Cash Flow Underwriting ?? Compliance

When implemented correctly, cash flow underwriting produces a significant ROI for lenders while also advancing regulatory priorities and complying with all applicable laws and regulations.

With cash flow underwriting, lenders can expand market opportunities and revenue while maintaining or reducing credit losses. Cash flow underwriting can also bring powerful financial inclusion benefits with strong regulator support. But cash flow underwriting is complex—requiring new processes, data models, and policies. To meet regulatory obligations, cash flow underwriting solutions must be built from the ground up with compliance front-of-mind.

Over the past ten years, pioneering market participants like Prism Data have developed mature technology, documentation, processes, and best practices to support cash flow underwriting at enterprise scale. These solutions help banks and lenders avoid regulatory pitfalls and implement cash flow underwriting in an effective and compliant manner.?

Done correctly, cash flow underwriting can become a core part of the credit strategy at any institution and fits firmly within all applicable laws and regulations, including the Fair Credit Reporting Act (FCRA) and fair lending laws like the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA). Below we provide a brief survey of how key laws and regulations apply to this emerging area.

Regulator Support

Cash flow underwriting enjoys a high level of regulatory support that is rare for new technology.

In addition to ensuring financial providers follow the rules, regulators have a strong policy interest in developing an inclusive financial services marketplace. When it comes to credit, achieving this aim requires more than traditional credit scoring. Over 100M Americans have a low credit score or no credit score at all, even though only a small fraction of these consumers will ever default on a loan. And these consumers are disproportionately likely to be Black or Hispanic, younger, first- or second-generation immigrants, people with disabilities, or survivors of domestic violence.

Cash flow underwriting enables more comprehensive, fair and accurate credit assessments, including for individuals underserved by traditional credit scoring. It can be a powerful tool for financial inclusion, as well as consumer protection. ?

In 2019, the Consumer Financial Protection Bureau (CFPB), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Board of Governors of the Federal Reserve System, and National Credit Union Administration (NCUA) (collectively, the “agencies”) came together to issue an Interagency Statement on the Use of Alternative Data in Credit Underwriting that actively encouraged responsible cash flow underwriting.

In their words:

"The agencies recognize alternative data’s potential to expand access to credit and produce benefits for consumers. . . . In addition, the agencies are aware that the use of certain alternative data may present no greater risks than data traditionally used in the credit evaluation process” (emphasis added). More specifically with regard to cash flow underwriting, the agencies recognized that “using alternative data, such as cash flow data, that are directly related to consumers’ finances and how consumers manage their financial commitments may present lower risks than other data” (emphasis added).

Cash flow data allows for more detailed and accurate underwriting, without the risks associated with other forms of “alternative data.” The agencies highlighted three key advantages of cash flow data compared to other data sources—cash flow data is:

1. Specific to the borrower;
2. Extracted from reliable sources like bank account records; and
3. Accessed with explicit consumer permission.

These factors drive data accuracy, enhance transparency and provide consumer control. The agencies also noted that cash flow data “is a well-established part of the underwriting process” and “can generally be explained and disclosed to the borrower, as may be required under the Equal Credit Opportunity Act and the Fair Credit Reporting Act.”

Regulatory support for cash flow underwriting has only grown in the years since the Interagency Statement. In 2020, the OCC created Project REACh to incubate new solutions to accelerate financial inclusion, including cash flow underwriting. In 2023, as part of announcing its ongoing rulemaking on Personal Financial Data Rights, the CFPB described cash flow underwriting as “an important use case for consumer-authorized financial data” that is beneficial for consumers.

Regulators are in favor of responsible, compliant use of cash flow data, and this support is powerful. Still, cash flow underwriting is not exempt from the high standards and strict requirements involved in credit decisioning. Implementing this complex new approach in a compliant manner requires deep experience and expertise, particularly when it comes to compliance with fair lending laws and adverse action requirements under the FCRA and ECOA.

Fair Lending Laws

Fair lending laws, including the ECOA and FHA, prohibit the use of protected characteristics in underwriting models—i.e., disparate treatment—as well as the use of underwriting criteria that have a disproportionate negative impact on protected classes—i.e., disparate impact. Compliance with these rules is complicated, especially when applied to the bank account transactional data that powers cash flow underwriting. This data is extremely detailed and provides rich information regarding a consumer’s financial life. At the same time, raw cash flow data often includes information that should not be factored into underwriting decisions.?

