implementing a kenyan credit information sharing system: progress and challenges

POLITICAL & ECONOMIC RESEARCH COUNCIL

by Michael Turner, Ph.D. & Robin Varghese, Ph.D.

Nairobi, Kenya – December 9th, 2008

Implementing a Kenyan Credit Information Sharing System: Progress and Challenges

2

Introduction

Information Sharing in Theory & Practice

Legal Notice No. 97

Findings: The State of Implementation

Conclusions: Lessons and Recommendations

Agenda

3

Background:

PERC US-based non-profit, research institute Focus on development International experts on credit reporting, credit access

(retail/commercial) Advised governments in 15 countries

Australia, Brazil, Chile, China, Guatemala, Honduras, Hong Kong, India, Japan, Singapore, South Africa, Sri Lanka, Trinidad & Tobago, United States

Introduction

Assess CRB implementation process Examine business logic of credit information sharing

Provide findings from interviews with banks

Progress to date

Immediate and near-term challenges

Provide findings from interviews with bureaus

Provide recommendations based upon findings

Why are We Here?

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Introduction

Information Sharing in Theory & Practice

Legal Notice No. 97

Findings: The State of Implementation

Conclusions: Lessons and Recommendations

Agenda

Types of Reporting Systems

NEGATIVE ONLY Applications (not approvals) Delinquencies (90+) Defaults Bankruptcies Liens Bad checks Purged 5-10 years

POSITIVE PAYMENT

All negative data All Positive (on-

time) payment data Public record data Account balance Account type Lender Date opened Inquiries Purged 5-7 years

FULL FILE (also includes) Debt ratios (revolving to total

debt) Credit limit Amount paid/balance due Portion of accounts repossessed/

written off Estimated income range Assets Interest rates (unusual) Socio-demographic Obsolete 7-10 years

Benefits of Sharing Credit Information

Consumers Reduced probability of over-extension Greater and fairer access Credit offers reflect credit risk and credit capacity

Lenders Improved loan portfolio performance Reduced provisioning and capital adequacy

requirements (Basel 2) Sustainable & affordable growth into new markets

The Economy Better financial services efficiencies Affordable growth in domestic consumption

The Economy

LendersConsumers

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Lender Benefits from Credit Information Sharing

Furnishers can reduce losses.Furnishers can reduce losses.

0%

3%

6%

9%

12%

15%

0% 15% 30% 45% 60% 75% 90%

Acceptance Rates

Defa

ult

Rate

s

100% Reporting Full File 75% Reporting Full File 50% Reporting Full File

25% Reporting Full File 0% Reporting Full File

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Borrower Benefits from Credit Information Sharing

More information brings excluded into the reporting system and thereby widen credit access.

Increases in acceptances disproportionately enjoyed among traditionally excluded: Ethnic/racial minorities Low-income Women Young

Table 5: Change in the Acceptance Rate with Reporting Regime Change

U.S., with Utility Data

U.S., with Telecom. Data

U.S.Full-File

Colombia Full-File

(without = 1.00) (without = 1.00) (Neg. only = 1.00) (Neg. only = 1.00)

Ethnicity

Asian 1.14 1.08    

Black 1.21 1.11 1.28  

Hispanic 1.22 1.17 1.37  

Other 1.11 1.11    

White 1.08 1.08 1.22  

Age

18-25 1.14 1.11.47 18.31 (c)

26-35 1.06 1.06

36-45 1.05 1.06 1.22 6.48 (d)

46-55 1.06 1.06 1.21 4.54 (e)

56-65 1.06 1.06 1.203.85 (f)

>65 1.14 1.13 1.19

Household Income (000)

<20 1.26 1.22 1.36 (a)  

20-29 1.15 1.14 1.3 (b)  

30-49 1.1 1.08 1.24  

50-99 1.06 1.05 1.21  

>99 1.03 1.03 1.18  

Gender

Female 1.09 1.08   12.39Male 1.08 1.08   5.91

(a) Actual Range is <15,000; (b) Actual Range is 15,000-29,000; (c) Actual Range is 18-32; (d) Actual Range is 32-42, (e) Actual Range is 42-50; (f) Actual Range is > 57.

