The Rise of Alternative Data in Consumer Lending

Traditionally, lenders have relied on credit scores and historical financial data to assess a borrower’s creditworthiness. However, as financial behaviours evolve and the limitations of conventional credit assessments become apparent, the role of alternative data in lending decisions is gaining prominence.

Recent findings from the LexisNexis® Risk Solutions 2024 Global Consumer Lending Confidence Report reveal a notable shift in how lenders perceive and utilise alternative data. With 86% of lenders globally expressing greater confidence in using alternative credit data compared to a year ago, it’s evident that this emerging approach is not just a trend but a fundamental change in the industry.

The Growing Confidence in Alternative Data

In the UK, the adoption of alternative data has seen a remarkable uptick. 84% of lenders reported increased confidence in making consumer lending decisions based on non-traditional data sources. This shift underscores a growing awareness that past credit interactions do not always provide a complete picture of a borrower’s financial behaviour. One common misconception about using more data in lending decisions is that it leads to higher rejection rates.

However, there is growing evidence that alternative data actually helps identify lower-risk consumers who may have been overlooked by traditional credit assessments. As a result, lenders can approve more applicants and offer them better terms, fostering financial inclusion and driving business growth whilst maintaining a robust risk policy.

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Challenges with Traditional Credit Data

While confidence in alternative data is increasing, reliance on traditional credit data is waning. The report highlights that 59% of lenders feel less confident in making lending decisions based solely on traditional credit scores. A key reason for this is the coverage gap—91% of lenders reported that traditional data alone does not provide a full evaluation of at least a quarter of applicants. This is a significant concern, as it means a substantial portion of potential borrowers may be either misclassified or excluded from credit opportunities altogether.

Another major drawback of traditional credit data is its latency. In the UK, repayment data used in conventional credit models can be up to two months out of date. This delay can lead to inaccurate assessments of a borrower’s current financial situation, potentially resulting in unfair declines, mispriced loans or missed lending opportunities. Alternative data, on the other hand, offers more real-time insights, allowing for fairer and more reliable credit decisions.

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Addressing Economic Challenges with Smarter Lending

The UK’s ongoing cost-of-living crisis has amplified the need for more flexible and inclusive lending solutions. Consumers are increasingly turning to credit products, including credit cards and Buy Now, Pay Later (BNPL) schemes, to manage their expenses and purchases. While these options can be beneficial when used responsibly, excessive reliance on credit, particularly in the face of rising interest rates, can lead to financial difficulties.

The report indicates that 43% of respondents have observed an increase in loan delinquencies over the past year. Consequently, 95% of lenders anticipate that loan collections will be a major challenge in the next two years. In response, nearly half of surveyed lenders have prioritised proactive monitoring of loan portfolios to detect early signs of financial distress.

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Regulatory Considerations and the Role of Alternative Data

Regulations also play a crucial role in shaping the adoption of alternative data. In the UK, the Financial Conduct Authority’s Consumer Duty regulations stress the need for lenders to act in the best interest of consumers, including those who may be financially vulnerable, and emphasise that reliable data is crucial in adequately supporting customers.

By integrating alternative data into their decision-making processes, lenders can identify early warning signs of financial distress and provide tailored support to at-risk customers. This not only helps consumers manage their financial obligations more effectively but also enhances lenders’ ability to maintain a healthy loan portfolio.

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The Link Between Greater Financial Inclusion and Growth

One of the most significant benefits of alternative data is its potential to improve financial inclusion. Traditional credit scoring models often disadvantage individuals with thin credit files—those who have limited credit history despite being financially responsible. These individuals may include young professionals, immigrants, or people who primarily use debit rather than credit.

The misconception that a thin credit file equates to a high risk of default is slowly being debunked. Alternative data allows lenders to evaluate creditworthiness more accurately enabling more people to access credit and secure better interest rates, reducing financial inequality while also presenting lenders more opportunities which may otherwise have been missed.

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Looking Ahead

The increasing adoption of alternative data represents a paradigm shift in the lending industry. As lenders continue to explore new data sources and refine their assessment models, the potential for more inclusive, efficient, and accurate lending decisions will only grow.

For financial institutions, the key to staying competitive lies in embracing these innovations while ensuring compliance with evolving regulations. By doing so, they can not only mitigate risk and enhance customer satisfaction but also contribute to a fairer and more accessible credit ecosystem.

As we move forward, one thing is clear: the future of consumer lending will be defined by data—smarter, more diverse, and more inclusive data that empowers both lenders and borrowers alike.