As Credit Reporting Systems evolve over the last decade, World Bank Task Force laid down guiding principles for data processing. My take on it while financial technology space creates innovative risk management tools.
This post is written by Anshul Bhardwaj, Research Fellow, January 2021.
Foundations of Credit Reporting System
Improvisation is the key factor behind the development of any economy and a financial system. We continuously need to improve financial systems at every step in order to make them more resilient. Global economies try to build their Financial infrastructure around such principles as their foundations are highly dependent on their financial systems. This is directly or indirectly linked with every participant of any economy, be it an individual or a business entity. This blog covers the journey of failure to success of building such resilient financial systems and organizations in growing economies.
Poor Financial Infrastructure of any country (mostly in middle income economies as my focus is), poses a barrier to provide financial services. Across the population of an economy, poor financial infrastructure brings high risks involved in lending money to borrowers and the high number in defaults of loan repayment or NPAs. This stops FIs to offer their services to potential users. There is a clear lack of tools and systems to understand the creditworthiness of underbanked customers.
In order to overcome their failures and manage risks, FIs have started gathering data from different sources and activities of users. They have started processing analytics on such data to prepare reports which help them to know the creditworthiness of a borrower. Known as ‘Credit Report’, such systems need to be continuously improved by financial institutions and financial service providers in order to minimize the risk over the investments. Over the last 5 years, growing this field in the financial sector, many advanced tools, methods and startup companies have entered into the market with different products to prepare credit reports of an individual or of small middle enterprise borrowers. This plays a major role in the growth of the financial markets by evaluating risk on investments.
Credit Reporting System:
While working with FIs, technology providers and other different entities, Credit Reporting Systems(CRS) builds their own credit infrastructure. This can be classified into three main types of networks namely- Credit Registry, Credit Bureau and Commercial Credit Reporting Companies. This helps the financial markets to overcome the risk on investments. These systems determine better loan portfolios which aim at reducing lending default risks and at the appropriate allocation of more loans to borrowers. This also helps FIs to increase their ability to offer more credit, insurance, and other financial products to the consumers.
To derive high-quality credit information on borrowers, entities such as credit bureaus, work on different data points like historical credit history, a number of transactions, capacity, assets, purchasing power, character, buying behavior, the purpose for which credit is required, and much more. They analyze deeply, processing data, identifying patterns and trends upon which they create a report for every borrower (be it individual or a business) to calculate risks behind these borrower’s repayment of credit.
Credit Reporting system entities are focusing on the fundamental problems of the credit market arising between lenders and borrowers such as: Assurance of creditworthiness, credit rationing and money problems. They solve these problems by working on a complete credit assessment through which financial market participants and visionaries recognize the overall risk in a credit portfolio’s management. This is a vital exercise to achieve financial stability in the markets and make FIs stronger to take decisions in the context of lending. This also ensures systems become more safe and minimizes systemic risk.
In a competitive market of financial intermediaries, it gives benefits to borrowers to get credit at lower interest rates and access diversified financial products as they strive to maintain a good credit history. E.g in India, borrowers strive to maintain a good CIBIL score or in the U.S where Experian score is sought for by FIs and individual borrowers in a good shape.
The credit scores help FIs to know the creditworthiness of borrowers and access credit to them easily. A fast access to loan also means customers can focus on their purpose (for which they are borrowing credit) rather than the struggles behind getting a loan.
Major Concerns of DATA PRIVACY AND PROTECTION around Credit Reporting Systems:
With the development of Credit Reporting Systems around the globe, some major concerns have been raised on their use of data. Data protection, consumer privacy, and relevant issues of data protections have been highlighted as one of the major concerns. The data and information on individuals or on businesses are routinely accessed by Credit Reporting Institutions(CRIs), Financial Institutions and other related participants of the market. They use this for credit assessment and related product offerings.
However, there was a clear lack of guiding principles, regulations and financial supervision to control these systems so as to overcome above privacy concerns. The Credit Reporting Standards Setting Task Force was thus launched by the World Bank in 2009, with the support of banks for the international settlements, to overcome such issues, and aiming to provide a core set of general principles to guide these efforts in any given jurisdiction.
These Principles describe that the CRS is safe, efficient and reliable. This ensures that they can be useful in all countries. It’s not intended to be used as a blueprint for the design or operation of any specific system. However, there are key characteristics that should be satisfied by different systems and the infrastructure to support them, to achieve a common purpose, namely expanded access and coverage, fair conditions which are safe, efficient service for borrowers and lenders.
The Principles set by the Task Force are intended for credit reporting service providers, data providers, regulators, policymakers, financial supervisors, and all financial intermediaries. This Taskforce has also developed a set of specific roles, one for each of the participants in the credit reporting system.
Different economies around the world developed different credit reporting systems, according to their market. The World Bank played a significant role in assuring that these economies and CRS (under different jurisdictions) follow the principles laid down by them.
Principles For Credit Reporting:
The Principles to monitor Credit Reporting System as set by Task Force (launched by the World Bank) to ensure the safety and security of data related concerns around the world. They ensure that the CRS is safe, efficient, and reliable which supports all consumer rights and can be used by any country.
The key factors around which these General Principles were organised are: 1)Data 2)Data Processing 3)Governance Arrangements 4)Legal Regulatory Environment 5)Cross-Border Data Exchange
Principle 1 Data - Credit Reporting Systems should have accurate, timely, and sufficient data-inclusion, positive-collection on a systematic basis from all relevant and available sources, and should retain this information for a sufficient amount of time.
Principle 2 Data Processing - Credit Reporting Systems should have rigorous standards of security and reliability and be efficient.
Principle 3 Governance and Risk Management - The governance arrangements of credit reporting service providers and data providers should ensure accountability, transparency, and effectiveness in managing the risk associated with the business and fair access to the information by the users.
Principle 4 Legal and Regulatory Environment - The overall legal and regulatory framework for credit reporting should be clear, predictable, non-discriminatory, proportionate, and supportive of data subjects and consumer rights. The legal and regulatory framework should have an effective judicial or extrajudicial dispute resolution mechanisms.
Principle 5 Cross Border Data Exchange - Cross border credit data should be facilitated where appropriate frameworks are provided.
With such reforms in place, the industry of Risk management in the lending space is continuously growing.
However, this is a long term exercise. Many FIs have started experimenting with alternative data pointers which are not part of the prevailing Credit Reporting Systems. The use of these alternative data pointers and their efficacy can only be judged over a sizable lending data and lending performance of the loan portfolio, over a stretch such as 10 years.
Banks, NBFCs, MFIs and fintech are all collaborative partners in understanding the NPAs and delinquencies thus observed over their selected loan portfolio, when alternative data pointers are taken into consideration. Time and size of their data model can only tell how the CRS will evolve.
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