Defined Terms and Documents       

Key finding from major financial reviews/investigations in different countries

Comprehensive credit reporting

Currently the Australian system can be gamed. In a system where credit reports can not include data on the existence of credit facilities but only negative data such as defaults, consumers who are struggling with their debt level can acquire more finance in order to meet current credit commitments. As long as the consumer meets their minimum required payment they can easily access further credit, adding to their existing burden.

This absence of defaults on a credit report combined with an incomplete picture from an application increases the likelihood that a lender will approve a credit request. This information asymmetry allows a borrower to achieve short term relief to their credit problems but over the long term simply adds to their already problematic debt levels. This problem was also identified in the United Kingdom by a Treasury Select Committee inquiry into credit card charges and marketing in 2005 which included an examination of credit reporting. That committee found that:

• Lenders may be unable to assess accurately a consumer's ability to take on additional debt. A consumer making the minimum repayment across a number of different credit cards may be struggling with debt but may be seen to have a good credit record.

The committee also found that:

• lenders need to share full information regarding credit card accounts and to assess ability to repay using full credit data and an examination of consumer's full credit commitments in relation to income.

And the Chairman of that committee was reported as saying,

• Sharing more data will stop people being allowed too much credit and will prevent unmanageable levels of debt from building up.

The data shows then that comprehensive reporting increases sustainable lending and reduces default rates, ensuring a more efficient and effective credit market for both lenders and borrowers.

It is also important however to recognise the benefit these gains provide to the broader economy. An ACIL-Tasman study conducted for MasterCard examined this issue. That report found that a shift to comprehensive reporting in Australia would result in a:

• One-off increase in capital productivity of 0.1%, which would translate into economic benefits to the Australian economy of up to $5.3 billion, in net present value terms, over the next decade.

Once the benefits of comprehensive reporting are recognised, the question becomes what level of comprehensive reporting is desirable? Asking this reflects the fact that the level of benefit derived from comprehensive reporting is linked to the level of comprehensive reporting allowed. On this issue there is much debate. That debate is built around three strands of thinking.

• The first strand is opposed to any form of comprehensive reporting and believes that no further data should be allowed on credit reports.

• The second strand believes that Australia should move to a full-file positive reporting model like that in the United States.

• The third strand is the Dun & Bradstreet view that the first step should be the development of a model that finds a balance between the two extremes of the negative only and full-file positive models.

However it is worth noting that there has been considerable movement on this issue since the debate was placed back on the political agenda in 2004. While a number of lenders continue to believe the introduction of the United States model would be the most desirable, Australia's major lenders and credit providers which form the Australian Retail Credit Association have come to a general agreement on a moderate model which balances the two extremes. Each party can speak for themselves but from Dun & Bradstreet's perspective the reasons for the moderate approach are clear.

Firstly it is worth understanding what the D&B model looks like. In addition to the negative data currently allowed in Australia we have argued for four additional data elements. They are:

• whether a credit application has been approved and if so what type of credit
• the lender
• date opened, and
• credit limit.

We believe this minimal additional data provides some critical elements that allow a lender to acquire a better understanding of a borrowers' financial position and their capacity to meet new credit commitments. While not ideal, D&B believes that demonstrating the benefits that can arise from even this minimal additional data will be critical to the success of any future reform. Quite simply, given the level of opposition in some quarters to any reform and the controversy that accompanies reform of the Privacy Act in general, we believe that an attempt to move to a full-file positive model would not be successful.

Furthermore such an approach would deny us the opportunity to take a small but significant step in such an important debate. It is also worth noting that this has been the approach of many other countries. It took the United States three decades to produce the system it has today. And it is a system constantly under attack by those opposed to reform.

Other countries like the United Kingdom and Japan have also opted for reform on an ongoing basis rather than an immediate shift from negative-only to full-file positive reporting. However it is also important to understand that our more moderate model is not just about what is possible. There are very real benefits that can be derived from an intermediate model.

In Japan a more comprehensive reporting system, similar to the proposed D&B model for Australia has reduced the probability of delinquencies exceeding sixty days by 34.1% for the mean loan. The value of more comprehensive data in Japan increases as the loan amount increases. The Japan model reduces the probability of delinquency by 41.3% for the mean large loan.

Recently Staten refreshed his research at the request of the Australian Finance Conference to include an analysis of the impact of an intermediate model in addition to negative-only and full-file positive. The research showed that while a full-file model had the greatest impact on reducing default rates, an intermediate model brings significant improvement. With a target approval rate of sixty per cent the default rate under a negative-only model is 3.35%. Under an intermediate model the default rate is 2.46% and under the full-file model it is 1.9%. This research is important in illustrating to those sceptical of the moderate approach that there is a real benefit, particularly when examined through the prism of responsible lending.

So if the Australian Law Reform Commission does recommend reform of Australia's credit reporting laws and the Federal Government implements those changes, how does the industry prepare for change?

First lenders must use the data. It seems an obvious point but the reality is that there are a number of lenders who currently are not availing themselves of the data available under current laws, while others are availing themselves of only a limited amount of this data. This includes the need to consider alternative data, particularly as the credit cycle turns. Alternative data is data provided by utilities and telecommunication companies in addition to the traditional data provided by the banking and finance industry.

