As the US Consumer Financial Protection Bureau (CFPB) turns its attention to applications of machine learning and alternative data within credit markets, small businesses are likely to feel the advantages of the technological developments, says Brock Blake, CEO of Lendio.
“With the CFPB's regulatory support, more fintech innovators will be able to meet the financial needs of entrepreneurs, which means small businesses remain sustainable,” he says. “And as machine learning and artificial intelligence advance, fintech providers in the small business space and beyond will be able to serve a wider swath of customers."
“The online lenders that rose up out of the ashes of the recession have made great strides in proving that alternative data can be a reliable source for determining the creditworthiness of borrowers.
The CFPB clarified its stance on alternative data and machine learning in early August. It details the bureau’s request for information (RFI) on the use of the technologies in the credit process, and progress made since its first no-action letter (NAL) issued to data firm Upstart Network in 2017.
At the time of the NAL, the regulator said it had no intention of taking action against the lenders under the Equal Credit Opportunity Act (ECOA), relating to its underwriting methods or use of alternative data fields.
As a condition of receiving the NAL, Upstart Network agreed to a model risk management plan and to provide the CFPB with outcomes from its use of alternative data. According to the CFPB, the tested model approved 27 percent more applications than a traditional model and yielded 16 percent lower APRs for approved loans.
“In many consumer segments, the results provided show that the tested model significantly expands access to credit compared to the traditional model,” reports the CFPB. “The Bureau encourages lenders to develop innovative means of increasing fair, equitable, and nondiscriminatory access to credit, particularly for credit invisibles and those whose credit history or lack thereof limits their credit access or increases their cost of credit.”
According to a 2019 whitepaper from Experian, 65 percent of lenders say they are using information beyond traditional credit reports to make their lending decisions for businesses and consumers. The top three additional sources of underwriting information were found to be verification of income, verification of employment and judgements on property. 66 percent of the lenders asked declined more than five percent of applications due to insufficient credit history data.
For Caton Hanson, co-founder and chief legal counsel of financial health firm Nav, while traditional credit reports aren’t going away any time soon, alternative data can be crucial for those looking to expand their markets.
“When they understand the benefits, consumers are often onboard as well. Many consumers, for example, don’t understand why healthy bank account balances shouldn’t boost their credit scores,” he said, over email. “Business owners are often frustrated that many of their vendor, lenders or suppliers don’t report their payments to business credit bureaus. These are problems that are being solved today with technology.
“It’s helpful that the CFPB recognises the potential benefit of alternative data in helping improve access to capital. New innovations in finance bring scrutiny, naturally, and it’s important that the right balance is struck between giving consumers more options, while protecting them from predatory practices.”