Cashflow underwriting is an area that fintechs have explored extensively, outlining that credit scores pose a limited picture of consumers’ financial health and can do more harm than good.
“The system is broken (or inequitable is more appropriate),” said Lauren Crossett, CRO of Pinwheel, during a Fintech Coffee Break episode earlier this year. “Consumers are unhappy with the traditional scoring system….income is something that folks want included in determining their creditworthiness.”
Credit scores, used for decades, have failed to provide an accurate, up-to-date picture of consumers creditworthiness.
“Cash flow data gives us the ability to fill in much more of that overall financial picture,” said Jason Gross, CEO, and Co-founder of Petal and Prism data.
“If you think about traditional data, or what’s in your credit report that drives your credit score, it’s the liability side of your balance sheet. But it’s missing your assets, cash flows, and income.”
“If we thought of consumers as we think of businesses, it’s really hard to understand what’s going on with the business by looking only at their liabilities.”
At times scores can be severely affected by one off events, affecting consumers for years despite their financial situation changing. In addition, newcomers to the US, unable to transfer their credit history from overseas, can be restricted from financing options.
While the power of cashflow underwriting has been well known in fintech circles for some time, this week the CFPB, too, seems to have proved its importance.
CFPB Reports Evidence of Data that can Predict Serious Delinquency
The acknowledgment came in the form of a 26 July blog post on the CFPB website.
“Cashflow data,” the post stated, “may provide lenders with more information about how applicants manage current obligations than they could learn from applicants’ credit repayment histories alone.”
The bureau identified three proxies from the self-reported data of the CFPB’s Making Ends Meet survey that seemed to predict serious loan delinquency: high accumulated savings, regularly saving and no overdrafts, and paying bills on time.
Their analysis of the data showed that consumers who self reported positive cashflow performed considerably better (by 20%) in avoiding serious delinquency on payments. The cashflow data also predicted serious delinquencies despite respondents having the same credit scores.
“Cashflow data may help lenders better identify borrowers with low likelihood of serious delinquency, even if these borrowers’ credit scores may have otherwise prevented them from receiving credit,” they stated.
“More research needed” but results bring weight to earlier comments
While they recognised their findings ran in accordance with other, existing, surveys, the CFPB writers also called for more research to “understand the extent” in which cash flow data may inform lenders on applicants’ ability to repay loans. The CFPB’s research was deemed “limited” due to a “small” sample size of data that was self reported.
However, the findings seem to run in accordance with comments the CFPB has already made towards improving the inclusivity of lending in the US.
Late last year, Director Rohit Chopra said in prepared remarks at Money 20/20 that the regulators will be working on rules to improve personal financial data rights for Americans. During his speech, Chopra turned to current underwriting models calling for methods that would encourage lending with less bias.
“Today, many companies are now exploring new underwriting models that return to core principles – assessing ability to repay without attempting to use outside information to model a consumer’s presumed ability to repay,” he said.
“Transaction data will be especially useful for these purposes, and help bring an end to the current reliance on the three-digit social credit scores derived from credit reports that are cloaked in secrecy and rife with inaccuracies.”
He explained that the approach could open out access to financial products, a sentiment that was echoed in this week’s blog post. The writers concluded that evidence showed that “using positive cashflow data in underwriting may improve access to credit for populations with historically low credit scores.”
