Post on 29-Dec-2015
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Assessing Infrastructure for Intermediation: Legal Framework and Credit Information Systems
Thorsten Beck
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Introduction
Infrastructure is set of institutions and rules for functioning of financial system
Legal infrastructure: laws and their enforcement, corporate governance
Informational infrastructure: credit information sharing, accounting and auditing rules and practice
Transactional infrastructure: retail and wholesale payment systems
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Legal framework
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The Importance of the Legal Framework for the Financial System
Financial contracts depend on certainty of legal rights and predictability and speed of their fair and impartial enforcement
Regulation and supervision of financial system requires legal and regulatory framework
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Private Credit and Creditor Rights
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Creditor Rights Index
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Private Credit and contract enforcement0
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Days to Enforce a Contract
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Legal framework - overview
Financial sector legislation Corporate sector framework Collateral and creditor rights Insolvency framework Judicial system
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Legal Framework: Financial Sector Legislation
Central Bank, Bank Supervisory Authority Legislation Independence, objectives, accountability
Banking/financial institutions legislation From cradle to grave, bank secrecy
Payment system legislation and regulation Finality of payment, zero hour rule
Anti-money-laundering (AML), Combating the financing of terrorism (CFT) legislation
Government debt management legislation Capital markets legislation Insurance sector legislation
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Legal Framework: Corporate Sector Framework
Company law Regime for formation, registration and operation of
companies Different types of companies (limited liability, joint
stock, partnerships etc.) Corporate governance
Relationship between stakeholders of companies Directors’ duties Shareholder rights Audit and accounting practices
Laws and regulations Regulatory agencies enforcing legislation and
regulations Business culture and practices
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Legal Framework: Collateral and Creditor Rights
Predictable, transparent and affordable enforcement of unsecured and secured claims outside the insolvency system
Civil Code, laws on insolvency, land, pledge, mortgages, execution
Registers for movable and immovable property, registration procedures
Restrictions on ownership, transfer, pledge Loan documentation Role of Notary Public Court / non-court enforcement procedures
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Legal Framework: Insolvency Framework
Legal framework for corporate insolvency Provide for timely, efficient and impartial
resolution Maximize value of assets and recoveries Efficient liquidation of nonviable and rehabilitation
of viable businesses Equitable treatment of similarly situated creditors Transparent procedure Framework for cross-border insolvencies
Informal out-of-court procedures for work-out Institutional framework
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Legal Framework: Effective Insolvency and Creditor Rights Systems
Principles and Guidelines for Effective Insolvency and Creditor Rights Systems
Developed in 1999/2000 by WB and other organizations and experts
35 principles in four areas: Creditor rights and enforcement systems Corporate insolvency Credit risk management, debt recovery and
informal enterprise workout practices Effective implementation of legal mechanisms
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Legal Framework: Judicial System
Courts are “slow, corrupt, incompetent and expensive”. Judges
Appointment, dismissal, independence, salaries, promotion Infrastructure
Location of courts, buildings, libraries, computerization, budget, administration
Procedures Code of Civil Procedure, filing fees, appeal procedures,
injunctions, case management, allocation of cases, execution of judgments
Court Officials Prosecutors, bailiffs, police, court staff, lawyers, bar
associations, discipline Arbitration, mediation, specialized courts
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Legal framework: Cross-country comparisons
Doing Business database; case study approach: Claim equals twice country’s income per capita, creditor
(plaintiff) is 100% right, judicial process, which ends in favor of creditor:
Number of procedures legally required between the parties Time (days) spent in dispute resolution until payment Cost (fees, duties etc.) of going through the court procedure, relative to
debt value
Transfer of land and building in a peri-urban area of the country’s most populous city, 50 times income per capita.
Number of procedures legally required to register property Time (days) spent in completing procedures Cost (taxes, fees, duties etc.) relative to property, only official costs
Insolvency: time (in days), cost (as percentage of estate) and recovery rate (cents on the dollar)
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Legal framework: Cross-country comparisons
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Mozambique
Zimbabwe
Zambia
Tanzania
Malawi
South Africa
Days to Recover Debt Outside Insolvency
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Mozambique
Zimbabwe
Zambia
Tanzania
Malawi
South Africa
Days to Resolve Insolvency
Source: Doing Business project, http:\\rru.worldbank.org\doingbusiness
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Credit information systems
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The Role of Credit Reporting Systems in Financial Markets
Reduce asymmetric information between borrowers and lenders
Allow lenders to more accurately evaluate risk and avoid adverse selection
Strengthen incentives for borrowers to repay, reducing moral hazard Increase the cost of default Provide an incentive for good borrowers:
Reputation Collateral
Increase competitiveness, reduce segmentation
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Private Credit and Credit Information Sharing
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Credit information systems - overview
Institutions and sources of information
Public vs. private registries Elements of a robust credit registry
system
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Financial Information Infrastructure: Primary Institutions & Sources of Data
Consumer Credit Reporting Firms & Registries Commercial Credit Reporting Firms & Registries Corporate Registries Ratings Firms Microfinance Credit Bureaus Industry Specific Databases (insurance,
property management, utilities, cell phones, agricultural commodities, etc.)
