On the use of credit bureaus to fight benefit fraud

The UK government has just announced plans to use credit bureaus to fight benefit fraud. The exact role of these agencies and the process for screening benefit applicants are yet to be decided[1], but there are high expectations regarding the savings that such collaboration may generate.

How do credit reference agencies work?

These agencies collect data from various sources, such as previous lenders, utilities or the court. The information helps organisations see your borrowing and spending habits, and whether you defaulted on previous loans. The credit history and spending behaviour is also used to calculate your credit score.

A potential lender or a company with whom you wish to establish a relationship – e.g., a mobile telecommunications operator – will usually consult your credit report before deciding whether to do business with you and on what terms. So, if credit scoring and credit reports are so widely used by private firms, isn’t it a good idea to extend their application to the management of public money?

Yes and no.

Credit bureaus collect data not traditionally gathered by benefit agencies, and may help develop a more complete picture of the citizen’s sources of income and spending patterns. That, in turn, could help tailor advice to the applicant – for instance, regarding areas of overspending – though, as far as I am aware, that is not the plan at the moment. It may also help identify non-declared sources of income or, exactly, who leaves in a given address and, thus, detect fraudulent claims, as intended.

An additional benefit may be dissuasion – a bit like the effect that installing highly visible speed cameras has on the average driving speed on a given road. Specifically, potential fraudsters may be discouraged from making fraudulent claims if they believe that there is a higher likelihood that they will be caught.

But there are problems, too.

It is important to realise that you do not have one definitive credit rating. Each agency will calculate its own rating, based on the information that it collects and the algorithms that it developed. Moreover, credit reports often contain errors[2]. This may be because of something as simple as the wrong door number on your process, to something fairly complicated like a contested charge. Correcting such mistakes can be an expensive and frustrating exercise, likely to be most punitive to those elements of society already under financial pressure.

Moreover, credit-scoring systems rely on historical data, which is detrimental to transient members of the population such as students, poor people and the homeless, as well as to those who conduct their transactions mostly in cash and/or use prepay services. A further limitation of relying on historical models is their relevance to predict future – for instance, while economic recessions are cyclical, economic crisis of the nature and extent of the one following the sub-prime problems in the US in 2007 are relatively rare events, with its unique effects and modelling challenges.

Furthermore, setting-up and running credit checks has costs, which will reduce the net benefit of using these agencies to fight benefit fraud. And that is without considering the actual costs of investigating and prosecuting fraudsters, which may exceed any money to be recovered.

Lastly, running credit checks tends to be a highly mechanistic process, relying only on data that can be quantifiable and handled by the IT systems in use. The inability to handle qualitative data is a major weakness of most screening systems: evidence from default rates in the subprime loans market suggests that customer screening that relies solely, or predominantly, on quantitative data tends to systematically under-predict the default rate.

As a tax payer, I am in favour of initiatives that cut on benefit fraud, including this one. Using credit bureaus has its merits, but also its pitfalls that I hope the Department of Work and Pensions will take into consideration. Above all, I can not help but feel discouraged that in 2008-09 the public money ‘lost’ to benefit errors represented about 4 times that lost to fraud. I don’t know why there is such a high level of financial losses due to clerical errors, but it strikes me as very odd and inefficient. Surely, there is something that government could learn from private firms there, too?!

[1] A report is due in the Autumn
[2] Consumer welfare groups advise individuals to check their credit reports regularly, at least once a year

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