With systemic factors at play that cannot be resolved by banks and credit unions alone, creating financial resilience and helping reduce reliance on expensive, alternative financial services is complicated. However, there’s a solid case for banks and credit unions helping accountholders improve their credit scores in the quest for overall financial health.
The financial services industry understands having a good credit score is not the same thing as being financially healthy, as access to lower-cost cash flow sources and credit services is often only possible if a consumer has a healthy credit score. The alternatives, however, are expensive and can contribute to continued financial fragility.
According to a recent Federal Reserve Economic Well-Being report, in 2021, 19% of adults in the U.S. were either unbanked or underbanked, requiring alternative financial services like payday loans, check cashing services, pawn shops, or title lending to meet their cash flow needs.
Unbanked respondents did not have any bank accounts, though they may have used alternative financial services like payday loans, check cashing services, pawn shops, or money orders to meet their needs. Those considered underbanked had an account but appeared to have insufficient access to traditional financial services to meet their day-to-day needs and instead had to rely on more expensive, alternative financial services.
Relying on alternative financial services is expensive. Beyond their own cost, and often at rates far higher than bank or credit union provided services, 53% of banked adults who used credit alternative financial services (payday loans, advances, pawn shop loans, auto title loans, or tax refund advances) paid an overdraft fee in the last 12 months. That’s nearly five times the rate of the overall banked population. In addition, 63% of those who rated their credit as “poor” or “very poor” paid an overdraft fee, compared to the 3% who rated their credit as “excellent”.
As a possible explanation, the Federal Reserve suggests those who self-rated their credit as poor or very poor were already in a precarious financial position and more likely to unintentionally overdraft their accounts. Alternatively, without access to less expensive forms of credit, these individuals may intentionally use overdrafts as a form of short-term, high-cost credit. So how can banks and credit unions help their accountholders improve their credit scores and gain access to previously closed-off credit options without compromising the safety of their own balance sheets?
With 61% of the U.S. consumer population interacting weekly with digital banking channels, there’s never been a better time to embed credit tools into your digital banking platform. “The financial services ecosystem exists to enable consumers to improve their financial health,” said Jacob Bouer, Director of Strategic Partnerships at Array, in a recent press release. “This movement is both necessary and urgent. Consumers will find them elsewhere if financial institutions do not offer credit monitoring and identity protection products.”
Beyond simply providing access to credit information, the Consumer Financial Protection Bureau report, Consumer Voices on Credit Reports and Scores, notes a critical next step is making it easier for consumers to interpret credit reports and determine what actions they need to take next. Look for integrations that offer specific actions an accountholder can take to maximize their score or a credit score simulator that shows how credit scores can be impacted by specific credit actions or behaviors.
With as many as 70 million adults in the United States having neither traditional credit scores nor robust credit histories, financial institutions can utilize alternative credit scoring models to expand access to lower-cost financial services. Evidence shows that new scoring models can strengthen a lender’s ability to reliably rank risk, efficiently evaluate applicants for offers of credit, and increase approval rates all while maintaining acceptable levels of risk.
Though much of the onus falls upon consumers to create their own financial resilience and success, banks and credit unions can materially impact the financial health of their accountholders. Whether through actionable insights and credit scoring information embedded in digital banking or by expanding inclusion to utilize alternate data in credit decision-making, helping consumers build their credit scores and credit files can strengthen both individuals’ financial health and that of your institution.
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