Ex-OTS Director: Fair Isaac's Dominance of Credit Scoring Poses Systemic Risk
Wednesday, 06 Nov 2013 08:08 AM
Although most people blame Wall Street investment banks for the subprime mortgage debacle and financial crisis, Fair Isaac played a central role in the drama, Bowman writes in an article for American Banker.
Fair Isaac dominated the businesses of providing consumer credit scores to lenders, and the company and its legacy system continues to rule the sector that's vital for bank lending. Most private lenders rely on Fair Isaac credit scores to make lending decisions.
As Bowman sees it, relying on a single entity is unacceptable, especially in consumer lending which accounts for 70 percent of the U.S. economy.
Lack of widely accepted alternatives, especially for mortgages, poses "serious safety and soundness concerns, as well as operational risk, to lenders and financial regulators," Bowman writes.
If Fair Isaac withheld the credit score or was unable to provide one, lenders would fail to meet regulations.
Yet tradition and regulations unintentionally support Fair Isaac's dominance and block new competitors.
"Serving as the gatekeeper to consumer credit, this legacy credit score provider has been baked into the lending process and incorporated into banking guidelines and financial regulations as a "too basic to fail" proxy for all consumer credit evaluations," he explains.
Regulators and lenders must open the door to credit score alternatives, recommends Bowman, whose law firm has lobbied for VantageScore Solutions, an alternative credit score provider. Competition, he says, would encourage transparency, innovation and choice and improve the reliability of scores.
Unlike Fair Isaac's FICO credit score, the VantageScore includes traditional data, such as rental payments and utilities, according to BankRate.
"Adding nontraditional data can increase a lender's approval rate by 5 percent to 15 percent," Ankush Tewari, director of strategy and market planning at LexisNexis, tells BankRate. "They can book more creditworthy consumers and not make offers that are too risky.
"Lenders want to grow their business, but they don't want to repeat the mistakes they made before the recession," Tewari adds. "One of the ways to solve that problem is to look at other data sources to add to the traditional credit bureau files."
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