The five federal financial regulatory agencies recently issued a joint statement on the use of alternative data in underwriting by banks, credit unions and non-bank financial firms. The agencies sought to highlight the consumer benefits of using alternative data in terms of credit availability.
In the statement, the agencies described how a well-designed compliance management program can enable companies to account for relevant consumer protection laws and regulations to ensure all opportunities, risks and compliance requirements when using alternative date in credit decisions.
“[D]ata that present greater consumer protection risks warrant more robust compliance management,” the agencies wrote. “Robust compliance management includes appropriate testing, monitoring and controls to ensure consumer protection risks are understood and addressed.”
Alternative data includes information not typically found in consumers’ credit reports or customarily provided by consumers when applying for credit, the statement explains. Such data include cash flow information derived from consumers’ bank account records.
“Improving the measurement of income and expenses through cash flow evaluation may be particularly beneficial for consumers who demonstrate reliable income patterns over time from a variety of sources rather than a single job,” the agencies wrote. “Cash flow data are specific to the borrower and generally derived from reliable sources, such as bank account records, which may help ensure the data’s accuracy. Consumers can expressly permission access to their cash flow data, which enhances transparency and consumers’ control over the data. Additionally, creditors’ use of cash flow data can generally be explained and disclosed to the borrower, as may be required under the Equal Credit Opportunity Act and the Fair Credit Reporting Act.”
The agencies noted that the use of alternative data can be done in a manner consistent with applicable consumer protection laws – such as fair lending laws, the Fair Credit Reporting Act and Dodd-Frank Act prohibitions against unfair, deceptive or abusive acts or practices. In fact, the agencies asserted that “the use of certain alternative data may present no greater risks than data traditionally used in the credit evaluation process.”
“For example, the agencies are aware that some firms are automating the use of cash flow data to better evaluate borrowers’ ability to repay loans,” the agencies wrote. “While this is a rapidly developing area of innovation, analysis of cash flow data generally focuses on assessing whether a borrower is able to meet new or existing recurring obligations by evaluating income and expense activity over time. The evaluation of a borrower’s income and expenses to help determine repayment capacity is a well-established part of the underwriting process.”
They asserted that alternative data use could help improve the speed and accuracy of credit decisions. Additionally, the agencies stated that its use could help institutions evaluate the creditworthiness of consumers who currently may not obtain credit through traditional credit avenues.
The statement was issued jointly by the Federal Reserve, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the National Credit Union Administration.