The Credit Catch-22: How Young Adults are Redefining Credit and Lending Norms

Credit and lending are not what they used to be. Rather, younger generations are tapping into credit and lending differently than previous generations. The evolving needs and expectations of younger consumer generations, particularly Generation Z (Gen Z), are set to transform the entire credit and lending landscape.

The question is whether financial institutions are ready.

Financial institutions are at a pivotal juncture, facing what could be an existential crisis if they fail to adapt to these changes. The traditional credit scoring and lending models, which have long dominated the industry, are proving inadequate for a generation markedly different from its predecessors regarding economic challenges and technological engagement.

It’s a critical crossroads for FIs, with many unaware or stuck in a loop of inaction. Some are taking notice and seeking technology solutions that make it easier to serve younger, future generations of consumers. Some of them were at the FinovateSpring 2024 conference. What we’re doing with Bloom+ and consumer-permissioned data resonated with them — so much that we won Best of Show among 60 other presenters.

To quote one gentleman we spoke with after the presentation, “There is a chasm of discrepancy between how banks think they’re serving their customers and how customers think banks are serving their customers.”

Will FIs address this discrepancy amidst changing consumer behaviors, or will they let it be their death knell?

The State of Credit and Lending Among Gen Z

Gen Z’s entrance into the financial marketplace is marked by their unique socio-economic challenges and a credit system that is increasingly misaligned with their realities and needs. This demographic cohort, already significant in size and influence (they represented 20% of the US population with spending power to the tune of $360 billion as of 2023), faces an economic environment marked by higher inflation and changing job markets, which starkly contrasts with that of previous generations at the same life stage.

The core of the problem lies in conventional credit data systems — specifically, their failure to adapt to a landscape in which traditional data points no longer paint a complete picture of an individual’s creditworthiness.

Economic Backdrop and Gen Z Use of Credit

As detailed in TransUnion’s “Solving for Z” study, Gen Z is navigating a financial terrain defined by a 32% cumulative inflation over the past decade. Despite nominal income figures suggesting an improvement over Millennials at a similar age, the real value of their earnings, when adjusted for inflation, is lower. Existing credit and lending frameworks that do not adequately account for the nuances of modern financial activities compound this economic strain.

What’s more, Gen Z is more wary about carrying debt than previous generations, turning instead to mobile wallets and alternative payment options like Buy Now, Pay Later (BNPL), especially when the cost of goods is inflating rapidly. Gen Z is attracted to the flexibility, convenience, and ease of these simpler and digitally native credit options. And while flexible credit options like BNPL operate much like other loans, regular payments to BNPL are not included in traditional scoring models.

Unfortunately, alternative borrowing options can come at a higher cost — and not just for Gen Z but for all underserved consumer segments that have thin or no credit histories. Pew Research reports that high-cost credit products cost Americans more than $20 billion annually.

That is to say, consumer credit behaviors are changing, but credit scoring models are not changing with them.

Inadequate Data Furnishment and the Need for Alternative Data

Traditional credit scoring models and data furnishment systems are inadequate for several reasons. Primarily, they rely heavily on data that Gen Z either does not have or is not reflective of their financial stability, such as mortgage payments and long-term credit histories. Moreover, these systems are riddled with inaccuracies and outdated methodologies that fail to capture a true and fair view of an individual’s financial health.

The lack of integration of alternative data — such as rent, utilities, and other digital payments (like BNPL) — into credit assessments further exacerbates the issue. These data types are particularly pertinent for younger consumers who may not yet have access to traditional credit but who regularly meet other financial obligations that demonstrate their creditworthiness. The conventional models’ failure to incorporate such data misrepresents a consumer’s credit profile and unjustly restricts their access to necessary financial products.

Still, lenders lean into these models and this incomplete data when making lending decisions. It’s financial gridlock — younger generations don’t have the storied credit histories of previous generations that lenders rely on for decisioning and can’t develop them due to restricted credit access.

Something has to give. Financial institutions can’t survive without serving the younger generational consumer base. Creditworthiness and credit access are tightly coupled with how FIs will serve the next generation — and what happens to the bottom line if they are unable to?

Consumer-Permissioned Data Poised to Shift the Narrative

Consumer-permissioned data is well-positioned to drive change in the credit industry. It’s emerging as a vital element in painting a more accurate picture of a consumer’s financial behavior, empowering consumers with more control and transparency.

This type of data allows consumers to share information directly from their financial accounts, providing lenders with a timely, accurate, comprehensive view of their financial activities. Consumer-permissioned data is especially critical for populations like Gen Z, who may be active financial participants but remain invisible in traditional credit systems due to their unconventional financial behaviors or newer forms of earning and spending.

When paired with permissioned data, the accurate and timely furnishing of traditional data can revolutionize the credit landscape. It allows for a dynamic credit assessment process that is both inclusive and reflective of modern economic activities and challenges. This dual approach not only helps correct inaccuracies but also creates a credit system that is robust, fair, and adaptive to economic changes and consumer needs.

For Gen Z, the inadequacies of the current credit and lending frameworks are not just minor hurdles but significant barriers that impact their financial trajectories. Financial institutions and credit agencies must rethink their data strategies by incorporating alternative and consumer-permissioned data into their models.

This shift is not just about keeping pace with technological advancements but about fundamentally reshaping the lending landscape to foster inclusion, accuracy, and fairness — qualities that are indispensable in serving Gen Z and all future generations effectively. The impetus should be a drive towards greater customer-centricity and a recognition of the economic impact of customer lifetime value on the bottom line.

Bloom: The Conduit to Better, Fairer Lending Decisions

Bloom recognized this dilemma with our initial furnishment solution. We saw the negative impacts that credit data inaccuracies and errors had on consumers and the lenders who were unable to serve them.

We saw that it was unfeasible to make informed, intelligent lending decisions based on traditional credit data alone — and the financial implications for FIs and consumers alike. We developed our consumer-permissioned data solution to address the needs of the entire ecosystem:

1. Financial institutions can empower consumers with the ability to opt-in to consumer-permissioned data while retaining sovereignty over their customer base for the long haul;
2. Credit bureaus receive a wealth of robust alternative credit information in a formatted, accurate, timely way; and
3. Consumers take the reins on sharing data that can help them round out credit profiles, unlocking access to new and better credit opportunities while gaining insights and transparency about what impacts their credit score.

This API-based solution (available in low- and no-code implementations) serves as a conduit between FIs and credit bureaus. We handle the compliance and formatting so FIs can focus on serving and nurturing their core customers both now and in the future.

An Impetus for Change

The experiences and expectations of Gen Z consumers serve as a stark warning to the credit industry. Financial institutions that continue to rely on outdated models and fail to engage with the needs of newer generations risk obsolescence. Embracing innovative credit models, leveraging alternative data, and fostering transparent consumer interactions are not merely optional strategies; they are imperative for institutions aiming to thrive in a rapidly evolving financial landscape. As we move forward, the ability of these institutions to adapt and innovate will determine their relevance and success in meeting the needs of future generations.