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Rejiggering the credit-scoring system wont do much to expand credit access. Instead, banks and financial services companies should start thinking about new ways to evaluate the situational factors that influence borrowers reliability.
August 10 -
Incorporating bill and rental payment data into consumer credit scores would be a boon for underserved Americans. New legislation in Congress could help credit reporting agencies realize this goal.
June 19 -
Disruption in credit scoring is healthy, but the new models touted by marketplace and other alternative lenders are still untested, especially about how loans will perform in a downturn.
February 11
It has been said that small businesses are the V8 engine of the U.S. economy, providing an estimated 60% to 80% of the U.S. jobs and powering local and regional economies. Following the recession, small businesses have been an important driver in overall economic recovery. But the rebound in small-business lending has lagged the consumer recovery. Some blame banks for not making enough loans, while others say lending demand from small-business owners has been weak. Either way, it is clear that access to small-business credit will remain a hot topic as the recovery continues.
According to a forthcoming study based on our statistical analysis on small businesses' credit histories, almost half of the small businesses tracked by traditional commercial credit bureaus have only one line of credit, and usually it's a credit card. These businesses are called "thin files," because they simply don't have enough credit history to rank as a full-file portfolio. And then there are the countless other small businesses considered "no file" that lack any line of credit. They have perhaps never applied or been approved for credit.
The intriguing thing is that among these two groups, those with thin files and those with no files, there are many businesses that would still present "good risks" to credit providers. As banks refocus on lending to small businesses, it is not just about keeping bad risks from entering the credit system. It is also about expanding the market by finding those firms that would be likely to repay but that have been on the fringes finance because they lack traditional credit bureau records. There are millions of such businesses out there.
Lenders can evaluate many thin-file and no-file small businesses by using noncredit "alternative" data sources and thereby bring them into the financial system, which will in turn help fuel economic growth.
So what is alternative data? Generally, alternative data consists of the "footprints" a business leaves while conducting business. These are often intuitive. For instance, did they go through an annual registration process at the state level? Did they develop contacts or apply for a special business license? Did they set up a business telephone line and utilities? Who are the people connected to the business, and what footprints did those individuals leave?
We can then monitor these footprints over time almost like a heartbeat or pulse. For example, is the business status in the secretary of state's office still active and in good standing? Or was the business phone active for a while, but then disconnected? And so on. This alternative data typically gives lenders a read on a small business more than three years before it secures its first credit instrument, providing an understanding of a thin-file or no-file small business that is simply not available via a traditional credit history alone.
Similar to traditional credit data and payment information, alternative data can establish a small business' likelihood of repaying a loan. For example, in the consumer space, if someone has lived in the same house for decades, they have what we call "address stability," a type of alternative data that predictably shows that somebody is likely to pay back a loan or credit card bill. It paints a picture of a good risk. There are similar dynamics in small business: details of a small business' history, length of activity, firmographics and other basic "data footprints" are solid indicators as to whether its credit history is thin or nonexistent.
This is not to say that banks should just give small businesses the thumbs-up and create a bubble akin to the subprime business. Banks still have to make good decisions. Rather, this is about making use of improved technology and alternative data sets that are now available to identify creditworthy small businesses and invite them into the financial system.
Ben Cutler is a senior director for small-business risk strategies at LexisNexis Risk Solutions. He can be reached at
