Regulators give wary nod to use of alternative data in underwriting

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Regulators are cautiously open to the use of alternative data to improve consumer access to credit, financial agencies said in joint guidance released Tuesday.

The agencies said they recognized that the “use of alternative data may improve the speed and accuracy of credit decisions and may help firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system.”

While regulators repeatedly stressed the importance of following applicable consumer protection laws in the guidance, the document’s tone on the whole seemed open-minded. It will likely be seen by banks and the fintech industry as a green light for certain practices that have been operating in fuzzy legal territory for years, like using artificial intelligence to determine creditworthiness.

“The agencies are aware that the use of certain alternative data may present no greater risks than data traditionally used in the credit evaluation process,” regulators wrote.

Fintechs have contended for years that relying on traditional underwriting, such as credit reports, leaves many consumers without access to credit. Several firms employ cash-flow data, among other alternative measures, to assess consumers' creditworthiness.

The guidance was jointly released by the Federal Reserve Board, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, Consumer Financial Protection Bureau and the National Credit Union Administration.

The guidance follows a report released in July by the Government Accountability Office that urged regulators to provide specific guidance on the use of nontraditional data in credit underwriting, saying that the lack of certainty was acting as “a barrier to further financial innovation in expanding access to credit."

The GAO, which presented its initial draft findings to the agencies in December 2018, recommended regulators “communicate in writing to fintech lenders and banks that partner with fintech lenders on the appropriate use of alternative data in the underwriting process.”

In the guidance, the agencies highlighted a few areas in which alternate data in credit underwriting could potentially improve credit underwriting, including small business loans, and practices that “may present no greater risk than data traditionally used in the credit evaluation process,” such as analyzing the cash flow of consumer checking accounts.

Such use of alternate data “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 said.

Regulators repeatedly stressed the importance for companies to comply with existing consumer protection law and said that the use of alternate data would naturally come with risks that would need to be monitored. But they also said certain uses of data would present fewer risks than others: namely, using data “directly related to consumers’ finances and how consumers manage their financial commitments may present lower risks than other data.”

Notably, the agencies did not weigh in on the specific value or risk of using artificial intelligence and other automated processes to determine creditworthiness, only going as far as to say that they were aware of its ongoing use among “some firms” and referring to it as “a rapidly developing area of innovation."

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Law and regulation Alternative lending Jelena McWilliams Joseph Otting Randal Quarles Kathy Kraninger FDIC OCC Federal Reserve CFPB