Credit bureaus are essential elements of the financial infrastructure that facilitate access to finance. Today, less than 25 percent of th...
Credit bureaus are essential elements of the financial infrastructure that facilitate access to finance. Today, less than 25 percent of the people living in developing countries have access to formal financial services, compared to up to 90 percent in developed markets. Financial sector development unleashes the productive power of enterprises and facilitates inclusion of the informal sector in the formal economy. Access to savings and credit in rural areas allows farmers to smooth consumption and often survive the unpredictable risks of droughts and natural disasters. Obtaining a loan to send children to school helps a family create better lives for their children and reduces the need for harmful child labor. Having long-term financing to build a proper home is the direct result of a complex interplay of different financial intermediaries within the right financial infrastructure and regulatory framework. Banks play a central role in extending financial services within an economy. In most markets,
commercial banks began by focusing on large companies and select retail clients. Initially, their organizational structure made it too costly to serve smaller business clients and the mass markets. Accordingly, it has been primarily through informal financial services and non-bank credit that at least some of the needs of smaller entrepreneurs and communities have been and are being met. These include money-lenders, supplier credit, and many forms of mutual financial self-help groups, such as the Rotating Savings and Credit Associations or Tontines in Africa.The credit union movement that originated in the 19th century and has since spread around the world is probably one of the most prominent examples of the power of these mutual financial self-help groups.The rise of credit unions and the revival of banks’ social commitment towards their communities inspired the rise of microfinance in developing countries over the past two decades.
The approach to lending, however, has remained traditional: making decisions, based on subjective judgments, about a borrower’s propensity to repay supported by alternative risk-mitigating mechanisms such as group guarantees. A true revolution in lending occurred with the introduction of modern financial technologies, and this revolution has made access to credit almost ubiquitous in developed markets.The technologies allowed banks to move from the traditional approach where credit is granted based on subjective judgment to more automated processes based on quantitative models. As a result, lenders are able to deliver financial services at significantly reduced costs and expand credit to broader segments of the economy, thus further democratizing financial services. In particular, the introduction of credit scoring in the fifties in the United States— coupled with the automation of workflow and credit underwriting—played a key role in the rapid rise of consumer lending. Credit bureaus are critical in helping lenders make faster and more accurate credit decisions. Credit histories not only provide necessary input for credit underwriting, but also allow borrowers to take their credit history from one financial institution to another,
thereby making lending markets more competitive and, in the end, more affordable. The first chapter of this Guide provides the basis for understanding the operations of credit bureaus. It draws on the most recent empirical research conducted by the World Bank on the industry trends and the effects of using credit information on availability of financing and improved risk management. Although the first credit bureaus may be traced back to the early eighteen hundreds in London, modern credit bureaus have rapidly evolved only since the fifties fueled by improvements in technology and expansion of credit. Among the developing and emerging markets, Latin America has some of the oldest credit bureaus in the world,but not until the nineties did credit bureaus take off in most other developing and emerging markets. Between 1990 and 2005, the total number of private credit bureaus has more than doubled. In Asia, many emerging markets turned towards credit reporting after the financial crisis in the nineties. New credit bureaus have emerged at a rapid rate in Eastern Europe over the past five years, with many of the projects that started in the nineties eventually coming to fruition.
The Middle East and North African region has only recently seen a growing interest in credit reporting, with new developments underway in Morocco, Egypt, and Pakistan. Sub-Saharan Africa, except for South Africa which is home to one of the oldest existing credit bureaus, is still lagging behind, but many reform-minded countries are taking the lead to support their development in line with reforms for greater access to financing. Chapter 1 also discusses the roles played by consumer and commercial credit bureaus to support lending to small businesses.
With the rise in retail banking, small business lending has become the latest frontier in innovation. Historically, small business borrowers represent a difficult market to serve because of the traditional high-cost approach of judgmental credit evaluation. Wells Fargo pioneered the adaptation of consumer lending technologies to small business lending in the nineties in the United States. Although no dedicated small business credit reporting existed in the United States until a few years ago, consumer credit histories of the owner of a business proved highly predictive of the credit performance of that business. The innovations in small business lending have since been adopted widely in developed countries and have also begun to find their way into developing countries. Microfinance institutions, which have relatively high operating costs,have seen this innovation as an opportunity to reduce cost and become more competitive. As traditional retail lenders have started poaching their clients in some markets, such as Bolivia, it has also become more important for microfinance lenders to join and support credit bureau initiatives.
