Every financial newspaper, blog, and website are writing about the same thing these days: online lending and “non-traditional” data. There is certainly a reason for all the hype. According to Morgan Stanley analysts, “Marketplace lending is in liftoff,” with a 123% CAGR since 2010. A recent study by the University of Cambridge, Judge School of Business reported $36Billion in marketplace lending 2015, almost triple the number in 2014. With this new platform of lending come new sources of data. Big Data, or alternative data, refers to the information outside the standard credit reports that online lenders are using to access borrowers.
LendingTimes.com recently looked more closely at Lenddo, one of the many FinTech companies utilizing alternative data. Lenddo advertises that they analyze over 12,000 variables when accessing a borrower’s credibility, but what are some of these variables? Unlike traditional lending companies that look at a person’s credit reports (reported installment and revolving credit), Lenddo and other marketplace lenders are taking into account all payment obligations such as utilities, rent, and telecom bills, amongst thousands of other factors.
Where to Find Data for Those Lacking Data?
Companies that are sourcing alternative data are targeting customers that may traditionally have no credit or a short length of credit history. A good starting point could be the Alternative Credit Reporting companies like Microbilt.
The more traditional FICO score breaks down into five factors: Payment History, Accounts Owed, Length of Credit History, New Credit and Credit Mix. For an under or unbanked potential customer living mostly outside the financial system, that is not a lot of information to go off. But using alternative data sources, an online lender can not only see what is normally considered for a credit report but all the other information a customer is willing to provide.
New data sources that are being included in a potential borrower’s assessment range from his phone bill and utilities bill payment track record account to his Quickbooks account. Customers are being asked to sign over permission to access personal mail, bank accounts, social media accounts, shipping data, and aggregated financial information.
Using alternative data an online lender can verify a customer’s identity through social media, email, and mobile phone to protect against potential fraud. They can also look at a customer’s monthly cash flow over bank accounts and online financial accounts like Paypal. If a small business claims to be profitable and is trying to take out a loan to expand to another branch, the online lender can not only access quantitative information about sales, products, and costs but also look up company reviews and ratings on various social media sites, such as Yelp and Facebook.
Open to Interpretation
Using alternative data certainly has its pros and cons for both sides. While using Big Data can paint a more detailed picture of the potential borrower it also can place the customer in a very vulnerable position. Because the online lending platform is relatively new to the financial system, and the concept of alternative data sources even newer still, it is fairly unregulated. This means they can be a lot more lenient with their regulations than traditional lenders, but they also get to look at and interpret a lot more information about borrowers.
For instance, a potential borrower decides they want to buy a boat, and they go apply for a loan at a traditional bank down the street. The customer has a short credit history that does not include any mortgage, car, or school loans. He has only one line of revolving credit; he has been late on payments occasionally. On paper he doesn’t look too great; the bank denies them the loan. That same customer decides to apply for a loan online. The online lender is able to see that the potential borrower has been successfully making on-time rent payments to a landlord for years, consistently pays utility and cell phone bills, and on top of all that, can see that this customer has also been paying for sailing lessons for over a year. According to the FinTech algorithm, the online lender is using, this customer is low to medium risk, and qualifies for the loan.
Unfortunately, not all cases go this way of the guy and his boat. When online lenders start using qualitative data instead of just quantitative, a lot of information gets left up to interpretation. Using subjective data can lead to stereotypical and discriminatory decision-making, as well as privacy and security issues with customers. While using alternative data sources for online lending gives a greater insight into a borrower’s financial situation, it can be argued that lenders are being given too much access into their customer’s personal life for an often times an indefinite amount of time.
Changing the Way Lenders View Borrowers
The most important thing to note about alternative data sources is that they are changing the way lenders view borrowers. With the use of incredibly complicated algorithms, companies like Lenddo, TransUnion and Kabbage are transforming thousands of bits of information about a customer into a simpler numerical score. But it is what online lenders are doing with these scores that is so unusual. Unlike the traditional lender who made wide sweeping judgments about default risk, online lenders are able to cherry pick certain borrowers and manage default rates that increase profitability.
What Happens Next?
These companies are incredibly innovative and rapidly growing. While some banks (eg. Santander and Scotiabank) have already started working with alternative data source companies, many others are still hesitant to jump on board. A recent Washingtonpost.com article noted the “disquieting parallels with subprime mortgages” and marketplace loans. That journalist is not the only person feeling nervous about the online lending bubble’s imminent burst. Forbes named marketplace lender and Big Data pioneer, Kabbage (with a revenue of $41million as of January 2015) on their list of Top 100 Most Promising Companies two years and a row; while things are looking optimistic, it will be interesting to see what happens next.