Rethinking the FICO Score


FICO-6-20-18.pngFor decades, pre-dating many banking careers today, the tried and true method to evaluate credit applications from individual consumers was their FICO score. More than 10 billion credit scores were purchased in 2013 alone, a clear indicator of how important they are to lenders. But is it time for the banking industry to reconsider its use of this metric?

The FICO score, produced by Fair Isaac Corp. using information from the three major credit bureaus—Equifax, TransUnion and Experian—has been considered the gold standard for evaluating consumer credit worthiness. It focuses squarely on the concentration of credit, payment history and the timeliness of those payments. FICO scores have generally proven to be a reliable indicator for banks and other lenders, but in an age operating at light speed, in which many purchases can be made in seconds, a score that can fluctuate in a matter of days might be heading toward obsolescence.

Some believe a person’s credit score should be considered only in parity with other, more current indicators of consumer behavior. A study released in April by the National Bureau of Economic Research says even whether people choose an Apple or Samsung phone “is equivalent to the difference in default rates between a median FICO score and the 80th percentile of the FICO score.”

Consider the following example. A consumer pays off an auto loan, resulting in a reduction in their FICO score. This is largely due to the reduced amount of credit extended. That reduced score could become a deciding factor if the customer has applied for, but not yet closed, a mortgage 60 or so days before paying off the vehicle and could affect the interest rate of the applicant.

That leaves a bitter taste for anyone with average or above average credit who has demonstrated financial responsibility and, it could be reasonably argued, would be a much better candidate for credit extension than someone with the same score who doesn’t give two flips about the regular ebbs and flows in their credit.

For all its inherent benefits to the industry, the traditional credit score isn’t perfect. Banks could be using their own troves of customer data to evaluate their credit applications more accurately, more fairly or more often. This could be a boon for institutions hoping to grow their deposit base or enhance their loan portfolios. Some regulators have indicated their attention to this approach as well. The Federal Deposit Insurance Corp.’s Winter 2017 Supervisory Insights suggests data could be a helpful indicator of risk and encouraged member institutions to be more “forward-thinking” in their credit risk management.

“As new risks emerge, an effective credit [management information system] program is sufficiently flexible to expand or develop new reporting to assess the effect those risks may have on the institution’s operations,” the agency said.

That suggests the FICO score banks are currently using might not tell the full story about how responsible credit applicants might be.

“My personal opinion is that among most people, if you have someone who thinks about [their digital footprint and credit], you’re already talking about people who are financially quite sophisticated,” Tobias Berg, the lead author of the NBER study and an associate professor at Frankfurt School of Finance & Management, told Wired Magazine recently. The study examined a number of data points that go far beyond what is incorporated in a FICO score.

That certainly has value for banks. The data they already collect about their customers could be used to determine credit worthiness, but there’s a counter argument to be made. Digital footprints are much easier to manipulate more quickly over time by changing usernames, search history, devices and the like. Using an Android over a more expensive iPhone could be a negative in the study’s findings, for example, which might not reflect the customer’s true credit profile.

But FICO scores are not reviewed as regularly as they could be, and a swing of a couple dozen points from one moment to another can significantly sway some credit applications.

For now, fully abandoning the FICO score isn’t a likely or manageable option for banks, nor one that’s favored by regulators, but the inclusion of digital data in credit applications is something that could be adapted and be beneficial to both the bank and customers eager to expand that relationship with their institution.

Giving Small Business Borrowers ’True’ Credit


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Small business owners and entrepreneurs are the engine that fuel the global economy. Lending to small businesses has been the heartbeat of the over 5,500 community banks, and it’s also how many of the nations largest banks have prospered.

Yet the market for these loans has become commoditized—or as highly accomplished venture capitalist Marc Andreessen has said, have been “eaten by software.”Why? Because banks still treat small businesses and entrepreneurs like they are individuals applying for a personal loan and not a commercial entity with real economic value.

The problem is the current business data and credit scoring infrastructure that most banks use to underwrite loans was not made for the entrepreneur. It was made for the consumer and does not acknowledge the value of the actual business itself to the entrepreneur.

When entrepreneurs go to a bank for a loan, they are always asked two questions.

What is their credit score?

What is their current income or salary?

Simple credit scoring and current income verification is not enough as it does not fully value the entrepreneur and the businesses’ capacity.

Seventy percent of a business owner’s net worth is tied up in their business, but few banks look at anything beyond the value of the real estate, their credit score and their current income. Sixty-seven percent of all private companies are funded at levels that are actually less than they should be because the value of the underlying business has historically been overlooked.

This traditional approach to small business lending is out of date. Today, because of technology and an infinite amount of data, business owners can plug in information about their company and match it against similar businesses to find out what their business is worth, and then leverage that data for loans, insurance coverage or other financial planning matters. Banks like Univest Corp., insurance companies like Penn Mutual and credit bureaus like Equifax and Experian are starting to use and offer online databases to measure a business’ value not just for loans, but for financial planning and risk scoring.

If you are bank, take advantage of new advancements in big data and apply them to your actual core business. Focus your efforts on what used to be your bread-and-butter customer—the small business owner. But be aware that today’s entrepreneurs know that the lending process has now become democratized and they are only a browser away from a better deal. Change the game. Go further. Inspire the next great wave in lending by giving entrepreneurs and small business owners true credit.