Economic Benefits from Credit Information Sharing

* p < 0.1** p < 0.05***p < 0.01

Source: IMF International Financial Statistics; World Bank, Doing Business database

VARIABLE Model I Model IV (reduced)

Constant -142.40*** (35.31)

-130.80*** (32.20)

Log of GDP per capita (adjusted for PPP)

20.31*** (4.65)

16.85*** (3.87)

Avg. Change in G DP (1995-2004)

-1.20* (0.70)

Legal Rights of Creditors (from 0 to 10)

4.55** (2.07)

4.80** (1.97)

Credit Information1 (from 0 to 6)

-3.87 (2.88)

Private Full-file Coverage (0 to 100, as percentage of adults)

0.72*** (0.20)

0.67*** (0.16)

Private Negative-only Coverage (0 to 100, as percentage of adults)

-0.02 (0.86)

Public Full-file Coverage (0 to 100, as percentage of adults)

-0.11 (0.41)

Public Negative-only Coverage (0 to 100, as percentage of adults)

0.16 (0.46)

R squared 0.7075 0.6883 F-stat (p value)

16.93 (1.88e-012)

44.9 (1.887e-015)

Residual Standard Error 29.45 29.12 N 65 65

Lesson: what matters?• Wealth• Creditor Rights• Reporting

o Private bureauo full-fileo with widespread participation

For a country, going from no adults to having all (100% of) adults with positives and negatives in a private bureau increases private sector lending by more than 60% of GDP.

(Without the US and UK, which have high private sector lending, the estimated increase is still more than 45% of GDP.)

PERC Estimations Consistent With Harvard/World Bank Study

Study by Harvard and World Bank economists of 129 countries (for years 1999-2003)*

Private bureaus increase lending as a share of GDP by an estimated 20 percentage points

But didn’t take into account effects of participation rate or reporting system (negative only vs. full-file)

*Simeon Djankov Caralee McLiesh Andrei Shleifer, “Private Credit In 129 Countries.” National Bureau Of Economic Research, Working Paper 11078, http://papers.nber.org/papers/w11078.pdf

Established: Financial sector mobilizes savings and allocates

capital for investment and consumption growth.

Some estimates of impact.* If private sector lending increased by 33% of GDP, results for economy: +1.0% annual per capita GDP growth +0.8% annual per capita capital stock growth +0.8% annual productivity growth

Finance is Crucial to Economic Growth

*Derived from findings of Ross Levine, “Financial Development and Economic Growth: Views and Agenda” Journal of Economic Literature, Vol. 25(June 1997), pp. 688–726. Their findings are consistent with those of other studies, see Jose De Gregorio and Pablo Guidotti, “Financial Development and Economic Growth.” World Development, Vol. 23, No. 3, (March 1995) pp. 433-448. Their reported impacts were larger.

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Uses of information: Enables cheap automated application models Behavioral models for monitoring More efficient provisioning Assists with new product development Fraud detection, AML

Wide Uses in Lending

At the core of a rich information sharing system: sound business logic.

At the core of a rich information sharing system: sound business logic.

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Introduction

Information Sharing in Theory

Institutional Framework: Legal Notice No. 97 & Credit Providers Assoc.

Findings: The State of Implementation

Conclusions: Lessons and Recommendations

Agenda

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Given benefits, why hasn’t it emerged without intervention?

Often unmet technical preconditions ICT infrastructure

technical capacity deficiencies high coordination costs (e.g. transmission protocol)

Data practices (e.g. data dictionary)

Competitive Concerns Cream skimming, poaching Less savvy fear relatively more savvy

Institutional framework necessary: For coordination For protection of data subjects: rights of access, redress For rules that prevent unbalanced strategic manipulation by one user against others

Market failure implied

Why Regulations?

