Is Europe facing a credit invisibility crisis?

A guest editorial by Tamas Kadar, chief executive officer and co-founder of SEON

Credit invisibility is becoming a pressing concern across many parts of Europe and is undoubtedly contributing to growing rates of financial exclusion affecting the continent. Here, Tamas Kadar, chief executive officer and co-founder of SEON explores the topic in more detail and examines what could be done to turn the tide on an alarming issue.

From the migration of financial services online to the emergence of new payment methods and the digitisation of various services, much of our financial lives have been transformed over the past few decades. However, some aspects have remained largely unchanged. One such area is the enduring importance of credit. Just as it always has been, credit – particularly ‘good’ credit – remains a crucial factor for individuals seeking to access a wide range of financial products. Consequently, building a strong credit profile is as important as ever.

In the UK alone, over 5 million people are classified as ‘credit invisible,’ meaning they lack sufficient credit history to be scored by traditional credit reporting systems. Unfortunately, this problem is not confined; it extends worldwide, posing a significant challenge to a core tenet of our financial systems.  

Understanding the problem

A closer examination of Europe’s credit invisibility crisis uncovers the underlying factors exacerbating this issue. One common thread among the individuals affected is the inability to access traditional credit in the first place. Without the opportunity to utilise credit services, individuals cannot build ‘good’ credit records, leading to their exclusion from the financial system. This yields a vicious cycle, one that is causing harm not only to the financial well-being of individuals across Europe but also to the broader economy.

To fully grasp this threat, it’s essential to understand the demographics disproportionately affected by credit invisibility. Most notably, credit invisibility has become a significant issue for young people. Crucially, this concern doesn’t just pertain to young adults with low incomes, who have traditionally struggled to access credit, but also extends to a wider range of younger individuals, many of whom would likely be reliable and responsible credit recipients if only given the opportunity.

Managing a misalignment

This brings us to the question: why has this occurred? The answer lies in a growing misalignment between the financial behaviours of young people and the criteria upon which traditional credit assessment systems are based. While much of the financial services sector has evolved over recent decades, the criteria used by traditional credit assessment systems have remained largely unchanged since the 1970s.

There are two areas that seem particularly relevant to this rationale. The first is the declining prevalence of homeownership among young people in Europe. Historically, successful mortgage repayments have played a major role in how individuals build their credit scores. However, between 2012 and 2020, home ownership rates across the European Union dropped, especially among young adults aged 20-29, who have increasingly relied on private rentals. Additionally, the age at which 50% of the EU population lives independently outside their parental home rose from 26 to 28 between 2007 and 2019.

The second factor is the decline in credit card usage among younger Europeans. Influenced by a growing preference for alternative payment methods and a general aversion to debt accumulation following the financial crisis, credit card use has stagnated or even declined in various European countries among younger people. The rise of payment methods like Buy Now, Pay Later (BNPL) have also played a role. Although BNPL shares similarities with traditional credit, it does not contribute to building a credit record in the same way.

The alternative path

In response to credit invisibility, alternative data sources offer a promising path to more accurately assess creditworthiness. With the right approach, alternative indicators such as payment histories for mobile phone bills and adherence to long-term contracts can serve as effective barometers of creditworthiness, comparable to more traditional factors. Where credit history is limited or non-existent, these alternative data points help to fill the gap and can enable more people to demonstrate financial responsibility.  

Moreover, alternative data points are more closely aligned with the modern behaviours of individuals in this decade. While rates of home ownership and credit card usage have declined, the average person maintains an increasing number of monthly subscriptions. By analysing the consistency of payments for these digital subscriptions and utility payments, lenders can take meaningful steps to enhance the inclusivity of credit systems. This approach could unlock a new customer base of previously credit-invisible individuals, allowing them to participate more fully in the financial system.

Unlocking financial inclusion for all

By embracing the power of alternative data points, credit lenders will soon realise the wealth of untapped information they can gather about applicants that is currently underutilised. Device intelligence and digital footprint analysis offer an even more powerful tool in this regard, enabling financial institutions to gain deeper insights into their customers’ online activities. This approach provides a level of precision, agility and accuracy that was previously unimaginable – all with minimal disruption to the user experience.

Ultimately, in an era marked by declining rates of home ownership and credit card usage – two key pillars of traditional credit assessments – the need to rely on alternative data points has never been greater. By harnessing diverse data sources, the financial sector can extend its reach, refine risk assessments, drive innovation and foster financial inclusion, all while adapting to the evolving economic landscape.

Image: SEON

Guest Editorial This article was produced specially for Fintech Intel by an expert guest contributor.