China weighs credit database options
By Sue Anne Tay
WASHINGTON - One of the main reasons for China's perpetual trade surpluses with
other countries is its low level of consumer spending, which reduces the amount
of foreign goods bought by the country's 1.3 billion people. This phenomenon
has many causes, some of which, such as the remarkably high savings propensity
of Chinese citizens, are not likely to change soon.
But other barriers to consumer spending are changing, and chief among these is
the availability of consumer credit. For the first
time in China's history, credit for such purchases as houses, major appliances
and cars is now widely available.
This change, which promises to revolutionize Chinese spending habits, is
largely due to the recent introduction of missing pieces of financial
infrastructure: chief among them, a nationwide personal-credit information
database, which became operational in January. However, the specific form of
the credit reporting system, which will affect the way a consumer-credit
culture develops, has not been entirely resolved.
China's credit information database is operated by the new National Consumer
Credit Bureau (NCCB), which instantly became the world's largest
consumer-credit bureau upon opening. The database currently contains personal
identity information for 340 million people, but is still far from
comprehensive.
The government is acutely aware of the importance of a full-fledged credit
reporting system. Not only does such a system make credit more accessible to
Chinese citizens, it can help to mitigate financial risk and stabilize a
financial system that is undergoing rapid reform. More than 100 countries have
credit-reporting systems, in which public credit registries and private credit
firms play varying roles depending on the market-orientation of the industry.
In setting up the NCCB, Chinese regulators have looked at varying international
models that will guide the development of China's credit-reporting system.
The importance of a credit reporting system
The immense potential of China's consumer-loans market is a key driver for a
credit database. Starting from nearly zero in 1995 and growing to an
approximate US$240 billion by the end of 2004, Chinese consumer demand has been
strongly and steadily increasing.
Mortgage lending made up 80% of all loans to households in 2001, a fact largely
attributed to the 1998 urban housing system reforms, followed by auto loans
(6.2%) and other loans for such things as education and travel. It is no
surprise that investors have been trying to enter the lucrative mortgage and
auto-financing business. Domestic and foreign banks will issue an estimated 50
million credit cards in China within the next five years.
The small-medium enterprise (SMEs) business-lending market remains woefully
untapped - SMEs contribute to 60% of gross domestic product (GDP) but account
for only 16% of loan portfolios of Chinese banks in 2005. This disparity has
been attributed to the paucity of credit information, and often asymmetric
possession of information, between borrowers and lenders. To address this, a
credit information databank targeting enterprises has also launched operation
on a trial basis and plans to start full operation mid-year.
The formation of the NCCB
Several years ago, under an edict from the State Council, the People's Bank of
China (PBoC) began organizing commercial banks to build a nationwide personal
information database.
Participating in the NCCB are four state-owned banks, 12 shareholding banks,
115 city commercial banks, 56 urban cooperatives and 67 rural cooperatives.
Plans are under way to include foreign banks this year, which makes good sense
as they will be allowed to enter the consumer finance sector on an even playing
field by the end of this year in accordance to World Trade Organization (WTO)
stipulations.
Currently, the NCCB allows both positive (credit exposure in good or normal
conditions) and negative (late payments and defaults) consumer-credit
information-sharing - a right step toward greater transparency. The database
keeps basic information and transaction records of checking and bill-payment
accounts. According to a Goldman Sachs report, the PBoC plans to negotiate with
other ministries to include information related to social-security programs,
housing provident funds, taxation, education, court rulings and utility-bill
payments. With an estimated 13% consumption growth for 2006 alone, this
information should help lenders better assess the profile of the consumer-loan
market and adjust services to better serve their customers.
Analyzing credit reporting system models
A basic credit-reporting system is made up of a public credit registry and/or
private credit-reporting firms that function within the necessary legal and
regulatory framework for credit reporting and privacy. Many countries have
public credit registries, normally operated by a central bank or bank
supervisor. Alternatively, some have chosen not to operate a public credit
registry but rather leave credit reporting services to private firms.
When comparing the utility of public and private credit registries, it is often
believed that a public credit registry can better protect the privacy of
consumer/firm data from private firms that sometimes cross legal boundaries. On
the other hand, private credit registries have proved more effective in
collecting a broader spectrum of information and providing more comprehensive
services for customers.
