By Yuka Hayashi
WASHINGTON -- Consumers with spotty or no credit histories might find it easier to get loans after federal banking regulators endorsed alternatives to traditional methods of assessing creditworthiness.
The regulators on Tuesday backed the use of information such as borrowers' cash flow as an alternative to the traditional credit-evaluation system, which relies on scores issued by companies such as Equifax Inc. and Experian PLC based on applicants' past history of borrowing and repayments.
Alternative data "may help firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system," the regulators said in a written statement. "To the extent firms are using or contemplating using alternative data, the agencies encourage responsible use of such data," the regulators added.
An estimated 45 million to 60 million consumers lack the credit history needed to generate reliable credit scores under the current system, and millions more don't have access to affordable credit because of low scores, according to FinRegLab, a nonprofit research organization. The problem is particularly acute for people with low incomes.
In a study this year, the group concluded that data on incomes and spending is one of the most promising ways to improve access to credit. It said more than 96% of U.S. households have bank or prepaid accounts, and their current account information is now easily accessed electronically. The study looked at lending data from fintech firms that already use alternative data in making lending decisions, including Accion, the U.S. Network Inc., Kabbage Inc., LendUp Global Inc. and Petal Card Inc.
"It's helpful to have the agencies weigh in," said Kelly Cochran, deputy director of FinRegLab. "It's particularly useful for banks, but also nonbanks, who have been thinking about these data."
Lawmakers introduced several bills this year to improve the credit-scoring system and held hearings to discuss the use of alternative data. The Government Accountability Office has urged regulators to clarify their stance on the use of alternative data to help fintech firms comply with fair-lending laws and help banks better manage potential risks stemming from working with fintech companies.
The use of alternative data and analytical methods has raised questions about fairness and the risk of lending discrimination. For example, some lenders use people's occupational history and educational background as factors in loan evaluation, saying that they are strong predictors of repayments.
Consumer advocates say such data discriminate against many people and would only enhance income inequality and the gap between those with and without access to inexpensive credit. Some lenders have been criticized for their attempts to use data gleaned from social media.
In their statement Tuesday, the regulators, including the Federal Reserve and the Consumer Finance Protection Bureau, said lenders using such data must take steps to ensure that consumer-protection risks "are understood and addressed."
Write to Yuka Hayashi at email@example.com
Corrections & Amplifications
This article was corrected at 7:06 p.m. ET to reflect the correct company name of Accion, the U.S. Network Inc.. The original version of this article incorrectly referred to it as Accion international.