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Key Provisions Mandated negative reporting (NPL) to all licensed CRBs

From banks, finance companies and savings and loans No provisions for MFIs and SACCOs

Licensing process for CRBs Technological requirements (security, data integrity) Sound business plans and adequate capitalization

1 February 2009 deadline for reporting of NPL data (all NPL data on books) 1 February 2009 first date to submit CRB license application

Banking (Credit Reference Bureau) Regulations 2008

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Credit Providers Association (KBA members and others) developed additional set of industry codes to promote: Positive information sharing through practices such as reciprocity Diffusion of data reporting standards (formats, frequency, quality) Collection practices (consumer content, notification)

First industry steps are about developing business value of credit information sharing. Industry to be congratulated.

Proposed Constitution and Code of Conduct for CPA

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Introduction

Information Sharing in Theory

Institutional Framework: Legal Notice No. 97 & Credit Providers Assoc.

Findings: The State of Implementation

Conclusions: Lessons and Recommendations

Agenda

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Interviews with banks 1 small: < Ksh 2B in assets; < Ksh 1B in loans and advances 4 medium: Ksh 10B < x < Ksh 20B in assets; Ksh 6B < x < Ksh 17B in loans and advances 1 large: > Ksh 80B in assets; > Ksh 45B in loans and advances Survey: sent to all KBA members

Interviews of at least: Risk managers ICT Managers Credit Managers And often

Legal Other operational manager

Examination of database

State of Implementation: Approach

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Banks interviewed about implementation efforts undertaken to date, including: Technical: Information & Communication Systems

changes to systems; interfaces with core banking systems and bank database

Operational Data extraction and data transfer formats Data collection process from loan application onward Notification--informing consumer/borrowers

Educational Awareness: Informing staff from loan officers to risk managers to IT

Bank Interviews: Topics/Focus

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Banks were also interviewed about:Their attitudes towards a credit reporting system and what they expect from it

Generally supportive--willingness to participate Expect need for continued CBK involvement

Challenges in the implementation process: Technological—shortages of IT, skills, operational guidance on reporting to

bureaus Operational—educational materials, curricula for training, use of data Regulatory—meeting regulations, clarifications, gaps in law and codes Market--competitive concerns

Bank Interviews: Topics/Focus

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Finding 1A: Furnishers Need Clarification

Efforts among some banks have reached impasse.

Banks need technical guidance to push ahead: Final data template (required fields and optional ones)

o Issue of existing/historical NPLs vs.o Accounts going forward (stalled also until final data template defined)

Final data exchange file format(s) Transmission structure

to central point v. to CRBs leased lines v. encrypted protocol over Internet

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Finding 1B: Furnishers Need Clarification

Efforts among some banks have reached impasse.

Banks need guidance on CRBs to push ahead: Guidelines for CRB licensing/re-licensing

o Frequency of security audito Transparency of data security standardso Specification of other data uses, e.g., use of data for model

construction (permissibility requirements)

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Finding 2: Challenges for Banks

IT and SkillsDevelop scripts to extract data

o Some smaller banks need modest IT investmento Some smaller banks need consulting assistanceo Medium and large ones interviewed are ready save for clarification

issues

Customer communications Working on notices; need model notices Public education concerns given potential PR fallout

BUT chiefly, how to meet the deadline for filing? Banks manually completing forms (many will not be complete) CRBs expecting delivery of physical media (DVD-ROMs) on Feb. 1

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Finding: Need for Further Clarification for CRBs

CRBs are preparing for Feb 1…. Apply for license Ready to receive data from creditors

BUT, guidelines needed for CRB (re-)licensing Transparency of data security standards

o What are acceptable standards for data security?o What are acceptable standards for physical security?

