When Will Risk-based Pricing of Retail Loans Be the Norm?
What does an excellent credit score do for you? If you go by CIBIL’s (Credit Information Bureau of India Limited) television advertisements, it fast-tracks loan processing and ensures service with a beaming smile from your banker. But a high credit score has little commercial benefit; it makes no difference to your cost of borrowing. On the other hand, a dispute with your credit card company, a decade ago, may have caused you to be listed as a defaulter with CIBIL and you would be denied a loan even today. Worse, there is large-scale ignorance about credit reports and credit scores among savers until they are confronted with a loan rejection. In many cases, even that is not a wake-up call because potential borrowers are not even told why their loan application was rejected. Many of these are people who had been pushed into a loan ‘settlement’ without explaining that it will cripple their future borrowing capacity.
 
This is not how the system works around the world. In most developed countries, your credit score dictates the interest you pay on credit cards and loans; so every adult is conscious about her credit score. Moreover, unlike in India, only the most egregious defaulters get shut out of the credit system; the rest simply pay higher interest rates. The fact that good borrowers get better credit rates has probably been responsible for widespread awareness about credit information reports, especially since lenders aggressively market their loan offerings on this basis. 
 
It is over a decade since CIBIL, India’s first credit information company (CIC), was set up. Now, there are four CICs; and, yet, ignorance about credit reports remains as high as ever. This is mainly because of the Reserve Bank of India’s (RBI) failure to introduce risk-based pricing and to create a level playing field among CICs by giving them equal access to historical data—until a year ago. 
 
Moneylife Foundation, our not-for-profit organisation, has been running a credit helpline and a credit counselling effort for six years. It has repeatedly lobbied RBI to make the system more equitable for borrowers and create better awareness about credit reports. This is even more imperative today when the government is pushing financial inclusion in a big way and encouraging microfinance and small borrowings through Mudra loans. 
 
Our latest effort is a detailed memorandum that we submitted to RBI governor Dr Raghuram Rajan on 16 May 2016, after I had raised the very same issue a year earlier, at a meeting on 25 May 2015. But when it comes to consumer issues, RBI seems to move at an excruciatingly slow pace. We learn that the governor has asked the appropriate department to look into the concerns raised by us. The key issues that we have raised, based on feedback from our credit helpline, a survey among those reported as defaulters and consultations with all stakeholders, are:  
 
  1. Lenders must be made to follow RBI regulations and disclose their reasons for rejecting a loan. Even today, most people are not told that they have been reported as defaulters in their credit report and awareness about credit information itself is abysmal. 
     
  2. Introduce the concept of ‘Lender’s Liability’ for consumer borrowings, where genuine disputes regarding interest rates and charges are resolved quickly and equitably, instead of harassing consumers.
     
  3. Correct the wording of Credit Information Companies (Regulation) Act 2005 to ensure that negative data is preserved for ONLY seven years, rather than a ‘minimum’ of seven years. This is being interpreted to mean that negative credit data can haunt a person for the rest of her life. At a time when the government is working on fair bankruptcy laws for companies, surely individuals deserve better treatment. 
     
  4. Introduce risk-based pricing, where good borrowers get lower interest rates, while those with previous default have an opportunity to rebuild their credit history, albeit at a higher rate. 
     
  5. Introduce a fair and swift grievance redress mechanism to help people resolve flaws in their credit report, in many cases created by ignorant bankers. 
 
The simplest and best way of creating awareness about the credit information process is to allow lenders to decide loan rates based on credit scores or risk assessment. Since RBI does not deign to engage with NGOs on the issue, it is unclear whether it has concerns about misuse and proper implementation.
 
We have recently found that Bank of Baroda (BOB) has, in fact, issued an internal circular introducing the concept of ‘risk-based pricing’ of car and home loans from April this year. This means that the interest you pay will depend on your credit score. Using CIBIL scores as the basis, BOB has said that those with a high score of 800+ will be able to borrow at the base rate; those in the 760-800 range will pay 0.25% above the base rate, 725 - 760 will pay 1% above the base rate and those with a score of 675- 725 will pay 1.5% above the base rate. 
 
