Credit scoring was invented almost 50 years ago by two pioneers of operations research named Bill Fair and Earl Isaac who went on to found Fair, Isaac andpany, known moremonly today as “FICO”, the creators of the now ubiquitous FICO score. But credit scoring and FICO scores specifically really came of age in the late 80’s when the ability ofputers to process large amounts of data finally caught up with the mathematics. Today FICO scores are used for almost all lending decisions in one form or another.
In recent years there have been challenges to FICO hegemony focused on real and perceived weakness of the score and an interest in getting a piece of what has be a very large market. VantageScore was launched through a joint venture of the three bureaus to produce a score that maintained it’s consistency across the bureaus. More recently other scores are being marketed using non-traditional data, like rental and utility payments, in an effort to accurately score those consumers that don’t have traditional credit records.
In addition, all three bureaus have created their own versions of credit scores mostly for sale directly to consumers rather than to lenders (although there are efforts to market these scores to lenders as well). Some have even argued that FICO’s days are numbered – that otherpetitors will edge FICO out over time. While there is obviously significantpetitive pressure on FICO scores there are also some pretty hefty barriers to ovee in order for that to happen.
Operational ubiquity. Today FICO scores are used in a myriad of ways to support all kinds of credit decisions within a financial institution. Everywhere from marketing (deciding who is a good risk to solicit to) to the lending decision (which applicants to take) to customer service (increasing/decreasing lines for example) all the way through collections (who’s likely to repay). Rarely is a FICO score used alone in these decisions. Moremonly it’s used as part of an automated decision-making strategy wherein decisions can be made instantly through a series of decision trees.
Larger lenders use the score as an input to customized models they’ve built for specific situations or portfolios. After a recent review one major US lender recently identified over 600 places they were using a FICO score in their business processes. Switching to a new score not only means proving the new score is better (a long process in itself) but extensive testing to ensure all of those moving parts are still working as designed. Citibank recently announced that after an 18 month review they’ve decided it’s safe to switch to the latest version of the FICO score (FICO 8). This wasn’t a migration to a new score mind you, just a more recent version of the score they’re already using. The barriers to entry are indeed high…and expensive.
Regulatory Pressures. After the recent meltdown regulators are understandably putting more scrutiny on credit scores and scoring methods. They’ll be looking for extensive documentation and transparency on how the scores were developed and how they’re being applied. Many financial institutions will want to pass that liability to a third party. New entrants may find it difficult to displace FICO’s longevity and position (if not transparency).
Consumer pressures. Consumers are bing more and more educated about credit scores. So far it’s been slowing but eventually they’ll start demanding to see the scores that are actually being used for a credit or insurance decision. For a lender using a custom score or a specialty score this is awkward because most consumers won’t understand what they’re looking at. The lender will be more inclined do disclose an industry standard that has amon meaning. The Fair Access to Credit Scores Act, which bes effective in late July 2011 will fuel this demand.
There’s no getting around the fact that the FICO score is seeing intensepetitive pressure. Given the significant switching costs it appears that new entrants have their work cut out for them. I’ve oftenpared converting away from one credit score to another like replacing a gasket deep within your engine. The part costs about $.99 but the labor is about $5,000. That new gasket better be a whole lot better than the old one. It’s the same when swapping out a deeply imbedded credit score in lieu of another.
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