Strengthening the retail credit rating capability in India: prospects and challenges

Abstract

Credit rating of individuals is a service that is still in nascent stage in India. Banks that extend credit to consumers allow them the luxury to purchase a good/service before they have the money to pay for it. The expectation is that the individual will pay it back later with interest. However as the creditor runs the risk of default by the debtor, they look for the credit worthiness of the debtor. Retail credit rating measures how credit worthy an individual is, based on his loan repayment capacity which is assessed by parameters like monthly income, assets owned, previous credit history etc, and assign a numerical value to the credit worthiness. The rating is done by a credit bureau which maintains a database with personal and financial details. Every time a customer defaults on credit repayment, the bank informs the credit bureau and the database gets updated and the credit rating declines. The ease with which the individual can access credit in future depends on his credit rating. This study is basically to study the prospects and challenges in setting up a credit rating system in India to strengthen the retail credit rating. The Indian credit rating system has been studied in comparison with the system in the US and the flaws in the Indian system have been identified thus. Four major components of a credit rating system have been identified and this report attempts to study the progress India has made with respect to each 1. Credit Bureau and the Credit Score - The effectiveness of CIBIL and the score it calculates in contrast with the established 3 credit bureaus in the United States and the FICO scores used by the banks2. Bankruptcy Laws The various options available to a genuine defaulter in the US to file bankruptcy and a mechanism to enable creditors to treat will ful defaulters accordingly3. Disclosure Laws and other credit rating related laws Disclosure laws such as Truth in Lending in the US, which asks a creditor to disclose all the terms and conditions, compared to the equivalents in India4. Privacy Laws Laws which protect the borrower s privacy in the face of various kind of private information being used by different arms of the same bank for different products and how consumers in the US and India are being treated The subprime crisis in the US has been studied in the light of the argument that the credit rating system failed in identifying the subprime borrowers and the associated high risk. Various challenges in the implementation of a robust credit rating system in India have been studied in view of the shortcomings in each of the 4 pillars mentioned above. Appropriate recommendations that can be implemented have been devised to address the challenges identified.