Financial Sector Assessment:A Handbook In many developing and emerg ngmarket is constrained by (a)the lack relared publications by ents and onals;(b) e non-availability of stand guidelines and practice manuals in a country context;(c)the lack proper train ing on the practical application of both standards and the code of ethics for profes sional accountants and auditors;and (d)a rudimentary academic environment that is illustrated by deficient curriculum,lack of appropriate academic literature,and a shortage of well-trained instructors. .A greater participation of developing countries in the process of developing and revising the standards is critical to facilitate the design and implementation of standards that reflect the realities in developing cour Rea ing an in mework of principles for the nd ofh A&A profession is important 10.3 Credit-Reporting Systems and Financial Information Services The concept of credit-reporting systems finance is a new subject and ha received increasing attention in recent years in light of its key role in improving information 10 available to financial intermediaries for their decisions and,thereby,facilitating improved access to finance.Credit reports are becoming more and more important throughout the world,fueled by demand for that type of data not only from banks and other financial intermediaries but also from private firms,retailers,employers,and others.Bank supervi- sors and regulators are also increasing their demand for high-quality credit data to more effectively monitor credit risks in sur ervised financial institutions.Credit-reporting sys- as pl ying mp Given ving credit riskm ements t text,governme as well as bank rvisors and ted in k answers owing ques ons.Wh at is a credit reporting system. does a credit report l s like? What would be good practices of a robust credit-reporting system in terms of the key elements involved? The discussion of those issues is organized as follows.Section 10.3.1 provides a brief introduction of credit-reporting systems and their role in financial development and sta bility.Section 10.3.2 describes the fundamental elements of a credit-reporting system and identifies good practices for credit reporting.Section 10.3.3 presents the potential uses of credit registries for strengthening credit risk measurements and the supervisory review proce ss.Section 10.3.4 bri iefly summarizes the role of c redit rating agencie 10.3.1 Introduction to Credit-Reporting Systems Credit or consum provide apid ndreliablep reporting firms and other credit information zed int atio and financial condition of pote ntial borrowers,be they indi viduals or firms,and help to support a well-functioning credit market.Credit reporting addresses a fundamental prob lem of credit markets:asymmetric information between borrowers and lenders,which 256
256 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 • In many developing and emerging market countries, observance of A&A standards is constrained by (a) the lack of access to the standards and related publications by students and professionals; (b) the non-availability of standardized implementation guidelines and practice manuals in a country context; (c) the lack of proper training on the practical application of both standards and the code of ethics for professional accountants and auditors; and (d) a rudimentary academic environment that is illustrated by deficient curriculum, lack of appropriate academic literature, and a shortage of well-trained instructors. • A greater participation of developing countries in the process of developing and revising the standards is critical to facilitate the design and implementation of standards that reflect the realities in developing countries. • Reaching an international consensus on a common framework of principles for the regulation and supervision of the A&A profession is important. 10.3 Credit-Reporting Systems and Financial Information Services The concept of credit-reporting systems in finance is a new subject and has received increasing attention in recent years in light of its key role in improving information available to financial intermediaries for their decisions and, thereby, facilitating improved access to finance. Credit reports are becoming more and more important throughout the world, fueled by demand for that type of data not only from banks and other financial intermediaries but also from private firms, retailers, employers, and others. Bank supervisors and regulators are also increasing their demand for high-quality credit data to more effectively monitor credit risks in supervised financial institutions. Credit-reporting systems are also seen as playing a key role in improving credit risk measurements as envisaged under the New Basel Capital Accord. Given the previous context, government officials, as well as bank supervisors and regulators, are interested in knowing answers to the following questions. What is a credit-reporting system? What does a credit report looks like? What would be good practices of a robust credit-reporting system in terms of the key elements involved? The discussion of those issues is organized as follows. Section 10.3.1 provides a brief introduction of credit-reporting systems and their role in financial development and stability. Section 10.3.2 describes the fundamental elements of a credit-reporting system and identifies good practices for credit reporting. Section 10.3.3 presents the potential uses of credit registries for strengthening credit risk measurements and the supervisory review process. Section 10.3.4 briefly summarizes the role of credit rating agencies. 10.3.1 Introduction to Credit-Reporting Systems Credit or consumer reporting firms and other types of public credit information registries provide rapid access to accurate and reliable standardized information on credit history and financial condition of potential borrowers, be they individuals or firms, and help to support a well-functioning credit market. Credit reporting addresses a fundamental problem of credit markets: asymmetric information between borrowers and lenders, which
