Problems Seen in New FICO Program
A new FICO score that has been specifically designed for underserved populations may be noble in its aim, but some are suggesting it could have unintended consequences for the consumers it seeks to help and the financial institutions who work with them.
"Anything that takes into account non-traditional information could be very favorable from our point of view," said Cliff Rosenthal, executive director of the National Federation of Community Development Credit Unions. "But one concern is the underreporting of positive information."
The new FICO score is based on alternative data, such as payday loan performance, to help determine a person's credit risk when there is little or no "traditional" lending data available. The idea, said the company rolling out the product, Fair Isaac, is to help the "unbanked" gain access to traditional financial services, which tends to be more economical than the alternative sources these consumers often must turn to instead. At the same time, the new FICO score will also help banks and credit unions reach out to a potentially lucrative, relatively untapped market.
The potential problem with underreporting is of particular concern, Rosenthal suggested, because many of the untraditional financial service outlets-payday lenders, pawn brokers, check cashers and others-often do not share their clients' payment histories.
"In general, it sounds like a step in the right direction," Rosenthal commented. "But there are other concerns. When credit unions are examined by NCUA, those examiners often rely pretty heavily on FICO scores. Our credit unions have argued that FICO scores don't always capture the full picture, and for many of our credit unions' members, there is no relevant score to look at. If NCUA sees the new FICO score as the answer and FICO scores become even more of a Bible for examiners, then that could cause problems."
CDCUs Ideal, Except...
Community development credit unions, perhaps moreso than most other traditional financial service providers, deal with exactly the consumer group for whom the new FICO score was developed-but it could end up being that CDCUs are the least likely to use the new score. "Most of these credit scores require that a financial institution order a minimum number of reports," Rosenthal explained. "For some of our small credit unions, they're just not ever going to reach that minimum."
There is also the question of whether the new FICO score and its goal of allowing the underserved greater access to traditional lending services will actually change the consumers' behavior.
"This is a very loyal group. But it's also a group for whom convenience is king," said Bob Hoel, executive director of the Filene Research Institute, which has done extensive research into who uses the non-traditional financial service outlets. "Many of these people work odd hours, several shifts or multiple jobs, so 'banker hours' don't work for them, and most credit unions close promptly at 5, 5:30 or 6 p.m. The new credit score won't change that."
And the new score won't change one thing. "Some will switch for a better price, some will choose not to because of the perceived switching costs, which we refer to as the agony of switching. It's the same reason that keep buying the same brand of cereal, even when there's a cheaper version of the exact same cereal on the shelf next to it," Hoel noted.
A 'Very High Number'
Hoel also echoed Rosenthal's concerns about underreporting of data-any data-for these consumers. Fair Isaac estimates that about 160-million people are already covered by the company's traditional FICO scores but that approximately 50-million didn't have enough credit history to generate a score for them. FI said it believes it now has enough alternative data on 25 million of those "unbanked."-a number which surprised Hoel by its size.
"That's still a very high number," he said. "Many people using these alternative financial outlets are quite loyal, but beyond that, these outlets have a captive client because they're the only ones who have any information on these people. Plus, many people are engaged in more informal financial transactions, lending among family members, pooling their resources. There simply isn't any information on any of these activities."
If nothing else, Hoel and Rosenthal agreed, the new FICO score indicates a growing interest among financial services to reach out to what is coming to be seen as a potentially lucrative segment of the market.
"Banks are seeing that they can profitably serve the underserved instead of writing off these segments," Rosenthal observed. "In the best of all possible worlds, the new FICO score will mean that people will have a choice of providers, and that's good for the consumer."
"I think [Fair Isaac] knows there's a real need for this market, and it won't just be banks and credit unions that are interested in this score. Some of the alternative financial service providers are probably interested in this, too," Hoel said. "Whenever consumers have more choices, they win."