The NAFCU Journal May-June 2020 - 40

COMPLIANCE CENTRAL

obtain credit from a financial institution,
as it allows for a more comprehensive
risk analysis. For example, a credit union
may determine a consumer with no
loan repayment history is an acceptable
risk because of a consistent pattern of
timely mobile phone bill payments and
sufficient cash flow.
The use of alternative data may also provide access to more timely and accurate
information. As credit unions and other
financial institutions are not required
to report information to the credit
reporting agencies, information about
a consumer's credit history may not be
included in a report at all. Information
that is included in a report can often be
months behind. Relying on other sources
of information, such as using alternative
data, may provide a more up-to-date
picture of a consumer's credit risk. For
example, real-time credit card balances
or a change in job status may show up in
the alternative data a credit union pulls
but may not be reflected on the consumer's most recent credit report.
Alternative data usage could also lead
to better pricing and terms for consumers. Having more information about
a consumer may lead a credit union
to assign a lower risk rating to that
consumer. As many credit unions use
risk-based pricing, this may move the
consumer into a higher credit tier with
a lower interest rate. Credit unions
using alternative data may also find it
less costly to verify information and
process credit applications; that cost
savings could be passed on to consumers in the form of lower fees.

What Are the Expectations for
Using Alternative Data?

In 2019, a group of federal regulators,
including NCUA, issued guidance
surrounding the use of alternative data
in the underwriting process. While the
regulators acknowledge the potential
40

benefits of alternative data, the guidance
warns of the risks and how those using
alternative data may mitigate some of
the risks.
As with any change to operations, the
guidance notes credit unions should
be aware of the applicable regulations
and how the new practice complies
with those requirements. Implementing
alternative data into credit underwriting
implicates state and federal fair lending
laws, credit reporting requirements and
the prohibitions on unfair, deceptive or
abusive acts or practices.
Fair lending laws apply throughout the
lending relationship, from advertisement to payoff, and generally prohibit
discrimination based on characteristics
such as race, religion, marital status,
gender and age. Outright discrimination - such as a policy to lend only
to married women - is not allowed.
Neutral policies that have a disparate
impact on a protected class - like giving borrowers who have more funds on
deposit a lower interest rate - are also
limited. Specifically, if a practice creates
a disparate impact, lenders can defend
the practice only if it serves a rational
business necessity and there is not a less
discriminatory way to meet that necessity. Whether the use of alternative data
raises any fair lending concerns will
depend on how the data is used.
The guidance uses the example of a
"Second Look" program to illustrate the
fair lending implications. Applicants
who have been denied credit would
get a second evaluation that includes
reviewing alternative data to potentially increase their credit opportunities.
While there is no prohibition on Second
Look programs, they must be designed
in compliance with the fair lending
laws. For example, a program in which
only certain applicants are afforded a
second look or the alternative data used

in the second look is different for each
applicant may lead to a disparate impact
based on an applicant's race or age, and
it could be a violation of the fair lending
laws. The general requirement is to treat
similarly situated individuals similarly.
Credit unions using alternative data
may be expected to explain how that
information impacted the credit
decision. The guidance reminds credit
unions that the adverse action notice
requirements under the Fair Credit
Reporting Act and Regulation B require
a statement of the specific reasons
an applicant was denied credit. For
example, if cash flow data was a primary
reason the applicant was denied, that
information must be disclosed on an
adverse action notice.
Despite some of the risks involved with
using alternative data, the guidance
encourages its responsible use. Understanding how it will be incorporated
into the underwriting process and
the potential risks of doing so is the
first step in developing a compliance
management program designed to mitigate the risks identified. The guidance
suggests the compliance management
program should include appropriate
testing and controls as well as ongoing
monitoring to ensure compliance with
the applicable regulations.
The use of alternative data in credit
underwriting is still in the early stages.
As credit unions implement innovations such as new underwriting models that incorporate alternative data,
consideration of the potential risks
and implementation of an appropriate
strategy is vital. This will help ensure
the effective use of alternative data as a
viable growth opportunity and limit fair
lending risk.
Jennifer Aguilar is senior regulatory compliance counsel for NAFCU.
THE NAFCU JOURNAL  MAY-JUNE 2020



The NAFCU Journal May-June 2020

Table of Contents for the Digital Edition of The NAFCU Journal May-June 2020

The NAFCU Journal May-June 2020 - Cover1
The NAFCU Journal May-June 2020 - Cover2
The NAFCU Journal May-June 2020 - 1
The NAFCU Journal May-June 2020 - 2
The NAFCU Journal May-June 2020 - 3
The NAFCU Journal May-June 2020 - 4
The NAFCU Journal May-June 2020 - 5
The NAFCU Journal May-June 2020 - 6
The NAFCU Journal May-June 2020 - 7
The NAFCU Journal May-June 2020 - 8
The NAFCU Journal May-June 2020 - 9
The NAFCU Journal May-June 2020 - 10
The NAFCU Journal May-June 2020 - 11
The NAFCU Journal May-June 2020 - 12
The NAFCU Journal May-June 2020 - 13
The NAFCU Journal May-June 2020 - 14
The NAFCU Journal May-June 2020 - 15
The NAFCU Journal May-June 2020 - 16
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The NAFCU Journal May-June 2020 - 18
The NAFCU Journal May-June 2020 - 19
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The NAFCU Journal May-June 2020 - Cover3
The NAFCU Journal May-June 2020 - Cover4
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