Over 420m credit checks are performed every year in the U.K. alone. Yet, between 10-14m customers in the U.K (c. 25% of the adult population) are under-banked and do not have access to credit from institutions that they know and trust such as traditional lenders. A large chunk of this population is represented by (you guessed it) students, young professionals and international workers - what we refer to as the Generation Z.
Ok, so do banks just not like young people?
Quite the opposite, in fact - the younger customers hold high life-time value, significant earning and loyalty potential which make them valuable assets for any bank.
Fine. So what is the issue?
Well, one of the issues is that the Generation Z is so different from previous generations that lenders have difficulties assessing the credit risk of young customers and current tools such as traditional credit scores, just do not cut it. As a result, an entire Generation is being disadvantaged by the current system. At the same time, banks lose up to £56bn in lifetime value each year.
Got it... What is a credit score again?
A credit score is a three-digit number that reflects how reliable you are when it comes to repaying money. Your credit score is based on how you’ve handled a loan in the past. The higher your credit score, the better your chances of being accepted for credit, and at a better rate.
Think about the credit score as your CV for credit - your CV should be complete, up-to-date, provide a strong signal of your skills and, depending on the stage of your career, an overview of your work experience so far. Unfortunately, for young customers, the credit score as currently construed, is often empty or filled with information that is irrelevant. This is equivalent to bringing an empty CV during an interview.
Since the development of the FICO score in 1956, credit scoring has pretty much remained the same and still relies on repayment history to estimate the risk of borrowers. Effectively, as long as you have paid off a loan in the past, you should be able to get a loan today. But what if you are a young person who never got a loan before? How would a bank know whether you will repay your loan or not?
This is what we call a Catch-22..
Who would expect a recent uni graduate to have the same CV as a CEO? Probably nobody. Rather, you would contextualise the graduate experiences given their age, try to understand if they share the character and the potential to develop skills that you are looking for. Most importantly, once you hire them, you should provide them with the support necessary to fulfil that potential that you so much believed in.
So why is the financial industry doing the exact opposite and relying on a concept that is often so unfair towards students and young professional when they are most in need? Perhaps lenders should not just refuse to engage with the Gen-Z on the back of old-fashioned credit scores. Rather, they could holistically look at the applicant, their path so far, the way they spend their money, their potential and support them in becoming the best version of themselves. Matter of fact, over 80% of students surveyed by ProGrad in 2020 shared that they would like professional, academic and extracurricular activities to be considered in credit decisioning - beyond simple credit history.
Why does it matter?
In the modern world of machine learning and big data, the choice to base credit evaluations on such limited information translates to lost business and lost trust. Lending decisions are often made on data that is collected with a time lag by traditional credit bureaus, meaning that they could be outright incorrect at the time a lending decision is made. Moreover, credit history provides information only on whether someone has successfully repaid their debt but provides little context with regards to why a default did or did not occur. Credit bureau data also provides no forward-looking context regarding how changes in the economy, labour market and education industry may impact credit risk going forward.
We need smarter ways to evaluate and give "credit" where credit's due. Today, everything from job offers to insurance policies to housing rentals to loans rely on credit scores, when these decisions could be based on a much more accurate collection of data. Using big data and future earnings potential to determine lower, personalized rates on credit will benefit financially responsible young people in a way the current system does not. This will allow reliable borrowers to pay less and get out of debt faster. By looking at the future earnings potential of young individuals, we unlock the power of one's current and future achievements and by leveraging the power of Open Banking we can reward young customers for being financially responsible. This means democratizing access to credit based on merit, rather than on a 70-year old set of rules, and allowing anyone with potential to pursue their dreams – whether that means enrolling at university, moving to a different city or starting a business.