The CFPB made an announcement in October that caused many consumer advocates to cheer and many bankers to scratch their heads. In short, the CFPB is ready to address the decades-old consumer complaint of being rejected for a checking account based on information that they believe is irrelevant, inaccurate or inconvenient.
Banks generally use closed-for-cause data to identify past losses or credit data to predict future ones. Increasingly, they are finding that a mix of these data types is highly effective for reducing consumer fraud and risk. Unfortunately, the CFPB missed the mark in their comments regarding banks decision making processes for demand deposit accounts (DDAs) and bankers may therefore miss the mark in their response. Happily, there may be a compromise.
Is closed-for-cause data a problem?
Nearly all institutions now use closed-for-cause data. This data simply indicates that a consumer held an account with a financial institution, but the account was closed for an adverse reason. It could be anything from fraud to an unpaid fee.
The value of this data is indisputable. Only a decade ago, fraudsters could move from bank to bank to credit union with the intent of fraud and little risk of being caught before the damage was already done. As adoption of best practices progressed to increasingly smaller institutions, the fraudsters had fewer banks to prey upon. This has been great news for banks that now share fraud information and experience fewer losses.
The impact of closed-for-cause has not been as good for consumers. Since the data isn't "credit data" regulated by the FCRA and FACTA, consumers have limited recourse if they believe they were unfairly labeled as high risk.
There are many cases of customers who forgot to close an account when they moved or were so barraged with overdraft fees that they abandoned their bank out of frustration, leaving a balance due in their wake. In some cases the adverse indication is entirely based on a bank error. Without recourse and with all banks having adopted this data in their account opening process, these consumers are effectively locked out of traditional financial services.
While closed-for-cause correctly identifies many of the consumers who plan to perpetrate fraud, it isn't able to predict fraud among consumers without a history of fraud. As a result, a smaller number of financial institution's have begun using predictive models based on credit data instead of or in addition to historical models. I've seen studies that show a minimal overlap between the two approaches.
For the bank, this means their fraud prevention efforts can be even more effective. Unfortunately, innocent consumers might be more likely to be denied an account.
Are DDA accounts credit accounts?
A key element of Richard Cordrays address on the subject was concern about credit data being used to evaluate deposit accounts. While this might sound egregious to some, most banks consider checking accounts to be a credit account.
There are a few reasons for this. Many checking accounts incorporate an overdraft option, though that could be easily declined. More subtle is the courtesy overdraft that many banks offer at no charge for customers in good standing. The real credit relationship, though, is from the nature of paying by check. There is an ancient and implicit relationship between the bank and consumer that allows the customer to issue a promise to pay without demonstrating that they possess the funds in their account.
It is this time gap that allows check kiting and remote deposit fraudsters to ply their craft. Credit risk can only be eliminated if check writing is removed from the account.
Another challenge to the CFPB position is that credit data is a remarkable proxy for understanding consumer attention to the personal details of their life. Even if credit data isn't technically relevant to opening a checking account, it can be a great predictor of consumers who are likely to abuse or neglect their accounts.
While the classic credit score used by most institutions narrowly predicts the likelihood of payment default within 18 months, it is widely applicable to many questions that relate to consumer attentiveness. Credit scores also rank order the likelihood of auto insurance claims and damaged apartments with stunning accuracy.
It is the nature of statistics that we are able to predict one thing with another. Proof of this came from a data study by J.P. Martin of Canadian Tire who analyzed a treasure trove of the company's credit card transaction details. One of the more interesting, predictive relationships he found was whether people buy felt feet for their furniture. Apparently, protecting your floor from scratches is incredibly correlated to protecting your finances from unexpected errors.
Should banks offer accounts to high risk consumers?
The question that the CFPB really raised, perhaps without intending to, is if it is appropriate for banks to offer accounts to everyone that requests one. While they tacitly acknowledged that fraud may be a real risk to FI's, it was clear that they are leaving that problem to other regulators. Their concern is that consumers are being excluded from "mainstream financial services" by the anti-fraud efforts. In the real world, we cannot predict with perfect accuracy who will turn bad, only the odds of someone turning bad compared to others.
My credit score was the same as people who strategically defaulted on their mortgage during the 2008 housing crash. No model was able to distinguish my risk from theirs. The reality of banking is, and has always been, that good players underwrite the bad. Our analytics help us to gauge and manage that risk.
The CFPB approach is to eliminate statistical risk as a tool in DDA opening, or more likely, to create a new account type for known bad risks who will be issued an account regardless. Ignore for the moment the eerie similarity to mortgage lending before the crash. There is no checking account product today that would be safe to provide to high-risk consumers.
So, assuming the CFPB doesn't abandon this effort as a fools errand, we need to invent a new account that addresses the consumer complaints while still protecting the FI from both fraud and those with a proven history of poor financial management. The good news is that it might be possible, although it would have fewer conveniences than many accounts today.
Is there a compromise?
The right mix of account features is necessary to eliminate risk while inclusively welcoming risky consumers into the mainstream. They would need to include; deposits cleared or insured before funds are available, all funds dispersed in real time (no float), and checks or payments issued only against available funds.
The ultimate compromise for regulators and consumers alike might look something like this:
- Prepaid debit card as the base account.
- Deposits through ATM and mobile with a paid option to immediately release funds.
- Option for checks or money order printed at the ATM based on available funds.
- No overdraft protection option, no upgrade option, and no checks.
- No regulatory headaches about disenfranchised consumers.
Many bankers will likely find that a real time banking product appeals to some of their existing customers as much as the CFPB. How about the notion that many consumers would be willing to pay a fee for the convenience of this type of account? Happily, there might be a compromise after all.
Eric Lindeen is marketing director for Zoot Enterprises Inc., a provider of loan origination, account acquisition and credit risk management solutions for large financial institutions. You can follow him on Twitter @EricLindeen.