public credit

The Future of Lending

Guest Post Magazine

The credit landscape of the country is at the cusp of a massive overhaul. A mega collection of credit (loan) data could be underway. The scale of this exercise feels unreal, yet necessary, but how?

                                                  

“The Public Credit Registry will transform how loans are given,” said Dr. Viral Acharya Former RBI Deputy Governor. In 2018, the Reserve Bank of India set up a High-Level Taskforce to formulate the functioning of PCR which is now in its final stage of implementation. Public Credit Register (PCR), as the name suggests, is a virtual register where all information about a person taking money on credit (loan) will be stored.  A Single Source of Truth for the entire banking industry. But why is such mass-scale centralization of borrowers’ data being taken up? 

 

Some common questions arise when a person asks out for a loan such as: 

  • Why does he need the loan, and for how long? (condition)
  • How much of his own money has he put in the business? (capital)
  • What can he keep in Submission (collateral) against the loan?
  • Does he already have any loans from anyone? And, has he repaid all of it on time? (character)
  • Can he repay the loan amount? Or will it be too big for him? (capacity)

 

Many people don’t even resort to asking these questions which are the key pillars of credit. But, banks make lending decisions based on these 5Cs of lending. However, one problem still remains in this process. The banks have to resort to   “judgment” based decisions.  They have to rely on the word of the borrower. 

Currently, Banks collect the information about a borrower through detailed Loan Application Forms and try to keep digital records of the same. As there are many banks as well as borrowers,  there is a need to store this information with a central authority in a common database, so that different banks can access this information, if necessary. 

 

The Role of private repositories of information

In the existing system, middle-men, like Credit Information Companies or Private Credit Bureaus (PCBs) collect a borrower’s information, the loan application filled out by the borrower, and present it to the banks. These private repositories collect credit-related information from banks all across the country, analyze it, and assign credit ratings to every borrower and then make it available to banks who use it to make credit decisions. 

 

There are currently 4 PCBs in India following this process. However, there are three major problems with the existing system of credit data collection. 

 

  • The existing structure is highly fragmented as there are various entities that are collecting and storing significant credit information. Thus, there is no single source of credible information for the banks to get a complete picture of the borrower.
  • The data collected by private repositories covers only 63.1% of the adult population in India (~543 million individuals and 23 million firms).
  • The major focus is on large and registered borrowers because of the availability of more reliable data than of small and unregistered borrowers like Micro, Small, and Medium Enterprises [MSMEs], sole proprietorships, etc.

As a result, there is a huge dependency on self-disclosures of information by borrowers, which is unreliable and incomplete.

 

Until a bank is sure about every deed of the borrower, they remain skeptical about the borrower and uncertain to give the loan. In case the borrowers are aware that lenders don’t have complete, authentic information about them, they may choose to take undue advantage and default on repayments. This is known as a “moral hazard”. Due to this information gap, lenders assume every borrower at average risk and their automatic response is to increase the rate of interest. Looking broadly at it from a good and bad borrower’s perspective. The person who has good intentions is overcharged and the bad one is undercharged. This phenomenon where the lender cannot distinguish between a good and bad borrower is called ‘Adverse selection. Therefore, Because of inadequate information, the loans are not provided to the right people at the ‘right rate’ at the ‘right time’. The credit market fails. This problem becomes more acute in the case of small borrowers Because there is a lack of authentic data relating to MSMEs in the existing credit information infrastructure. They either don’t get loans or get them at a higher rate or with delays in disbursements.

 

Small businesses in loss

There is also another problem – small businesses want small, frequent loans, while it is more cost-effective for a bank to give big, long-term loans with less paperwork, lesser to and fro, lesser hassle.  All of this starves the MSMEs and other unregistered borrowers from access to formal sources of credit. The demand for money for business leads them to the informal credit market. where the interest rates go as high as 40% per annum. MSMEs are the backbone of our economy. MSMEs contribute around 29.7% of GDP and 49.66% of Indian exports. They create employment for about 11.1 crore people, which (in terms of volume) stands second only to the agricultural sector. Despite holding such an important place in our economy, only 16% of MSMEs in India receive formal credit leaving 84% of these companies under-financed or financed through informal sources. The World Bank estimates the current credit gap for MSMEs in India to be at $380 billion. In the past, quite a few reforms have been taken to uplift the MSMEs. Nothing has proved to help them much.

 

This is where the Public Credit Register (PCR) comes into the picture. PCR as envisaged by RBI aims to solve all the problems that currently exist. It will act as the common database for all credit information. It will eventually cover all borrowers seeking loans from formal sources such as Banks, Non-Banks, and Cooperatives irrespective of the threshold or the size of the loans. It aims to give a 360-degree view of the borrower’s profile.  Everything that can be important for lenders in judging the creditworthiness of the borrower will be there in that register. Every little “business purchase”  made, will be tracked. Every penny unpaid or delayed will be scrutinized and recorded. This will be credit surveillance of a different kind – hitherto unheard of. As proposed by the committee, there will be 100+ fields in the report whose information about every borrower will need to be submitted by banks. PCR will be a win-win situation for all – borrowers, lenders, and the economy 

 

PCR benefitting the borrowers 

With PCR having alternate credit data such as GST, Income Tax, Utility Bill payments, etc., the small and unregistered borrowers/MSMEs who still have no access to formal credit and don’t have any prior recorded credit history will be able to come within the ambit of the formal credit market. PCR, with its awesome features, will reduce the gap of asymmetric information to a great extent and make the credit market more efficient. With the verified information available on a single platform, disbursement of loans would no longer take delays. Also, small borrowers who face difficulties in getting a small ticket size loan would easily get it with the reduction in bank’s time and cost in credit analysis for servicing each loan.

 

Default by the borrower would be logged in the PCR database immediately. This will act as an early warning sign for banks to prevent their money from fraud as well as to be more cautious while sanctioning further loans. Also, this will in turn bring more discipline within borrowers. PCR, as the single point of mandatory reporting of credit information, would also reduce the multiple reporting burden on the credit institutions like banks (especially for small-sized credit institutions) as well as ensure quality data is available. PCR will be integrated with various existing platforms like- GSTN Platform, Credit Information Bureau, Ministry of Corporate Affairs, Income Tax for PAN / TAN database, Judicial database, etc. This will ensure that Banks have access to verified and authentic data from all public databases of people on a single platform. As the PCR will record events on a real-time basis, continuous monitoring of loans given would be possible.

 

The economic benefit

PCR will give a complete picture of sectoral allocations of all the credit in the country. This will give a view to policymakers and will be helpful in making better economic policies in the country. PCR will truly transform the way loans will be given in the future. There are already some prominent innovations happening in the sector. Fund flow/cash-flow-based lending – With access to credit as well as non-credit information, banks are shifting from Balance Sheet based (assets and liabilities) risk assessment to Cash Flow based risk assessment. Besides physical collateral, a new collateral may emerge – “Reputation Collateral”. Meaning, rather than giving your properties paper, land, and other assets on collateral, where reputation built in the past by making duly payments/repayments of loans can be used for taking new loans. In the near future, PCR can also be leveraged by mechanisms like Open Credit Enablement Network (OCEN), which will help borrowers in availing instant short-term loans (within 5 minutes). 

 

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