TO have a higher degree of financial development, access to credible financial information is essential. Lenders, banks and leasing companies have to make informed decisions while lending.
The lender must know a borrower’s ability to pay back the loan on time. For this, the lender needs proof of income, liabilities and history of loans and defaults. The borrower can take loans from multiple banks and hide this information while applying for a new loan.
The borrower may also be someone new who has never taken a loan before. In this case, the lender has no idea if the borrower will be a good or bad customer. This is where credit information–sharing institutions come in. These institutions keep a record of all loans and the history of repayment and defaults of a borrower. These institutions typically take one of the two forms: they are either a public credit registry or a private credit bureau.
Both types of institutions serve the same purpose. They collect information on the credit history of the borrowers (individuals and/or small firms), including information on credit repayments, bankruptcies and court judgments, from various sources and sell it to the creditors.
The only difference between the two types of institutions is that a credit registry is usually maintained by the government — typically by the central bank. The private sector manages a credit bureau. In principle, they should be perfect substitutes. It shouldn’t matter whether a public or private entity supplies the information.
Setting up collateral registries to keep a record of asset ownership will allow borrowers to prove their creditworthiness
Despite the obvious benefits of credit bureaus, the proportion of the public covered by credit registries or bureaus is dismal. Only 9.9 per cent of the total adults were covered by the credit registry in Pakistan, according to the World Bank in 2017. Whereas, the coverage by private credit bureaus is only 6.7pc of the total adult population. India has 43.5pc of the adult population covered by credit bureaus. The share of the adult population covered by credit bureaus is 14.1pc in South Asia and 30.8pc in the entire world — well above that in Pakistan.
The State Bank of Pakistan (SBP) made efforts to gather information about the credit history of the public. In 1992, it established a credit registry called the Credit Information Bureau (CIB). It requires banks to share credit information with the SBP. Initially, the CIB collected credit information pertaining to defaults and overdue loans amounting to more than Rs500,000. However, 2006 onwards, the threshold was removed. The CIB updates its data every month and makes it available to eligible institutions.
In 2015, the government passed the Credit Bureaus Act that allows the private sector to venture into credit information gathering arena. Credit bureaus that will be registered under the Credit Bureaus Act 2015 will be able to collect and disseminate data to both financial and non-financial institutions. This may include retailers, insurance companies, utility providers and landlords, as notified by the federal government. They can undertake credit scoring and consolidate credit data for analysis and research purposes. This will also increase the coverage, scope and accessibility of credit information for better credit decisions.
A credit bureau with expanded and detailed information about the borrower can work wonders for financial development. It can lead to a credit-fuelled growth. Banks will have more information before making their lending decisions. This will, in turn, reduce the risk premia and lower borrowing costs. It will also allow middle-class consumers who otherwise have no way to show their creditworthiness to prove they are low-risk borrowers. This can lead to a growth in personal and car finance.
Similarly, this can also make it easier for people to get house building finance or mortgages. This can help small and medium enterprises that usually struggle to find credit financing for their operations as they do not have enough collateral (or proof of collateral). By including credit card, phone and utility bills in the credit information, SME owners will be able to provide proof of their creditworthiness. Credit bureaus will also lead to better documentation of the economy. People will be willing to transfer cars, houses, utility and mobile connections in their name so that they can build a better credit history.
Another information-sharing system that can work wonders for increasing the availability of credit to the private sector, especially SMEs, is the collateral registry. Most bank loans require some form of collateral. While land, property and cars are widely accepted as collateral for loans, the use of movable collateral (such as inventory, accounts receivables, crops and equipment) is restricted because these assets are not registered in anyone’s name.
A bank has no guarantee that the owner of the factory, in fact, owns the machinery in a factory, and that the owner will not sell this machinery after getting a loan against it as collateral. A collateral registry solves this problem. Collateral registries are publicly available databases of interests keeping a record of ownership of assets (both movable and immovable), allowing borrowers to prove their creditworthiness and potential lenders to assess their ranking priority in potential claims against particular collateral.
Collateral registries can lead to more financing for SMEs and services firms. The collateral registry will allow the banks to use machinery, office furniture, computers as collateral. Since all movable property and equipment will be registered with the registry, the borrower cannot sell the collateralised property without getting consent from the lender. In case the borrower sells the collateralised property, the lender can go to court to retrieve the property.
The writer teaches at United Arab Emirates University
Published in Dawn, The Business and Finance Weekly, September 28th, 2020