What is a waterfall?

A waterfall in the context of credit risk management is a way to stack your third party calls in a sequential way that saves operating expense and decreases your compliance risk at the same time. 

In this article, we will discuss a few ways of stacking the ways you can stack your third party calls without compromising fraud risk and credit risk. This is a strategy that’s been used in banking and fintech lenders for ages and it’s been proven effective and we like to share these strategies with you today.

Why is a waterfall strategy important?

Decreasing your compliance risk is one of the reasons why you would want to waterfall or stack your third party calls. One of the first things banks must consider is the ability to verify the applicant’s identity. 

In the virtual, online or mobile environment, it’s unlikely that the applicant is ready to talk to a banker or visit a branch. All of the upfront identity verification must be done up front as quickly as possible. Some firms use passive datasets to verify the applicant’s identity, some choose to use a more aggressive approach. 

In some cases, the banks will ask the applicant to take a selfie or record their head movement to verify the applicant’s identity with respect to government-issued identification cards with their photos.

Both approaches have their pros and cons. The passive way leaves room for identity thieves with stolen data to pass the KYC (Know your customer) rules. The aggressive way may turn some people off that are sensitive to giving out too much information when applying for credit online. 

Either way, the ability to complete identity verification is a must for banks or any other non-bank lenders. 

Reduction in compliance risk

Let’s talk about why this part of the process needs to be waterfalls. In some cases the applicant is not who they say they are and made it through the KYC stage of the underwriting process and if the bank pulls credit simultaneously, the bank might be pulling credit on right person but for the wrong reasons.

In another scenario, if the applicant fat-fingers the application and accidently typed in a piece of personally identifiable information that matches another person, the bank might be pulling the wrong person’s credit report. This could cause additional compliance risk and could also result in a decline decision where it could have been an approval decision.

We think that by water-falling the identity verification step and separating it from the subsequent credit underwriting can reduce a lot of compliance risk and potentially increase your conversion rate by knocking out some false positives from applicant’s mistakes on the application.

Let’s move this thought experiment further down the underwriting process.

Reduction in credit risk

Let’s say that the applicant has passed the KYC part of the process and is ready to be underwriting for their creditworthiness. Mind you that all of this is happening in seconds.

The bank might be using a multitude of credit products from third parties. Let’s take a look at some of the typical credit products a bank might use for a personal loan.

Credit reports and credit scores are a must for banks to understand the applicant’s creditworthiness. Credit scores and credit reports are costly but it’s part of doing business and banks must bury that cost. 

However, before the bank spends money on an expensive credit report and credit scores, the bank can use a less expensive product such as a Income Estimator to eliminate applicants that won’t be qualified for a financial product.

Most of the major credit bureaus have an income estimator product that costs less than the combination of credit report and credit score. Banks can stack this income estimator product in front of any credit report and score pulls to eliminate a certain percentage of the applicant beforehand.

This way, the bank can save operating cost and don't needlessly pull a credit report on applicants that won’t pass the income verification stage of the underwriting process anyway.

Increase conversion and upsell

Third party data providers such as credit bureaus have all sorts of enhanced attributes, trended variables that can tell a whole lot about the applicant. These datasets are wonderful but expensive.

Banks might need to make a decision after identity, credit report and credit score has been pulled. Out of all the approved applicants, should I spend more money on them to get them a better and more profitable product? On the flip side, the large number of declined applications, should I spend just a bit more to see if I can find another reason to approve them to increase my conversion rate?

With a waterfall strategy, this can easily be achieved. 

In your decision engine, you can define a decline path where additional data is called to see if the applicant can log into their bank account or payroll for further cash flow based underwriting and make an effort to approve them for something.

On the flip side, more expensive attributes can be called on the approved population to see if there’s any indication in the data that can increase the offering from $30,000 line of credit to say, $45,000 and therefore making the product more attractive for both the applicant and the bank’s bottom line.

Waterfall strategy is the way to go

It doesn’t matter how we slice and dice these strategies, water-falling your credit underwriting decision ultimately saves money and reduces compliance risk without calling all of the third parties simultaneously. 

Additional data off of the latter half of the approval or denial path can help you pick up more customers and sell more products. 

Either way, having your decision engine to do the routing based on these strategies can go a long way. Next time, we will talk about user permission based data.

About LendAPI

LendAPI is a DIY digital onboarding platform with a fully customizable product builder and an integrated graphical Decision Engine. LendAPI’s application workflow, sub-tenant management, third party integrations plus customer portal and communication methods is a complete end to end solution. It’s free to signup.