For as long as their have been economies, there has been credit—and that has meant the need to measure creditworthiness and assess risk. For much of our history, the practice of credit scoring was much the same -highly subjective and based on who you knew and how well the creditor knew you.
Fast forward to 2010, the widespread and standardized approach to credit scoring in the US faced several challenges, including the:
- Greater prominence of segments in society being overlooked by the current scoring system (e.g., unbanked or underbanked individuals)
- Rapid growth in the sheer size and variety of data (coupled with greater processing power) that can be utilized for credit scoring models
- Fragmentation of the financial services ecosystem with the entrance of more players focusing on specific services or consumers
- Bolder thinking to challenge the status quo and create new credit scoring models (particularly in light of the financial crisis).
Today, we are firmly riding the new wave of credit scoring, recognizing a one-size-fits-all approach to credit issuance is no longer effective.
What is this research About?
According to the Consumer Financial Protection Bureau (CFPB), 26 million people (11% of the population) in the United States are “credit invisible,” which means they have no formal credit history nor credit score. Some of these individuals may be underbanked, that is, they have a bank account at a financial institution but also rely on more costly channels like check cashing services and payday lenders. Others may be unbanked with no access to any formal banking services. The Federal Reserve estimates that almost 30% of house-holds in the US are either underbanked (20%) or unbanked (9%).
Despite credit scores being a key component for the adjudication of creditworthiness, for a significant portion of the population with no credit score or a thin credit file, obtaining loans are more challenging and potentially more expensive. The credit fragmentation of the population has necessitated the emergence of new credit scoring practices, a reflection that a one-size-fits-all approach is no longer sufficient.
This report provides an overview of the new wave of credit scoring, one that invites new entrants to unlock opportunities in the current system, design alternative or complementary systems, or reinvent what is means to be “creditworthy” altogether. To begin, a brief overview of the history of credit scoring provides a helpful context of the trends that are taking shape.
Filene thanks CU Direct and our members for making this research possible.