Consumer Creditworthiness: Banks Have Divorced Common Sense

by: Mark Sunshine

Consumer lenders that outsource their credit decisions to consumer credit rating agencies aren’t learning from past mistakes. By now lenders should have noticed that blind reliance on credit scores doesn’t work. Even so, most lenders continue to disregard good underwriting fundamentals and then can’t figure out why they continue to have bad credit performance. It’s almost tragic to watch bankers repeat the same mistakes year after year.

As I have often written, consumer credit bureaus and credit scores cannot be blindly relied upon by banks to make credit decisions. They have several flaws including:

  • A lot of information on consumer credit bureaus is wrong;
  • Even if the information on credit bureaus was accurate, it presents an incomplete picture of the financial health and ability to pay borrowers because credit bureaus tell lenders nothing about income, assets or family obligations of borrowers;
  • Credit scores are calculated in a “black box” environment without any way for consumers or banks to check their accuracy; and
  • Credit scores are supposed to be an independent predictive statistical indicator but because they are used by employers to make hiring decisions, which in turn affects the ability of borrowers to service their debts, credit scores have lost their statistical independence.

A better way for banks to underwrite consumer credit would be to actually take a look at the income, assets and liabilities of borrowers and make an independent assessment of the abililty of consumers to pay their obligations.

About 10 days ago the Wall Street Journal ran an article on consumer credit that contained a chart illustrating the incredibly high correlation between annual household income and mortgage delinquency rates. The Wall Street Journal accurately pointed out the obvious, i.e., people with low earnings have more trouble paying their obligations than people with high earnings. After all, low earners usually don’t have a lot of money and and it is money that is needed to pay back creditors.

Set forth below is the chart from the Wall Street Journal.


Bank managers that lend to consumers based upon credit bureau information need to be replaced by shareholders. Family income is a lot better indicator of creditworthiness but takes work and effort to verify. Credit bureau information provides lazy bankers the cover to say that they are doing their job when they actually aren’t.

If the banking system is going to get back its mojo, bankers have got to pay attention to common sense basics of good underwriting and try a lot harder to do a good job. Credit decisions based upon computer calculated credit scores doesn’t count toward effort or common sense.

After the surprise that borrowers need income to repay their debts I wonder if bankers will relearn the mystery of loan to value ratios?