Reporting on small and microbusiness segments of the economy, have been neglected by both consumer and commercial credit bureaus in the past. Even in the United States, it took time for an industry consortium to launch small business credit reporting in 2002. Several developing market credit bureaus, such as in Thailand, India, and more recently Turkey and the Kingdom of Saudi Arabia (KSA), have already incorporated provision of small business credit reporting into their business plans to avoid the mistakes of their more developed counterparts. The second chapter of the Guide summarizes the experience of the IFC credit bureau expert team in the development of private credit bureaus in countries around the world. The chapter presents analyses of the various approaches to the development of the bureau and discusses the technology, financial, and staffing issues a developing bureau must address. Development of a credit bureau takes a long time, and requires a long-term commitment of all stakeholders. The entire process of setting up a credit bureau, from initial discussions to public education and work on the legal and regulatory framework, to actual implementation of the bureau’s systems,to uploading data and issuing the first credit report may take five years or longer. Active participation of creditors and the strong support of government are necessary in this effort. In many emerging markets, banks are the largest creditor to individuals and firms in the formal system, hence credit bureau development often focuses initially on facilitating information-sharing among banks and then includes other creditors, such as telecom companies and retailers.
Credit bureaus are characterized by economies of scale, and coordination among creditors is critical for operations startup. In many cases, the strong support of bank supervisors as well as the willingness of government to provide easy access to public databases, are critical to enable credit bureau establishment. In some cases, the central bank opted to operate a credit registry and provide the data to lenders; more recently Russia and Kazakhstan chose a private sector solution with strong encouragement from bank supervisors to share information. Political support and willingness to share information are essential, but challenges do not stop there. Once the creditors are ready to share information, the bureau has to overcome multiple technical challenges.In several countries,the infrastructure for data exchange is inadequate; unique IDs are unavailable; or other identifying information, such as names, addresses, dates of birth, are recorded incorrectly and/or inconsistently. All these issue make the collection and merging of information difficult, but they should not stop the development of a bureau. In many cases, the setting up of a bureau serves as a wake-up call for lenders to start capturing and storing necessary information. Over time, it enables banks to better manage risks and optimize lending processes. Basic information exchange is a first step.The bureau uses this information to provide a comprehensive analysis of borrower creditworthiness through such techniques as credit scoring. The bureau can also use the information for portfolio monitoring and fraud detection— just a few of the value-added services discussed in Chapter 3 that a bureau can provide.
In many countries, information-sharing cannot begin because an adequate legal and regulatory framework is lacking. Chapter 4 presents an overview of approaches to regulating sharing of information.With the rise in retail lending and the collection of data on individuals and small businesses by credit bureaus, concerns about data protection and consumer rights are also on the rise.In some countries, this debate has been highly political; in others, the debate focuses more on recent abuses, such as identity theft. The latter has become much more than a nuisance, especially in the United States where people spend more and more time protecting the integrity of their credit histories. This situation emphasizes the importance of security measures that credit bureaus must take, but it also has more far-reaching implications for the kinds of data that can be used for credit decisions and the way bureaus ensure the quality of the data and value-added services they provide.
The difficulties in ensuring data quality, which many developing markets face, could delay the startup of a new credit bureau. Developing markets are not the only ones that face this challenge, however, as data quality concerns are also present in more developed markets, including the United States. A recent study by the Consumer Federation of America and the National Credit Reporting Association revealed a significant variation in credit score accuracy and in the quality of underlying credit history data among the leading bureaus.Accordingly, the future of credit reporting will not only require further consumer education on the use, benefits, and risks of credit reporting but also consistent endeavors by credit bureaus to ensure data quality and consumer access.
Credit reporting legislation should carefully balance the ability of creditors to share information with the individual’s right for privacy. Banks often use their secrecy and confidentiality provisions as an excuse not to share information. Banks generally are willing to provide information on defaults but not on good loans.This unwillingness to share positive information, however, limits competition and does not allow a good borrower to leverage his/her good credit history to obtain better terms of credit. The borrower has a right to have his or her credit history disclosed to any lender he or she may approach to obtain credit. The law should enable a credit bureau to facilitate information-sharing while at the same time ensuring data security and protection of data subject’s rights. Credit bureaus are an important element in promoting responsible lending. With the consumer lending crisis in Hong Kong (China) and South Korea just a few years ago, reckless credit card lending in the absence of credit bureaus with positive information led to the over indebtedness of individuals and subsequent rise in personal bankruptcies. Since then, Hong Kong (China) introduced positive credit reporting in order to reduce the risk of this happening again. As other markets struggle with predatory and reckless lending, credit bureaus can play a central role in allowing lenders to evaluate indebtedness of clients and setting prudent and responsible lending limits.
Rounding out the theoretical discussions and practical guidelines are five case studies about credit bureaus that have been established or are being established in recent years in different parts of the world: an example of a successful credit bureau serving microlenders in South Africa; a regional credit bureau in Central America,which is a promising solution for smaller markets where lenders operate on a regional basis;a credit bureau in the KSA that demonstrates the importance of the long-term commitment of the stakeholders to the bureau setup; the first credit bureau in Egypt, which demonstrates how a private credit bureau can be set up in a relatively short time when all stakeholder interests are aligned and the project has the strong backing of the authorities; and a Vietnamese bureau that shows the importance of a comprehensive policy for the development of the private credit bureau and highlights the importance of public sector support.
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