Long before credit bureaus saw the light of the day, lenders and businesses relied on a person’s past transaction history with them, word of mouth and home visits to know about their financial condition before money could be loaned or a product or service offered on credit. Needless to say, this qualitative approach to knowing about a person’s financial standing worked well but had its own pitfalls which meant that a wrong assessment can lead to loss for the lender.
Eventually, credit bureaus started to offer their services by employing representatives who can do all the legwork involved with collecting information related to a person’s credit worthiness. This was still far from the time of automated credit scoring and deep analysis of the reports. It was more of a decision-making process which required the representative to find out if a person was worthy of obtaining a credit or not.
The representative would visit different stores and lenders and accumulate data related to the payments and transactions conducted by the person who is being assessed. Representatives were not dealing with exact figures that can help them easily decide whether a person’s credit worthiness was good enough for a loan or not. It was found that these early reports to identify credit worthiness was very subjective. It reinforced social hierarchies and it was very biased where people end up being marked negatively because of their race, ethnicity and gender.
For most part of it, a representative was left with answers like, “He usually pays on time”. This could either mean that he is a good customer or there is a chance that this person may end up defaulting on payments too. It was easy for an enterprise to turn a person down even though they had good credit worthiness simply because the manager did not find the person’s conduct was not up to the mark.
Credit reporting started modernizing by the early 19th century when business started to grow and people wanted to depend on a better system where shopkeepers didn’t just have to depend on neighbors or acquaintances of the person borrowing the money. This led to different experiments through which lenders can find out the creditworthiness of a person in an impartial way. The most popular of these experiments was conducted by a merchant named Lewis Tappan in 1841. The experiment known as Mercantile Agency was started after the grueling phase of 1837 when the markets experienced a depression because of the over-extension of credits by merchants.
Mercantile Agency’s rival Bradstreet Company ended up creating a method through which the data collected by the representatives could be translated into actionable facts.
Mercantile Agency renamed itself as R. G. Dun and Company which came up with an alphanumeric system that could be used to evaluate credit reports. The two companies later merged and came to be known as Dun & Bradstreet. But most of the credit reporting at this time was limited to commercial businesses only.
Consumer credit reporting came into existence in the second half of the 19th century when credit lines started being offered to the consumers by department stores, the auto industry and other retailers.
Retail Credit Company (RCC) founded in 1899 in Atlanta, GA was one such company that accumulated information about a person through the many activities and transactions they conducted in their lives. It was criticized many times for having accumulated information which was not just about their finances but also about their social, political and sexual lives. Credit reports based on scoring like this was deemed to be biased and it could often be judgmental. He world was in need for an unbiased and impartial system of credit scoring which can help people obtain loans without the worry of being judged, not for their credit worthiness but for their character.
This led to the creation of an automated scoring system in the 1950s. It was devised by Bill Fair who was an engineer and Earl Isaac who was a mathematician. The system was
considered to be a failure when it was first introduced but its creators did not give up. They continued to improve and refine it using technology and computers till they formed the famed FICO score which is a popular credit scoring model used by many credit bureaus. Fair and Isaac sold their idea to a number of banks and financial institutions who found it to be very useful to find out the credit worthiness of their clients.
FICO was successful because of the availability of technology and computers which brought in a level of ease and eradicated human judgement which was creating partial scores earlier.
To further standardize the methods used for credit reports, the government of United States passed the Fair Credit Reporting Act in 1970 which regulated the system of credit scoring and identified various rules related to the amount of time for which the report was valid, how a negative component can affect the score and for how long can the negative component be taken into consideration. It highly increased the accuracy of data and improved the way in which credit worthiness was being calculated till then.
With its dark past, RCC changed its name to Equifax and continued to computerize all the data it had accumulated over the many years of operation and was soon joined by Experian and TransUnion who form the Big Three of credit reporting in the United States today.