Jeff For Banks

Why are banks slow to adapt alternative credit data? I’ll tell you why!

Deposit insurance. 
In order to get federally sponsored deposit insurance, that is industry self-funded mind you, the Federal government and state governments set up a regulatory scheme to ensure the safety of customer deposits.
All have benefited. The banking system is stable, which is critical to national and state economies. Depositor money is safe. Also critical. And let’s not forget about the thousands of employees that work for regulatory bodies, compliance personnel in banks, and consultants that help them comply.
So what am I talking about, that deposit insurance is why banks don’t do like FinTech lending firms and use alternatives to the FICO score in underwriting consumer credits? 
Our legislatures did not limit themselves to safety and soundness when they created banking law. No, they dabbled in money laundering, terrorism, drugs, Internet gambling, and, oh yes, fairness.
Fairness.
What does that mean?
Whatever you want it to mean.
So when yesterday’s American Banker asked why alternative credit data was a hard sell for small banks, running afoul of the Fair Lending Act was a key concern (see table).
I would argue that using alternative data to make consumer loan decisions scares bankers because it has not played out with the “fairness” laws and regulations out there, and the disparate impact doctrine used by regulators to determine if a practice is discriminatory. 
According to the FDIC, disparate impact occurs when a policy or practice applied equally to all applicants has a disproportionate adverse impact on applicants in a protected group. Even if it serves as a good predictor of a borrowers propensity to pay back the loan. If a financial institution uses payment of utilities in its credit decisions, and declines credit because prospective borrowers pay utilities late, this could have a disparate impact on a protected class. But bankers won’t know that when they establish the criteria. They have to find out later, after a bureaucrat in Washington does a white paper.
This application of law will continue to be a challenge for financial institutions looking to compete with FinTech firms and mine other data sources to predict a customer’s credit worthiness.
I got news for our lawmakers and regulators. I only know bankers that want customers to pay back their loans. And because deposit insurance is a national program, so should they.
~ Jeff