Benefits of more comprehensive credit reporting

55.48 The ALRC has examined views on the advantages and disadvantages of more comprehensive credit reporting over the current credit reporting system, and on the economic and social impact of introducing a system of more comprehensive credit reporting in Australia.^[62] In doing so, the ALRC consulted extensively with credit providers, credit reporting agencies, and consumer and privacy advocates; and received advice from a Credit Reporting Advisory Sub-committee.^[63]

55.49 There are a number of possible benefits that may result from introducing comprehensive credit reporting. Some of the possible benefits are discussed below, with reference to views expressed in submissions.

Improved risk assessment

55.50 The starting point for many of the asserted benefits of more comprehensive credit reporting derive from the claim that it would improve the accuracy of credit risk assessment. The benefits said to flow from improved credit assessment include lower rates of over-indebtedness and default, greater competition in the credit market and less expensive credit. For example, it is said that the introduction of comprehensive credit reporting would increase the ability of credit providers to ‘distinguish better between good and bad borrowers’ and, in turn, reduce the rate of default and ‘increase the volume of credit that can be provided to good borrowers’.^[64]

55.51 Submissions from credit providers were virtually unanimous in suggesting that more comprehensive credit reporting has the potential to enhance credit risk assessment significantly.^[65]

There is a general consensus amongst credit and risk professionals that the sharing of more information should lead to better decisions. When coupled with good regulatory protections for consumers the outcome is a robust and well balanced credit market.^[66]

55.52 GE Money Australia stated that:

Our experience in a number of international markets is that comprehensive or ‘positive’ credit bureau data adds significantly to our ability to accurately assess an applicant’s credit risk. This improved capability enables us to more accurately assess risk, which can in turn reduce credit losses (including fraud losses), a cost that is ultimately borne by consumers.^[67]

55.53 Stakeholders contrasted the predictive value of the information currently available to that available under more comprehensive credit reporting systems and submitted that inadequate data sharing under existing arrangements leads to problems of adverse selection and moral hazard.^[68]

Credit providers are currently only able to rely on information supplied by application, together with negative information provided in a credit report. If an applicant fails to disclose facilities they hold with other financial institutions, the credit provider is unable to make a fully informed lending decision resulting in the possibility of provision of credit to borrowers who are unable to meet their financial obligations.^[69]

55.54 In contrast, through the application of more comprehensive information a lender is able to ‘detect those individuals comprising the pool of high risk potential debtors’.^[70]

When overall levels of the borrower’s obligations are provided as part of the ‘positive data’ then less reliance is needed on the incomplete data provided in negative only data environments. Lenders can then use the full picture of a consumers’ indebtedness and their previous payment history to make a much more informed assessment of risk and hence a more responsible lending decision.^[71]

55.55 In this context, industry stakeholders presented a range of findings concerning the relative value of various possible data items in predicting lending risk. These findings are discussed later in this chapter.

Promoting competition and efficiency

55.56 Comprehensive credit reporting is also said to promote competition in credit markets. Among other things, more competition may mean that credit is more readily available, at lower cost, and in more forms than would otherwise be the case.

55.57 A 2004 report commissioned by MasterCard (the MasterCard/ACIL Tasman Report) stated that, for example, following increases in the types of personal data collected and used in credit reporting in the US in the 1980s and 1990s, there was ‘a wave of new entrants into the bank credit card market’. This led to ‘downward pressure on interest rates and fees for bank credit cards’ and ‘the introduction of differential pricing in bank credit cards … with lower interest rate margins for lower risk borrowers’, and an overall expansion in the credit card market.^[72] In response, it may be observed that many of these developments also occurred in countries where there were no similar changes to credit reporting—including Australia.

55.58 In the Australian context, Abacus–Australian Mutuals (Abacus) noted that the ability of larger credit providers to use internal databases of ‘positive’ credit data relating to their own customers offers a potential competitive advantage in assessing credit risk. More comprehensive reporting may help create more competitive markets, because consumers are less reliant on existing institutional relationships to obtain credit.^[73]

55.59 Other submissions also referred to the promotion of more competitive credit markets.^[74] For example, Dun and Bradstreet (Australia) Pty Ltd stated that

improved data sharing is critical to the efficient operating of credit markets, resulting in improved products and rates for consumers and more efficient pricing for credit providers.^[75]

55.60 Veda Advantage considered that more comprehensive reporting promotes competition in credit markets ‘by reducing information barriers for small or new credit providers’.^[76]

55.61 Stakeholders noted the possible role of more comprehensive credit reporting in reducing the transaction costs involved in assessing credit applications. For example, Experian Asia Pacific considered that more comprehensive credit reporting could facilitate more automation and ‘faster decisions’ in credit and other financial services transactions.^[77]

55.62 The need for reform of credit reporting to maintain ‘competitive neutrality’ among credit providers was highlighted.^[78] If more comprehensive credit reporting were introduced in Australia, this would also have a significant impact on the credit reporting market. For instance, it is said that this would enhance the capacity for competition between credit reporting agencies.^[79] This should make it easier for relative newcomers in the Australian credit reporting market to increase their market share more rapidly.

