What Is Alternative Credit Scoring & Why Is It So Important?

Alternative credit scoring is a new revolution in the finance industry that impacts credit accessibility, even for the unbanked and underserved.

Before now, lenders, financial institutions, lenders and banking agencies relied on only traditional credit scoring to determine a borrower's access to credit. In some cases, these institutions may ask for collateral assets such as cars, houses, and more to unlock an individual's access to better credit.

Although this method seemed to have worked, there was huge neglect of those without a bank account. The traditional credit scoring systems neglect them and make them credit invincible.

As a result, a sizable number of people around the world likely won't get a loan because they do not have a high enough credit history. Moreover, more than 1.7 billion people worldwide do not have access to a bank account, making this a potentially massive market.

The effect of this doesn't just affect customers; it also affects financial institutions as they get lesser customers, and lesser revenue, with the risk involved.

The advent of alternative data birthed alternative credit scoring. However, when used in conjunction with traditional credit scoring, there seems to be a broader view of customers' financial situation.

In the article, we'll discuss what alternative data is, what alternative credit scoring is all about, and why this new innovation is essential to all financial institutions in Africa.

What is Alternative Data

In the financial world, "alternative data" refers to information that can be used to inform investment decisions. Such data sets are frequently used by hedge fund managers and other institutional investment professionals within an investment firm.

When making investment decisions, having access to alternative data sets, which are collections of information about a company published by parties other than the company itself, can be beneficial.

Alternative data sets include credit card data, mobile data, Internet of Things (IoT) sensor data, satellite imagery, social media sentiment, product reviews, weather data, web traffic, app usage, and ESG (environmental, social, and corporate governance) data.

What is Alternative Credit Scoring?

Alternative credit scoring is the practice of evaluating a consumer's creditworthiness using information gathered from digital applications and platforms. Borrowers (even those with no credit history) can qualify for a loan using this method, which considers a variety of factors to determine creditworthiness and risk level.

Data collected from telecommunications systems, Transactional History, rent and utility bills (as at when due), retail purchases, social behavior, and other non-traditional forms are used to determine an applicant's true creditworthiness.

Financial institutions can now provide credit to previously unbankable populations, such as the underbanked, thanks to alternative credit scoring. People who have previously struggled to establish credit can get a leg up with the help of alternative credit scoring. It allows them to gain access to the financial system and obtain loans with minimal requirements.

The goal of alternative credit scoring is to make it easier for creditors to assess a borrower's creditworthiness by using their digital and non-traditional footprint.

Credit rating agencies consider an applicant's social and digital data in addition to the traditional FICO scores when making decisions. The willingness and ability of the applicant to repay the loan, as well as the applicant's financial stability, are also important factors.

How Does Alternative Credit Scoring Work?

Alternative credit score providers use tools such as Payment of utility bills, Financial Account Information, Telecom Service Remittances, Payments for rent and lease, mobile money transactions, and other data sets to generate an alternative credit score.

Most modern alternative data providers, such as Oystr Finance, incorporate elements of artificial intelligence (AI) and machine learning to accomplish it.

The applicant's history of paying bills on time demonstrates their motivation and financial discipline. It depicts a person's creditworthiness with the same transparency as a standard credit report.

A major reason for this is that traditional credit scores are only accurate for two to three years. The applicant's financial situation may improve or worsen during this time period.

A person's traditional-based credit score does not always reflect whether or not they are currently facing challenges due to job loss or other factors. Even if this were the case, the lender could still be held liable if the borrowers' loan applications were approved. ` On the other hand, a loan application from someone who can and will pay their bills on time may be rejected if they do not have a credit score.

Why is Alternative Credit Scoring So Important?

Alternative credit scoring comes with numerous benefits and advantages for both financial institutions and end consumers. Here are some benefits.

Improved Credit Worthiness

Financial institutions frequently reject loan applications from people perceived to have bad credit. The use of alternative data for credit scoring results in a more accurate and complete picture of the applicant's creditworthiness.

The data makes it easy to determine which applicants are less likely to have repayment issues by analyzing additional information such as the frequency of phone "load" top-ups and monthly bill payment patterns. It provides a wealth of data that enables business owners to make informed decisions without increasing the risk to their company.

Less Cost, More Revenue

Credit scoring using alternative data saves money for lenders. Borrowers who were approved for loans with high-interest rates (due to a lack of credit history) can also be reevaluated based on their digital footprint.

With the help of alternative credit data, lenders can make more informed decisions about loan terms and interest rates, providing a novel platform for assessing credit risk.

Financial Inclusion

Alternative credit scoring can help financial institutions include more people and offer more tailored products. It creates a market for lenders willing to serve underserved populations such as the unbanked and those with bank accounts but no credit history. The loan application of the underserved communities will be stronger if they use alternative data credit scoring. Borrowers with a low or nonexistent credit score can still be approved for a loan if they have a track record of timely bill payments.

Reduce Risks and Detects Fraud

In an increasingly complex fraud environment, alternative data allows you to digitally capture essential information from credible sources rather than manually collecting documents. Because alternative data fraud prevention goes beyond traditional consumer information and into new areas, you now have a plethora of data points to make quick and accurate fraud risk decisions.

Real-time Data

Traditional credit scoring models allow negative information to remain on a person's credit report for up to three years after the event in question. It will take some time for the applicant's credit score to recover from a dip and return to a healthy level.

Alternative data credit scoring allows lenders to use real-time data to make educated decisions. The information is useful for making a thorough assessment of the applicant's current creditworthiness and can be used promptly.

Conclusion

Using alternative data in credit scoring opens financial institutions to lesser risk, a broader view of customers' financial situations, and the ability to include more and serve the unbanked. It's becoming a necessity for financial institutions and lenders to embrace alternative credit scoring.Oystr Finance is an alternative data provider, offering transaction history, credit scoring, fraud detection data and much more. Visit our website to learn more.