Financial Technology: Agencies Should Provide Clarification on Lenders' Use of Alternative Data [Reissued with revisions on Mar. 12, 2019.]
Fast Facts
Financial technology—or "fintech"—can help connect lenders and borrowers online. Some fintech lenders told us that they use alternative data to help determine borrowers' creditworthiness. For example, lenders may supplement traditional data (such as credit scores) with information about a borrower's college degree.
Using alternative data could make loans available to more people, but could also have unintended effects. Fintech lenders may not know how to use the data and still comply with fair lending laws.
We recommended that the Consumer Financial Protection Bureau communicate with lenders about how to use alternative data.
A photo of money changing hands.
Reissued with Revisions Mar 12, 2019On March 12, 2019, this report was revised to insert Consumer Financial Protection Bureau and CFPB where we initially referred to the agency as the Bureau of Consumer Financial Protection and BCFP, respectively based on the agency’s preferences at the time we released the report.
Highlights
What GAO Found
Two recent trends in financial technology (fintech) lending—that is, consumer and small business lending by nonbank technology-based firms—include growth in loan volume and increasing partnerships between fintech lenders and banks.
- Growth. Data from a sample of 10 fintech lenders and literature GAO reviewed indicated that loan volume for fintech lenders has grown in recent years and is expected to continue growing. For example, personal loans provided by lenders GAO interviewed grew sevenfold from 2013 through 2017 ($2.5 billion to $17.7 billion). The fintech lenders also reported growth in their small business and student loan portfolios.
- Bank partnerships. Fintech lenders are partnering with banks to originate loans. Generally, loan applicants are evaluated using the fintech lenders’ technology-based credit models, which incorporate the banks' underwriting criteria. The fintech lenders then purchase the loans from the banks and sell them to investors or hold them on their balance sheets.
Some of the fintech lenders GAO interviewed said they use alternative data to supplement the traditional data used to make credit decisions or to detect potential fraud. For example, lenders may check the email address provided by a borrower against a list of email addresses that a third party has identified as fraudulent. Federal agencies and stakeholders generally define alternative data as information not traditionally used by the national consumer reporting agencies in calculating a credit score. Some alternative data (such as on-time rent payments) are financial and similar to traditional data, while others are nonfinancial (such as a borrower’s educational institution and degree).
Using alternative data in credit decisions presents potential benefits (such as the expansion of credit) and risks (such as the potential for disparate impact and other fair lending issues). The Consumer Financial Protection Bureau (CFPB) and federal banking regulators have monitored fintech lenders’ use of alternative data by collecting information and developing reports on alternative data, but they have not provided lenders and banks with specific guidance on using the data in underwriting. For example, CFPB’s fair lending examination procedures and the banking regulators’ third-party guidance on risk do not clearly communicate the agencies’ views on the appropriate use of alternative data. Nine of the 11 fintech lenders GAO interviewed said additional guidance would be helpful to clarify regulatory uncertainty, which some lenders identified as a barrier to further financial innovation in expanding access to credit. Further, federally regulated banks that have partnered with fintech lenders told GAO that clarification on appropriate use of alternative data would help them manage their relationships with those lenders. Federal internal control standards state that agencies should externally communicate the necessary quality information to achieve their objectives. With clear communication from CFPB and the federal banking regulators on appropriate use of alternative data in the underwriting process, fintech lenders would have greater certainty about their compliance with fair lending and other consumer protection laws, and federally regulated banks may be better able to manage the risks associated with partnering with fintech lenders that use these data.
Why GAO Did This Study
Fintech refers to the use of technology and innovation to provide financial products and services. Fintech lenders are nonbank firms that operate online and may use nontraditional (also referred to as alternative) data to make loan decisions. CFPB has supervisory authority over some fintech lenders. Fintech lenders that have entered into third-party relationships with banks may also be subject to indirect oversight by federal banking regulators. The three fintech lending segments that GAO reviewed are personal, small business, and student loans.
