History of Credit Scoring

How did all of this get started? In the very early days, when people bought things on credit at the general store, the store clerk wrote the purchase amount on a piece of paper that was then put into a “cuff.” A cuff was a paper tube that merchants wore on their wrists. (This is also the origin of the term “buying on the arm”—another way to say buying on credit.)

When a merchant offered too much credit or credit to the wrong person, he or she would lose money and have financial problems. Some would go out of business. Eventually, local merchant groups started collecting all of the information from these clerks’ cuffs and putting it together for other merchants to check before granting credit.

These systems were known as mutual protection societies or business roundtables; and sometimes chambers of commerce served the same role.

Whatever name it took, the local group’s scope was limited geographically, by town or county. And the data it collected was not consistent; it might included character references, employment information, insurance information or more detailed bank account information. In some cases, the information sharing even violated legal privacy protections.

While they were better than nothing, these informal local groups proved to be an inefficient way for businesses to protect themselves from bad debt. There was no verification that the information was correct; and local biases, favoritism and politics could make for unreliable reports—either too bad about good risks or too good about bad ones.

Plus, the people about whom information was being shared had no way of checking the reports. The only groups that could access the information were lenders and merchants. A merchant who didn’t like someone could cause that someone a lot of trouble.

The first independent, third-party consumer reporting agencies in the U.S. were established in the mid-1800s; several were national in scope, operating much like a modern-day franchise system. They were set up as a network of offices across the country.

Credit agencies differed from mutual protection societies in that they allowed anyone to access the credit information—for a price. Local branches paid a percentage of their profits to their central office in exchange for credit information from other locations. These outfits were the corporate ancestors of modern day companies like American Express and Wells Fargo Bank.

Technology developments in the late 1800s, including the typewriter and carbon paper, led to even greater efficiencies for independent credit agencies. Their accumulated information was more widely available, more accurate and covered a much larger geographical area.

These new credit bureaus had to deal effectively with various groups: their subscribers, the people and businesses about whom they reported, their branch office correspondents and the general public.

But, generally, these early credit agencies served a small part of the U.S. population. Through the early 1900s, most Americans stayed close to home and didn’t need credit companies to vouch for them in unfamiliar places.

World War II changed all of that. So many people travelled from coast to coast—and to Europe or Asia—in the course of fighting that war that a general taste for travel was created. So did the general wealth that Americans enjoyed during the post-WWII years. Rather that settling for a week at the nearby lake, families wanted to go to Florida or California…or Paris…for their vacations.

The more mobile population overwhelmed the existing credit agencies. A more scientific system was needed to track information on tens of millions of people. The plastic credit cards helped.

And the credit bureau system that the U.S. has now began to take shape.

Next: Credit Bureaus' Customers