Traditional credit scores may be a proven component of a bank’s lending operations, but the unprecedented nature of the coronavirus pandemic has their many shortcomings.
Credit scores, it turns out, aren’t very effective at reacting to historically unprecedented events. The Federal Reserve Bank of New York even went so far as to claim that credit scores may have actually gotten “less reliable” during the pandemic.
Evidence of this is perhaps best illustrated by the fact that Americans’ credit scores, for the most part, improved during the pandemic. This should be good news for bankers looking to grow their lending portfolios. The challenge, however, is that the reasons driving this increases should merit more scrutiny if bankers are accurately evaluate borrowers to make more informed loan decisions in a post-pandemic economy.
For greater context, the consumers experiencing the greatest increases in credit score were those with the lowest credit scores — below 600 — prior to the pandemic. As credit card utilization dropped during the pandemic, so too did credit card debt loads for many consumers, bolstering their credit scores. In some instances, government-backed stimulus measures, including eviction and foreclosure moratoriums to student loan payment deferrals, have also helped boost scores. With many of these programs expiring or set to retire, some of the gains made in score are likely to be lost.
How can a bank loan officer accurately interpret a borrower’s credit score? Is this someone whose credit score benefitted from federal relief programs but may have struggled to pay rent or bills on time prior to the pandemic and may not once these program expire? Compared to a business owner whose income and ability to remain current on their bills was negatively affected during the pandemic, but was a safe credit risk before?
There are also an increasing number of factors and valuable data points that are simply excluded from traditional credit scores: rent rolls, utility bills and mobile phone payment data, which are all excellent indicators of a consumer’s likelihood to pay over time. And as more consumers utilize buy now, pay later (BNPL) programs instead of credit cards, that payment data too often falls outside of the scope of traditional credit scoring, yet can provide quantitative evidence of a borrower’s payment behavior and ability.
So should bankers abandon credit scores? Absolutely not; they are a historically proven, foundational resource for lenders. But increasingly, there is a need for bankers to augment the credit score and expand the scope of borrower data they can use to better evaluate the disjointed, inaccurate credit profiles for many borrowers today. Leveraging borrower-permissioned data — like rent payments, mobile phone payments, paycheck and income verification or bank statements —creates a more accurate, up-to-date picture of a borrower’s credit. Doing so can help banks more safely lend to all borrowers — especially to “near prime” borrowers — without taking undue risk. In many cases, the overlay of these additional data sources can even help move a “near prime” borrower into “prime” status.
While the pandemic’s impact will continue reverberating for some time, bankers looking to acquire new customers, protect existing customer relationships and grow their loan portfolios will need the right and complete information at their disposal in an increasingly complex lending environment. Institutions that expand their thinking beyond traditional credit scoring will be best positioned to effectively grow loans and relationships in a risk-responsible way.