‘‘The technology behind credit scoring hasn’t been updated since the 1950s,” Douglas Merrill declared, invoking the image of the banker in a blue suit making decisions from behind a mahogany desk.

He’s exaggerating, of course. The modern credit rating developed by Fair Isaac Corp., known popularly as the “FICO score,” was developed in the 1980s. And the three companies that dominate the current scene – Equifax Inc., Experian PLC and TransUnion – jointly developed a proprietary rating that was unveiled in 2006.

Still, Merrill, who was once chief information officer at Google Inc. and a driver behind the search giant’s fervid data collection, believes most credit scoring is outmoded.

His company, Hollywood’s ZestFinance Inc., has developed an alternative model. It uses an algorithm that he said handles data “several orders of magnitude” greater than the other credit rating models. The company a couple of weeks ago announced a $20 million series C funding round, led by PayPal Inc. co-founder Peter Thiel, and brought its total raised to $112 million.

The venture is part of a class of financial tech companies that’s using big data and big processing power to reinvent the microloan business.

To optimists in the field, Zest and its brethren have the potential to upend the way underbanked customers are able to access cash, perhaps even convince the average bank to start considering these people as potential customers.

“That will be the crowning glory for our kind of innovation,” said Ryan Gilbert, co-founder and chief executive at San Francisco online financial service BillFloat Inc. “I’d love to see a day where large banks say, ‘Let’s try new models to bring these customers into the cycle of lending.’”

Zest claims that default rates of its approved borrowers are 60 percent lower than the average credit rating agency’s.

That kind of accuracy is vital for the company given its target customer: sub-subprime borrowers looking for loans of a few hundred dollars and whose credit files range from thin to nonexistent.

The market is big, however. A report from the Center for Financial Services Innovation put the revenue from interest and fees from underbanked customers, including payday loan borrowers, at $78 billion in 2011. Refining the credit-scoring process would allow more established banks to start servicing those customers – and tap into a little of that $78 billion.

But Arjan Schütte, a managing partner at Core Innovation Capital, a venture capital firm focused on financial tech startups catering to the underbanked, remains unconvinced mainstream lenders will get onboard. Even with improved technology, a big bank’s aversion to risk always gets in the way.

“There’s still too much stigma associated with this kind of customer,” Schütte said. “Now, if the startups figured out a way that makes heretofore subprime customers into prime, so your bank down the block could use their score, that would be a material change. But that isn’t happening across the board yet.”

New methods

For Merrill, the subject is personal. His sister-in-law was among the credit poor in whom the mainstream banking industry has little interest. Though her credit file was essentially nonexistent to the average bank, it didn’t mean she was necessarily a bad customer.

“Most credit ranking is unable to tell if a person’s bad score is because she is irresponsible or if she’s been through some financial trauma but wants to handle credit in the future,” Merrill said.

He began the business in 2009 along with Shawn Budde, the former head of subprime credit cards at Capital One Financial Corp. It was initially named ZestCash and functioned both as an underwriter and lender. In July of last year, the company formally dropped the lending part of its business to focus primarily on licensing its technology to other banks, becoming ZestFinance in the process.

It has grown to more than 60 employees, working in a building on Hollywood Boulevard east of Highland Avenue, an area few would consider a tech corridor.

Merrill has brought along some of the Google-y touches from his past – employees have access to a free weekly carwash and daily lunch catered by renowned L.A. chef Suzanne Goin.

Zest sells its credit-ranking system to lenders. So, for example, when a loan seeker fills out an application at a lender, the information is processed using Zest’s technology and the lender gets a credit score.

The company did not disclose revenue. Its only publicly acknowledged partner is SpotLoan Inc., a small lender based on an Indian reservation in South Dakota.

Merrill’s philosophy in scaling Zest is to combine experience in the traditional lending world with tech’s focus on data crunching.

Bringing those two sides to the table has churned out some interesting results, which Zest incorporates into its formula. For example, applicants who fill out an online application correctly capitalizing their names are less likely to default than those who do not, according to the company’s statistical modeling.

“It speaks to the meticulousness of a person’s financing,” Merrill said. “You can really tell a lot about the way a person navigates around the site.”

High rates

What Zest and the cohort of new-era money lenders have yet to change is the high interest rates associated with cash advance loans. BillFloat, which offers a bill-financing service that covers a customer’s personal expenses, markets a 35 percent annual interest rate on its loans. Various fees subtly push the cost even higher. And SpotLoan’s site is appended with a disclaimer warning customers that its loans are an expensive form of credit and should be used in emergencies only.

BillFloat’s Gilbert acknowledged the high rates, but countered that the longer these high-tech underwriters are around, the more likely rates will drop.

“The hope is that the better use of technology by companies that are innovative will result in a better performance,” he said. “You don’t want to make a bad loan to a good customer.”

There might be some hurdles that are beyond the scope of any individual underwriter. Online lenders are often more expensive than the cash-advance shops that are mainstays in seedier strip malls, according to Core Ventures’ Schütte. He attributes that to roundabout measures online lenders go through to acquire customers.

Doing a Google search of “payday loans” turns up a surfeit of sites, most of which are lead-generation companies that pay to appear at the top of the results. Such companies then charge actual lenders to direct customers to them.

“By the time a customer is on your site, you’re starting $150 in the hole,” Schütte said.

He hopes that Google will one day clean up that practice; it’s something the company has done previously for pharmaceutical searches.

Reaching a moment where underbanked customers have true options for loans could also inspire actual competition, forcing out some of the predatory lenders that have populated the space.

For Merrill, that would mark a major step forward in a banking industry that has done its best to avoid it.

“The credit world essentially froze decades ago,” Merrill said, “The real world didn’t.”