Unchaining the Shackles Imposed by CRAs - Open Future World

Unchaining the
Shackles Imposed
by CRAs

Unchaining the Shackles                DirectID | Page 2
Imposed by CRAs

    Contents
    An Introduction           P3

    The History of CRAs       P5

    Historical Data           P7

    Impacts on Businesses     P10

    An Alternative            P13

    Credit Risk, Redefined.   P17

    Mortgages                 P21

    The Future                P23

    Contact DirectID          P25

Unchaining the Shackles                                  DirectID | Page 3
Imposed by CRAs

     An
     Introduction
     Having co-founded several FinTech startups, the
     process of applying for retail credit was well known to
     DirectID Chief Executive Officer, James Varga.

     An application is completed, you provide a myriad of ID,
     and then the lender reaches out to one of three Credit
     Reference Agencies (CRAs): Experian, TransUnion or
     Equifax.

     Even with a near perfect credit score of 990, James
     Varga found himself on the receiving end of a declined
     application in an Edinburgh tech store. It’s ironic that
     such an incident would occur to the CEO of a credit risk
     oriented FinTech but will be a common anecdote for
     many.

     James moved from Canada to the UK some twenty years
     ago, and with an immaculate credit score it is difficult
     to rationalise why there would be an issue in accessing
     retail credit for a laptop.

Unchaining the Shackles                                  DirectID | Page 4
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      During Applications Customers Rarely
      Find out why an Application has been
      Declined. They are Usually Referred to
      the Credit Agency Directly, which can
      be a Lengthy Process.
      Credit bureaus hold all sorts of information on
      individuals, such as address history, credit history,
      time in country, but if any of these don’t stack in your
      favour, even when you can comfortably afford the credit
      allowance in question, problems with applications can
      occur.

      These features are attributed to a tried and tested point
      scoring system to satisfy a lenders minimal threshold for
      credit risk.

      Despite the financial services industry undergoing huge
      transformations driven by new technology in recent
      years, until recently, most lenders have followed the
      same methodology during the credit risk assessment
      period. James’ story is a perfect example of why the
      historical methods of relying on bureau data may no
      longer be the answer for lenders.

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   The History
   of CRAs

Unchaining the Shackles                               DirectID | Page 6
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      The Earliest Use of Credit
      Reference Dates to the 1800’s.
     Two brothers, Cator and Guy Wooolford,
     compiled a list of customers who were good
     payers and later sold these to suppliers in the
     US. By the 1970’s the business, now called
     Equifax, evolved to using electronic data and
     became recognised as the most established
     CRA in the world.
     As this became mainstream practice in
     consumer lending, legislators devised the
     Consumer Credit Act 1974. This was the
     first of many regulations to help protect
     consumers using credit services. The use of
     CRA data and the way in which they collect
     data was legislated within the act. They
     defined CRAs as a business “comprising
     the furnishing of persons with information
     relevant to the financial standard of
     individuals, being information collected by
     the agency for that purpose”.
     For the legislation written in the years
     to follow the aim was clear: to ensure all
     information kept on consumers was relevant,
     accurate, and made available when called
     upon by businesses for making decisions or
     to the subject of the data directly.

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   Historical
   Data

Unchaining the Shackles                                   DirectID | Page 8
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     Data Consistency
      When a lender requests information from an agency,
      or calls multiple, they use this information to inform
      their assessment of risk in writing a loan. Where this
      becomes a problem is the lack of consistency between
      the separate organisations.

      Each agency records information as a separate entity
      that operates completely independently from the others.
      The reports that each bureau holds on an individual is
      likely to be variable, in other words, depending on which
      agency a lender decides to use to inform their decision
      making can ultimately determine whether a loan
      application is accepted or declined.

      This raises the question of whether this information can
      truly be considered accurate.

      Data That is no Longer Fit for Purpose
      Lenders – particularly SME’s, have been hit hard by
      the pandemic. The affects this has had throughout the
      lending chain has been felt sorely by consumers at the
      bottom of the chain.

      The lending sector is at a crossroad; the demand for
      short term credit has soared in the last 12 months but
      this has come at the at the expense of risk volatility,
      especially with the growing presence of vulnerability in
      the UK.

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     In the Past Underwriting Teams have
     Relied on Bureau Data to Evaluate an
     Individual’s Creditworthiness
     They often struggle to determine whether an individual is in a
     sound position to borrow because of the accuracy of the data.
     Often the data acquired by lenders from the CRAs can date back
     as far as a year. Speaking generally, the financial circumstances
     for most of the UK population are likely to have changed in that
     period of time. With the increasing number of people who find
     themselves in financial hardship, a huge risk is presented to the
     debt book of lending organisations.