Chapter 10:Assessing Information and Govemance leads to adverse selection and moral hazard.Credit information sharing allows lenders to more accurately evaluate risk and to avoid adverse selection.Similarly,credit-reporting mechanisms strengthen incentives for borrowers to repay and thus reduce moral hazar because late or nonpayment with one institution can result in sanctions from many oth- ers.Credit reporting expands access to finance,especially for lower income consumers, micro-enterprises,or small businesses.Credit reporting can also play a key role in improv ing the efficiency of financial institutions by reducing loan processing costs,as well as the empi n done to provide evidence of the importance of credit ies mple appelli and Pagan 20o1 analy e the effec oth private and 1 ind a positivee of bank ng (as a percentage of G P)and decrease in credit ris Barron and Staten (2003)show that greater availability of information reduces default rates and improves access to credit.Kallberg and Udell(2003)demonstrate that data from Dun and Bradstreet Corporation,a private credit information firm,have greater predictive power in calculating probability of default than a firm's financial statements.Galindo and Miller (2001)argue that firms in countries with better credit information are less credit constrained because they rely less on internal funds.Overall.theoretical and empirical analyses show that banks'sharing of information on borrowers helps to curtail the effects of advers and moral edit risk kets,an strengthens the st tability of the banking system 10 10.3.2 Elements of a Robust Credit-Reporting System nce c or the improvement in,or the assessing of,an existing credit-reporting system.This section describes several fundamental elements with respect to the structure of a sound credit-reporting system.It is not a comprehensive and complete illustration but a general guideline.The appropriate design of the system in any particular economy may largely vary by its size,the level of penetration of financial services,the degree of competition,and the legal framework.The implementation of Basel ll may also affect the design and operation of the systems(see section 10.3.3). 10.3.2.I Providers and Users of Credit Data clude both fir and s a1 inancial intermediarie Credit card issuers,insurance firms,automobile finance companies,and mortgage enders and guarantors .Retailers (appliance retailers and others) .Firms providing business-to-business credit and trade credit .Microfinance institutions 257
257 Chapter 10: Assessing Information and Governance Infrastructure 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 leads to adverse selection and moral hazard. Credit information sharing allows lenders to more accurately evaluate risk and to avoid adverse selection. Similarly, credit-reporting mechanisms strengthen incentives for borrowers to repay and thus reduce moral hazard because late or nonpayment with one institution can result in sanctions from many others. Credit reporting expands access to finance, especially for lower income consumers, micro-enterprises, or small businesses. Credit reporting can also play a key role in improving the efficiency of financial institutions by reducing loan processing costs, as well as the time required to process loan applications. Some empirical work has been done to provide evidence of the importance of credit registries in credit markets. For example, Jappelli and Pagano (2001) analyze the effect of credit registries—both private and public—and find a positive effect on the volume of bank lending (as a percentage of GDP) and a decrease in credit risk. Barron and Staten (2003) show that greater availability of information reduces default rates and improves access to credit. Kallberg and Udell (2003) demonstrate that data from Dun and Bradstreet Corporation, a private credit information firm, have greater predictive power in calculating probability of default than a firm’s financial statements. Galindo and Miller (2001) argue that firms in countries with better credit information are less credit constrained because they rely less on internal funds. Overall, theoretical and empirical analyses show that banks’ sharing of information on borrowers helps to curtail the effects of adverse selection and moral hazard, reduces credit risk, improves access to credit markets, and strengthens the stability of the banking system. 10.3.2 Elements of a Robust Credit-Reporting System Good practices of a robust credit-reporting system are presented in this section to provide broad guidance on issues to consider in establishing a new credit-reporting system and in identifying areas for the improvement in, or the assessing of, an existing credit-reporting system. This section describes several fundamental elements with respect to the structure of a sound credit-reporting system. It is not a comprehensive and complete illustration but a general guideline. The appropriate design of the system in any particular economy may largely vary by its size, the level of penetration of financial services, the degree of competition, and the legal framework. The implementation of Basel II may also affect the design and operation of the systems (see section 10.3.3). 10.3.2.1 Providers and Users of Credit Data Typically, in a credit-reporting system, the major credit information providers and users include both financial firms and several categories of non-financial firms: • Commercial banks and other regulated financial institutions • Non-bank financial intermediaries • Credit card issuers, insurance firms, automobile finance companies, and mortgage lenders and guarantors • Retailers (appliance retailers and others) • Firms providing business-to-business credit and trade credit • Microfinance institutions