GAO was asked to review several fintech lending issues. This report, among other things, (1) describes recent trends in fintech lending and (2) examines fintech lenders’ use of alternative data and the extent to which federal agencies monitor lenders’ use of the data. GAO reviewed literature and agency documents; analyzed relevant federal guidance; conducted interviews with agency officials and industry stakeholders; and collected data from 10 fintech lenders (selected based on size, products offered, and other factors).
Reissued with revisions on Mar. 12, 2019.
On March 12, 2019, this report was revised to insert Consumer Financial Protection Bureau and CFPB where we initially referred to the agency as the Bureau of Consumer Financial Protection and BCFP, respectively based on the agency’s preferences at the time we released the report.Recommendations
GAO recommends that CFPB and the federal banking regulators communicate in writing to fintech lenders and banks that partner with fintech lenders, respectively, on the appropriate use of alternative data in the underwriting process. The agencies each stated that they plan to take action to address GAO’s recommendations.
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Consumer Financial Protection Bureau | The Director of the Bureau of Consumer Financial Protection should, in coordination with the federal banking regulators and with input from relevant stakeholders, communicate in writing to fintech lenders on the appropriate use of alternative data in the underwriting process, including issues to consider when selecting types of alternative data to use. (Recommendation 1) |
In December 2019, the Board of Governors of the Federal Reserve System, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency (the agencies) issued an interagency statement on the use of alternative data in credit underwriting. The statement broadly highlights some potential benefits and risks of using alternative data and encourages firms to responsibly use alternative data. However, the statement does not provide firms or banks with specific direction on the appropriate use of alternative data. In March 2021, the federal banking regulators and the Consumer Financial Protection Bureau (CFPB) issued a request for information (RFI) on Financial Institutions' Use of Artificial Intelligence, including Machine Learning, and in July 2021, the banking regulators issued proposed third party risk management guidance for comment, both of which discuss alternative data. In June 2023, the banking regulators issued final interagency guidance on third party risk management, but the guidance does not address specific topics, such as alternative data, or specific types of third-party relationships, such as relationships with fintech companies. Further, the banking regulators and CFPB have not issued any documentation related to the RFI as of April 9, 2024. To fully implement this recommendation, CFPB needs to provide, in coordination with the federal banking regulators, finalized written communication that gives banks that engage in third party relationships with fintech lenders specific direction on the appropriate use of alternative data in the underwriting process. Without such direction, banks partnering with financial technology lenders may not effectively manage associated risks, including compliance with fair lending and other consumer protection laws.
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| Federal Reserve System |
Priority Rec.
The Chair of the Board of Governors of the Federal Reserve System should, in coordination with the other federal banking regulators and the Bureau of Consumer Financial Protection and with input from relevant stakeholders, communicate in writing to banks that engage in third-party relationships with fintech lenders on the appropriate use of alternative data in the underwriting process, including issues to consider when selecting types of alternative data to use. (Recommendation 2) |
In December 2019, the Board of Governors of the Federal Reserve System (the Federal Reserve), the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency (the agencies) issued an interagency statement on the use of alternative data in credit underwriting. The statement broadly highlights some potential benefits and risks of using alternative data and encourages firms to responsibly use alternative data. However, the statement does not provide firms or banks with specific direction on the appropriate use of alternative data. In March 2021, the federal banking regulators and the Consumer Financial Protection Bureau issued a request for information (RFI) on Financial Institutions' Use of Artificial Intelligence, including Machine Learning, and in July 2021, the banking regulators issued proposed third party risk management guidance for comment, both of which discuss alternative data. In June 2023, the banking regulators issued final interagency guidance on third party risk management, but the guidance does not address specific topics, such as alternative data, or specific types of third-party relationships, such as relationships with fintech companies. Further, the banking regulators and Consumer Financial Protection Bureau have not issued any documentation related to the RFI as of April 9, 2024. To fully implement this recommendation, the Federal Reserve needs to provide, in coordination with other federal banking regulators and the Consumer Financial Protection Bureau, finalized written communication that gives banks that engage in third party relationships with fintech lenders specific direction on the appropriate use of alternative data in the underwriting process. Without such direction, banks partnering with financial technology lenders may not effectively manage associated risks, including compliance with fair lending and other consumer protection laws.
