Background to Data Standards

Background

Organisations aiming to implement advanced responsible lending practices are being impeded by constraints within the Privacy Act that limit their ability to share customer information among other lenders. The Privacy Act was developed over twenty years ago and no longer supports a modern practical (electronic) means of providing financial services.

 

Australia is one of three OECD countries to have this type of credit reporting (France and New Zealand are the others).

 

Effective retail credit assessment should be comprehensive and consider all key elements of the potential borrower’s financial position. The Privacy Act, however, restricts the breadth of information available to lending organisations from credit reporting agencies in order to assess an application for credit. The information is essentially limited as follows:

  • Enquiry records for those applications where a credit report was requested as part of the assessment of applications for credit made by the customer in the last five years.
  • At the discretion of the lending institution, a default listing - whether the customer has defaulted on a debt obligation
  • Certain public record data such as a court judgement, bankrupt filing or a voluntary debt agreement.

As a result of these restrictions, retail lenders are heavily reliant on information provided by customers to make a credit decision as there is not practical means of verifying that the information is either complete or accurate.

Information about how an account has been conducted (other than being in default) is not available. Current credit limits, balances, and history of payment behaviour (have payments been made been on time) is not available.

 

Enquiry records do not state whether the credit was actually granted so it is not possible to identify whether a consumer is simply shopping around to get the best deal or attempting to amass credit they will be unable to pay back. The suggestion of lenders contacting other institutions where customers had enquired about credit is not practical and would add significant cost to the provision of credit.

 

Imprecise knowledge of a borrower’s likelihood of repaying results in two symmetrical problems: low-risk borrowers are mistaken as high-risk borrowers, and high-risk borrowers are mistaken as low risk borrowers. Consequently, low-risk borrowers face high interest rates that act as subsidies for high-risk borrowers while high-risk borrowers receive subsidies for and are thereby drawn into the market. Average prices go up to reflect the disproportionate presence of high-risk borrowers on delinquency rates and in response, lenders ration loans. That is, given two individuals with identical risk profiles and preferences, one will receive a loan and another will not.

 

Presenting accurate information about potential borrowers to a lender allows:

  • Interest rates to be fine-tuned to reflect the risk of the individual borrowers, such as lower interest rates for lower-risk borrowers
  • Lower average interest rates
  • Greater lending through reduced rationing
  • Lower rates of delinquency and default for given economic conditions

The lending industry needs a better means of assessing credit and mainstream lenders have put forward detailed proposals as to how enhancements to credit reporting improves lending decisions. But credit reporting reform alone is not the answer - we need to holistically review regulation that deals with use of information for credit decisions and lending practices.

 

ARCA has provided submissions to the ALRC and Productivity Commissioner about proposed new data standards and is working to provide an industry template for uniform reporting within the existing regulatory framework.