In preparation to develop China's credit-reporting system, the PBoC and the
NCCB consulted relevant experts from the World Bank, the International
Financial Corp and international private credit-reporting firms such as
Equifax, TransUnion and Italy's Banca d'Italia. Understandably, because there
is no perfect model, given China's unique circumstances such as its immature
banking system and massive population and geography, regulators have had to
evaluate the strengths and tradeoffs of each system.
Credit reporting in the United States is almost exclusively handled by private
reporting firms. It is dominated by the "three bureaus" - Equifax, TransUnion
and Experian - while Dun & Bradstreet captures the small-business
credit-reporting market. These firms purchase and unify data collected from
independent reporting bureaus and then make this extensive credit information
available inexpensively to all individuals and business entities. Creditors are
regulated by the 1990 Equal Credit Opportunity Act, whereas consumer-credit
borrowers are protected by the 1997 Fair Credit Reporting Act.
The US model is considered one of the most sophisticated credit-reporting
systems, but not necessarily one that the Chinese would adopt. Aside from the
obvious absence of the sophisticated legislation and dispute-resolution
mechanisms necessary to support such a system, Chinese firms have yet to
achieve the expertise of their US counterparts in this area.
Ideologically, too, the dominance of private credit-reporting firms in the US
model conflicts with Beijing's need to retain majority control over its
financial system; even the most advanced reforms unfolding in the Chinese
banking sector have yet to result in any significant foreign majority
ownership. This means that even if China were to encourage private
credit-reporting firms to capture the market, it remains uncertain whether
foreign players such as Equifax or TransUnion would be allowed much prominence.
Without an initial framework to support the growth of private credit bureaus,
Beijing is not ready to relegate the industry to market forces at such an early
stage.
On the opposite end of the spectrum is the French model, in which the public
credit registry, Service Central des Risques, is the single compiler and
disseminator of all data received from reporting institutions. Banque de France
supervises separate registries for enterprises and individuals that abide by
the same regulations that prevent data and ratings compiled by the central bank
to be published or communicated to third parties. The emphasis on privacy and
non-discrimination is particularly significant in Europe, which recalls the use
of business and personal data by the Nazi regime during World War II to seek
out and persecute Jews, not just in Germany but in occupied France and the
Netherlands.
However, experts have pointed out that this restricted use of data has economic
tradeoffs. By limiting access to borrower information, lenders are less able to
tailor services distinctively to the consumer-lending market. Nonetheless, the
French government has remained firm on its strict policy of data protection.
Chinese regulators are unlikely to restrict the use of data that would inhibit
economic growth, given that China's credit culture has not blossomed to its
fullest potential and the government does not face similar privacy pressures.
More important, PBoC officials have not completely discarded the notion of an
active private sector within the credit-reporting system. There are inherent
worries about a single overbearing public credit registry that will perpetuate
price monopolization of product services and management malaise as the central
database grows.
The Italian model, on the other hand, reflects the integration of the private
and public sectors while retaining a significant measure of government control.
Italy's credit-reporting system, considered one of the most complete and
accurate registries in Europe, requires all commercial banks and other
financial institutions under the supervision of the Banca d'Italia and branches
of foreign banks operating in Italy to participate. Information on large loans
valued above a certain amount is reported to the public credit registry,
Centrale dei Rischi, while data on smaller loans are left to private
credit-reporting firms and later sent to the public registry. The Centrale dei
Rischi also disseminates compiled data, at no cost, to credit institutions.
Given the Chinese government's preference for government control over the
financial sector, this model would allow room to maneuver while permitting
increased entry of private credit bureaus to improve the efficiency of the
overall credit-reporting system. Chinese regulators expect strict regulation
over the commercial use of the information contained in the public credit
registry - a significant control mechanism. Also, the Chinese are aware that
"private credit reform" is not a substitute for a public credit registry, but
rather plays a complementary role within the system. Hence the government would
be open to a mixed model that accommodates both public credit registries and
private reporting firms. The challenge lies in striking the right balance.
Institutional obstacles and considerations
As China continues to expand its public credit registry, it needs to address
several institutional issues.