Other Public Data (public databases, Chambers of Commerce / Better Business Bureau, media)
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Information in credit reports
The heart of the credit report is the detailed payment history it providesPositive payment history empowers good
borrowers, creates reputation collateralNegative payment data encourages honoring
obligations
Lender Account No. Date Opened & Credit Limit & Payment
Date Reported Past Due History
B of A XXXX 1-1-2000 $5,000 30 day - 1
6-1-2004 $0
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Public vs. Private Credit Registries
Feature Public Private
Purpose Bank supervision & credit checks for lenders
Credit checks for lenders
Source of information
Supervised institutions (banks)
Varied sources (banks, retailers, telecoms)
Participation mandatory?
Yes No
Positive Info? Yes In some cases
Minimum loan size
In some countries No
Fee for service No charge or minimal charge
Yes
Basis for operations
Government Regulation
Contract
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Advantages and Shortcomings of
Public Credit Registries
Advantages Public credit registries can compel banks to report, especially
important in economies with concentrated financial systems Public credit registries can operate where the legal
environment is inhospitable for private ventures Public credit registries may engender additional confidence,
depending on country experiences Public credit registries provide data for bank supervision
Shortcomings: Data sources and distribution of data are more limited for
private credit registries Public credit registries have fewer resources (staff, funding,
technology) Public credit registries do not offer value-added services such
as credit scoring Public credit registries offer limited consumer attention
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Elements of a Robust Credit Reporting System
Providers and users of credit data Institutional arrangements Quality of the data collected Quality of the data distributed Legal framework for credit reporting Regulatory framework for credit reports Use of credit information for bank
supervision Consumer outreach & education
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Providers and users of credit data
Commercial Banks and other regulated financial institutions (credit card issuers, insurance firms, automobile finance companies, mortgage lenders/guarantors)
Retailers (appliance retailers, other stores) Firms providing business-to-business credit,
trade credit Microfinance institutions Other businesses which provide goods or
services on credit (utilities, cell phone providers, agribusiness, etc.)
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Providers and users of credit data
What is the financial market structure? How concentrated is the banking / financial sector?
What are the main financial sector products? Are banks lending to a broad spectrum of the population? Do
they offer varied products & services? What are the most important non-bank sources of
finance? How are these changing? In the real sectors of the economy, what are the most
important sources of financial services and credit? Are there special industry credit services?
What role does microfinance play?
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Institutional Arrangements for Private Credit Registries
Institutional Type
Pros Cons
Private firm w/ no bank ownership
All types of data, independence
No automatic access to data
Private firm w/ bank ownership
All types of data, Special access to bank data
Independence may be questioned
Bank association Access to bank data, integrity
Only bank data, only bank access
Chamber of Commerce
Retail & non-bank data, broad cover, historical record
No bank data, Limited funds for modernization
Commercial & credit insurance firms
In-depth data on commercial sector
Limited coverage, High cost per entry
Industry-specific databases
In-depth data on single sector
Lmtd. Scope – can’t cross -check data
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Quality of the Data Collected
Collect both positive & negative information Maintain data for a reasonable time frame – 5
years minimum Do not delete negative data when debt is repaid Data should be inaccessible after a certain amount of
time
Credit reports should not include highly sensitive information such as political or religious affiliation, etc….
Other identifying information, such as gender, should be evaluated more carefully
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Quality of the Data Distributed Integrity and transparency are paramount
Special standing of any group, including owners or government, will discourage participation
Open system preferable, reciprocity not necessary
Access to more detailed information preferable Loans described individually, not aggregates Institutions providing credit identified
Restrictions to prevent “cherry-picking” Distribution reflects privacy considerations
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Legal framework for credit reporting
Legal framework should encourage information sharing among lenders Provide legal clarity regarding acceptable
information sharing practices Consideration of privacy issues important
Broad privacy or data protection laws may unduly limit credit reporting – balance privacy with economic impact of limiting access to data
Competition policy aspects of credit information
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Legal framework for credit reporting:Consumer protection
Borrowers should have access to their own data
Notice of adverse actions based on report Record who has accessed data as part of
report Consumer-friendly procedures in place to
challenge erroneous information in reasonable time frame
Clearly established privacy policy
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Regulatory framework for credit reporting
Regulatory framework usually weaker than legal framework in developing countries
Regulatory framework with enforcement Can, and do, regulators effectively enforce
laws and regulations, via: Audits Lawsuits Fines Reviewing industry codes of conduct
Do consumers have the ability to bring complaints outside the judicial system?
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Use of credit information for bank supervision
Supervisors include financial institutions’ use of credit information as part of inspections, both on- and off-site
Use data from PCRs to identify large problem borrowers, to fine-tune regulations and in analytical work to identify risk-categories of borrowers
Require publicly (government) owned financial institutions to provide data to legitimate credit reporting firms, associations
Encourage all financial institutions to participate in credit reporting
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Consumer Outreach and Education
Readily available information on managing credit and on the rights & responsibilities of borrowers regarding credit reporting Printed materials at appropriate level, language
(internet, banks, retailers, government offices can all provide access)
Radio or television public service ads Role of industry in providing consumer assistance Outreach to lenders on importance of credit
information Outreach to other interested parties (judges,
microfinance institutions, etc.)