Practitioners of cash flow underwriting must employ strict vigilance to avoid inadvertently including such information in a decision. Compliant cash flow underwriting requires sifting through bank account data on a granular, transaction-by-transaction basis to identify valid underwriting insights while excluding data points that may create disparate treatment or impact. Only cash flow underwriting systems that have been built from the ground up with this in mind, and tested extensively in-market, can produce this result with confidence.?

In July 2019, the nonprofit innovation center FinRegLab released a groundbreaking empirical study that analyzed the use of cash flow data by six non-bank financial services providers, including providers utilizing Prism Data’s CashScore?. In addition to validating the efficacy of cash flow underwriting for predicting creditworthiness generally, the study found that the cash flow underwriting models studied “appeared to predict creditworthiness within [protected populations] at least as well as traditional [credit scores and attributes], and better in select cases.” Furthermore, the study’s results indicated that “cash-flow variables and scores do not create a disparate impact among protected populations” (emphasis added).

Fair Credit Reporting Act (FCRA)?

For years, the FCRA has been a source of confusion as it relates to cash flow underwriting. Indeed, the FCRA (enacted in 1970) never contemplated today’s technological capabilities that allow consumers to instantly share digital copies of their financial records. But modern cash flow underwriting can still be implemented in a manner that fits squarely within the requirements of the FCRA.?

Unlike traditional credit bureau data that is collected by and obtained from credit bureaus or consumer reporting agencies (CRAs), cash flow data is typically provided by the consumer themselves (sometimes with the help of a financial data aggregator) to the lender in support of their application for credit. It is the digital equivalent of a consumer handing paper statements to a loan officer inside of a bank branch. The work of cash flow scoring providers like Prism Data begins after this data collection has occurred; Prism provides lenders with the tools they need to properly assess the data they have obtained either from a CRA or from the consumer directly.

Contrary to some popular misconceptions, the FCRA does not require your cash flow scoring partner to be a CRA. Lenders are permitted to make credit decisions—both approvals and declines—based on cash flow data from both CRA and non-CRA sources, so long as the requirements of the FCRA are met.(1) Prism’s products are available through both CRA and non-CRA solutions to fit every use-case, and each solution is offered in a manner that complies with the FCRA and is permissible for use in credit decisioning.

Equal Credit Opportunity Act (ECOA) Adverse Action Requirements

In addition to FCRA requirements, the ECOA directs lenders to accurately disclose the specific principal reasons for taking an adverse action. This can be complicated as applied to cash flow underwriting and is an area where an experienced partner is essential.

When making decisions based on traditional credit bureau data, adverse action reasons are highly standardized; with cash flow data, new adverse action reasons are required. Cash flow models and scores must enable lenders to ascertain and disclose the specific principal reasons for a given outcome. This “explainability” can be complex from a data science perspective and is an area of increased scrutiny for regulators.?

An effective cash flow underwriting platform must be able to provide specific, accurate, and clear adverse action reasons, and must maintain robust documentation and model governance practices. These reasons must be statistically accurate, and should withstand scrutiny from both regulators and consumers. Proven capabilities in this area are absolutely essential for compliant cash flow underwriting. The right cash flow underwriting partner has built its data processing and analytical capabilities from the ground up with fair lending compliance and explainability front-of-mind, and can pair predictable scores with accurate and specific reason codes that are ready to be used for credit declines.?

With nearly a decade of experience providing cash flow underwriting capabilities to regulated financial institutions, Prism Data is a proven platform capable of delivering market-leading analytical tools like the CashScore? in a fully-compliant manner. Prism’s solutions are offered through CRA and non-CRA sources to fit the requirements of any use-case.

If you’re ready to learn more, we would be excited to hear from you!

(1)?For declines based on CRA information (like credit reports), the FCRA requires disclosure of certain information about the CRA and the credit score (if it was a factor). For declines based on non-CRA information (like insufficient income shown on a consumer-supplied W-2), the FCRA requires the lender to (a) provide notice that the consumer has the right to make a written request, within 60 days, for disclosure of the nature of the information used and (b) disclose the nature of such information if requested.