April 6, 2018

The Senate Banking Bill may open up a new market for fintech startups providing financial credit worthiness data. By dismantling a regulatory monopoly that FICO holds, new and better models may be developed and used to serve customers better.

Legislative History (or, A Funny Thing Happened on the Way to the Senate)
But first, a little history. It has taken eight years, but the Senate has finally managed to pass a financial reform bill that earned bipartisan support to roll back some of the provisions of 2010 Dodd-Frank bill. The “Economic Growth, Regulatory Relief, and Consumer Protection Act” (hereafter, “EGRRCPA” since it is so fun to say out loud) led by Senator Mike Crapo passed in the Senate last month.

The wide-ranging bill is tough to summarize, with 54 sections amending multiple laws. Most news reports have focused on the regulatory relief that some community and regional banks will receive as the bill increases the asset threshold at which the bank would become subject to greater regulatory reporting and oversight.

While not widely reported, many experts in the housing industry took notice of Section 310 of the Senate Banking Bill. Currently, Fannie Mae and Freddie Mac can only buy mortgages that are underwritten using a FICO score, giving FICO a regulatory monopoly on nearly half of the $1.6 trillion mortgage originations market. Section 310 introduces competition into the credit scoring of mortgage borrowers by allowing Fannie and Freddie to explore and validate alternative credit scoring providers.

This idea has been around for years, which shows how it can take a long time for financial innovation to work its way through the regulatory system. Freddie Mac CEO Don Layton mentioned in November 2014 that the government-sponsored entity (GSE) was studying alternatives to FICO. It took until December 2015 to be introduced as a bipartisan bill in the House of Representatives as the “Credit Score Competition Act”. The bill went nowhere for over a year, and then was re-introduced to the House in early 2017 and stalled there for a while. However, the Senate picked up the idea and in late 2017 introduced its own version of the bill.

The bill still did not get passed on its own, so Crapo amended his major EGRRCPA bill about a week before passage in the Senate to include Section 310, creating this credit score competition. It took almost four years, but now the idea has finally been passed as one small portion of the broader financial reform bill.

The story hasn’t ended yet – the House will probably make some changes in order to pass their version of the bill, and the final version needs to be approved by both chambers before it goes to the President to be signed into law.

FICO Competitors (or, Between a Rock and a Hard Place)
The biggest immediate beneficiary of this change would be VantageScore – the FICO alternative created by the three main credit bureaus, Equifax, Experian, and TransUnion. Despite the intense backlash of last year’s data breach, Section 310 may actually help Equifax if the VantageScore gets used by the government-sponsored entities.

However, this still leaves an oligopoly, and doesn’t really help consumers who either don’t have or don’t want a long credit history. VantageScore is still mostly based on how many different types of debt you have, their age, and usage of debt. In order to meet the needs of the tens of millions who don’t have or want a credit history, the industry needs more options that take other factors into account.

This is not just about mortgages – credit scores have been used by insurers to price insurance, employers assess a potential employee, and landlords to screen potential tenants.

In part 2, I’ll talk about the problems of the existing credit scores and how startups can work together to make the system better for consumers. Also, I would like to hear from you if you have any thoughts or connection to companies who are working on this.