Is This the End of the Road for Credit Scores?

4-8-13_Sutherland.pngFast Fact: PayPal’s mobile payment processing jumped from $141 million in 2009 to $4 billion in 2011 and is estimated to more than double in 2012. In just over two years, Square has more than 2 million merchant customers—25 percent of the U.S. merchant population.

Some of the holiest tenets of consumer banking are being questioned. Newer players with a totally different attitude toward their customers who understand technology and the Internet are winning market share and earning customer loyalty. 

In the context of financial transactions, the credit score is to individual fitness what the heart is to physical wellbeing. This has been the be-all-end-all metric that determined consumer lending for over half a century and has powered many a consumer revolution in loans, cards or mortgages.

However, the logic and algorithm of the credit score were developed before the age of connectivity, databases, analytics and big data. And although the credit score has transformed itself over time by improvising for various asset classes, it has not truly leveraged big data to assess individual financial potential as opposed to actual performance.  Are we therefore now beginning to see the end of the credit score as we all know it?  

With the growth of digital wallets, mobile payments and the generational shift away from paper checks and brick-and-mortar bank branches, is it time for a new credit score or new metric to enable the next revolution in lending? Or will current providers embrace a “different strokes for different folks” attitude as the millennial generation overtakes the baby boomers as the single largest customer segment for a banks’s services and products? 

Fast Fact: Annual check usage in the U.S. has dropped from 16.9 billion in 2010 to 5.1 billion in 2012. Average customer visits per branch per year have dropped from 21.3 in 1995 to 3.2 in 2012.

The growing volume of payments with social dollars versus physical currency could signal an opportune time to revamp the underlying credit score algorithm and logic or even adopt a totally different approach. Consider, for example, the growing reluctance of the 19- to 30-year age group to open a bank account or write a check. Unlike other generations, they now have choices and providers to enable a variety of financial transactions. 

Also, the not-so-palatable fact is that this new generation of transactions is faster, safer, more convenient and less costly—four dangerously compelling reasons for retail banks to revisit and realign the prevailing offerings. 

Consider the success of the prepaid card as the emerging alternative to the bank account and the resurging demand for payday loans as the preferred financing medium. We are already seeing startup banks promote alternative scores such as the CRED from Movenbank, which uses social media status as the leading input into this very interesting, real-time metric. Will we see Facebook, Google and Apple providing input to credit bureaus to complete the social aspects of a consumer’s credit profile?

Fast Fact: Prepaid debit card payment volumes have grown from $202 billion in 2011 to $297 billion in 2012.

In the past, the terms “unbanked” and “un-bankable” were virtually synonymous and represented a huge market. That, however, is no longer true. In fact, today’s “unbanked” provide a better business opportunity compared to the “banked.” It is therefore essential that we need to evolve new metrics to supplement the credit score as we know it today. A recent Sallie Mae and Ipsos survey found that the percentage of undergrad students who own a credit card was down from 49 percent in 2010 to 39 percent in 2012—a further indication of the lack of desire among the millennial consumers to have any credit history. That might be a good thing in some ways, given the state of the economy and the need to rein in consumer spending. But it might not be a good thing for the economy, as the supply chain cuts production even before we know it and has a head-on impact on the entire value chain.  

This notion of “credit-less” consumer s raises a number of questions:  Will large institutions like Citigroup, Bank of America and JPMorgan Chase & Co. choose to evolve their own internal metric to score a consumer rather than relying on the credit bureaus? Interestingly, in developing countries where there are no credit bureaus, that is exactly the case. Banks have their own surrogate credit scores and this approach seems to be working well in those markets. 

But will Starbucks, which makes more than 30 percent of its daily store sales on a mobile wallet, be reporting to credit bureaus soon? Or will Amazon, mobile wallet company Isis or Google do so?  More to the point… should they? Or instead should they embrace big data analytics and be their own card issuer because they already have daily data on a customer’s behavior? And if that’s the case, will it impact a customer’s credit score or his financial health if he switches from a $4.50 latte three times a day to a $1.80 coffee daily? 

Are we headed for a new world where a micro finance credit bureau will emerge and manage all interactions of less than $500? With the convergence of telecom, tech, banking and retail industries during the next few years, it will be interesting to see the demise of the credit score as we know it and the growth of a new medium of rating consumer credit. As it is, ask the folks from Canada, the United Kingdom or Asia who relocate to the United States with large bank balances (and, in some cases, Swiss bank accounts) yet are unable to get a mortgage or credit card and end up purchasing everything with cash. Even in the traditional sense, we have quite a way to go before the credit bureau is able to do the greatest good for the greatest number.