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| Federal Deposit Insurance Corporation |
Priority Rec.
The Chairman of the Federal Deposit Insurance Corporation should, in coordination with the other federal banking regulators and the Bureau of Consumer Financial Protection and with input from relevant stakeholders, communicate in writing to banks that engage in third-party relationships with fintech lenders on the appropriate use of alternative data in the underwriting process, including issues to consider when selecting types of alternative data to use. (Recommendation 3) |
In December 2019, the Board of Governors of the Federal Reserve System, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration, and the Office of the Comptroller of the Currency (the agencies) issued an interagency statement on the use of alternative data in credit underwriting. The statement broadly highlights some potential benefits and risks of using alternative data and encourages firms to responsibly use alternative data. However, the statement does not provide firms or banks with specific direction on the appropriate use of alternative data. In March 2021, the federal banking regulators and the Consumer Financial Protection Bureau issued a request for information (RFI) on Financial Institutions' Use of Artificial Intelligence, including Machine Learning, and in July 2021, the banking regulators issued proposed third party risk management guidance for comment, both of which discuss alternative data. In June 2023, the banking regulators issued final interagency guidance on third party risk management, but the guidance does not address specific topics, such as alternative data, or specific types of third-party relationships, such as relationships with fintech companies. Further, the banking regulators and Consumer Financial Protection Bureau have not issued any documentation related to the RFI as of April 9, 2024. To fully implement this recommendation, FDIC needs to provide, in coordination with other federal banking regulators and the Consumer Financial Protection Bureau, finalized written communication that gives banks that engage in third party relationships with fintech lenders specific direction on the appropriate use of alternative data in the underwriting process. Without such direction, banks partnering with financial technology lenders may not effectively manage associated risks, including compliance with fair lending and other consumer protection laws.
|
| Office of the Comptroller of the Currency |
Priority Rec.
The Comptroller of the Currency should, in coordination with the other federal banking regulators and the Bureau of Consumer Financial Protection and with input from relevant stakeholders, communicate in writing to banks that engage in third-party relationships with fintech lenders on the appropriate use of alternative data in the underwriting process, including issues to consider when selecting types of alternative data to use. (Recommendation 4) |
The Comptroller of the Currency agreed with the recommendation. In December 2019, the Board of Governors of the Federal Reserve System, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency (OCC) issued an interagency statement on the use of alternative data in credit underwriting. The statement broadly highlights some potential benefits and risks of using alternative data and encourages firms to responsibly use alternative data. However, the statement does not provide firms or banks with specific direction on the use of alternative data. In March 2021, the federal banking regulators and the Consumer Financial Protection Bureau issued a request for information (RFI) on Financial Institutions' Use of Artificial Intelligence, including Machine Learning, and in July 2021, the banking regulators issued proposed third party risk management guidance for comment, both of which discuss alternative data. In June 2023, the banking regulators issued final interagency guidance on third party risk management, but the guidance does not address specific topics, such as alternative data, or specific types of third-party relationships, such as relationships with fintech companies. Further, the banking regulators and Consumer Financial Protection Bureau have not issued any documentation related to the RFI as of April 9, 2024. To fully implement this recommendation, OCC needs to provide, in coordination with other federal banking regulators and the Consumer Financial Protection Bureau, finalized written communication that gives banks that engage in third party relationships with fintech lenders specific direction on the appropriate use of alternative data in the underwriting process. Without such direction, banks partnering with financial technology lenders may not effectively manage associated risks, including compliance with fair lending and other consumer protection laws.
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