Credit Reporting for Full Financial Inclusion · 3! ! Roadmap to Financial Inclusion Credit Reporting September 2013 I.!Introduction!!...

Credit Reporting for Full Financial Inclusion

Financial Inclusion 2020 Credit Reporting Working Group

September 2013

CreditReporting

FinancialCapability

ClientProtection

Addressing Customer Needs

Technology- Enabled Business Models

2 www.financialinclusion2020.org

Roadmap to Financial Inclusion Credit Reporting September 2013

About the FI2020 Roadmap Working Groups What will it take to achieve a state of full financial inclusion? In 2011, the Center for Financial Inclusion asked this question in a global survey, and over 300 practitioners gave their perspectives on the key opportunities and obstacles to financial inclusion. Based on the responses, the Center identified five priority focus areas that are key to achieving financial inclusion, which have been used as the basis for a broad consultative process toward a Roadmap to Full Financial Inclusion. Over the course of 2012 and 2013, this process engaged dozens of experts and industry participants in developing an action-‐oriented blueprint for reaching new and underserved markets. The five focus areas are:

• Addressing Customer Needs, chaired by the Consultative Group to Assist the Poor (CGAP), focuses on deepening our understanding of client needs and translating that knowledge into practice while expanding the range of financial services available to underserved markets.

• Technology, chaired by Visa, analyzes the potential of new technology-‐intensive channels to reach new customers, lower operating costs, increase security and diversify financial products available to low-‐income clients.

• Financial Capability, chaired by Citi, focuses on empowering clients to know their rights as consumers, and have the skills, attitudes, aspirations, and confidence to exercise those rights.

• Client Protection, chaired by the Smart Campaign, outlines steps to deepen the implementation of client protection measures for the benefit of consumers and stability of markets.

• Credit Reporting, chaired by the International Finance Corporation (IFC), promotes extending credit reporting systems in order to expand access for new clients while managing risk for financial institutions.

Each of the five working groups has crafted a roadmap that asks: What is the vision for this topic? What stands in the way of achieving the vision and where are the greatest opportunities? What are the enabling actions and corresponding actors who can advance the vision?

The Main Idea While experts agree on the principles of effective credit reporting, challenges to establishing credit reporting systems arise from the need to bring regulators, financial services providers and credit reporting providers together around a business model that works for all.

Effective credit reporting for BOP customers requires seamless data from the smaller financial institutions those customer tend to use – often requiring regulatory change. Smaller institutions may need assistance to prepare their internal systems to work with credit reporting.

New approaches are springing up that use alternative sources, such as mobile phone data and bill payment records, to overcome the “thin files” of new and low-income customers.

Client data privacy must be respected, with rules that give clients some control, such as access to their records, a way to correct errors, and some say over third party use.



I. Introduction Effective credit reporting systems enable financial institutions to learn about the past behavior of prospective clients1 efficiently and from reliable sources. When that information includes people who are relatively new to formal financial services, financial institutions are enabled to provide them a deeper array of product offerings or even to serve them for the first time. In this way, credit reporting systems can contribute significantly to financial inclusion. The availability of credit reporting information affects not only the provision of credit, but also the ability to offer bank accounts, insurance and other products. Credit reporting has important benefits for financial stability. By providing information on clients’ financial behavior and outstanding debt, credit reporting systems help financial institutions lend to clients who can sustainably use credit. At a large scale, this is essential for preventing over-‐indebtedness crises, such as those that have recently affected the financial sectors of a number of countries. Experts agree broadly on the principles of effective credit reporting systems. In 2011, a task force assembled by the World Bank Group published the “General Principles for Credit Reporting,” which articulated a consensus set of standards for effective credit reporting systems. These principles provide good practice guidance to new or developing credit reporting systems and underpin this roadmap. Despite the potential of credit reporting to contribute to greater inclusion, the development of effective credit reporting systems that work for people at the base of the economic pyramid has remained a challenge. Many actors, including legislators, regulators, financial institutions, credit reporting companies and more must come together around common solutions. The business models must work for both the providers of information and the users, while protecting clients’ rights. In many countries, credit reporting is not yet a reality for prospective base of the pyramid clients, but if the principles are consistently applied, this could change dramatically by 2020.

