Council Post: The Pandemic Is Putting Banks To The Test. Here’s How They Can Pass

CEO of OppLoans

The Covid-19 pandemic has laid bare many of the challenges inherent to our economic system. With unemployment remaining in the double digits and uncertainty about additional financial relief persisting, many Americans find themselves worried about paying for their basic needs. And unfortunately, more than a decade of what were considered sound practices for banks emerging from the Great Recession — unloading risky assets and keeping their balance sheets clean — has meant pulling away from serving the people who need the financial system the most: the millions who are locked out of traditional credit options.

The need for access to financial resources is greater than ever for middle- and low-income Americans, especially those struggling with their credit. Many of us are familiar with the statistic from the Federal Reserve that 37% of Americans would struggle to gather the money to pay a $400 emergency expense. But the pandemic has worsened the environment for the cash-strapped: According to a survey our fintech company conducted of 500 credit-challenged consumers, nearly three-quarters said they experienced a financial setback as a result of Covid-19. A majority of those respondents (60%) said they expect it will take a minimum of four months to regain their financial footing, but 12% don’t believe they’ll be able to bounce back at all.

This leaves the financial services industry between a rock and a hard place. Banks are the best-equipped and most reliable institutions to serve millions of credit-insecure Americans; however, disincentivized from taking the risk, some have pulled back or out entirely.

Yet I would argue that it’s possible — indeed, necessary — for banks to help right the ship, support Americans through the economic turmoil wrought by the pandemic, extend credit with guardrails and change the way the industry assesses “credit-worthiness.” It starts with better data coupled with the technology to make sense of it.

Here’s why. Banks are facing two major challenges when it comes to serving credit-challenged customers during this crisis:

1. Banks must remain solvent. This is an obvious point, but it underlies the crisis at hand. The housing boom of the mid-aughts, and subsequent proliferation of subprime mortgage lending, has left banks chastened when it comes to working with customers with poor credit.

2. Banks need information. Our financial system largely relies on “rules of thumb” and rough indicators to determine who is or isn’t likely to pay back their loans. One of the most common measures of credit-worthiness, the FICO score, can help paint a picture of a prospective borrower, but it is by no means a complete picture.

When determining whether to extend credit, lenders rely on FICO scores, because this has historically been the simplest way to cut through mountains of consumer data to identify reliable borrowers. But the era of big data has brought with it the ability to aggregate and analyze more information than ever, which means banks now can see a new picture and widen their reach of customers.

By leveraging the latest in alternative data, artificial intelligence and machine learning, banks can evaluate and, most importantly, make sense of a wide range of data points to understand whether someone is a) able to repay the loan and b) likely to do so. Such data includes not only credit history but also bank account balances, consistency of deposits, bank transactions, income levels and more. As a result, individuals who have been locked out of the system by a poor credit score may actually have a second chance at getting a loan and rebuilding their credit in the process. In turn, banks benefit from expanding their customer bases.

The Covid-19 pandemic is far from over, and a second stimulus proposal is in the works. Financial insecurity continues to weigh heavily on struggling Americans who couldn’t possibly have prepared for a crisis of this scope and duration. The number of consumers finding themselves in dire straits is likely to grow. It is up to financial institutions (and the fintechs that help them) to embrace the power of alternative data and analytics to expand credit access to the millions who need it to get back on their feet.

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