Alternative credit scoring
Updated: Oct 5
In some countries, such as the UK, China and the US, people pay a lot of attention to their credit scores. They do this for good reason, as a bad credit score can severely limit financial options, from their credit card limit to how much they can spend on a new home. Credit scores are also used for small business lending and can hamper an entrepreneur’s expansion plans. In continental Europe similar central credit scoring systems are much rarer, both for consumers and in particular for businesses. Some lament their absence, while others see them as a double-edged sword:
1) Having access to a centralised credit scoring system makes it easier and quicker to assess credit risk. This creates a cheaper and more efficient credit market and thus has a big societal benefit. 2) But what if your business credit score is poor due to a couple of difficult months last year, but is now back at full speed? A lender might decline your loan request on the basis of your credit score, especially if the score is based predominantly on historical data. So the “no” would come faster and more efficiently, which is good, but it may not actually be the right decision.
In the absence of centralised credit scoring systems, some innovative lenders have instead tried to amalgamate different data points into one comprehensive reliable profile. Such credit models are sometimes considered part of the alternative finance sphere. There are plenty of alternative finance lenders in the world, and some of the most innovative approaches are found in the developing world where access to data is limited, especially in Africa and India. Here are a number of real-life examples of such data points which are detailed in World Bank report on Alternative data transforming SME Financing:
Mobile lenders offer instant small loans using credit scores based on mobile transactions, SMS messages, emails, social network usage and even the number of people that are called per day. Other alternative metrics include how frequently a user chargers their phone, travelling distance, how contacts are added etc. Leading lenders in this domain is Safaricom´s M-PESA, Branch and Tala.
Behavioural and psychometric testing credit scores which are focussing on the customer´s behaviour within an app, e.g. what time of day are they applying and how much time is spent reading terms and conditions, as well as asking the applicant to fill-out a questionnaire which probes the applicants attitudes, beliefs and integrity.
Some actors, such as China Rapid Finance, are partnering up with other companies such as Tencent to access data on games such as Candy Crush Saga. Whether or not having reached 5000+ levels has a positive impact on your credit score is undisclosed.
One interesting aspect of these alternative credit assessments is the use of social factors. If you are keen to curate a respectable image of yourself on social media then maybe you are adverse to reputational risk and more likely to repay your loan. China has, however, taken this one step further and developed a ´social credit score´ which not only fuels your credit worthiness assessment, but also your prospects of getting a job or being enrolled in university, which sounds to us like something out of Black Mirror. Here is an example of how the ´social credit score´ system works in China, as explained in this article from the Wall Street Journal:
As you can easily imagine, developing a ‘social credit system’ may easily turn dystopic and carries great risk of infringement of the individual´s right to privacy and fair treatment. While this is the approach that China has taken this is far less acceptable in the West.
At Yoba we think that there should be a way that promotes access to reliable open datasets as well as ensuring a proportionate protection of privacy. Open Finance has the potential to fulfil this promise and the EU is currently looking into what shape and form this could take. Read more about this in our previous blog post.