August 2008 Issue
One of the biggest misconceptions about underbanked consumers is that they all are lousy credit risks.
Forty million U.S. households are unbanked or underbanked. Unbanked consumers have no formal account relationships with financial institutions, although they may once have had accounts. Underbanked consumers have an account but simultaneously rely on a host of nonbank financial products and services to meet their needs.
The definitions have little to do with credit profiles. In fact, a recent study by the Center for Financial Services Innovation found a big difference between consumers who are underbanked and those who are "subprime."
We surveyed nearly 3,000 unbanked and underbanked consumers across the country to understand their financial behaviors, attitudes, aspirations and credit scores. We received enough information to acquire credit profiles for 79% of our sample.
The results? Twenty-five percent had a prime credit score or better, according to VantageScore. One-third were subprime or high-risk.
But the most-staggering figure: 42% had no credit score. Most of these consumers had no credit file. A few of them had a credit file, but it had too little information in it to be scored.
Having a thin or no-credit file cannot automatically be equated with high risk. It simply means there is not enough data to determine a consumer's risk profile.
Imagine the immigrant who arrives in America with no credit history because his home-country experiences have no bearing here. Consider the widow whose credit file has lapsed because she relied for decades on her husband's credit.
Confusing underbanked consumers with subprime individuals can have devastating effects in today's economy, when the catch phrase of the day is "credit crunch" and the reputation risk associated with serving the underbanked segment is high.
As a growing number of businesses and employers use credit scores as a risk-management tool, more consumers are being shut out of opportunities to rent apartments, find jobs, qualify for insurance or open checking accounts.
Assuming that a lack of data is the same thing as negative data prematurely forecloses untapped opportunities for the financial-services industry at a time when the industry needs to leverage every good prospect it can find.
A small, but growing, cottage industry is taking shape to help financial institutions to understand thin- and no-file consumers better. These companies are collecting and analyzing data that do not typically appear in credit reports but are proving to be predictive of credit behavior. Rental-payment data, for example, look and feel a lot like mortgage information.
Remittances sent regularly to relatives abroad are powerful indicators of cash flow. And utility payments in particular have been shown to have strong predictive value.
A 2007 study by the Political and Economic Research Council found that, when utility and telecommunications data are included in credit files, the risk profile of unscorable consumers is similar to that of the general population.
Using utility data in underwriting increased by 10% the rate at which consumers qualified for loans. Acceptance rates increased dramatically for ethnic groups and lower-income consumers that traditionally are underrepresented in the credit system.
As consumers become more savvy about credit scores and their importance, they are looking for opportunities to establish, build and improve their credit histories.
Financial-services companies would be wise to assist them. Consumers will remember those banks, credit unions and card issuers that gave them a chance during tough economic times, and consumers will reward those institutions with their loyalty when the tide begins to rise again. CP
Jennifer Tescher is director of the Center for Financial Services Innovation, an affiliate
of ShoreBank Corp., in Chicago. She can be reached at JTescher@cfsinnovation.com.