55.63 Reference was made to the fact that the existing credit reporting provisions may operate as a barrier to new entrants into the credit reporting market and hinder competition.^[80] The reasons for this view include that it takes a long period of time to develop databases of ‘negative’ events, such as defaults on loans; and complex and prescriptive legislative requirements increase the cost to a new entrant of developing the information technology infrastructure needed to conduct consumer credit reporting. The benefits of competition between credit reporting agencies might include improved data accuracy and a greater range of related services available to individuals and credit providers.^[81]

55.64 Greater competition and efficiency in credit markets may have a range of flow-on benefits for individual consumers, such as lowering the cost of credit, increasing the availability of credit and reducing default rates.

55.65 Some argue that, by ensuring greater accuracy in risk assessment and management for credit providers, comprehensive credit reporting could help reduce the cost of credit for individuals—particularly for those who are a low credit risk.^[82] By allowing credit providers to assess risk more accurately, it would ‘increase their scope to set interest rates to reflect the risk premiums associated with different types of borrowers’.^[83] National Australia Bank, for example, stated:

Applicants who fail to disclose their true financial position create disproportional risks to credit providers which are subsidised by other borrowers. More comprehensive reporting will improve the veracity of credit information, enhance risk-based pricing and result in a fairer distribution of credit.^[84]

55.66 A number of credit providers confirmed that more comprehensive credit reporting has the potential to lead to lower cost credit.^[85] This outcome was attributed to the likely effects of increased competition among credit providers;^[86] reduced credit provider costs associated with the risk assessment process;^[87] and the reduced cost of bad debts.^[88] Another possible effect of more comprehensive reporting may be to increase access to credit, especially among low income earners.^[89]

55.67 Consumer groups expressed concern about possible lending and credit pricing practices that might be facilitated by more comprehensive reporting. The Consumer Credit Legal Centre (NSW) (CCLC) submitted, for example, that the ‘use of credit file information to trigger price variations on existing contracts should be expressly prohibited’ and warned that an enhanced ability on the part of credit providers to price risk ‘should not be accepted as being necessarily in the public interest’.^[90] Galexia Pty Ltd (Galexia) expressed concern about whether more information would lead to a range of undesirable credit marketing practices that are ‘entrenched elements of some jurisdictions where positive credit reporting is allowed’.^[91]

Effects on the credit market and lending practices

55.68 One of the claimed benefits of more comprehensive credit reporting is that it can reduce levels of over-indebtedness and default because credit providers will be in a better position to gauge when credit should be refused. However, some have challenged this proposition.

55.69 In response to the claimed link between the categories of personal information available to credit providers and overall levels of indebtedness, the Victorian Review cited research carried out in 2003 by Nicola Jentzsch and Amparo San José Riestra. This research found that evidence from the European and US markets does not support the argument that there is a relationship between the existence of comprehensive credit reporting and lower levels of indebtedness.^[92]

55.70 The Victorian Review suggested that, if this conclusion is correct, it throws into doubt whether more information in a credit report can assist in managing risk or aid responsible lending.^[93] The Consumers’ Federation of Australia (CFA) also has argued that, rather than comprehensive credit reporting decreasing the number of individuals defaulting on repayments, it is ‘likely to increase the number of consumer credit defaults’.^[94] The CFA maintained that research conducted by US economists Professors John Barron and Michael Staten (the Barron and Staten research), relied on by a number of the advocates of comprehensive credit reporting, is equivocal on this point,^[95] and that comprehensive credit reporting may result in either greater availability of credit (with the current rate of default) or a lower rate of default (with a correspondingly lower availability of credit), but not both.^[96]

55.71 This interpretation was restated in submissions to the Inquiry by consumer groups.^[97] The Consumer Action Law Centre stated that the actual outcome of more comprehensive reporting will depend on whether credit providers choose to reduce default rates or to advance more credit and that the latter outcome is more likely— leading ultimately to more default and bankruptcy.^[98]

55.72 MasterCard submitted that it is a misinterpretation of the Barron and Staten research to suggest that more comprehensive reporting may lead to either a lower default rate or more availability of credit with the same default rate (but not both). MasterCard stated that, while the actual levels of default and credit availability modelled cannot be achieved simultaneously (given the research assumes holding one parameter constant when modelling the impact of change to the other measure), lower default rates and greater availability of credit ‘are not mutually exclusive’ outcomes. Rather, ‘the Australian credit marketplace will find a natural balance’.^[99] Some credit providers conceded that the overall level of indebtedness is likely to rise, even though the overall proportion of bad loans would decline.^[100]

