The need for credit bureaus

If all of the creditors got together and shared information on their debtors, they should easily be able to determine which debtors defaulted and which debtors paid on time. To ensure that the information is not misused requires transparency and accountability. In countries without adequate enforcement or protection of rights, these issues are unlikely to be resolved

According to the game theory a debtor’s best move is not to pay back a loan. Creditors know this. So their best move is not to make the loan. Obviously this is not what happens. In developed countries creditors rely on the state to keep debtors honest. A failure to pay back a debt brings with it legal sanctions. In many emerging markets these sanctions are either not available or incredibly slow. So for many emerging markets creditors and debtors rely on trust built from relationships often within families, political parties, religions and even castes. Regardless of the sophistication the main element of the loan is trust. Trust built on information, which is why the development of credit bureaus and credit reporting agencies is so important to growing economies.


The idea of a credit bureau is to solve the problem of asymmetry of information between the debtor and the creditor. In smaller relationship-based systems this is usually not a problem. Everyone knows everyone else’s reputation, but as the population grows, the process become more difficult. How do you separate the worthy, the diligent and honest from the dishonourable, indolent and corrupt? What would stop a debtor with a bad history with one creditor from trying to defraud another? When do you know when a usually reliable debtor gets in too deep? How does a large creditor like a bank control its risk portfolio? What methods can a creditor use to screen or automate the process to bring the cost of credit down?


The best way would be to share information. If all of the creditors got together and shared information on their debtors, they should easily be able to determine which debtors defaulted and which debtors paid on time. But there are problems with such an arrangement and it has to do with information. Information has value and power. To share information requires losing both. Information can also be abused. To ensure that it is not misused requires transparency and accountability. Consumers must have access to ensure that the information is accurate. In countries without adequate enforcement or protection of rights, these issues are unlikely to be resolved.


Click here to read about how our credit-tracking system is in a mess whether RBI is playing its role. An analysis by Sucheta Dalal.


In more authoritarian countries like China and Vietnam, state control of information is paramount. Both these countries maintain credit bureaus controlled by the government. Public ownership has problems beyond the serious potential for abuse. The main problem is the size of the sample. The credit bureaus were owned and managed by the country’s central bank. The banks are more concerned with debts that might impact the economy. So the average minimum threshold for credit information in public bureaus was $30,000.  In countries with private bureaus the motivation is profit, so the average threshold is only $450.


Since creditors have an incentive not to share information, it is often better to provide a legal mandate, but sometimes the regulation itself is the problem. According Moneylife, the Mumbai financial newsletter, The Indian Credit Information Act requires only that lenders share information with at least one bureau. This has had the effect of creating a monopoly for the oldest private credit bureau, CIBIL (Credit Information Bureau India). Newer entries like Experian and High Mark are effectively shut out.


Brazil has one of the highest levels of consumer debt in the world. The average Brazilian household pays 25.8% of their incomes servicing their debts. This could be a serious problem in a country where the average interest rate on consumer loans is 34.6%. But the government only passed legislation allowing for credit bureaus to get information regarding the total debt rather than just defaults in 2011. The American company, Experian, has just bought out other minority interests in the local credit bureau, Serasa. The change in the law will allow Serasa to supply its credit partners, Brazilian banks, with other products including detailed credit histories, but given Brazil’s slowdown and the rise of consumer defaults, it may be too late.


Read here: Credit scores are a big zero, by Sucheta Dalal.


The need for sophisticated credit information was illustrated in the relatively urbane economies of Hong Kong, South Korea and Taiwan. Each of these countries experienced booms and busts in consumer credit between 1998 and 2005. Delinquencies rose to over 10% during the falls. The busts convinced most of the countries of South East Asia to establish bureaus in the last ten years.


Still consumer bureaus do not necessarily eliminate the problem of extensive consumer debt. Korea established a third credit bureau in 2006. The bureaus now cover 100% of borrowers. But as the economy grew, so did less regulated non-bank sources of credit. Korean consumers now have accumulated debt equal to 160% of their disposable income. This is higher than both the US figure and the Korean number before the credit crises. Like Brazil, Korea’s economy has been slowing, and with easy money even the best information cannot necessarily prevent a collapse.