     The changing nature of the employment market also
     raises questions about the use of CRA data. Employment
     opportunities have changed significantly over the last decade
     with fewer people relying on a traditional salary than ever
     before. Over 1 in 10 working adults in the UK work through gig
     economy platforms such as Uber, Deliveroo or Upwork. Despite
     such a large chunk of the population living without a traditional
     salary, CRA data doesn’t recognise these income sources as
     significant indicators of creditworthiness. This makes it difficult
     for gig economy workers to access traditional credit products.
     That goes for migrants too. People with new to country status
     tend to have a very limited access to these services. Bureaus
     rely on past data to build our credit profile based on things like
     our employment and address history, so getting onto the credit
     ladder can be a real challenge for migrants.

     The data provided by credit bureaus is incomplete and less
     appropriate for the world we live in. The adverse effect this has
     on both consumers and businesses is largely negative.

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   Impact on
   Businesses &
   Their Customers

Unchaining the Shackles                                         DirectID | Page 11
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     Business Impact
     For lenders, particularly SMEs, there’s a growing list
     of pains associated with using CRA data as a core
     component of credit risk decisions.

     The risk involved with using bureau data has
     skyrocketed since the beginning of the pandemic.
     To make adequate underwriting decisions in the
     onboarding process for example, an underwriter
     needs to be able to understand what an applicant can
     afford to repay based on their current income and
     expenditure. While this has always been the case, any
     credit risk decision is built upon what someone earns
     versus what they spend, but bureau data doesn’t
     capture the real-time nature of this.

     This also explains why underwriting teams are finding
     it difficult to identify vulnerable customers. The
     retrospective nature of the data they have access to
     makes it near impossible to understand an individual’s
     current financial circumstances.
     Although CRA data has long been the industry
     standard for credit decisioning, it is evident that the
     practice lacks the real-time element of affordability and
     creditworthiness assessment, both of which are key
     requirements for moving towards a functional post-
     covid world.

     Financial firms have started to seek alternative
     methods of credit risk assessment, and there’s one in
     particular that suits the nature of the new climate we
     find ourselves in.

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                          Customer Impact
                          If you’re familiar with the traditional lending
                          model, you’re sure to have heard the phrase
                          ‘to get credit you have to have credit’ - a
                          model that is inherently broken. Research
                          from PwC shows that between 10-14m people,
                          roughly a quarter of the population, struggle
                          to access mainstream credit sources, despite
                          having only minor blemishes on their credit
                          history.

                          Other sources of credit, such as Near-prime
                          credit cards, fail to serve customers with thin
                          credit files. The Near-prime credit card sector
                          which is served by just four providers, account
                          for only 8% of all credit cards held in the UK,
                          despite an estimate that 20-27% of UK adults
                          that would fall into the group eligible for such
                          facilities.

                          But it all comes back to the same problem –
                          lenders cannot be confident in an applicant’s
                          ability to repay a loan with the data they
                          currently have.

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   An
   Alternative

Unchaining the Shackles                                    DirectID | Page 14
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     As financial services have done
     at many key moments throughout
     history, the time has come for a
     change in thinking
      The traditional model has shown cracks for years, and
      the presence of the pandemic has forced businesses to
      consider new ways of working. Operating in the same
      way, just because that is the way things have always
      been done, is no longer an option.
      While lenders can use CRAs to determine what loans,
      credit cards, and other financial products an applicant
      has had, determining what the impact of a new financial
      product will have on an applicant remains challenging.
      Traditional methods of assessing affordability are largely
      inefficient, time consuming, and limited to historical
      information.

      And nearly all credit decisions, including on affordability
      and in collections and recoveries, are based on
      understanding a customer or applicant’s income.
      Without having a true reflection of income, it is nearly
      impossible to make a decision with 100% confidence.

      Open Banking makes answering that key question that
      all lenders want to know ‘what is your financial situation’
      much easier.

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      Bank Data
     Using bank data means that it is possible to understand
     the granularity that can be contained within some bank
     statements. With individuals receiving income from a
     diverse range of sources, including salary, income from
     part-time or gig economy work, pension or benefits,
     some individuals can receive money from more than one
     source on a monthly basis, and it can vary from month to
     month.

     The insights gleaned from bank data provide a lender
     with a detailed view of what outgoings the applicant has
     compared to that salary or income, making affordability
     and other credit risk calculation much simpler and faster.

     This can all be done in seconds when an applicant
     connects their bank account, giving a real-time view,
     and negating the need for any paper documents.

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     Sectors Where Bank Data Will Prevail
     in 2021
     The use of Open Banking data in credit risk decisions
     has seen a huge uptake since the launch of the
     programme in 2018. Last month, OBIE reported a total of
     670m API calls, double that of the year before. With that
     early success use cases are beginning to pay dividends
     to the effort that has been placed into Open Banking
     from the FinTechs, banks, and regulators.

     This marks the start of a move to an Open Finance
     model, in which data from a magnitude of different
     sources can be utilised. With the extra insights, and
     requirement for better technologies, there are several
     uses cases growing in strength.

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   Credit Risk,
   Redefined.