1 While we recognize that shades of meaning exist, within this document the terms client, customer and consumer are used inter-‐changeably.



The General Principles

The General Principles aim at the following public policy objectives for credit reporting systems: Credit reporting systems should effectively support the sound and fair extension of credit in an economy as the foundation for robust and competitive credit markets. To this end, credit reporting systems should be safe and efficient, and fully supportive of data subject and consumer rights. Data General Principle 1: Credit reporting systems should have relevant, accurate, timely and sufficient data—including positive—collected on a systematic basis from all reliable, appropriate and available sources, and should retain this information for a sufficient amount of time. Data Processing: Security and Efficiency General Principle 2: Credit reporting systems should have rigorous standards of security and reliability, and be efficient. Governance and Risk Management General Principle 3: The governance arrangements of credit reporting service providers and data providers should ensure accountability, transparency and effectiveness in managing the risks associated with the business and fair access to the information by users. Legal and Regulatory Environment General Principle 4: The overall legal and regulatory framework for credit reporting should be clear, predictable, non-‐discriminatory, proportionate and supportive of data subject and consumer rights. The legal and regulatory framework should include effective judicial or extrajudicial dispute resolution mechanisms. Cross-‐Border Data Flows General Principle 5: Cross-‐border credit data transfers should be facilitated, where appropriate, provided that adequate requirements are in place.



II. A Vision for Credit Reporting At the Client Level

While clients rarely interact with a credit reporting system, in a state of full financial inclusion it is almost certain that those who pay promptly will benefit from the services of such a system. Clients will be able to use their economic histories as testimonials to their creditworthiness and suitability as users of financial services. This information will include not only prior interactions with formal financial institutions but also interactions with entities such as utility companies, landlords, telephone companies and others. Clients will be incentivized to behave responsibly, knowing that defaults and delinquency will affect their continuing access to services. They will understand how information about them translates into a credit score, how they can improve their creditworthiness, and how they can confirm that information about them is accurate. Clients will be uniquely identified, and will carry their financial histories with them wherever they go, including across borders, giving them freedom to choose among providers. This paper envisions an ideal state in which these benefits are enjoyed by all people who are interested in using financial services, including segments that are currently unreached or discriminated against.

At the Provider Level

Financial services providers will value credit reporting services as an essential part of their risk management processes. They will benefit from being able to price their services with risk taken into account. Financial institutions will provide accurate and timely information to credit reporting systems, capturing both positive and negative information about client behavior, without incurring excessive costs. Each financial services provider will have clear and efficient internal processes for processing information from credit bureaus, resolving errors and handling disputes, and submitting data to credit reporting systems.

At the Market Level

The core of the vision advocated by the working group is for every country in the world to have implemented the “General Principles for Credit Reporting” to a substantial degree by 2020. In the ideal state, there will be consensus among the financial services industry and regulators that credit reporting is a critical component of the infrastructure of the financial sector. In order to support a credit reporting system, that infrastructure must facilitate the collection, protection and disclosure of information. Credit reporting systems will cover everyone who could use financial services and consents to their data being shared, particularly low-‐income populations, and they will cover all types of financial institutions, from fully regulated to semi-‐formal. Non-‐financial services providers, such as telecoms and utility companies will also see the value in sharing information and will participate in credit reporting systems.



