The Credit Bureau and access to finance

(The second instalment)

 

The first ever Credit Bureau has now been launched to service the Guyanese credit environment, and with it, the hopes and aspirations of several stakeholders are finally realised. The formation of CreditInfo (Guyana) Incorporated is the fruit of concerted effort, spanning a period of some seven years of preparation and planning, legislation, strategy, investigation and consultation.

But now the question on everyone’s mind is, exactly how is this initiative meant to help small and medium-scale enterprises and the Guyanese people in particular? Surely, such a monumental undertaking must carry with it significant benefits for all concerned, that much is clear. But what exactly are these benefits? Bear in mind that studies have shown this all-important SME sector to provide employment for approximately 60 per cent of the available workforce; so the significance of a functional mechanism to facilitate in the growth and expansion of this sector cannot be underestimated at all.

The primary role of a credit bureau in a developing market such as ours is to facilitate access to finance. From this central perspective, several subordinate insufficiencies are seen to be addressed in the context of individual and national development objectives. Credit bureaus are able to do this in an amazingly simple way: by increasing the reach and quality of information available to lenders and by customising these information services to the needs of the marketplace, so that all borrowers are now able to be better served by the financial system. This of course has significant implications throughout the spectrum of customer service.

The first consideration is the extension of traditional forms of physical security into what is known as “reputational collateral”. Put simply, this is the newly minted option for lenders and other providers of credit to include in the criteria for decision making such factors as: information on a borrower’s strong credit and repayment history with other institutions, faithful and timely payment patterns at GPL, GTT, and GWI, strong and committed repayment histories at retail hire purchase merchants such as Courts and Singers. All of this data would effectively flag a borrower as being a low risk, responsible person who is likely to address his new obligations in much the same way as he conducts his current financial commitments. The policy requirement of pledged cash, assets, or guarantors as collateral for a line of credit is now less important and can be relaxed sufficiently so as to allow persons to access finance and credit services that were previously completely out of their reach.

Further, we must also consider the levels at which societies operate, both from a situational and a cultural perspective. It follows that, for various reasons many persons have yet to venture into the formal banking system in ways that would allow them to amass the usual history that bankers and other creditors require. However, as a prerequisite of daily life, these “unbanked” persons would certainly have established relationships with the utilities, telecoms and other no-bank institutions in Guyana. These relationships, once documented and reported, work to create a non-bank credit history that could very well be instrumental in allowing them to access a first-time loan, credit card or overdraft facility from the formal lending/credit system.

The current deficient system where relevant, accurate and timely information on a borrower is not available on demand also imposes a heavy burden of investigative and authentication responsibilities on lenders. This is in response to what the credit reporting industry has termed “information asymmetry” which basically, is the natural, human tendency of certain borrowers and credit applicants to conceal the less desirable attributes of their financial history from the institution to which they are currently applying for credit.

On-demand access to this consumer data in an easily understood, user friendly format reduces or eliminates altogether the need for lenders to mobilise the human and other resources that would have been needed for cross checking, validation and verification of information thus provided by a prospective borrower during the initial application process.

More often than not, these necessary transaction costs are levied on the borrower in the form of fees and other charges attached to the application. Now, however the cost savings can conceivably be converted to lower interest rates, or simply more cost efficient processing charges for borrowers.

Another consideration is the long and onerous process of waiting for the decision making machine to commit to an approval/ denial decision. This of course is fueled by the need we have previously identified, which is the responsibility of the lender to verify and possibly add to the financial information provided by a borrower. When one factors in the caseload of applicants serviced by the commercial banking sector, it is hardly surprising that this process can sometimes drag on for several weeks or months. The credit bureau’s range of available reports and powerful decision making tools can significantly decrease the turnaround time for loans and other forms of credit, the effect of which is to make the system as a whole more efficient and certainly more amenable to credible and informed decision making.

However you look at it, this can only benefit a prospective borrower. Every serious minded, responsible Guyanese should be allowed a reasonable opportunity to own a credit card, have easier access to personal or business loans, mortgages, overdrafts, and to procure lines of credit at hire purchase merchants with a minimum of fuss. These are only a few of the advantages available to persons in the developed world where information/data sharing is now commonplace.

All taken together, the net effect of information sufficient to lower the risk of lending also allows a system where lenders can more accurately assign lower interest rates to qualified borrowers. This directly addresses and solves the problem of adverse selection; the unfortunate consequence of a particular defence mechanism where lenders seek to counter information asymmetries by assigning high rates of interest to their entire portfolio, thereby treating all borrowers as high risk in order to protect themselves from the few who actually might be. As easy access to information becomes a matter of course, consumers will find that once they are identified as being an acceptable risk, lenders will compete for the opportunity to provide their services. And how do lenders compete? Simply put, lenders tend to compete with each other by offering better service, higher lending ceilings, longer repayment periods and a variety of other innovative marketing strategies aimed at securing for themselves this consumer who is a good and responsible borrower.

The cost of borrowing can now be more affordable over the medium to long term.

There is compelling evidence supporting the assertions that we have made. According to a study done on 5,000 firms in 51 countries by the International Finance Corporation, which is the private sector arm of the IDB; the percentage of businesses reporting constraints in obtaining financing declined from 49% to 27% after credit bureaus began operating in their respective regions.

Further, credit bureaus tend to foster stability in the financial sector and by extension; the economy. A study of credit markets over the last 25 years shows that increasing the quality and reach of information sharing is strictly associated with GDP growth. It increases access to credit for a larger segment of the population, an important investment and development imperative.

There is also another perspective. Since banks and other lenders are operating with a finite capital base available for lending, the ability to differentiate between good and bad applicants means that their funds will be disbursed to recipients more likely to repay. Less bad credit means more funding available for qualified borrowers, which in turn will also revitalize the investment climate, lead to formation of new enterprises, support job creation and over a period of time can contribute in a meaningful way to a general upturn in economic circumstances both on an individual and a national level.

Finally, credit bureaus tend to encourage a more responsible credit environment. As borrowers and other users of facilities involving the need for credit are made aware that a lack of attention to financial obligations can lead to a less than optimum credit report or score, they are far more likely to service these obligations more efficiently. From any standpoint this can only have a positive and healthy impact on the prerogative of profitability and development for firms, and for the economy in the long run.

 

The next article in this series on the Credit Bureau will address the rights and obligations of the consumer under the law and the ways in which the Credit Bureau protects your privacy and upholds the principles of ethics and morals on which its service is based.