Unchaining the Shackles                                             DirectID | Page 18
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    Customer Onboarding
    Perhaps one of the earlier successes in Open Banking data,
    the use of bank data in customer onboarding has been well
    documented. Whether it be simply digitising bank statements
    to shorten the assessment time, or using the insights provided
    by third party providers to better understand an individual’s
    financial profile, the switch to Open Banking data is more
    efficient and accurate.

    Where bureau data will provide a more retrospective score
    to inform underwriting teams, insights gleaned from bank
    data on affordability, income verification, and cashflow, give
    underwriters the full picture. In a post-covid world where a
    recent loss of earning is more common in credit applicants
    these insights are invaluable.

Unchaining the Shackles                                                         DirectID | Page 19
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                          Portfolio Management
                          The demand for Open Banking in portfolio management has
                          surged. Not only can bank data provide a detailed view on one
                          customer, but it also opens the possibility to monitor behaviours
                          on a lender’s entire customer base. These insights give lenders
                          the power to identify behaviours and segments within their
                          portfolio and enhance their ability to manage risk across the
                          debt book.

                          Identifying clusters of emerging financial distress within a
                          portfolio is currently of high importance to lenders. Ultimately,
                          Open Banking gives a lender the ability to identify these
                          customers early and reduce the flow of customers to the
                          collections end of the business.

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    Collections & Recoveries
    In the unfortunate circumstance that a customer is passed to
    the collections team, a stressful and time-consuming process
    for the customer is instigated.

    When a customer becomes delinquent lenders still have to
    address the same affordability requirements found in a credit
    risk decision. The first step in the process can take hours of
    dissecting bank statements and, even when combined with
    CRA data, it doesn’t tend to show the full picture.

    By leveraging Open Banking, the customer merely has to login
    to their internet banking, and Open Banking will provide the
    collections agent with read-only access to the customer’s bank
    statement information.

    With no data asserted by the customer, agents are granted a
    complete and factual view of the customer’s financial situation
    – with no reliance on customers to provide information which
    can be exaggerated or potentially untruthful.

    This streamlines the whole collections process, creating a
    journey that is efficient, accurate, and far more suitable for
    the vulnerable customers that are likely to fall into financial
    hardship.

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   Mortgages

Unchaining the Shackles                                   DirectID | Page 22
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     Mortgages
     Just as in any credit risk decision, mortgage lenders
     must fulfil their internal and external policy around
     affordability and creditworthiness during the mortgage
     application process. A huge amount of resource is
     dedicated to understanding the credit profiles of
     mortgage applicants. Traditionally this has been done
     by calling out CRAs to build an understanding on past
     borrowing habits and other credit score impactors,
     supplemented by 3 months of bank statements for an
     underwriter to depict line by line.

     With Open Banking insights mortgage underwriters can
     gain a much better view of the financial indicators found
     in a strong, or insufficient, mortgage application. The
     process of data collation and analysis is rapidly sped up.

     It’s not just in the credit risk decision that Open Banking
     is adding value to mortgage applications. Mortgage
     providers can implement Open Banking in the Decision
     in Principle stage before it gets to an underwriter.
     Customers then have a realistic view on what a lender
     can offer before CRAs or any physical financial data is
     involved.

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   The
   Future

Unchaining the Shackles                                    DirectID | Page 24
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     As we move to a global, and an
     inherently digital, economy, we
     must recognise the need for
     change.
    At the core of this change is the need for financial
    institutions to achieve maximum efficiency. The
    firms that bootstrap from the Covid era will rely on
    technologies developed by FinTechs to save time,
    resource, and cash. Leveraging data and insights
    will empower them to make effective decisions and
    help propel their organisations forward.
    Open Banking has seen its best year yet in terms
    of adoption, influence, and capability. And yet, it
    merely marks the tip of the iceberg. As momentum
    increases from regulators around Open Finance,
    the potential to go even further in the key use cases
    has never been greater.
    With access to an even wider range of accounts
    such as credit card spend, long term investments
    and alternative bank accounts, the potential
    for even more valuable Open Banking services
    becomes huge.
    Open banking FinTechs and tech companies are
    supplanting CRAs because of their willingness
    to embrace new and more effective tech to make
    better decisions. Even at the current stage, access
    to Open Banking data sets is proving far more
    valuable than the methodologies that laid the
    groundwork for credit risk decisions some 200
    years ago.
    Both businesses and consumers are starting to live
    and breathe the rewards of replacing old practices
    with Open Banking. And with that, the regulators
    are guiding financial services to an Open Finance
    model, which upon success, will likely lead to an
    open data ecosystem, destined to benefit us all.

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     Contact
     Website
     directid.theidco.com
     docs.direct.id
     support.directid.co

     Phone
     United Kingdom
     +448451193333

     North America
     1 855 343 5670

     Address
     United Kingdom
     83 Princes Street,
     Edinburgh, EH2 2ER
     North America
     1890 Market Street, Suite 200,
     San Fran, CA94102