HSE learns whether a bank needs to know as much as possible about a borrower

(ORDO NEWS) — Economists from the HSE have shown that collecting all possible information about borrowers does not always reduce the risks of the banking sector. Sometimes more is not better: increasing the volume of data to a certain extent, on the contrary, increases the risks of loan defaults.

The study is published in the WP BRP HSE University, Series: Financial Economics preprint series . When deciding whether to issue a loan or not and under what conditions, banks try to collect as much information about the client as possible. It is assumed that the more data the analysts or the algorithm have at their disposal, the more accurately they will be able to assess whether the client is able to repay the debt.

The source of such information for the bank is, among other things, a credit history: information about previously taken loans, their amounts and the timeliness of making payments, about the characteristics of the borrower (for example, about his financial statements), and the like. Banks can obtain such data by contacting a credit bureau or credit registry.

However, some studies show that the desire to accumulate as much information about the borrower as possible can have “side effects”. For example, data on loan defaults are drowned in the mass of information and no longer play such an important role in incentivizing the borrower to behave in good faith. Thus, data on non-payment ceases to have a disciplinary effect, and the motivation of people to make payments on time decreases.

How are the credit risks of banks related to the amount of information collected? The answer depends on which effect prevails: credit risks may decrease due to an increase in the accuracy of forecasts regarding defaults, or increase due to a decrease in credit discipline.

The authors of the work analyzed data on the volume of information collected by banks and the level of credit risks in order to understand what the relationship between these parameters looks like. Economists also assessed how this relationship is affected by the quality of the institutional environment in the country and the degree of development of its financial institutions. To do this, they used data on 80 countries for 2004-2015.

To answer these questions, the authors of the article compiled a mathematical model in which the dependent variable was credit risks (the share of overdue loans in the total volume of loans issued) in a particular country and in a particular year, and the independent variable was the index of the depth of disclosure of credit information, as well as a number of control variables .

The credit disclosure depth index is calculated by the World Bank as part of the Doing Business project, its value depends on whether information is collected on both individuals and legal entities, whether it includes only data on non-payments or on timely repaid loans , too, information for which the term is stored in the databases, whether the borrower has access to his credit history, and so on. This index takes the highest values ​​in the USA, Canada, Argentina, Germany, the lowest – in Luxembourg, Afghanistan, Iraq. In Russia, it is close to the maximum.

In addition, economists divided countries into groups depending on the degree of effectiveness of public administration (through the corresponding index of the World Bank), the protection of property rights (the index of the International Property Rights Alliance) and the level of development of the financial system (two metrics of the International Monetary Fund).

Calculations have shown that the relationship between the level of information disclosure and credit risks is indeed non-linear, the graph has the shape of an inverted U: with an increase in the volume of information collected, the risks first increase, but from a certain moment begin to decrease, and at the maximum values ​​of the credit information index, the risks are much less than at the minimum.

In countries with effective governance, risks begin to decrease at lower values ​​of the index (in absolute terms, the risks also turn out to be lower), that is, in a lower-quality institutional environment, the regulator can reduce credit risks only by introducing a system of credit bureaus and extensive requirements for collecting information about the borrower. Similarly, the relationship between disclosure and risk is affected by respect for private property and the level of sophistication of financial institutions.

“Thus, the results of this study suggest that central banks in emerging economies should be cautious about introducing new information exchange requirements in credit markets (for example, expanding the range of borrowers or types of loans reported to credit bureaus).

If such innovations are sporadic and are not accompanied, for example, by increasing the retention period of a credit history, providing online access to credit files, expanding the list of borrower data providers, they may not lead to the desired reduction in credit risks, ”said one of the authors of the work, senior Maria Semyonova , Research Fellow at the Institute of Research Institute and Associate Professor at the School of Finance, Faculty of Economic Sciences, Higher School of Economics .

The study also identified countries where the level of disclosure is the least advantageous in terms of credit risk. These include Malta, Mauritania, Mozambique, East Timor and others. The results suggest that it may be worthwhile for these countries to change their regulation on the sharing of credit information to collect significantly less or much more data than they currently do.

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