Other stories by William Gamble


(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)


Sensex, Nifty on a slippery slope: Weekly Market Report

The Nifty is likely to hit 5,950 and maybe head even lower

The market ended lower this week, mainly on macro-economic concerns and a clutch on lower-than-expected third quarter results from corporates. Although the Reserve Bank of India (RBI) announced a 25 basis point cut in repo and CRR rates on 29th January, the central bank cautioned on inflation and the fiscal deficit front. A dip in the January manufacturing output also weighed on investors. Stock specific movement is expected to drive the market in the week ahead as companies continue with the third quarter earnings reports.


The Sensex declined 322 points (1.60%) to 19,781 and the Nifty fell 76 points (1.25%) to close the week at 5,999. The market is on a slippery slope. The Nifty is likely to touch 5,950 and maybe head even lower.


The market ended flat on Monday ahead of the RBI’s quarterly monetary policy review. The central bank’s rate cut did not enthuse investors as concerns about the economy led the benchmarks lower on Tuesday. The volatile market settled higher on Wednesday on late buying in rate-sensitive sectors.


The market edged lower on Thursday as the government revised the economic growth for fiscal 2011-12 to 6.2% from the earlier estimate of 6.5% and weak global cues. The market closed lower on Friday on a fall in India’s manufacturing output in January and weak corporate results of Bharti Airtel and BHEL, among others.


BSE Consumer Durables and BSE Fast Moving Consumer Goods (up 2% each) were the top sectoral gainers while BSE Capital Goods (down 3%) and BSE Oil & Gas (down 2%) were the chief losers.


Coal India, Cipla (up 4% each), ITC, Hero MotoCorp (up 3% each) and TCS (up 1%) were the top performers on the Sensex in the week. The losers were led by Bharti Airtel (down 8%), Tata Motors, Larsen & Toubro (down 5% each), State Bank of India and Jindal Steel & Power (down 4% each).


The major gainers on the Nifty were Axis Bank (up 9%), Coal India (up 5%), Cipla (up 4%), ITC and DLF (up 3% each). The main laggards on the index were Bharti Airtel (down 9%), Tata Motors (down 6%), L&T (down 5%), Reliance Infrastructure and UltraTech Cement (down 4% each).


Shedding its nine-month long hawkish monetary policy stance, the Reserve Bank of India (RBI) on Tuesday cut the short-term lending (repo) by 0.25% to 7.75% and cash reserve ratio (CRR) by similar margin to 4%, releasing Rs18,000 crore primary liquidity into the system. The RBI, however, reduced the growth projections for the current fiscal to 5.5% from its earlier estimate of 5.8% and moderated the inflation rate to 6.8% for March-end from earlier projection of 7.5%.


The HSBC manufacturing PMI, an indicator of the country’s manufacturing output growth, eased to 53.2 in January 2013, from 54.7 in December 2012. While the overall rate of growth remained firm, the growth slipped to a three-month low.


Among corporates, Bharti Airtel, India’s leading telecom services operator, posted a lower than expected third quarter net profit of Rs284 crore. The profit which fell for the twelfth quarter in a row is down a whopping 72% compared Rs1,011 crore same period last year.


BHEL’s net profit declined 17.5% to Rs 1181.85 crore on 3.17% decline in total income to Rs10,552.09 crore in Q3 December 2012 over the corresponding previous quarter. The company’s total order book position fell to Rs113,700 crore at the end of the December quarter from Rs122,300 crore in the previous quarter.


A series of freak trades in Tata Motors and UltraTech Cement towards the end of the trading session on Friday saw the two scrips tumbling around 10% before making a recovery. Tata Motors’ shares tumbled 9.98% to Rs 268.25 per shares before recovering to close at Rs 281.65, down 5.4%. The UltraTech scrip dropped 10% to Rs 1,712.35 apiece. The share pared its losses to close at Rs 1,837.75, down 3.4%.


An NSE (National Stock Exchange) official said the orders were within the exchange’s limits and came from a single broker. The official clarified these were not freak trades, but added the exchange would look into the matter.


On the international front, US gross domestic product (GDP) unexpectedly fell at a 0.1% annual rate in the December quarter, its first decline since the 2007-09 recession. Meanwhile, payrolls in the world’s largest economy increased by 157,000 workers in January following a revised 196,000 gain in the previous month and a 247,000 jump in November.


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