Gerard Scimeca – Chairman, CASE
July 16, 2020
As the financial crisis of 2008 and the pandemic have shown, there’s no crystal ball to warn us when and how our economy may be turned upside down. But not all economic blindsides are created equal or affect us the same way.
Twelve years ago, the United States didn’t experience shortages of basic household items or suffer through key food staples doubling in price. And as painful as the housing crash was for the nation more than a decade ago, it didn’t result in more than 40 million people across the country losing their jobs, as we have sadly seen over the past three months.
Despite not reaching the widespread severity of our current downturn, the economic recovery following 2008 was slow and grueling, in large part due to a credit crunch that limited access to loans for consumers and small businesses. That’s not something we can afford to repeat with so many out of work and a harrowing number of our nation’s small businesses teetering on a cliff. The critical ingredient for ensuring the swiftest economic recovery possible remains, as it always has been, borrower access to capital.
Just in the nick of time, a key development in the lending industry is paving the way to ensure that we don’t see a repeat of the widespread borrowing limits we saw in 2008 that cramped the economic rebound. The industry standard credit scoring model is now incorporating highly predictive data to measure individual borrower “resilience” in an economic downturn.
The benefits of this enhancement are obvious. More plainly, lenders may now consider how well a borrower will be able to weather an unpredictable economy and still fulfill loan obligations. Employing a resilience index alongside the traditional FICO scoring model, lenders will have a powerful tool to manage and calculate the latent risk inherent in unforeseen economic downturns that affect their customers.
As our nation labors to recover in a dire economic environment, this innovation is welcome news. With lenders utilizing this tool, consumers who previously would have been denied credit in response to economic misfortune may now qualify by demonstrating lower risk through a higher resilience profile. As an example, consider a potential borrower with a FICO score below a determined cutoff. If that same borrower has a long credit history, low credit card balances, and fewer overall accounts, the new data models would likely grade this borrower as highly resilient and well-positioned to manage credit in an economic slowdown. This is just one of many scenarios in which a scoring model that incorporates resilience can help a borrower’s chance for loan approval vastly increase.
The determining factor in every loan application is, of course, risk. The cost of default is baked into every lending decision, influencing whether a loan is extended, the amount, and the terms. Credit scoring models that incorporate additional data and innovation can produce a more coherent profile of borrower resilience that not only lowers the risk for lenders but also reduces costs for borrowers.
There are some critics, including a few members of Congress, who don’t want any changes to credit models during the recovery, claiming this is no time to introduce data that might move the goal posts. What the critics fail to note is that resilience considerations will in fact move the goal posts closer to borrowers who are most in need of loans.
As evidence, consumer data analyzed during the 2008 crisis was overlaid with the resiliency model and returned results showing that far more consumers would have been eligible for loans with a resilience model factored in. Specifically, for every borrower who would previously have been approved for credit under the FICO Score 8 model but denied under the new scoring system, 4.3 previously ineligible borrowers would now be approved, a ratio of more than 4-to-1. The power of this innovation in assessing borrowers’ ability to pay is precisely the kind of progress that will prevent widespread credit restrictions on millions of otherwise creditworthy borrowers.
Economic storms are hard to predict, but they are much easier to prepare for when we equip ourselves with the right information. Better tools and more complete data are an advantage to every decision-maker in any industry, and lending is certainly no different. A resiliency index factored into loan decisions will expand access to capital for consumers and industry alike and help us avoid a repeat of the previous recovery with its low growth and lagging wages. Washington should not stand in the way of an innovation that equips both lenders and consumers with more complete information that will help all parties make better, less risky, and more financially sound decisions. Our recovery is counting on it.
