The future of consumer credit reporting.
Consumer credit reporting has been around almost as long as credit itself. Here's a look at the current model, why it's increasingly out of step, and where the system could go next.
The problem with the current model
Credit reporting was originally designed as a blacklist of bad customers, stopping borrowers who had defaulted from simply moving bank to bank with a poor record. Over time that premise evolved into something more statistical: identify borrowers who look like the bad customers.
On the surface that sounds sensible. Build a model that finds consumers who share characteristics with those who have defaulted, and you can predict who might default before they do. The problem is that this approach can't tell apart the person desperately seeking credit from the one simply shopping around for a better rate. And because defaults can cluster around certain postcodes, for many reasons, everyone living in that area is penalised.
Let's be honest: credit providers are in the business of providing credit, not denying it. Yet the system builds models of negative behaviour to find people likely to behave negatively, which by definition excludes creditworthy people who merely resemble those with poor records. Reducing someone's access to credit just for applying is hard to defend, and judging them by their postcode is unfair, in some industries outright illegal. Most lenders accept this is how it works; most consumers are surprised by it.
Where you live could determine if you can get a mortgage, with Australia's biggest credit scoring company now applying postcode data when assessing applications.ABC News (Australia), 7 February 2022
Credit scores have gotten attention over the past few years from critics decrying their accuracy and their use of data that is reflective of historical bias.Forbes, 26 February 2021
The current system pits the consumer against the credit provider. A lack of transparency makes the information questionable, and a focus on negative inputs creates negative outcomes for everyone.
How this hits the credit industry
If you've read this far you might be thinking "so what, this is how I manage risk." But the current model has real consequences. Consider how external dispute resolution (AFCA) complaints affect your business, and how much time you spend responding to budget repair agencies. The most common answers we hear: more is spent managing complaints than on core business, and repair agencies are a burden on consumers who don't realise you're there to help.
Here's the uncomfortable part: consumers trust a budget repair agency ahead of you because they never understood how credit reporting worked when they took the credit, or how it was affecting them.
The current regime no longer passes the pub test
Step back and look at privacy more broadly, and a clear shift is under way. The Cambridge Analytica and Facebook episode was an awakening for many consumers about how their information can be used against them. GDPR was already ahead of that curve, introducing the idea of informed consent: a higher bar for being transparent about how someone's data will be used, rather than burying it in terms nobody reads.
Since then, regulators worldwide have shifted. In Australia, the Privacy Act is under review, and the roll-out of Open Banking and the Consumer Data Right has reset the benchmark for the transparency now expected around consumer information. None of this applies directly to credit reporting today, but it's a clear signal of where community expectations on fairness and transparency are heading.
There is a better approach
Credit reporting is an essential tool for any credit manager. Bank statements help determine affordability, but they say little about how well a consumer is meeting their existing commitments. Meanwhile, traditional bureaus are becoming less relevant: for many providers the cost of dealing with old enquiries and complaints outweighs the value, and as providers reduce their engagement or opt out, data quality spirals.
A better approach brings credit reporting into the light. Pair transparency with encouragement to meet obligations and lift creditworthiness. Let consumers fairly challenge what's reported, and proactively correct it when it's wrong. Remove inappropriate proxy variables like enquiries and postcode, and you take real strides toward removing prejudice from your decisioning. Credit reporting can become a tool that enhances a consumer's creditworthiness rather than detracting from it, reducing the need for repair agencies and disputes, and producing better outcomes for everyone.
A final word
Some will read this with a closed mind and say they've run their business the same way for years and don't need to change. But through this period of disruption, with the rise of neobanks and buy-now-pay-later, new regimes like the Design and Distribution Obligations, and the changing attitudes of younger generations toward credit, it's worth asking: do you really believe the old methods of risk management will support you into the future?