III. Current Status and Issues Credit reporting around the world has grown significantly over the last several decades. The World Bank and International Finance Corporation (IFC) joint report, “Doing Business 2013,” states that approximately 146 countries around the world have either a credit bureau or a credit registry. The number of credit bureaus around the world between 1990 and 2011 is estimated to have tripled, with much of this growth happening in Central and East Asia, the Caribbean and in Europe. Despite this growth, credit reporting remains underdeveloped in many countries, and a relatively small number of countries have effective coverage at the base of the pyramid. Many markets are evolving from a past in which credit reporting may have been limited to commercial banks, offered by only one service provider, with data only on loan defaults of blacklisted clients, updated infrequently and unusable across borders. If credit reporting is to be useful enough to contribute to financial inclusion, each of these limitations must be overcome. The Consultative Group to Assist the Poor (CGAP) and IFC’s “Credit Reporting at the Base of the Pyramid: Key Issues and Success Factors” provides a deeper look at these issues. The General Principles lay out the conditions that enable an effective system, starting with data quality. Only if data covers positive as well as negative behavior, comes from relevant sources, and is current and accurate will it be valuable enough for providers to actively participate in credit reporting systems. Achieving this level of data quality in turn requires secure and efficient processing and governance that allows all parties to put confidence in the system. Confidence in the system is supported by a clear and predictable legal environment that balances the collection and sharing of data with consumer rights and where ultimately consumers would transport their credit histories when they migrate across borders. Client information must first and foremost be protected, requiring that necessary legislation curtail the potential exploitation or misuse of client information by actors with profit-‐seeking interests. Effective credit reporting systems must also be viable businesses. A market is required in which credit reporting services sell their reports to financial institutions, who contribute their customer data as a condition for receiving reports. Credit bureaus are financially viable only if a sufficient number of financial services providers are willing to both contribute their data and pay for reports. Financial institutions will only use and pay if the reports enhance their ability to attract customers and manage risk. At the base of the pyramid, where loans and accounts are small, these challenges are heightened. Because of the multiple interests involved, the process of establishing a well-‐functioning credit reporting system requires sustained coordination among different types of actors. Governments, because of their responsibility for consumer rights and financial sector stability, are generally called on to lead these coordination processes. This has often stretched the capabilities of regulators and policymakers. Governments can benefit from model regulations, new legislation and policy assistance. From understanding the complexities of setting up a sound credit reporting system, to promoting competition among providers, to the challenges in overseeing this system, capacity building for policymakers and regulators is a clear need. The World Bank and the IFC have taken leadership as multinational donors to support this work.



New credit reporting technology will not work unless you build capacity and educate people on how to use it. The credit report might be there, but the user has to look at it and have the systems and know-how to use this information effectively.

–Tony Lythgoe, Principal Financial Specialist & Head, Financial Infrastructure, IFC

In considering how to create credit reporting systems that contribute to financial inclusion, the working group highlights three important challenges that are particularly salient for lower income customers: coverage of “thin file” customers, building the business case for base of the pyramid providers, and protecting customer rights. Inclusion of People with “Thin Files” Traditionally, credit reporting was limited to commercial banks or in some cases other regulated financial institutions. Effective credit reporting for financial inclusion requires participation from all financial services providers, both regulated and unregulated. In many countries, policy change must take place to enable credit bureaus to include providers at the base of the pyramid other than banks, such as microfinance NGOs, finance companies and credit unions. Such change may require working across regulatory agencies that oversee such institutions, and, as discussed below, another challenge is to ensure that smaller financial services providers are willing and able to participate. Opening credit reporting to the full range of financial services providers will enable coverage of many lower income customers. However, what about the financially excluded or customers who have never received a loan from a formal financial institution? Much of the financial activity of the poor takes place in the informal sector where transactions are unrecorded and cannot be used to build the individual’s financial history. The poor are left with “thin files” and reputational collateral that is not sufficiently documented or accessible to establish credit worthiness. A prerequisite to covering new customers is the ability to establish unique identity. Credit reporting systems use a variety of information to establish identity, but in the absence of widely used national ID cards, financially excluded people often lack the other forms of identification needed to link behavioral data to the correct individual. There is ongoing debate about the extent to which the implementation of national identification systems can alleviate this problem, as one identifier may be insufficient for effectively establishing financial identity. The next challenge is to obtain relevant data on clients new to financial services. Very promising developments are now occurring in the use of alternative data from sources other than financial institutions based on activity low income people already engage in. These sources include phone usage and payments, utility payments, rental information, remittance data, behavioral data, and even social media to demonstrate reputational collateral. Successful models that incorporate non-‐traditional data could dramatically change the credit reporting landscape. Today, a number of start-‐up companies work with alternative data to build new models for assessing credit worthiness. New data analytic techniques extract useful information from newly abundant sources. One of many examples is Cignifi, which operates in Brazil and Mexico. Cignifi uses complex data analytics of mobile phone behavior and payments to create an assessment of credit worthiness (for financial services providers), predict churn behavior (for telecommunication companies), and provide



First Access— to Base of the Pyramid

First Access is a social enterprise that facilitates access to financial services and other products designed for consumers at the base of the pyramid, through its patent-pending technology. They process and understand new types of consumer data using a wide range of alternative data sources, including mobile phones, in order to bring people with thin files into the system. First Access launched in Tanzania, with plans to expand to other countries in East Africa.

