Private credit registries are an increasingly common way for banks to share information about borrowers – and a helpful tool for reducing losses on unprofitable borrowers. But new research by Professors Jan Bouckaert and Hans Degryse, published in the July 2006 Economic Journal, shows that they also reduce competition between banks and raise the cost of credit for good borrowers who have suffered bad luck.
Banks disclose information about their borrowers” repayment history to reduce entry into their market niche. This disclosure of information is very often looked at as a solution to prevent bad borrowers from making markets function properly. But as this study shows, that is not the only story.
A recent World Bank survey points out that in 70 countries, credit information exchange between lenders takes place. Exchange of information happens in all major Western countries, and has been introduced in many countries that recently experienced financial liberalisation. This observation illustrates the growing importance of borrower information exchange between banks.
Credit information exchange between banks often occurs through public and private credit bureaux. Public credit registries are mainly organised around the central bank. Private registries in contrast are initiated voluntarily.
While access to data in public registries is often limited on the grounds of reciprocity, this does not apply to private credit registries. More than 50% of the private credit registries do not require lenders or others to provide data to get access. The World Bank survey indicates that the voluntary release of credit information is an important empirical observation.
An important reason why incumbent banks voluntarily disclose their borrowers” repayment history is to reduce the extent of entry by new competitors. In the absence of information on repayment histories, new competitors will make loan offers whenever the average borrower shows good investment opportunities.
Disclosure of repayment histories invites entry into the segment of successful borrowers only. But it prevents entry into the segment of good borrowers with bad luck whose repayment histories are pooled with unprofitable borrowers.
As a result the incumbent enjoys monopoly rents on these good borrowers with bad luck, increasing its overall profits.
While information disclosure is helpful to the banking industry to reduce the losses on unprofitable borrowers, it also dampens banking competition by locking in good borrowers with bad luck.
‘Entry and Strategic Information Display in Credit Markets” by Jan Bouckaert and Hans Degryse is published in the July 2006 issue of the Economic Journal.
University of Antwerp