What data will be mandated and what will not subsequently? Specification of acceptance of data disclosure requirement: Mail? Web? Specification of reverification procedures

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Immediate Clarification v. Evolving Industry Standards

Some issues must be quickly settled through industry coordination: Reverification procedures Transmission protocols if not specified by regulators

Some issues will be settled by industry coordination but over time: Data dictionary of required fields (CRBs are coordinating to develop) What will have to be mandated, what is voluntary (innovation in system)

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Immediate Clarification Issues for CBK

Some issues must be settled by CBK quickly: Final specification of required fields Data exchange format (singular or accepted list) Transmission structure Elaboration of guidelines on permissible uses of data

oNot immediate for deadlineoBut as positive data comes in

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Perhaps Chief Finding

The implementation process underway is for a regulatory obligation, not for the implementation of a system a sound business logic. Every bank interviewed, with a single exception, discussed credit

information sharing as a compliance issue.

No unprompted discussion of:

o Identifying optimal methods to send/receive data;

o Using data for improving loan portfolio performance;

o Building scoring models

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Explaining the Chief Finding

Banks understand the value of info sharingo Aware of efficiencieso Aware of value of positive datao Aware of benefits of analytic products

But operationally, what is being instituted is compliance procedures for regulatory obligations Implementation of business enabling system is either absent or proceeding slower

o Issues such as sharing data while addressing competitive concerns are part of a system built by business logic

o CPA Codes of Conduct one step towards keeping industry focused on business case for credit information sharing

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At The Same Time…

One cannot let the perfect be the enemy of the good…

31

Introduction

Information Sharing in Theory

Institutional Framework: Legal Notice No. 97 & Credit Providers Assoc.

Findings: The State of Implementation

Conclusions: Lessons and Recommendations

Agenda

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Considerations for Data Format Clarification

For clarification in reporting formats: Final data template of required fields should be specified

quickly, including harbors for missing data (historical)

o Simplified

o Specify that excel form v. data format

Final data exchange file format(s): issues for consideration

o Open standard v. proprietary: i.e., low cost, non-proprietary

o Adequate availability of skills, ease of training

o Extensibility and customizability

o Commonly accepted best practice standards for security and privacy, e.g., PGP

(pretty good privacy)

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Considerations for Transmission Structure Clarifications

For clarification in transmission structure: (Report to central source v. Report to each bureau)Transmission to CBK or CPA site for retransmission to bureau

o Pros: Simplified Less worry about entry and exit of new CRBs

o Cons: Inserts regulators or industry association into a business process Single site = Single critical point of failure

Issue of leased lines v. Interneto Unless existing CBK lines used, leased lines expensiveo Routing to CBK introduces regulator into market/business process

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CRB Licensing & Re-licensing

Need clarification on guidelines for CRB (re-)licensing Frequency of security audit

Transparency of data security standards

Potential solution: use internationally recognized standards,

ISO/IEC, BS, etc.

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Technical Operational Challenges for Bank Compliance

IT and Skills: Banks need to address this

Must allocate necessary resources for data extraction/transmission

Some banks lack wherewithal to develop script

Customer communications

Provide some model notifications

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Certification for CRBs by Int’l Standards

Consider international data security certification standards

Transparent to CRBs and to banks

Clear certification procedures

Change periodically with changes in tech, so are current

Solves problems of need for modifying standards and

compliance re-certification

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CBK Must Avoid Over-Clarification

Some issues must be quickly settled by CBK:

Final specification of required fields

Data exchange format (singular or accepted list)

Transmission structure

But too much clarification by CBK does not effectively

balance regulatory and business systems.

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On Chief Finding

Current implementation process has banks focusing on compliance and not on business processes/opportunities:

Project manager must guide industry through this division and lead

stakeholders to:

o Better understand and act upon system’s business logic

o Foster the creation of industry norms and relationships that make the system

one for growth and efficiency

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Reality Check…

Lenders better off embracing process than just doing minimum necessary to comply.• Focus on efficiency enhancements• Focus on new product developments• Fuller participation (positive information sharing) yields greater benefits

• Sustainable growth in new markets• Improved loan portfolio performance• More efficient provisioning• Fairer lending

To realize these benefits, you--the banking industry--must engage the process and create a system for business and compliance, not just for compliance.

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