Lending companies across the world prefer extending loans to customers who hold a long credit history. This enables them to evaluate the credit habits of potential borrowers and thereby mitigate the associated lending risks. Historical data, therefore, increases your chances of receiving loan sanctions and if you possess a good credit score, you are assured of favourable interest rates and terms.
This can, however, be a problem area for loan applicants such as students, retirees or anyone who has never availed of credit and, hence, holds no credit history. Such a scenario directly impacts their credit score and eligibility to obtain any kind of loan. Lack of credit history and score among the unbanked and underbanked populace has resulted in a yawning divide leaving a significant number of people ineligible for securing credit.
What is Credit Scoring?
The traditional form of credit scoring revolves around credit bureaus that collect and store financial information of individuals and businesses taking up credit. In India, agencies like Equifax, TransUnion CIBIL, CRIF Highmark and Experian receive credit details from different banks and financial institutions. As and when required, they access these records and generate a credit report which provides an overview of one’s previous credit history and repayments.
They summarise each report in the form of a three-digit number called a credit score or CIBIL score ranging from 300 to 900. A high credit score, usually above 750, is recommended if you wish to apply for credit. Anything lower may fetch you loans at higher rates of interest with stringent terms or possibly even credit rejection.
| Credit Score | Rating |
|---|---|
| 800 – 900 | Excellent |
| 750 – 800 | Very Good |
| 625 – 750 | Fair |
| 625 and below | Low |
How is Credit Score Calculated?
Credit rating agencies consider these parameters when assigning credit scores:
- Payment history – It signifies regularity in payments and indicates whether a borrower has ever missed a payment or defaulted on a loan.
- Credit utilisation ratio – This shows if you can manage credit within the given limit.
- New credit – It denotes the number of ongoing loans that may leave you with lesser cash reserves to handle additional credit.
- Credit mix – It establishes the kind of credit diversity in your portfolio.
- Length of credit history – Older active accounts signify how well you manage payments over a longer duration.
What is Alternative Credit Scoring?
Alternative credit scoring is a system of calculating credit scores using current, relatable and easily available data about applicants, primarily through their digital footprint, to determine creditworthiness. It helps induct people into the credit system by giving them easy loans and making them a part of the banking and lending industry. Alternative credit scores bring down the risks for alternative lenders and also lower borrowing costs.
What are the Benefits of Alternative Credit Scoring?
Alternative credit scoring benefits the lending sector at large in the ways mentioned below:
1. Enhanced Assessment Pattern
Alternative credit scoring focuses on current parameters rather than historical data, which makes it a more viable option for individuals with no credit scores. Credit reports can be created according to the current financial habits and social interactions of applicants; supporting a better understanding of their ability, stability and intent to repay the money they seek to borrow.
2. Wider Market Reach
A large number of people, who are either bank account holders with no prior credit history or individuals who have no access to banks, cannot apply for loans as they have nil credit scores. And even if they do apply, they have minimal chances of securing loan sanctions because zero credit history marks them as risky borrowers.
Alternative credit scoring has levelled the playing field for such applicants as lenders are eager to offer loans in accordance with applicants’ payment discipline and alternative credit scores. This opens up the market providing ample opportunities to both lenders and borrowers while making interest rates more competitive.
3. Increased Efficiency Systems
Automated alternative credit scoring models allow lenders to bring down loan origination costs. They may then transfer this benefit to customers in the form of lower interest rates and other associated charges. They can further cut down on bias and errors commonly found in manual underwriting through the use of automated loan underwriting processes.
4. Better Deals for Borrowers
Alternative credit scoring with real-time data analyses applicants’ behaviour based on past bill payments, e-commerce purchases, bank transactions and more. This way, existing borrowers who were previously charged a higher interest rate due to limited credit history can now refinance their outstanding loans at more attractive rates and terms. Moreover, it stands to benefit both borrowers and lenders as lending companies using alternative credit scoring can attract additional customers with preferential services compared to regular lending firms.
What are the Features of Alternative Credit Scoring?
Alternative credit scoring differs from traditional credit scoring in several ways. Some of the striking features include:
Alternative credit scoring is calculated on three basic factors:
- Ability to repay debts
- Willingness and intent to pay on time
- Stability to ensure complete loan repayment
Credit scoring companies pick the applicant’s social and digital information to evaluate these aspects. They use tools that access multiple relevant data through AI and ML-powered algorithms such as:
- Utility bill payments
- Bank account details
- Rental and lease payments
- Transaction details
This information demonstrates the applicant’s intent and ability to pay their monthly dues in a disciplined manner. These often depict a person’s credit behaviour more effectively than the usual credit report wherein credit ratings remain valid for a longer duration. During this period, an individual’s financial discipline may change for better or worse. Thus, someone with a good credit score might receive loan approvals even though they may be presently experiencing financial difficulties. At the same time, a person without credit may be capable of paying off loans and yet face loan denial because of nil credit scores.
What is the Best Model for Credit Scoring?
Alternative credit scoring works best in terms of accuracy and outreach when compared to traditional credit scoring methods. Furthermore, the banking sector benefits from a larger customer base, boosting economic activity and growth among the hitherto under-represented citizenry.
Alternative credit scoring models have already been implemented in China, USA and several European nations, empowering both fintech-enabled lenders and new borrowers with accessible credit. Such credit rating systems are projected to usher in positive changes in developing nations like India where a large population has restricted access to banking facilities. While lending firms in metropolitan cities have adopted alternative credit scoring to provide quick short-term loans such as payday loans, tier 2 and tier 3 cities are yet to catch on.
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