insights on optimal product offerings. Although the Cignifi model is new, it demonstrates the potential for business solutions based on data sharing and analysis. While much of this type of innovation is taking place in start-‐up companies, many of the established credit bureaus are also exploring the space. Regulatory restrictions and market forces may currently stand in the way of such alternative credit reporting. Rules may prevent credit bureaus from obtaining such information, and revisions may require cooperation of multiple regulatory agencies (for example, telecommunication company regulators). Moreover, alternative data providers, such as telecoms companies, may not wish to voluntarily share their data in a desire to maintain a competitive market position, and they will either need to be paid or to receive some benefit from use of the credit reporting services. Accordingly, if the opportunities presented by alternative data are to be realized, market-‐building is required so that alternative data providers have a business case for participating in data sharing and the legal and regulatory environment allows for it. Creating Incentives for Base-‐of-‐the-‐Pyramid Financial Institutions The potential benefits of credit reporting for base of the pyramid financial services providers are clear. Replacing existing resource-‐intensive methods for assessing credit-‐worthiness with the use of a credit score can automate much or all of the loan-‐approval process, cut costs, and, it is hoped, allow the institution to provide clients with faster access to credit. But getting to those benefits is not so easy. Providers serving base of the pyramid customers have usually developed without benefit of credit bureaus, so when credit bureaus become available they may need both encouragement and assistance to use them. For example, the microfinance industry developed its own credit assessment methods, such as group lending or high-‐touch interaction between loan officers and borrowers. Many microfinance institutions prefer not to share information to prevent competitors from accessing their clients. Providers may also fear that the use of a credit reporting system will lead some existing borrowers to be disqualified. As credit reporting becomes more necessary due to heightened competition, microfinance institutions have greater incentives to use credit reporting. Even so, the use of credit reporting by a microfinance institution requires substantial change to traditional operations and will require documenting individual credit behavior within group lending. If credit scores are an add-‐on to existing credit-‐assessment methodologies, the process can feel unnecessary and costly. Moreover, for credit reporting services to be useful, they would need to align with the services these providers offer, like group lending and very short-‐term loans. If the data in a credit bureau is only updated once every several months, it may not be useful to microfinance institutions. Consequentially, credit bureaus should update information as frequently as possible with real-‐time updates as the goal.



Overcoming the gap between credit reporting services and base of the pyramid providers requires both to make changes. The credit reporting industry will need to make adjustments, for example through standardizing definitions (e.g., the difference between micro and SME loans) and data-‐collection formats (e.g., point at which a loan becomes past due). Base of the pyramid service providers may also have to change their operations. They will need new or updated systems to enable them to exchange information with the credit bureau. Specialized staff needs to be hired and trained in using these systems and communicating data properly. They must comply with quality standards, because submitting poor-‐quality data can have important consequences for consumers and providers. Depending on how it plans to use credit reports, a provider may need to change lending methodologies and other operations. Building this capacity requires human and financial resources. Smaller financial institutions may often find it difficult to raise the funds needed to build their institutional capacity. Donors and support organizations have an opportunity to support this process, with the rationale that expanding credit reporting will increase financial access to marginalized populations. In addition, the running costs associated with using credit reporting services cause some smaller financial services providers to question the sustainability of participating in credit reporting system (although there are sometimes misconceptions about the scale of such costs). These include routine subscription and inquiry fees, as well as data dispute resolution costs. Only when providers are convinced of the value for their money will they use credit bureau services at the volume credit bureaus need to be financially viable. Protecting Consumer Data Data privacy rights are important for financial consumers, whether rich or poor. As the credit reporting landscape changes, regulators charged with upholding these rights must respond to the new opportunities with rules that preserve those rights without stifling the development of credit reporting systems. Governments may need to amend rules governing who owns and who can use data in order to open the way for alternative data to be sourced and analyzed. Today, alternative data start-‐ups and pilots are paying attention to national policy and regulation on usage of data when deciding where to try new models. The General Principle on customer rights states that customers should be allowed to give or deny their consent for use of data, assured of access to data collected on them and offered a path to correct errors in the data. In order for privacy rights to be protected, customers must be informed about how credit reporting affects them. Their rights and responsibilities as consumers of financial services need to be transparent and easy to understand. Given that credit reporting at the base of the pyramid is just emerging in most markets, initiatives by policymakers, non-‐profits, financial services providers, and the credit reporting industry are needed to educate and empower customers about credit reporting.