It also lists 725 as the cut-off score for normal process of loan applications while, those will lower scores will need clearance by seniors. The Bank will ignore small credit card defaults of up to Rs10,000 for existing customers with a satisfactory payment record. This is a very pragmatic decision which recognises that a poor and unfair grievance redress system, combined with rampant mis-selling of credit cards and mishandling of disputes by banks, especially in the 2006-08 period, have caused many good borrowers to be classified as defaulters. 
 
Since BOB’s bold new initiative has not been publicised at all—not even to those of us who were on BOB’s customer services committee (I have recently resigned), I decided to use social media, to find out if other banks had evolved or announced such policies. I sought feedback on Twitter about whether their banks had offered a differential interest based on their CIBIL score for home and car loans. Since social media comprises literate and net-savvy consumers, this was a good sample; however, constraints of Twitter did not allow me to find out how many had sought a loan after April 2016, when banks have presumably introduced risk-based pricing of loans. 
 
As many as 1,006 persons responded to my quick poll, over a few hours. A massive 47% said they were not offered risk-based interest; 35% said they had no idea that there was such an option. This, essentially, means that 82% of borrowers had no clue. Another 16% had never sought a loan while 2% claimed they had got a lower rate. Here, too, one person wrote to say he checked the wrong box by mistake. Some said that differential rates were being offered by finance companies. This is, indeed, true and companies like Capital First, have done path-breaking work at risk-assessment for small-ticket loans which has played a significant role in financial inclusion. 
 
But the bigger banks, both public and private sector, are largely unmoved.  Strangely, HDFC Bank has been sending out e-mailers offering personal loan sanctions without bothering about credit reports. This raises another vital question. Why does India’s most aggressive bank, whose parent promoted CIBIL, want to ignore credit scoring mechanism? Is the system flawed? Or has it become a tool of harassment? Strange as it may seem, our very visible and voluble RBI governor, who is forever in media headlines, has almost never spoken on consumer issues or focused on them.
 
Since all stakeholders, including credit information companies and debt repair agencies, agreed that there was poor consumer awareness, need for risk-based lending and a quick dispute resolution mechanism, we wonder when RBI will make this happen.
 
(You can read our detailed memorandum at http://tinyurl.com/zdfyreb).
Comments
Manish Sharma
8 years ago
Superb points Sucheta. It is important that financial institutions in India start using credit score to decide on lending rates. It will solve a multitude of problems. The first would be to create awareness around the existence of such scores, which in turn will lead to financial prudence by borrowers. The second, hopefully, would be the availability of such scores free of cost to borrowers, so that they don't have to wait until a loan application is rejected. The third, as you have mentioned, should make the whole system more equitable for borrowers - as there would be more and more current/prospective borrowers trying to make their voices heard for making the system more 'equal'.
Finwizz Finwizz
8 years ago
Good Pointers... Risk based pricing is definitely a good thing...
Srinivasan
8 years ago
Your article is spot on. Great to hear that BoB actually makes use of it (even if it is only for car loans right now)... Wish this was getting the due visibility and publicity.
In general our PSB will not get into doing such things unless mandated by RBI or their largest stock holder. As far as our Private Banks and MNC Banks - they would like to prolong their milking of the customer, until there's publicity of some banks doing it or being pushed by the regulator...
Amit Kale
8 years ago
Absolutely will said everything. .i always thought what was the use of great credit score in india and i thought may be there is is some which i don't know. .but now it seems indeed there is not much benefit of it in india
Prasad Khandkar
8 years ago
In the US, ONE credit score report per year must be provided for FREE to the consumer (each consume being identified by his/her social security number) - so agencies such as equifax, transunion are forced to send a free credit score report to every consumer at least once per year. In India, CIBIL forces a consumer to purchase every report. Each consumer must have a right to look up his/her credit score report at least once a year without paying for it. After all, this is our data - why should we pay for it?!
Manish Sharma
Replied to Prasad Khandkar comment 8 years ago
Exactly, this is our data. Personally identifiable information such as PAN, date of birth, annual income, phone numbers, number of relationships with financial institutions. The fact that the report is priced at Rs. 500 per report, makes it a huge deterrent for many people who unfortunately remain in the dark about the havoc that banks have played with their credit scores.

It is time.
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