As the Consumer Financial Protection Bureau takes a closer look at alternative data, the American Bankers Association delivered an eight-page comment letter containing a half dozen suggestions about the current and potential use of alternative data and modeling techniques in the credit process.
Along with the suggestions, ABA also raised regulatory concerns, especially when using alternative data might trigger the CFPB to take action for what the bureau could allege as unfair, deceptive, and abusive acts and practices (UDAAP).
Authoring the material was Nessa Feddis, the association’s senior vice president and deputy chief counsel for consumer protection and payments. Feddis began by outlining a foundation of ABA’s stance regarding alternative data.
“As a general matter, banks support the use of alternative data sources to evaluate credit applicants, particularly people with no or ‘thin’ credit files who may be eligible for credit,” Feddis wrote. “The use of alternative data, coupled with mobile channels of access to bank products and services, may have potential to expand financial services and open the door to people who otherwise have limited or no access to mainstream credit.
“However, banks have concerns about the reliability and predictability of some alternative data and about consumer protections promoting privacy and data security,” she continued. "In addition, it should also be emphasized that banks recognize the importance of fair lending and demonstrating that underwriting models are sound.”
Feddis then went into six suggestions that could quell concerns about UDAAP allegations among other aspects of leveraging this technology. The recommendations included:
1. Alternative data providers should be sensitive to consumer privacy and data security and ensure that data are accurate and reliable.
2. Regulators must recognize that application of disparate impact liability in supervision and enforcement causes banks to retreat from using alternative data, limiting inclusion and competition.
3. To promote the use of alternative data in mortgage lending credit decisions, regulators should provide guidance on how banks can test and demonstrate that models comply with the Fair Housing Act’s disparate impact liability, consistent with the Supreme Court’s Inclusive Communities framework, and also meet supervisory safety and soundness expectations about model validation.
4. Regulators must also recognize that the persistent threat of an undefined UDAAP sanction hovers like a dark cloud over financial innovation and will cause banks to retreat from using alternative data.
5. A supervisory approach that reduces banks’ compliance risk will encourage banks to use alternative data as a tool to develop products, especially small dollar loans, designed for people who may not qualify under traditional underwriting standards.
6. The bureau should reconsider its Project Catalyst and No Action Letter policy to promote testing of alternative data and foster innovation without the risk of triggering fair lending and UDAAP liability.
“Banks are enthusiastic, but cautious, about using alternative data and models to innovate and improve customer access to credit and product affordability,” Feddis wrote to close her letter to the CFPB.
“A number of factors impede experimentation and use of alternative data,” she continued. “Fair lending, UDAAP, and model validation challenges, risks and costs are primary obstacles. Lack of assurance about the predictability, reliability and accuracy of the data as well as privacy and data security concerns also cause banks to hesitate.
“Simply put, the compliance and reputation costs and risks can overwhelm the uncertain return,” Feddis went on to say in the letter available here.