A Wall Street article “Silicon Valley: We Don’t Trust FICO Scores” is currently making waves concerning the usefulness of traditional credit scoring, the FICO score. A new generation of lenders (FinTech upstarts) is challenging the usefulness of one of the bedrocks of the modern financial system: the FICO score.
One could take umbrage with a number of statements made in the article. First of all the second headline of the article “Lending upstarts challenge usefulness of traditional consumer credit rating” adds to the general confusion about the difference between a credit rating and a credit score. Credit rating is an opinion about the credit standing of a business or individual derived through credit models and human involvement. Credit scoring is a statistically derived numeric expression of a person’s creditworthiness that is used by lenders to access the likelihood that a person will repay his or her debts. Thus the unfortunate use of the term credit rating may give rise to the notion that the author may not be completely at home with this subject.
The key aspect of Silicon Valley not trusting the FICO score is misplaced. BIIA has observed that many of the FinTech startups don’t even start with the use of credit bureau data and FICO scores. Instead they prefer to tap into alternative data sources, for example social media, combined with extreme analytics. Regular comments by FinTech online lenders state that their credit scoring models are more accurate and thus yielding higher credit acceptance compared to FICO or other credit bureau products.
Most likely their risk models can accept higher risk than traditional lenders due to the proclaimed lower cost in online lending. The second reason is the aim of capturing market share by honing in on customer segments, currently ignored or rejected by traditional lenders. There are many people who are enamored by the un-bureaucratic online lending, and as the Wall Street article suggests, there is a huge pool of so called “underbanked” prospects. Whether these new scoring models aimed at expanding credit will hold up in a tougher business environment has yet to be seen.
The article lists commentaries from Social Finance Inc. (SoFi), which offers student-loan refinancing, has decided to do away with FICO scores in its credit decisions. Affirm Inc., which finances the purchase of consumer goods at the point of sale; subprime lender Avant Inc.; and Earnest Inc., which makes student and personal loans, are said to have moved beyond the traditional FICO credit score. These voices may be relevant in Silicon Valley but there are many more online lenders elsewhere who could have been used as examples.
For example take Kreditech, a German online lender, which claims to use big data methods and complex machine-learning algorithms to make better credit decisions. The technology identifies, scores individuals from anywhere in the world in seconds and decides over an instantly paid out credit, based on up to 8000 data points (anything that can be found online). Kreditech says it uses this technology to provide banking products to customers in emerging markets where traditional banks lack ‘oldschool’ scoring data and thus do not serve private customers. It makes modular products (identification, scoring products, and payment options) available to external B2B customers (e.g. microlenders, banks, retailers, debt collectors).
Kreditech is taunting data protection authorities, credit bureaus and banks with its use of social media data and algorithms which use personal relationships between people or whether an applicant is a regular visitor of Casinos, to derive at a decision whether to grant credit or not, or at what cost. That in itself is now causing a backlash in consumer sentiments about credit scoring methods, as the population believes that online lenders use credit scores from credit bureaus. This is an unfortunate side effect of FinTech online lenders going their own way, some perhaps with questionable practices, in credit scoring.
What does FICO say about this: According to the Wall Street Journal article, FICO’s Chief Executive William Lansing last month said that lenders using alternative ways of judging creditworthiness are unlikely to have an impact on his company. “There’s virtually nothing that they do that we can’t do.” Perhaps it can be safely assumed that as long as credit bureaus are in the business to deliver quality data underlying the FICO score, Lansing has nothing to worry about.
About the author: Joachim C Bartels is Managing Director and Editor-in-Chief of BIIA.com. The content of this article does not necessarily reflect the opinion of the members of BIIA.