Credit bureaus crucial for financial stability

Credit bureaus crucial for financial stability
Published: 12 December 2013
In  a modern economy, economies are usually run on credit with corporates, individual, societies and clubs providing credit to one another. A cycle of credit is thus created in an economy where each economic agent is one way or the other in receipt of credit from another.

Any hiccup within the cycle might end up disturbing the smooth flow of resources among the economic agents.

It is then important that the economic agents understand the centrality of keeping the cycle ongoing without deliberate actions to disturb it.

This is so given that credit is important especially for the industry responsible for producing goods and services.

In Zimbabwean scenario, this cannot be overemphasised.

With the current level of capacity underutilisation, credit either from suppliers or banks helps firm to expand the control of production which means more goods and services, more surplus.

Credit for the producers also serves as a channel for greater profit - well - if they retail product for credit more income will gather.

The important part of it is that the banks are usually at the end of the spectrum through underlying the majority of credit flowing in the economy.

The weaknesses currently inherent in our corporate sector makes banks more reluctant to provide much credit which result in decreases in aggregate demand leading again, to an even worse borrowers' condition.

Whilst from household perspective, inadequate access to credit limits poor people from a fair share of resources in society, depriving them of basic needs and opportunities in life.

Universally, the credit providers are now facing the big challenge of non-repayment of credit.

These credit providers include banks, credit retail shops, telecommunication companies, service providers and other involved in providing credit.

The challenge of non-payment of credit is hence derailing economic progress as the good candidates for credit are being denied credit as the credit providers are not sure of their creditworthiness.

This brings to the fore two important interrelated terms in economics which need to be dealt now rather than later: adverse selection and moral hazard.

Adverse selection: is the problem created by asymmetric information before the transaction occurs.

Adverse selection in financial markets occurs when the potential borrowers, who are the most likely to produce an undesirable (adverse) 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 back.

The problem of moral hazard and adverse selection can be overcome through monitoring the behaviour of borrowers and this can be done through well-established institutions underpinned by strong legislation. These institutions are the credit reference bureaus.

The credit reference bureau should be a 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 Credit Reference Bureau should be established so as to assist banks in determining credit worthiness of their borrowers.

CRBs allows for credit information sharing among the financial institutions and other credit providers.

In this case the lemons in an economy (those who have reputation of failing to honour their obligations) are distinguished from oranges (those with good credit record).

This will resolve the question of how can banks differentiate oranges from lemons or how can we resolve the challenge of moral hazard and adverse selection.

Studies around the world have shown that there are benefits associated with the establishment of credit reference bureau in an economy.

The legislation is important because of the nature of information that is supposed to be held by these institutions.

Given the extent of confidentiality of the information and the associated sensitivities, it is important that the Government through its various arms comes up with legislative framework that will create a win-win scenario for the economy and the various economic agents without prejudice to any one section.

Some of the benefits of creating a credit reference bureau are:
CRB reduces borrowing costs and loan delinquencies to a significant extent;
CRB can enhance effective risk identification/monitoring and credit extension and
CRB can ensure that credit flows to deserving borrowers and reduce to those less deserving ones.
Given that ultimately all credit providers are reliant on banks to some extent, a well-functional credit reference bureau will help in maintaining financial stability in an economy.

Sanderson Abel is an economist. He writes in his capacity as Senior Economist for the Bankers' Association of Zimbabwe. He can be contacted on <> or on 04-744686, 0772463008

- Sanderson Abel I Herald
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