Credit bureaus and reputation collateral

Recently, there has been an increasing number of reports on the high level of consumer spending in the UAE, the correspondingly rising levels of debt and the inflationary impact this is having on the national economy.

While some have called for restrictions on access to credit as a remedy, that is hardly a cure-all.

Most people here live on a budget, and may sometimes need credit to meet their obligations. Dramatically limiting access to credit would therefore have a negative impact on individuals - and would do harm to businesses and the economy as a whole. In fact a rise in an economy's credit level is a sign of a healthy economy.

According to the Journal of Economic Literature, a 33 per cent increase in private sector lending results in a one per cent growth in the gross domestic product (GDP).

Today, it is common practice here to extend credit simply based on current salary. This is far from the best, or most accurate, way to gauge creditworthiness. Here is where credit bureaus can come into play.

They empower public- and private-sector institutions, to determine the future financial behaviour of customers based on vital information about past performance, which will strengthen their overall financial decision-making process.

Credit bureaus collect, collate and disseminate credit-related information from various traditional sources such as financial institutions, government departments, businesses and consumers, as well as non-traditional sources such as utility providers.

They provide important, impartial and strictly confidential data, that plays a key role in facilitating opportunities for new business, employment and insurance.

Credit bureaus, however, help not only lenders, but also benefit borrowers and the economy as a whole. They provide information that depicts a borrower's credit history, protects creditors from risk exposure, prevents application fraud, shields consumers from financial mismanagement, and increases profit-making opportunities for lenders as well as borrowers. Further, they reduce the cost and turnaround time of lending decisions.

In many ways, today's credit bureaus simply institutionalise a process that has existed since time immemorial, or at least since the invention of credit.

Long before the start of our current information age - back when data were far more difficult to collect, collate and disseminate - individuals and businesses nevertheless offered goods and services without immediate payment.

Relying only on good faith, shopkeepers, for instance, provided trusted customers with a bottle of milk, a stick of butter and a pound of flour in exchange for the promise to make good later on the debt incurred.

This informal system proved most effective with well-known customers, who lived nearby and who had demonstrated a past history of repaying their debts in full and in a timely manner. Informal communities of businesses shared information about those who repaid their debts and those who didn't.

But, for obvious reasons, few businesses would extend credit to customers they didn't know.

Special incentive

In this simpler age, word-of-mouth was everything. In smaller communities especially, where just about everyone knew just about everyone else, there was a special incentive to honour one's debts: if you didn't, your neighbour would find out, sooner rather than later, leaving an indelible stain on your personal reputation.

Today, in our globalised world, credit bureaus rely on this age-old premise. Individuals and businesses still care deeply about their image, and, as borrowers, seek to protect their reputation by meeting their obligations in a timely manner.

Credit reports, which include both positive and negative information, help build what is referred to as "reputation collateral" - a form of collateral that can be used against a credit facility, just as a pledge of physical collateral (like a house, a car or a piece of property) can improve access to credit.

Credit bureaus serve as storehouses of such information, which they disseminate to organisations that are then better able to assess the creditworthiness of potential and existing clients.

The flow of information is, of course, two-way: this system relies on both the outflow of data to businesses, and the inflow of data from them. It is a virtuous cycle, which leads to improved financial performance, stronger risk management and greater access to credit.

Yesterday, one could only extend with confidence credit to a small, personally trusted circle of acquaintances. Today, thanks to credit bureaus, no one is a stranger - and, as a result, access to credit has never been more widespread.

For individuals who seek to realise their dreams, like for businesses that target future growth, the ability to build "reputation collateral" has therefore dramatically increased their options and eased access to sources of funding.

By expanding upon the work that is currently underway here, we will soon be able to extend this same promise to everyone in this nation.

The writer is chief business officer at Emcredit.