A key objective is to strengthen the corporate and individual bankruptcy
framework. Industry experts are calling for the speeding up of legislation to
provide a complete legal basis for the industry. A reform of China's bankruptcy
law was debated for 10 years and only passed recently. Yet judges and relevant
legal and banking professionals still have to be trained to understand and
execute the law.
The central government is aware that credit systems and corresponding
legislation are currently developed independently by different governmental
departments and local governments.
Shanghai and Shenzhen have enacted some of
the necessary regulations after establishing local credit-reporting systems,
but these are seen to be local, incomplete and regulated in a rudimentary
fashion. Developing national frameworks while integrating the various
municipalities into the system is a key priority that will prove challenging.
Currently, no data-protection laws exist to protect consumer-credit borrowers
and regulate creditors. Although privacy clauses can be found in China's
constitution, banking laws and Supreme Court decisions and interpretations,
there has not been any significant decision specifying whether the Civil Law
protects personal data as a matter of privacy. More comprehensive privacy- and
data-protection laws are needed, beyond specific articles in banking laws that
state the confidentiality of individual deposits and savings information. To
address this, a section of the China Civil Code that would specify the right of
privacy with respect to credit is being drafted. This project was first
discussed in 2002 but remains incomplete.
Another problem is determining the authority that will manage the public credit
registry. The State Council had previously engaged agencies including the
Ministry of Commerce, Ministry of Public Security and State Development and
Reform Commission when drawing up plans for a credit system - many of whom have
now expressed interest in becoming the supervisory authority.
Even though the PBoC has emerged as the main regulator of the credit-reporting
bureau, Beijing is unsure whether it is the right agency to handle the
administratively strenuous tasks and the many responsibilities, one of which
includes ensuring banks share information willingly and accurately - a
challenge given the intransigence of some banks. Tasks include widely educating
consumers about available credit and the rating systems, as well as counseling
citizens to avoid over-indebtedness. These tasks are currently undertaken by
only a few non-governmental organizations, which is inadequate.
Data quality also needs to be improved. Foreign and domestic banks that have
started compiling their own consumer-credit database have not found any
historical database of statistics on bankruptcies, defaulted loans and
household debt-service (ratio of debt payments to household income) burdens
that can give an accurate profile of past lending activities and behavior. They
have also found the quality of data to be compromised by poor corporate
governance, insufficient disclosure standards and faulty accounting standards.
China has to improve its credit-reporting system, and many investors are
counting on its success. The general asymmetry of information between borrowers
and lenders is the underlying cause of many of the bad loans in China.
Information sharing promotes transparency, which is much needed in China's
banking system. Not only does an effective credit-reporting system improve risk
management and increase efficiency by reducing the time and costs of processing
loan requests, profitability is boosted by more accurate pricing and targeting.
The competition will force domestic banks to compete more effectively against
foreign banks and will contribute to an overall increase in lending.
For borrowers, background and financial information strengthens borrower
discipline and reduces moral hazard. Adding to the physical and traditional
collateral available to borrowers, "reputation collateral" can be secured with
good credit. The most significant advantage is making financing available to
people who normally would not have access to loans.
Access to small-business loans provides resources for aspiring entrepreneurs
and allow for greater geographical mobility. The public benefits of this
financial policy act in favor of President Hu Jintao's and Premier Wen Jiabao's
attempts to close the widening urban-rural poverty gap.
In conclusion, the debate over the future of China's credit-reporting system is
about access versus stability. The government has embraced the idea of having a
complementary vibrant private sector working with the public credit registry
and is fulfilling its role as an enabler by developing the legal and regulatory
frameworks.
Although the recent establishment of the National Consumer Credit Bureau is a
reminder of China's growing financial sophistication, the government still has
many challenges to overcome as it plots the direction of its credit-reporting
system. If it does succeed, it will be a boost to financial inclusiveness in a
country with a vast number of potential borrowers waiting in the wings.
Sue Anne Tay is a researcher with Hills Stern & Morley LLP, focusing on
Chinese politics, finance and economics. All views expressed above are those of
the author and do not represent the views of the firm.She can be reached atsatay@hillsandstern.com.
