Finding 65 million consumers: Using alternative data to acquire new customers

By Michael Emancipator

Relationship banking is nothing new to community banks. Community bankers personally know and understand their customers, which allows them to provide a service big banks can’t compete with. Now, novel underwriting techniques and recent regulatory guidance have enabled community banks to understand and serve their customers even better.

Further, not only can alternative data help community banks better serve existing customers. It can also help them tap into the 65 million consumers that have little or no relationships with any bank.

What is the market size and potential?

Approximately 14 million Americans are unbanked, having no relationship with a bank. An additional 50 million are underbanked, meaning they have a basic relationship with a bank yet still rely on alternative financial service providers to meet their needs.

The lack of a relationship with banks can costs consumers up to $40,000 over their lifetime in check-cashing fees and thousands more on high-interest loans from alternative providers. This means that the nearly 65 million unbanked and underbanked Americans stand to greatly benefit from a more formal relationship with a community bank.

Furthermore, while some consumers either do not have enough money to keep in an account or simply do not want a banking relationship, many others lack sufficient credit history to establish that relationship. That is where alternative data can help bridge the gap.

What is alternative data?

Alternative data is generally understood as data that is not provided in traditional consumer credit reports. So while traditional credit reports might not contain enough history for a bank to feel comfortable with the credit risk, alternative data provides additional context that could present a fuller picture of consumers and their credit risk.

Some early examples of alternative data and techniques include analysis of a consumer’s cash flow, utility and rent payment history, and even educational history.

In fact, the Consumer Financial Protection Bureau issued its first No-Action Letter to a fintech that used education and employment history to underwrite consumer loans, including credit card refinancing and debt consolidation.

How can banks use alternative data?

Many banks use alternative data to augment their traditional underwriting models, typically using the technique to get to “yes” when an applicant has been denied using traditional data and techniques. Additionally, alternative data could be used to improve the speed and accuracy of credit decisions. While community banks can develop in-house solutions to access and use this data, many community banks might find it more efficient to partner with a fintech that specializes in alternative data.

What do the regulators say?

In light of the benefits of alternative data for both consumers and banks, the federal banking agencies recently issued an interagency statement recognizing alternative data’s potential to expand access to credit and produce benefits for consumers.

The regulators emphasized that the use of alternative data may improve the speed and accuracy of credit decisions and may help firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system.

While the regulators’ acknowledgement of alternative data’s benefits is a positive factor, the statement stresses that banks must still maintain a well-designed compliance management program that provides for a thorough analysis of relevant consumer protection laws and regulations to ensure firms understand the opportunities, risks and compliance requirements before using alternative data.

Although the potential for some downside risks associated with the use of alternative data exists, the opportunity to establish closer relationships with existing customers, or to nurture relationships with new customers, can certainly be a competitive advantage that supercharges community banks’ relationship-focused, high-tech, high-touch business model.

Michael Emancipator is ICBA vice president and regulatory counsel.