Credit bureaus and registries for financial sector development
Usman Khalid and Muhammad Shafiullah
Financial sector development is one of the key drivers of economic growth. It can improve access to finance for consumers and firms alike while also facilitating the inclusion of the informal sector in the formal economy. However, 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, any other 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 a new borrower who has never taken a loan. Under all of these circumstances, the lender has no idea if the borrower will be a good borrower or a bad borrower. This is where credit information sharing institutions come in handy. These institutions keep a record of all loans, history of repayment and defaults of a borrower. Such institutions typically take one of two forms: either a public credit registry or a private credit bureau.
Both types serve the same purpose. They collect information about 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 these 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. Whereas, the private sector manages a credit bureau, and in principle, they should be perfect substitutes as it should not matter whether a public or private entity supplies the information.
Despite the obvious benefits of credit bureaus, the proportion of public covered by credit registries or bureaus is abysmal, as depicted in Figure 1. In Bangladesh, only 0.9 per cent of the total adults were covered by the public credit registry in 2017, according to the World Bank. Bangladesh's public information credit registry coverage compares poorly with South Asian counterparts. In terms of public credit registry, Maldives tops the league with 18.8 per cent, followed by Pakistan and Afghanistan with 9.9 per cent and 1.0 per cent respectively. In the remaining four South Asian economies, zero per cent of adults are registered with the public credit registry. The average for public credit registry coverage for South Asia and the World are 3.8 per cent and 13.6 per cent, respectively. Bangladesh's statistics are even worse regarding coverage by private credit bureaus. Zero per cent of Bangladesh's adults are covered by private credit registries. When compared to South Asia, Bangladesh's private credit registry coverage is one of the worst, along with Afghanistan and Maldives. Here, India tops the chart at 43.5 per cent (thus eliminating the need for a public credit registry), followed by Sri Lanka at 35 per cent, Pakistan at 6.7 per cent, and Nepal at 1.7 per cent. The average for private credit information coverage for South Asia and the World stands at 14.1 per cent and 30.8 per cent respectively. This demonstrates poor performance of public and private credit registry in Bangladesh compared to South Asia and the rest of the World.
Bangladesh Bank (BB) made efforts to gather information about the credit history of the public. On August 18, 1992, BB established a credit registry called the Credit Information Bureau (CIB) that requires banks and non-bank financial institutions to share credit information with BB. Initially, the CIB collected credit information on individuals and firms for loans larger than Tk 50,000 or outstanding credit card debt larger than Tk 10,000. Since an April 26, 2018 circular, credit information on all outstanding loans of Tk 1.0 and above are registered into the system.
In 1995, the first credit rating agency - Credit Rating Information and Services - was formed by the Bangladesh Securities and Exchange Commission (BSEC). Subsequently, in 1996, the private sector's role in credit information was recognised, when the BSEC enacted the Credit Rating Companies (CRC) Rules 1996 to oversee credit rating in Bangladesh. Since then, many other credit rating agencies have been established, including Credit Rating Agency of Bangladesh, National Credit Ratings, Emerging Credit Rating, ARGUS Credit Rating Services, Alpha Credit Rating and WASO Credit Rating Company (BD). Subsequent rules, guidelines and circulars propagated by the BSEC, BB and the Chief Controller of Insurance made it mandatory for firms and financial institutions to get credit ratings prior to listing in the stock exchange, initial public offering (IPO), as well as for some commercial operations of banks and insurance companies. Unfortunately, these agencies record credit ratings of firms and institutions, rather than individuals. This is exhibited in the zero per cent coverage of adults by private credit information bureaus in Bangladesh (Figure 1).
Credit bureaus and registries with comprehensive and detailed information about the borrower could work wonders for the financial development of Bangladesh. Banks will have more information on which they can base their lending decisions. This could, in turn, reduce the prevalence of non-performing loans in the country's banking sector. Bangladesh has one of the highest rates of non-performing loans (NPLs) in South Asia at 9.2 per cent of total gross bank loans - which is higher than the South Asian average of 8.4 per cent and more than double the World average of 3.7 per cent (Figure 2). Unsurprisingly, this is against the backdrop of one of the lowest credit information coverage, regionally and worldwide.
The high prevalence of non-performing loans imposes a risk premium on the financial markets, resulting in higher borrowing costs. Credit information registries allow banks and financial institutions to make informed decisions and lower non-performing loans. This eventuates in lower risk premia and affordable borrowing costs. If the country's banking sector reaches this point, it can allow middle-class consumers, who otherwise have no way to show their creditworthiness, to prove that they are low-risk borrowers. In turn, there can be a boom in personal and car finance. Similarly, it could be easier for people to get house building finance or mortgages. This could also help small and medium-sized enterprises (SMEs). SMEs across the world 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 and be able to secure loans. The credit bureau 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. These developments in the financial markets have the potential to put Bangladesh on a credit-fuelled higher growth trajectory.
A different type of information sharing system that can work well to increase availability of credit to the private sector, especially for SMEs, is the collateral registry. Most loans from banks 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 the machinery 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 could 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 the consent from the lender. In case the borrower sells the collateralised property, the lender can go to a court to retrieve the property. For example, collateral registries have been established, with the help of the International Financial Corporation (IFC), in developing Latin America and the Caribbean. In particular, collateral registries experienced widespread response, largely from SMEs, in Colombia and Mexico.
In summary, to boost productivity and economic growth in Bangladesh, the financial sector must be developed rapidly. One way to achieve this goal is to improve the availability and access to credible financial information regarding the creditworthiness of the creditors. Introducing credit bureaus-both public and private-that keep a record of lenders income, credit history and other essential information can help solve the problem of access to credible financial information and boosts financial development. However, it is crucial that these credit information bureaus cover the majority of the country's population in order to be effective. In addition, setting up collateral registries that keep a record of ownership of assets (both movable and immovable) of SMEs and service firms can help these firms get loans by increasing their collateral value.
Dr Usman Khalid ([email protected]) and Dr Muhammad Shafiullah (muhammad.
[email protected])are assistant professors of Economics at the University of Nottingham Malaysia.