Home » Industry » Why Credit Reference Bureaus Are a Noble Idea

The recently announced Monetary Policy Statement by the governor of the central bank informed the market that a Credit Registry Department has been established as a unit in the Bank Supervision Division to co-ordinate the collection of credit information from all banking institutions and micro-finance institutions and maintain the databank for the credit registry.

This move is geared towards the operationalisation of the Credit Reference Bureaus (CRBs) as a strategy to reduce the amount of NPLs in the economy.

The introduction of Credit Reference Bureaus in our financial landscape is an effort to encourage the sharing of information by credit institutions, so as to reduce the incidence of serial defaults by bank customers as well as to minimise the incidence of non-performing loans.

What is the role of Credit Reference Bureaus?

Credit reference bureaus are meant to complement the central role played by banks and other financial institutions in extending financial services within an economy. CRBs help lenders make faster and more accurate credit decisions. They collect, manage and disseminate customer information to lenders within a provided regulatory framework. Credit histories not only provide necessary input for credit underwriting, but also allow borrowers to take their credit history from one financial institution to another, thereby making lending markets more competitive and, in the end, more affordable.

Credit bureaus assist in making credit accessible to more people, and enabling lenders and businesses reduce risk and fraud. Sharing of information between financial institutions in respect of customer credit behaviour, therefore, has a positive economic impact. Banks play a central role in extending financial services within an economy. In support of this role, credit bureaus help lenders make faster and more accurate credit decisions.

How do CRBs work?

The CRB should usually be privately owned, profit-making establishment that as part of its regular business collects and compiles data regarding the solvency, character, responsibility, and reputation of a particular individual or business in order to furnish such information to subscribers, in the form of a report allowing them to evaluate the financial stability of the subject of the report. Credit bureaus ordinarily prepare and issue reports for lending institutions and stores that investigate the financial reliability of an applicant for credit prior to the execution of the credit agreement.

The CRBS are meant to deal with the moral hazard and aerse selection problems through monitoring the behaviour of borrowers. The operations of the CRBS should be underpinned by g legal framework so as to be better able to deal with the aerse selection and moral hazard problems.

Aerse selection is the problem created by asymmetric information before the transaction occurs. Aerse selection in financial markets occurs when the potential borrowers who are the most likely to produce an undesirable (aerse) outcome – the bad credit risks – are the ones who actively seek out a loan and are the most likely to be selected. Moral hazard is the problem created by asymmetric information after the transaction occurs. Moral hazard in financial markets occurs when the lender is subjected to the hazard that the borrower has incentives to engage in activities that are undesirable (immoral) from the lenders point of view, because those activities make it less likely that the loan will be repaid.

What are some of the benefits of CRBs?

Some of the benefits of creating a credit reference bureau are:

CRBS can assist in the identification of “serial defaulters”, who borrow from various banks with no intention of repaying the loans.

CRBs assist in resolving the “information asymmetry” problem which arises because of the environment of lack of a credit information sharing mechanism.

CRBs reduces borrowing costs and loan delinquencies to a significant extent

CRBs can enhance effective risk identificationmonitoring and credit extension.

CRBs can ensure that credit flows to deserving borrowers and reduce to those less deserving ones.

A well-functioning credit reference bureau framework will help in maintaining financial stability in the economy.

Is a Good Credit Record as good as Collateral?

In conclusion, it should be understood that the introduction of CRBS will inculcate a culture of observing credit terms. SMEs and individual borrowers stand to benefit greatly from the introduction of CRBS since they will be able to use their credit histories as collateral unlike in the current scenario, where they were constrained from accessing credit due to lack of physical collateral. Credit information will be exchanged by credit givers in the economy on a monthly basis.

The recent study by the Bankers’ Association of Zimbabwe into the informal sector, showed that there is large appetite for bank loans by the informal sector players but they do not qualify for bank credit on the basis of traditional collateral. The introduction of the credit bureaus will help those players in the informal sector to start building their capacity to borrow from the formal sector since the credit information sharing will allow banks to quickly distinguish between good and bad borrowers.

A good credit record will become a g collateral asset in its own right and borrowers should start building their good credit reputations now, so that when the system is fully operational, they will not be denied credit or be charged at higher interest rates that are commensurate with the risk they pose.

Sanderson Abel is an economist. He writes in his capacity as Senior Economist for the Bankers’ Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on abel@baz.org.zw or on numbers 04-744686 and 0772463008.

Source : The Herald