The working group recommendations are straightforward, in part because of the work already done in developing the General Principles on Credit Reporting. They follow directly from the preceding discussion. Effective client protection measures must be considered for all of these recommendations, as is further discussed in the roadmap on Client Protection.

1. Implement Credit Reporting in Line with the General Principles on Credit Reporting in Every Country (or Regionally)

by 2020 Policymakers and central bankers should use the General Principles on Credit Reporting to implement or improve credit reporting systems. In countries with lagging credit reporting systems, regulators and government officials should focus on applying best practices for addressing the complexity, time and extensive collaboration required by a range of actors for establishing effective credit reporting. Action Point: Conduct independent assessments to identify how the local credit reporting market can be improved.

Action Point: Track progress using the metrics established by the World Bank’s Task Force on Credit Reporting.

Action Point: Enlarge comprehensive credit-‐reporting coverage to include BASE OF THE PYRAMID providers and their customers. To broaden credit history coverage for BASE OF THE PYRAMID customers, governments should incentivize or require all financial services providers, including unregulated institutions, to report to all credit registry, credit bureau, or an alternative credit-‐information sharing systems. To do so, they should create an environment across both regulated and unregulated institutions that allows for the credit reporting ecosystem to develop.

IV. Recommendations

ProvidersRegulators



2. Enable Alternative Data to Be Collected and Shared to Build the Financial Histories of Borrowers with Thin Files

Policymakers and providers from different sectors (financial institutions, telecommunications companies, utility companies, etc.) should collaborate whenever possible and appropriate to enable sharing of alternative data. Credit reporting service providers should work to identify and serve the data analytics needs of alternative data providers.

3. Build the Technical Capacity of Microfinance Institutions and Other Small or Rural Providers at the Base of the Pyramid to

Incorporate Credit Reporting into their Operations For financial institutions to use credit reporting services, they need adequate MIS systems and underwriting processes that smoothly incorporate data from credit reporting systems. These system changes are often costly and time consuming, and are an important deterrent to credit bureau use.

Action Point: Establish a US $50 million global fund that provides repayable grants to deploy specialists that help equip small financial institutions to interface smoothly with credit reporting and integrate reporting into operating processes.

Action Point: Implement customized credit reporting services for group loans, and small /frequent loans that are especially designed for low-‐income households. These services would be designed around the lending methodologies and borrower realities found at the base of the pyramid (e.g. mixed personal and business accounting). Action Point: Work with core banking providers which cater to microfinance institutions to ensure their systems can export/import data to credit bureaus.

Providers

ProvidersRegulators

SupportOrganizations

Capacity- Building Agenda



This working paper was created through a series of consultations with an experts’ working group on Credit Reporting. We wish to express our gratitude to the Credit Reporting Working Group members for their active participation in group discussions and thoughtful contributions.

We also thank the many additional experts who reviewed drafts of the paper and provided input. Finally, we wish to thank the many CFI and Accion staff members who provided support including Allison Bernstein, Merene Botsio, Elizabeth Davidson, Anita Gardeva, Sonja Kelly, and Amanda Lotz.

The Center for Financial Inclusion accepts responsibility for the views expressed in this paper. Those views do not necessarily reflect the views of individual working group members or their organizations. Experts Working Group on Credit Reporting

Tony Lythgoe, IFC (Chair) Anita Gardeva, Center for Financial Inclusion (Facilitator) Cecilia Bouras, Western Union Cornelio Pimentel, Consultant, Brazil

Joachim Bartels, BIIA Michael Turner, PERC Neil Munroe, ACCIS Syed Mohsin Ahmed, Pakistan Microfinance Network

This publication was produced by Financial Inclusion 2020:

1101 15th Street NW, Suite 400, Washington, DC 20005 USA Tel 202.393.5113 Fax 202.393.5115 www.centerforfinancialinclusion.org

Credit Reporting for Full Financial Inclusion · 3! ! Roadmap to Financial Inclusion Credit Reporting September 2013 I.!Introduction!!...

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