31 July 2009
John Scott argues that in the debate about credit reform there are too many opinions and not enough knowledge.
Credit and privacy. Could there be two more controversial issues? The debate about credit reporting reform has been contentious since Dun & Bradstreet first placed it on the agenda in 2004. A recent marketing campaign promoting easy to understand but otherwise meaningless credit scores by one industry participant has further increased community tension about the data available to lenders.
The debate is hampered by lots of opinions but far too little knowledge. This leads to a range of arguments such as more information will lead to irresponsible lending similar to that which caused the sub-prime crisis in the United States; and that more people will be disenfranchised from the mainstream credit system thus leaving them vulnerable to sub-prime lenders. These are very powerful arguments. They are also false.
First, it's important to understand why this debate matters so much. Consumer spending accounts for around 60 percent of the New Zealand economy. Much of this spending is driven by credit.
Furthermore credit is the primary tool for wealth creation in New Zealand through its use to purchase the family home and other assets.
This means that the health of the New Zealand economy is linked directly to consumer spending and credit. The importance of this link is all too obvious in an environment where depressed consumer confidence, and therefore consumer spending, has contributed significantly to the extended economic downturn currently being experienced in New Zealand.
Clearly then the quality of the lending decisions made in New Zealand matters. Yet for something which is so critical to the well being of the national economy and household budgets, the information driving credit decisions in New Zealand is dangerously limited.
Currently, New Zealand operates a negative-only credit reporting system. This means that a credit report can only include some basic identification details, a listing of credit applications and any negative events such as defaults or bankruptcies. Importantly, a credit report is not allowed to record whether an application has been approved or rejected.
This means that lenders are being asked to make credit decisions based on information that doesn't even include a brief overview of existing credit commitments. It is a recipe for disaster.
What then do we make of the concerns and criticisms levelled at comprehensive credit reporting? The first and obvious criticism is that a comprehensive reporting system in the United States didn't avoid the sub-prime crisis. It's an easy argument to make but it misses some key points.
The sub-prime problem in the United States arose for multiple reasons, many of which are related to the way in which banks and other organisations on-sold sub-prime loans to investors and the level of transparency around the quality of those loans. Counter-party risk in credit and investment markets was the critical issue.
That sub-prime borrowers defaulted on their mortgage repayments should never have been news to the world. By their very nature sub-prime borrowers are riskier than the average borrower and as a consequence have a higher propensity to default. Both the lenders and regulators knew, or at least should have known, that this was the very nature of sub-prime lending.
However, the scale of the defaults took everyone by surprise for the simple reason that too many of those sub-prime borrowers had not been effectively assessed for risk. In many cases they had not been assessed at all. This lack of assessment was made worse by outright fraud. There are hundreds of stories of mortgage brokers, and some consumers, under investigation in the United States for fraud related to mortgage applications.
Clearly then the problem wasn't credit reporting. Rather it was a failure to properly use credit reports and in some cases a result of outright fraud. Blaming credit reports for this crisis is like blaming a car crash on a stop sign because people refused to pay attention to it.
The second argument against reform is that it will lead to more people being disenfranchised from the mainstream credit system thereby making them vulnerable to unscrupulous lenders. Evidence from around the world shows exactly the opposite happens.
A key reason why many consumers are denied credit is the lack of historical information on which lenders can base informed decisions. With so many unknowns, the default position of most responsible lenders is to deny credit. However, with the inclusion of positive information on credit reports, lenders are able to assess credit applications from a broader perspective.
Furthermore, by including non-bank data such as telco and utility data, a much clearer picture is able to be compiled on those members of the community that have had little interaction with mainstream bank lending in the past. Global research shows that the inclusion of both non-bank and positive data significantly increases the number of people gaining access to the mainstream credit market. This increase is most prevalent amongst women, immigrants and indigenous communities who are those most likely to be relying upon sub-prime lenders at the moment.
In addition the global research shows that defaults come down. There are two recent examples. Research in Japan showed that comprehensive reporting reduced the delinquency rate for the mean loan by 34 percent. The shift to comprehensive reporting in Hong Kong in 2002 saw a decline in credit card write-off ratios from 13.6 percent to 3.7percent. So yes, some people will be denied credit but it can only be a good thing if it avoids them and the economy the pain of future default.
The final concern offered by opponents of credit reporting reform is a general privacy concern and in particular, that this additional data will be used to marketing to those who are most vulnerable. This concern is the easiest to deal with. Currently the law prohibits the use of credit reporting data for marketing purposes and Dun & Bradstreet is proposing no change to that law. Credit reports should be used only for the purposes of credit assessment and to preclude at risk customers from unsolicited credit offers.
The global credit crisis is a powerful reminder of the need to ensure that credit markets are built on a solid foundation of thorough credit assessment. At the same time, the state of the New Zealand economy, impacted by the rapid decline in credit demand, is an important demonstration of the critical link between the health of our national economy and the free flow of sustainable credit.
If we are going to demand that lenders act responsibly then it is critical to provide them with the necessary information to do their job. Furthermore, given the symbiotic relationship between credit and our national economic health it is critical we have the tools to keep credit flowing. This is the essence of a comprehensive credit reporting system.
John Scott is the General Manger of Dun & Bradstreet New Zealand. D&B is the world's leading provider of credit, marketing and purchasing information.
For further information and comment please contact:
Danielle Woods,
D&B Australia
Ph: +61 2 8270 2926
John Scott,
D&B New Zealand
Ph: 9359 8045
About D&B
D&B is the world's leading provider of business-to-business credit, marketing and purchasing information and receivables management services. D&B manages the world's most valuable commercial database with information on more than 150 million companies.
Information is gathered in 193 countries, in 95 languages or dialects, covering 186 monetary currencies. The database is refreshed more than 1.5 million times daily as part of D&B's commitment to provide accurate, comprehensive information for its more than 150,000 customers.
The Australasian operations were bought out by the senior management group in August 2001. It was the first MBO of a wholly owned subsidiary in D&B's history worldwide.
Today Lazard Carnegie Wylie owns an approximate 90% stake in DBA and the local management team a 10% stake.
Strategies for future growth include developing DBA's commercial and consumer credit referencing business; expanding its receivables management outsourcing business; maintaining its lead in the development of unique credit and risk scoring products; and developing new products specifically tailored to the Australasian market. DBA currently employs over 500 people in Australia and New Zealand.
