When a significant portion of the population is shut out from traditional credit systems, banks are turning to alternative data to make lending decisions. As millions of individuals remain “credit unserved,” new approaches are being used to assess creditworthiness and extend loans.
In countries like India, where nearly half of the adult population under 65 is considered “credit unserved,” a large gap exists in access to credit. This group, about 480 million people, includes gig workers, students, micro-entrepreneurs, and those from underbanked communities. These individuals lack a credit score, primarily because they’ve never taken out a loan or used a credit card. Even those who are financially responsible might be denied credit simply due to a lack of formal credit history.
To bridge this gap, financial institutions are increasingly relying on alternative data sources to evaluate creditworthiness. These data points offer a glimpse into a person’s financial behavior, providing insights into their ability to repay loans, even without a traditional credit score.
Banks Embrace Alternative Data for Credit Risk Assessment
Alternative data is essentially any information that doesn’t come from traditional credit reports but can still indicate financial responsibility. Examples include timely rent payments, utility bill payments, UPI transactions, and even online shopping patterns. For instance, a person who consistently pays rent and utility bills on time or regularly makes digital payments for everyday expenses is showing evidence of financial reliability, even if they have no formal credit history.
The use of alternative data helps banks and lenders understand a person’s repayment behavior beyond the scope of a credit report. Data sources might include information gathered from service providers, such as telecom companies or utility firms, or even from permission-based access to a borrower’s bank transactions or phone bills. This new approach allows financial institutions to gauge a person’s ability to manage debt, providing more inclusive lending opportunities for those who would otherwise be excluded from the traditional credit system.
How Banks Collect and Analyze Alternative Data
Unlike traditional credit scoring systems, which primarily assess past borrowing and repayment behavior, alternative data opens up a broader view of a borrower’s financial habits. For example, rent payment history can be a strong indicator of someone’s commitment to meeting financial obligations. Regular payments for utilities, mobile bills, and even digital wallet bills can help banks gauge the person’s overall financial discipline.
The collection of such data usually involves accessing financial transaction records, which may include digital payment histories, social media activity, and even information from public databases. With permission, banks might even evaluate a borrower’s entire bank transaction history to get a comprehensive view of their financial behavior.
This form of data gives banks a more nuanced understanding of a person’s financial management skills, often revealing a level of responsibility that a traditional credit score cannot reflect. What’s more, this type of data allows banks to make more informed decisions about extending loans to people who have never had the chance to build a formal credit history.
The Impact on Underbanked Communities
For individuals in underbanked or financially excluded communities, alternative data is providing a vital lifeline to access credit. Gig workers, micro-entrepreneurs, and other individuals who have irregular income streams or no formal borrowing history often face challenges in obtaining loans from traditional financial institutions.
By utilizing alternative data, banks can assess these borrowers’ financial behaviors without relying solely on their credit scores. This opens up new possibilities for financial inclusion, helping people who might otherwise be excluded from the formal credit market gain access to much-needed loans for education, business expansion, or personal needs.
In this way, banks are not just evaluating a person’s past but also their present-day financial habits, which can be just as telling when it comes to making lending decisions.
Future Prospects: A More Inclusive Financial System?
As the world moves toward more data-driven decision-making, the role of alternative data in credit risk assessment will likely continue to grow. Financial institutions are recognizing the need to create more inclusive credit systems that allow individuals to prove their creditworthiness through non-traditional means. This could ultimately reshape the financial landscape, making credit more accessible to underserved populations.
With advancements in data collection and analysis technologies, we might soon see a future where access to credit is not limited by a traditional credit score. Instead, a broader spectrum of financial behaviors will come into play, offering a more accurate and inclusive way to assess credit risk.
