4 Essential Insights for Lenders Exploring Cash Flow Underwriting

Cash flow underwriting (CFUW) has emerged as an innovative approach in the financial services industry that promises to change how lenders assess borrower creditworthiness. Powered by open banking and consumer-permissioned data, cash flow underwriting moves beyond traditional credit scoring, offering a more dynamic view of an individual's financial health.

Lenders who are already using cash flow underwriting are seeing promising results. As shared during our inaugural Cash Flow Underwriting Summit, early adopters of cash flow underwriting observed decreased losses and customer acquisition costs. They’ve also seen an increase in consumers opting in for data permissioning. Open banking and the 1033 rule have further accelerated the adoption, enabling lenders and consumers to securely share financial information.

Although the future of cash flow underwriting is promising, lenders might be wary of adopting new underwriting methods due to inherent risks, compliance complexities, and technological challenges. But the risk of not adopting it is too high. In this article, we’ll briefly define cash flow underwriting and consumer-permissioned data before outlining four key considerations for lenders exploring CFUW.

What is Cash Flow Underwriting?

Cash flow underwriting is a credit assessment approach that evaluates a borrower's ability to repay a loan by analyzing their actual income and spending patterns in real-time. Unlike traditional credit scoring, which relies heavily on historical performance, cash flow underwriting examines real-time cash flow, providing a more holistic and well-rounded picture of a borrower’s risk.

There are many challenges with traditional credit scores. For starters, they can be hard to get. A 2022 financial inclusion survey found that 49 million Americans don’t have one. 

But even those with scores experience obstacles. The same survey found that millions of Americans fall into the subprime and near-prime categories, meaning their ability to secure loans at reasonable interest rates is limited. 

Cash flow underwriting offers a solution, expanding financial access for near-prime and subprime borrowers while creating new opportunities for lenders. By analyzing income stability, bank balances, recurring expenses, and overall financial health, lenders can responsibly extend credit to those traditionally underserved by the credit system.

What is Consumer-Permissioned Data?

Consumer-permissioned data (CPD) is the information that individuals voluntarily share from their bank accounts with third-party services. Sharing is usually done via secure API connections. This approach allows consumers to decide what financial data they wish to share and provides lenders with real-time insights into borrower behaviors. 

Now that we’ve covered what cash flow underwriting and consumer-permissioned data are, what should lenders looking to implement CFUW be aware of? We’ve shared 4 key considerations for lenders to think about before starting:

The lack of historical data can be a significant challenge in cash flow underwriting. As Richard Franks, Global Head of Risk Strategy at PayPal shared, the traditional way of testing new types of data is to buy an archive dataset and test historical performance. But in the case of most consumer-permissioned data, there isn't an archive of data to purchase. 

Lenders can address this by partnering with fintech companies specializing in alternative credit scoring. Companies like Nova Credit, a global credit analytics firm, have developed consumer-permissioned workflows that seamlessly integrate into a lender’s core experience, leveraging years of expertise to facilitate adoption.

Regardless of the approach, lenders should first identify a strategic use case and develop a pilot program. From there, they should assess outcomes, and gradually scale their implementation.

Tim Bates, Principal at Efficient Frontier Risk Strategies and author of Fintech Takes: Cash Flow Underwriting — A Practical Credit Risk Implementation Guide for Lenders, highlights that CFUW has been most effective in lending categories that:

• Are revolving in nature

• Serve mid-to-low-tier credit quality borrowers

Lenders should assess their risk appetite before adopting CFUW. Those operating in the super-prime segment may see fewer benefits compared to those willing to take on more credit risk.

Key Borrower Groups to Target:

• Subprime Borrowers: Individuals with low credit scores who might be denied loans based on traditional credit models. However, by assessing their cash flow, lenders can identify creditworthy borrowers who would otherwise be excluded.

• Near-Prime Borrowers: Those with borderline credit scores who demonstrate financial stability. Lenders can mitigate risk by offering adjusted interest rates and terms based on cash flow insights.

Regardless of the target group, lenders must develop robust risk assessment frameworks that leverage cash flow data while maintaining sound lending standards.

Implementing cash flow underwriting requires navigating complex regulatory landscapes. Common compliance challenges include fair lending, consumer data protection, and regulatory evolution

With respect to fair lending, CFUW should be assessed as part of the lender’s holistic credit policy to ensure that strategies and use cases do not introduce discriminatory practices or outcomes. Lenders should also consider implementing FCRA-compliant solutions when using cash flow data for credit decisioning.

During the CFUW Summit, Rebecca Kuehn, Partner at compliance law firm Hudson Cook, shared “In my practice a lot of lenders I work with prefer to get FCRA products because they can give an adverse action notice. It identifies the consumer reporting agency and their contact information, and then the consumer has someone to call and ask about that data. A lot of people like that because it eases some of the compliance burdens in-house.”

As far as consumer protection goes, lenders are advised to implement strict data privacy and security protocols. Organizations should also ensure they factor in time to review all lending policies, board-level governance requirements, credit standards and lending guidelines, and update accordingly. 

Lastly, as regulatory frameworks evolve, particularly under the new administration, lenders should stay informed and adaptable to evolving compliance requirements.

Lenders have two primary options for implementing a cash flow underwriting model:

1. Partner with a vendor specializing in CFUW solutions.

2. Develop a custom in-house model.

While some lenders build custom models, most start with vendor-developed solutions due to their ready-to-use frameworks. According to Tim Bates, vendor models offer key advantages:

• Faster, simpler implementation

• Pre-built compliance and risk mitigation features

• Multi-lender data insights, reflecting industry experience

Jason Capehart, Head of Data Science at Mission Lane, emphasized that in-house models require substantial investment in data science, machine learning, and legal compliance expertise. “It’s a tough space to navigate,” he cautioned.

For lenders new to CFUW, leveraging a vendor model can provide a cost-effective and efficient entry point.

Cash Flow Underwriting: The Future of Consumer Credit

Cash flow underwriting is transforming the finance industry by providing lenders with a more comprehensive view of borrowers' financial health. By leveraging detailed cash flow data, lenders can make more informed and inclusive lending decisions, and drive new revenue growth. Although implementing it can seem like a significant undertaking, companies can overcome many of the challenges by partnering with the right vendor. Those who hesitate to embrace this transformative approach risk being left behind in an increasingly digital and data-driven financial ecosystem.