Improving financial inclusion for the credit invisible

Remember the scene in Spiderman 2 when Peter’s grandma goes to the bank and faces an unhelpful banker who cannot resolve her crisis? Although banks have come far since 2004, their traditional risk management approach still makes this representation a reality for many.

Historically, banks provide loans to customers with good credit scores—or customers receive high-interest rates to compensate for the risk that they might not pay the loan back. These measures protect the banks and exclude millions of people from financial inclusion. In the US alone, roughly 80 millionadults live in rental housing, yet just 1.8 million (2.3%) have rental payments reported in their credit files.

Instead, the additional 97.7% of individuals are trapped in a cycle of renting and debt. They either have no credit score or low scores due to the outdated parameters associated with financial capability.

Today, banks that take this approach may put themselves at risk of becoming obsolete. Innovations in fintech and digitization are enhancing credit access. Especially for individuals who have long been ignored by the historical financial system, and are leaving traditional banks in the rearview mirror.

Let’s take a look at what banks can do to stay at the forefront of customers' minds and support the ‘credit invisible’ with low risk.

There’s more to financial capability than managing loans

In old-school fashion, banks look at bill-paying history, unpaid debt, and how much credit is used versus what’s available to calculate credit scores. This forms the basis for lending mortgages, credit cards, vehicle loans, other credit products, credit limits, and interest rates.

However, what happens when someone lives in a remote location or has limited cash flows? They could find it difficult to get a loan due to a lack of credit history. Or what about if they rent a house but don’t have a credit card? These customers have zero debt, but still struggle to obtain affordable mortgage payments as they have no credit history.

Fintechs and neobanks are beginning to recognize that we need to look at the customer holistically: How quickly they pay bills, income versus outgoings, and transaction patterns. We need to look at the whole picture to get the whole picture. Is the customer a practical spender, or do they tend to opt for a more expensive range? Credit providers such as retailers, suppliers, and utility companies can answer these questions. And banks that choose to include this alternative data into their algorithms can begin to reduce the risk of providing loans to customers without traditional credit scores.

Fintech partners increase credit visibility

Application programming interfaces (APIs) and artificial intelligence (AI) have drastically improved banks' ability to keep up with digital transformation. Partnering with fintechs enables them to access customer data without explicitly seeing customer transaction history, but rather, creating unique profiles based on each customer's financial capability.

These can then guide whether a customer is good at making payments on time, what categories and price ranges they spend on, and if they are at low risk to the bank of receiving a loan at a more affordable rate.

Imagine Zack just finished school, has been paying his phone bills consistently for the last year, and saves enough working at the local bar to rent a house for $800/month. He wants to get a loan for a car so he can start a new job, but the bank rejects him for having little to no credit history. Instead, he goes to the car dealership, which does another credit check, reducing his credit score even further. He's also at risk of being offered a subprime auto loan, which can have very high interest. Since he's desperate, he might take the loan because he thinks it's the best he can do.

Today, banks can look at utility bills, cost of living, and income to generate a realistic assessment of the customer's spending habits. Rather than crippling Zack with a high-interest loan or forcing him to continue working locally at a lower salary, they can create a holistic view of the customer to paint a picture of what each one is capable of. This way, Zack gets the opportunity to earn more and is increasingly likely to take a mortgage with the same bank that helped him—sooner rather than later down the line.

Fintechs and neobanks are entering the market, reaching untapped opportunities that, in turn, benefit the wider economy. When banks and fintechs partner, they can increase financial liquidity for those that previously suffered from credit invisibility. Assessing customers' financial capabilities based on their spending habits holistically, as opposed to simply via credit cards and loans, creates a more accurate understanding of the customer, enabling banks to provide more affordable products while keeping risk low for the bank.

Read our blog for more about improving financial inclusion.

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