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Fed Governor sounds warning on alternative credit scoring data

05 December 2016  |  9475 views  |  2 Fed Reserve

A Federal Reserve governor has cautioned fintech firms about the risks of using non-traditional data such as social media information to judge creditworthiness, warning that it could lead to them falling foul of fair lending laws.

Lenders are increasingly looking to break free of the traditional credit scoring models and find new ways, such as Facebook connections and education levels, to evaluate potential customers who lack traditional credit histories.

But, speaking at conference, Fed Governor Lael Brainard warned that the use of such data could raise consumer protection issues because it "may not necessarily have a broadly agreed upon or empirically established nexus with creditworthiness and may be correlated with characteristics protected by fair lending laws".

The use of new types of data also raises transparency concerns, says Brainard, because people - and even regulators - may not always know how specific information is used to make decisions and what behavioural changes consumers might take to improve their credit access and pricing.

The Governor was generally positive about the potential of fintech for "socially beneficial innovation" that can help to improve how people pay, get paid, get credit and manage their money.

However: "'Run fast and break things' may be a popular mantra in the technology space. It is ill-suited to an arena that depends on trust and confidence...There are more serious and lasting consequences for a consumer who gets, for instance, an unsustainable loan on his or her smartphone than for a consumer who downloads the wrong movie or listens to a bad podcast."

With an ever-growing number of partnerships between banks and fintech firms, the Fed is "actively reviewing" vendor risk management guidance.

Brainard says that the rapid pace of change and large number of players in the fintech space raises questions about how the Fed conducts its regulatory and supervisory activities but she believes that the organisation is "well-positioned to help shape this innovation as it develops".

"Ultimately, regulators should be prepared to appropriately tailor regulatory or supervisory expectations, to the extent possible within our respective authorities, to facilitate fintech innovations that produce benefits for consumers, businesses, and the financial system. At the same time, any contemplated adjustments must also appropriately manage corresponding risks."

Comments: (2)

Hitesh Thakkar
Hitesh Thakkar - FIS Payments Software and Services India - India | 08 December, 2016, 14:31

This is welcome move from Regulator to consider other parameters for scoring and eligibility for lenders#Fintech. Ofcourse, actual dos and don'ts that comes up will impact largely on growth of Fintech in lending space.

 

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Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune | 08 December, 2016, 17:35

Facebook has already told Admiral, effectively, that what happens on FB should stay in FB - and not be used to calculate insurance premium. Now this warning from Fed. Let's see where this goes...

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