SBP proposes addressing information asymmetries to improve credit
Amid weak regulations and poor credit reporting systems, formal credit to the private sector in Pakistan has declined both in absolute and relative terms over the past few decades, says a State Bank of Pakistan report, ‘Private Credit Bureaus: Enhancing Credit Penetration by Addressing Information Asymmetries’.
Based on the private sector credit to GDP ratio, Pakistan slipped to the bottom of the World Bank’s developing and emerging economies Index (2019) that comprises 19 countries, down three notches from its position a decade ago. The central bank study revealed this in a special section as part of The State of Pakistan’s Economy third quarterly report for the fiscal year 2021.
The authors argue that Pakistan has introduced reforms and regulations to increase access to finance, which helped banks improve their profitability, but market failure in the form of information asymmetries was the reason why commercial banks were averse to lending to the underserved segments, such as housing, agriculture, and SMEs. Because of the weak credit reporting system, lenders (banks) find it difficult to distinguish between good and bad borrowers. The government’s increasing debt requirement, on the other hand, added to the problem. To put this in context, consider the following statistics: SME financing in Pakistan declined from just under 20% in 2005 to less than 5% in 2020, while the overall net budgetary borrowing in the same period rose from under 10% of the GDP to a third of it.
Citing the major reason for low credit penetration in Pakistan, the authors say information asymmetries or lack of quality data sharing in credit markets prevents efficient allocation of finance and restricts overall credit penetration in the economy. “This is particularly disadvantageous to low-income individuals and micro, small, and medium enterprises who lack sufficient collateral or credit history,” they add.
To address this challenge and develop a credit reporting system in the country, Pakistan introduced the Credit Bureau Act 2015 because there was enough evidence from advance and emerging markets to show how effective functioning of private credit bureaus resulted in a noticeable increase in credit offtake in those countries. Following that regulation, Pakistan also issued licenses to two private credit bureaus, which collect information and prepare credit reports for individuals, SMEs, and businesses that can be used by banks for efficient lending.
However, the country’s credit reporting system continues to face operational, legal, and policy level challenges that are preventing credit bureaus to adequately address the challenge of information asymmetries, the authors say. The current law makes it mandatory for banks to be a member of at least one credit bureau, which is not helping. Of the 32 banks reporting data to the credit bureaus, 20 are members of both while 11 are members of one credit bureau. As a result, neither bureau has a full coverage of credit institutions thus the problem of information asymmetry continues to persist in the country. Besides, the current scope of credit bureaus is limited to individuals and sole proprietor–corporations and SMEs are not yet covered.
The authors propose that all banks should become members of both the bureaus and then credit institutions (banks) can choose the bureau of their liking to purchase various value-added services. This will mean the bureaus won’t compete on information or data accumulation but fight for market share in the value-added services segment. This could minimise information asymmetries in the credit market. They also propose changes or additions in the existing regulations to allow the bureaus to compete on a full spectrum of loan segments and credit information services.
They also propose streamlining and standardisation of data reporting format and daily updates. Another recommendation is to introduce legal and national policy level reforms to increase availability and use of alternate data to help the unbanked segments that can build credit history and increase their access to finance.
Among other solutions that can help Pakistan achieve potential returns on its credit reporting system is the adoption of digital solutions like mobile wallets, fintech, and e-money companies that have transformed core banking. These companies have resulted in enhanced accumulation and availability of financial data, providing greater potential for credit information.
Pakistan has already taken various steps to improve the credit reporting system, but the existing framework needs to be improved on a par with international best practices to make it more effective, the authors concluded. You can read the full report on private credit bureaus in Pakistan here.