarily be denied access to credit because they cannot be statistically separated from poorer risks
Alternative data show significant potential to improve the status quo by enhancing the accuracy of existing scores (achieving better risk separation), and by rendering visible many of today’s credit invisibles. Progress will come about through the private sector efforts of established lenders and credit bureaus, as well as the innovations of FinTechs, alternative data vendors and big data analytics firms, operating in the free market. There may also be a limited role for regulatory and/or legislative initiatives. The end result will be better and fairer access to credit for individuals, with macro benefits for the whole economy.