Open Alternative Paths to Profits with Alternative Data
The regulatory reform and economic turbulence of recent years have put a tight squeeze on the profitability of financial institutions. In response, bankers know they need to cut costs and reduce charge-offs. They also need to unlock new revenue opportunities through keener insights into customers and new applicants. How can financial institutions achieve these goals in a hotly competitive market? How can you make more profitable decisions at the point-of-sale while reducing risk and fraud?
One innovative way to build revenue from new customer segments, improve risk assessments and reduce charge-offs is using alternative data to know your customers better—especially customers with thin files or limited credit histories. Alternative data can include payment histories of mobile phone accounts, utility bills, apartment rental detail and even payday loans.
Finding More Good Payers
Every financial institution wants to identify and capture profitable households, and demand deposit accounts (DDAs) are the primary gateway for establishing a consumer relationship. However, the traditional consumer risk assessment tools most institutions use at account opening are not effective with the “unbanked” and “underbanked” population. These tools can be enhanced with relevant payment data.
Getting to Know Your Customers, Again
As the economy’s tepid recovery continues, there is a real advantage to identifying and serving good payers. As one industry observer writes in a financial blog, “Take a second look at your ‘unprofitable’ accounts, and you may find a golden opportunity to profitably expand services to existing customers and create a ‘regulatory friendly’ new revenue channel at the same time.”
Michael Sisk, contributing editor of American Banker, points out the problem of concentrating acquisition efforts on consumers with high credit scores and pristine payment histories. “The trouble with this strategy,” he wrote, “is that every institution knows who these customers are and, what’s more, most of these people already have a mortgage, a car and all the credit cards they need.”
According to Sisk’s article (“No Credit, No Problem.” American Banker. November 1, 2011), financial institutions are increasingly relying on alternative data to identify good customers they might ordinarily overlook. The article quotes Aite Group’s Christine Pratt: “They want to keep their good customers and make the pool of potential customers grow, but in a risk-sensitive way.”
Completing the Picture
Alternative data adds new dimensions to a financial institution’s ability to evaluate consumer risk. Using the non-traditional, trade-line data delivers incremental decisioning power to generic risk models based on credit files alone.
Traditional credit file attributes provide only a partial picture of a consumer’s monthly financial obligations. The picture is much more complete when bankers can see consumer payment behavior with rent, cable, phone, water, gas or electric bills.
Banks struggle not only with assessing risk on deposit accounts, but also with awarding credit to consumers with little or no credit history. Understanding the payment behavior of consumers, particularly payments not on the traditional credit file, is the key to unlocking lifetime profitability.
Some alternative payment information can also provide a more complete trade-line view of consumer behavior over time, which enables powerful analytic applications that can be applied beyond the population of unbanked and underbanked consumers. For example, in the case of a customer attempting to rebuild credit, alternative data can provide tremendous insight.
Charge-offs Fall Off
Equifax researchers have demonstrated conclusively that financial institutions can use alternative data to more precisely identify charge-off risk without impacting new account volumes. Using data contributed by two large banks, Equifax tracked new account performance for the 12-months. Findings of the analysis, completed in the fourth quarter of 2011, were compelling:
- Using their conventional risk assessments, the banks experienced a charge-off rate of 9.3 percent of approved accounts, with an average charge-off amount of $300.
- Had the banks used alternative data as an incremental determinant in account screening, they would have identified 40% of charge-off accounts and 39% of charge-off amounts in the bottom decile.
Putting Alternative Data to Work
Start by estimating the market size. At joinbankon.org, you can download estimates of the number of unbanked and underbanked households in your area.
Next, select a reliable source for alternative data.
And finally, set up a risk assessment process that appropriately combines alternative data and conventional credit files to fit your bank’s strategy. You can employ alternative data effectively to meet different goals:
- Open more accounts, including offering new products tailored for underbanked consumers
- Reduce charge-off risk with improved DDA risk decisioning
- Find hidden opportunities by modifying your rules and setting risk appropriate terms for attracting and rewarding responsible consumers
With alternative data, you can confidentially make low-risk point-of-sale offers and expand your reach by securely tapping into the largely underserved thin-file, no-file consumer segments. And, by having a better, more comprehensive view of consumer risk and opportunity, you will be better equipped than your competitor’s to grow your primary household portfolio.
Want to learn more? Send us an e-mail.
This post was contributed by: Brad Jones.
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