Introduction to Credit-Reporting Systems
Credit or consumer reporting firms and other types of public credit information registries provide rapid access to accurate and reliable standardized information on credit history and financial condition of potential borrowers, be they individuals or firms, and help to support a well-functioning credit market. Credit reporting addresses a fundamental problem of credit markets: asymmetric information between borrowers and lenders, which
leads to adverse selection and moral hazard. Credit information sharing allows lenders to more accurately evaluate risk and to avoid adverse selection. Similarly, credit-reporting mechanisms strengthen incentives for borrowers to repay and thus reduce moral hazard because late or nonpayment with one institution can result in sanctions from many others. Credit reporting expands access to finance, especially for lower income consumers, micro-enterprises, or small businesses. Credit reporting can also play a key role in improving the efficiency of financial institutions by reducing loan processing costs, as well as the time required to process loan applications.
Some empirical work has been done to provide evidence of the importance of credit registries in credit markets. For example, Jappelli and Pagano (2001) analyze the effect of credit registries—both private and public—and find a positive effect on the volume of bank lending (as a percentage of GDP) and a decrease in credit risk. Barron and Staten (2003) show that greater availability of information reduces default rates and improves access to credit. Kallberg and Udell (2003) demonstrate that data from Dun and Bradstreet Corporation, a private credit information firm, have greater predictive power in calculating probability of default than a firm’s financial statements. Galindo and Miller (2001) argue that firms in countries with better credit information are less credit constrained because they rely less on internal funds. Overall, theoretical and empirical analyses show that banks’ sharing of information on borrowers helps to curtail the effects of adverse selection and moral hazard, reduces credit risk, improves access to credit markets, and strengthens the stability of the banking system.