Alternative data is highly predictive of future defaults. In particular, it draws clear links between those that default on low value and non-bank debt and their eventual default on high value bank debt such as home mortgages.

For lenders to receive the full benefit of a comprehensive reporting system, even a moderate one, lenders must make use of the available data. And for lenders to have credibility in their push for more data they must demonstrate that they are maximising the potential of what is already available.

Second lenders must maximise their data sharing. The issue of data sharing is as important as the issue of the type of data that is contained in credit reports. The three generations of credit reporting were referred to earlier.

Australia currently resides in the first generation of credit reporting and the proposed reforms will allow Australia to progress to the second generation. However reaching the third generation, which brings the greatest uplift, does not require further legislative reform. Rather it requires broader participation from lenders in the credit reporting system. It is a reflection of the fact that data sharing brings benefits to lenders and borrowers in addition to the type and amount of data shared.

Once again we turn to approval and default rates to demonstrate the point. Research from Dr Michael Turner of the Information Policy Institute, one of the world's leading experts on credit reporting, demonstrates the benefit that comes from increased data sharing. His research shows that the greater the level of comprehensive data sharing with a credit bureau, the lower the default rates.

 
Data sharing and default rates

Where there is full-file positive reporting and one hundred per cent of lenders sharing data with a bureau produces a default rate of approximately seven per cent for a target approval rate of sixty per cent. The default rate jumps to nearly nine per cent when only seventy-five per cent of lenders are sharing data; and to approximately 10.5% when only twenty-five per cent of lenders share data. The gap between default rates grows the more selective lenders become with their approval targets. The point is also demonstrated when examining the issue from the perspective of improved access for consumers.

In an emerging economy where minority groups have poor access to mainstream credit, the introduction of comprehensive data and lenders' willingness to share this data with credit bureaus provides greater access to mainstream credit for women and the young. When one hundred per cent of lenders share comprehensive data, males and females have very similar access to credit. However when the amount of lenders sharing data drops to twenty-five per cent there is a significant gap between men and women, in men's favour, when seeking access to credit.

The same is true when examining access by age. Access to credit for young people becomes most difficult when lenders have comprehensive data but do not share it with each other. Older people with more established reputation collateral suffer the least when lenders fail to share data.

So data sharing is as critical as the type and amount of data. It is an important point because just as there are lenders in Australia that want comprehensive reporting but aren't making use of already available data, there are lenders that are not maximising benefits for themselves and borrowers by sharing data. Third lenders must realise the full potential of any reform.

A number of organisations have argued that the benefit of an intermediate reporting model is not sufficient to entice lenders to upgrade their systems to report and receive this new data. This has been held out as an attempt to convince regulators to go for the full-file positive model on the basis that anything less would effectively result in no change. It is a spurious and dangerous line of argument. As we have already seen there are very real benefits to be derived from an intermediate model. But more importantly any future decision on a move to a full-file positive system by government will be largely based on whether lenders have sought to maximise the responsible lending benefits available from the first round of reform. A failure by the industry to do so because we didn't get all of what we wanted when we wanted it will ensure that the opportunity to turn this reform into the first of many will be lost.

A modern economy cannot grow without access to affordable and sustainable credit. It is vital to our long term future and our ability to ride out external shocks. Critical to credit growth being affordable and sustainable are risk management and assessment processes. Credit reporting is at the heart of this equation and reform that provides innovation and competition is critical to an effective system. With the Australian Law Reform Commission due to hand its report to government in just a couple of months we have a unique opportunity to underpin the future growth of the industry and the broader economy.

Report to the Congress on the Profitability of Credit Card Operations of Depository Institutions

Card issuers also closely monitor payment behavior, charge volume and account profitability and adjust credit limits accordingly both to allow increased borrowing capacity as warranted and to limit credit risk.

Aside from questions about the profitability of credit card operations, credit card pricing and how it has changed in recent years has been a focus of public attention and is consequently reviewed in this Report. Analysis of the trends in credit card pricing here focuses on credit card interest rates because they are the most important component of the pricing of credit card services. Credit card pricing, however, involves other elements, including annual fees, fees for cash advances and balance transfers, rebates, minimum finance charges, over-the-limit fees, and late payment charges.17 In addition, the length of the "interest-free" grace period, if any, can have an important influence on the amount of interest consumers pay when they use credit cards to generate revolving credit.

Consumer Credit Reform and Behavioural Economics: Regulating Australia’s Credit Card Industry 

This note explores the recent reforms enacted under the National Consumer Credit Protection Amendment (Home Loans and Credit Cards) Act 2011 (‘Amendment Act’) and Regulations. The note links the reforms to behavioural economics by identifying how the reforms address two key consumer biases – optimism and imperfect self‐control. The note examines how the reforms seek to alter the behaviour of consumers vulnerable to Financial Hardship as an alternative to uniform or ‘blanket’ disclosure.

Increased blanket disclosure, which involves providing standardised, non‐customer‐specific information about the risks and benefits of financial products, is the predominant response to customer protection and the predatory sale of financial products by lenders. Vulnerable consumers often display low levels of financial literacy (which may undermine the utility of blanket disclosure for these consumers), and the increased vulnerability to financial hardship increases the need for regulatory intervention.13

National Credit Reform: Enhancing Confidence and Fairness in Australia’s Credit Law

Financial System Enquiry  -  Final Report - March 1997