Responsible lending

55.73 Submissions in support of more comprehensive credit reporting also focused on its possible role in reducing default rates and encouraging ‘responsible lending’ practices.^[101] Responsible lending can be defined in different ways and is manifested in different institutional policies and practices.^[102] The basic obligations of responsible lending include that credit providers should lend only what their customers can afford to repay, help to prevent over indebtedness, and market their products and services responsibly.^[103]

55.74 Credit providers also have legal obligations not to provide credit where capacity to repay has not been reasonably established. In particular, under s 70 of the Consumer Credit Code,^[104] a court may reopen an unjust transaction.^[105] In determining whether a transaction is unjust, the court may have regard to, among other things, whether ‘the credit provider knew, or could have ascertained by reasonable inquiry of the debtor at the time, that the debtor could not pay’.^[106]

55.75 At least in theory, a better understanding of a credit applicant’s existing financial obligations should assist credit providers to avoid lending to those who are over-committed and to intervene to manage existing customers who become over-committed. More comprehensive credit reporting is said to place the onus on the credit provider to ensure responsible lending, rather than relying on the borrower to reveal their existing commitments, which applicants often fail to disclose fully.^[107]

55.76 In submissions, consumer groups expressed continued concern about the actual impact on the credit market of more comprehensive reporting—particularly in the absence of a ‘specific legislative requirement upon all credit providers to lend responsibly having regard to all reasonably accessible data’.^[108] Consumer groups are not confident that more comprehensive reporting would automatically result in more responsible lending decisions.

55.77 The CCLC stated that current casework experience ‘suggests that the improvement in responsible lending predicted by the credit reporting agencies will not occur as a consequence of an extended credit reporting system but would have to be specifically imposed by the legislature’.^[109] The Australian Privacy Foundation considered that:

no convincing evidence has been produced to support the claim that more information would be used to lend more responsibly rather than to increase the total amount of lending. In the absence of better regulation of lending practices, (and especially in the current economic environment), the Australian community cannot take the risk that more comprehensive credit reporting would not be used irresponsibly, with the potential for significant harm not only to individuals but also to the overall economy.^[110]

55.78 The Uniform Consumer Credit Code Management Committee (UCCCMC) agreed that it remained unclear what actual impact more comprehensive reporting would have on lending practices. The UCCCMC noted that the Ministerial Council on Consumer Affairs has an ‘in-principle interest’ in tools—such as more comprehensive reporting—that ‘can enhance assessment of capacity to repay as it can, in theory, promote responsible lending’.^[111]

55.79 It was noted in submissions that more comprehensive credit reporting would enhance the ability of credit providers to comply with responsible lending obligations. For example, MasterCard stated that more accurate information on a credit applicant’s capacity to repay would make the Consumer Credit Code a much more effective tool ‘to prohibit over-extension, or impose sanctions on those [who] breach such prohibitions’. MasterCard submitted that consumer groups should, on that basis, lobby for the introduction of compulsory comprehensive credit reporting in Australia ‘in much the same way that their counterparts in the UK are outspoken supporters of positive credit reporting there’.^[112]

55.80 Consumer groups and others were sceptical about claims that more comprehensive reporting would be used to promote responsible lending, at least in the absence of positive legislative obligations.^[113] Legal Aid Queensland submitted:

[T]here is insufficient evidence to predict that this extra information would be used by industry to lend responsibly … Even the industry players … have conceded that the overseas experience does not support either more responsible lending or a decrease in defaults. The only claim is that the percentage of bad loans would fall.^[114]

55.81 The Consumer Action Law Centre, in opposing more comprehensive reporting, stated that while access to additional information in credit reports would improve credit providers’ ability to assess risk, ‘we fear this could be used as much to increase irresponsible and exploitative lending as it would to achieve “responsible lending” objectives’.^[115] Similarly, the Cyberspace Law and Policy Centre stated:

In our view there remains insufficient evidence that any extra information would be used responsibly to the benefit of individuals, and no guarantees that it will not instead be used to increase the total volume of lending, and to target different classes of borrower and loans in ways which would contribute to over-commitment and financial stress.^[116]

55.82 The Australasian Retail Credit Association (ARCA), a peak body of credit providers and credit reporting agencies interested in the operation and reform of the credit reporting system, claimed that more comprehensive credit reporting would increase levels of ‘financial literacy’^[117]—the knowledge necessary for individuals to make informed decisions about the management of their personal finances—which in turn assists credit providers to lend responsibly. Arguably, individuals in jurisdictions that have systems that record ‘positive’ information about credit history are more aware of their ‘credit rating’ and the consequences of late payments or default. Individuals also have more potential to improve their credit record after a default by subsequently establishing a solid repayment history.^[118] In Australia, by comparison, many individuals are not even aware of the credit reporting system unless they have actually been refused credit as a result of information in their credit information file.