Blockchain-based credit scoring is considered a frictionless solution that helps tackle the limitations of the traditional model with more trust and transparency.
Credit scoring is important to individuals, businesses, financial institutions, and regulators. Over the past decade, this model has been continuously improved by incorporating more data-related technologies and going digital solutions. As the arising of these new technologies and alternative online models, what can lenders do to keep their competitive position? Blockchain-based credit scoring can be a great answer to their concern.
What is happening with traditional credit scoring?
Cashless, quick and easy payment and convenience with many privileges when you need to make a loan are the benefits that make the demand for using credit services increasing. According to IBISWorld, in the US alone, the total value of the credit market has reached the threshold of US $111 billion by 2020 and increases by 3.5% each year.
The lending system includes two main components: the lenders and the borrowers. The lenders mostly are banks, credit unions, and any individual who has money for lending.
Typically, before making a loan, the lenders have to conduct an assessment of the loan quality, that is, the ability to recover the initial amount and profit from the loan.
As the growth of the financial system, the eligibility for a loan now mainly depends on the borrower’s credit score (Fair Isaac Corporation’s FICO score is the most reliable and popular, used by 90% lenders), which is calculated into a three-digit number, based on the borrowers’ payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%).
The point of credit scoring is to help lenders accelerate the lending process and increase the commercial loan industry size, benefiting both the lenders and borrowers with lower cost.
Since it became important in lending in the 1970s, credit scoring has reached part of its perfect goals. However, there are some drawbacks to the current credit scoring models, which remain in the process itself, such as:
- Limited access: It is required to own a credit card and a credit history, which brings in the problem with the unbanked and underbanked. These 3.5 million people can not or are limited to access to loans for financial need due to some reasons, namely: Some don’t have qualify ID issued by the government, which is required to open a bank account; Inconvenience — when they don’t have bank branches near their campus or it takes time to use them regularly; Bank fees are too high or charged with no clue, causing low transparency; Not steady or lack of services; Distrust of banking system.
- Limited data sources: Data is the only component to build these models, its quality and predictability are the keys to their success. While data used in current credit scoring relies upon an individual’s credit report only, causing mainstream lenders to possess too little credit information guaranteed to expand their loans effectively.
- The problem with security: The credit data breach at Equifax, one of the three biggest credit bureaus in the US in 2017, putting personal data of more than 148 million Americans exposed. Noted that the data breach doesn’t harm the customer’s credit itself but the way that data was used. The breached data can include customer name, password, security answers, email address, credit card number, etc. Particularly, even with a phone call and some basic information, more detail of customer data can be compromised, such as their credit number, account balance, etc. These kinds of breaches still happen with or without publicized because this is a centralized model, and customer data is held and controlled by other parties.
- Credit records are not portable: Due to some required regulations and the disconnect among different systems, credit records are forced to be re-created when customers move to other countries or sometimes using other credit unions’ services.
To prevent the rise of the consumer data breach and Identity theft, there’s the urge for a more optimal credit scoring model that can both benefit lenders and borrowers more with security and transparency to fulfill the ideal credit scoring model goal, so-called blockchain-based credit scoring.
How can blockchain revolutionize credit scoring?
Blockchain is a distributed ledger that is primarily used to store data with cryptography technology, specifically, the hash function. New block contains three components: new transaction data, the hash of the block, and the hash of the previous block, which helps to link blocks and create immutability.
On the basis of this decentralized technology, here are some advantages when using blockchain-based credit scoring that can tackle the unresolved problems of the current credit scoring model:
- Ensure security: As mentioned, blockchain technology offers a solution with immutability. Whenever an individual wants to change the information, it will need the permission of 51% of the chain nodes, which makes credit histories become more reliable to the lenders. Decentralized means that it is the customer who will keep and control their personal and transaction data, and remain a unified credit record with multiple duplicates cross-border. This prevents unnecessary personal data revelation and maintains data sovereignty rather than the current centralized credit scoring model.
- Allow approach to the unbanked and the underbanked: Blockchain makes it easier and cheaper to the unbanked and underbanked to approach to loan through a digital ID, also bringing up the chance for them to access in other financial services, education, and other sectors that require identity when the government doesn’t.
- Broaden sources of data: Blockchain can be used as an underlying technology for a credit scoring model to collect alternative data instead of traditional credit history. This alternative data includes payment information that is not found on traditional credit reports, behavioral information, or financial handling trends from activities like renting, utility bills, cell phone payment, homeownership status, and property values, etc. The point is to collect more up-to-date and richer information about customer financial performance. This also allows quantitative research to be applied in addition to the qualitative studies of the traditional model that helps to strengthen decision making.
The solution by akaChain
Built on Hyperledger Fabric, akaChain is an enterprise blockchain platform that aims to bring value to real business through its customized and ready to use decentralized solutions. According to our research in this financial sector, particularly in credit scoring performance, the non-banking data market is now even bigger than the mainstream market.
akaChain blockchain-based credit scoring platform gathers data from various data sources such as telecom, e-commerce, social media… generated from customer financial activities to proceed to score. Diverse data sources combine with blockchain features of high security, transparency is the core key that makes akaChain solution a potential and reliable choice to help financial institutions deploy an optimal and customized credit scoring model.
Mr. Giang Tran, CTO of akaChain, an enterprise blockchain expert said: “In this Fourth Industrial Revolution, data is the key to business promotion. We are witnessing major changes in the way data is collected, managed, and used than ever before. After decades, the traditional credit scoring model has already proved its work at some point but with blockchain, we totally can tackle the remaining weaknesses of the model. So the question is ‘Why accepting the good when you can make it great?’”
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