Working Paper
Brazilian Perspectives on Privacy in the
Context of Credit Reporting
Antônio José Maristrello Porto*
Many advanced economic societies have some form of a credit reporting
agency (CRA) that collects information on individuals’ financial condition,
including their history of repayment of loans. Before extending credit, potential
lenders consult the CRA. A surprising number of countries lack a robust CRA.
This article analyzes the benefits and costs that would come from the introduction
or the enhancement of a CRA in such a society. The creation and implementation
of a CRA reduces the asymmetry of information between creditor and debtor and
thus reduces the transaction costs involved in their relationship, increasing overall
wealth. The efficiency gains could result in lowered average interest rates and
greater access to credit. However, this increase in society’s welfare may be offset
by the loss of privacy and other costs falling on individuals. In addition to the
attendant loss of privacy to which many object, another cost of a credit registry
agency falls on those who will have false negative information about them
appearing in the CRA. The desirability of the creation, implementation and
enhancement of a CRA depends primary on how the gains of efficiency in the
credit market will be distributed, where the costs of false negative information
falls, and how much privacy individuals are willing to give up in exchange for
credit conditions. The final section of this paper presents the results of a survey to
try to measure how much privacy Brazilians’ consumers are willing to give up for
better credit conditions.
*Getulio Vargas Foundation/CPDE – Direito Rio. Praia de Botafogo, 190, 22250-900, Rio de Janeiro, Brazil;
e-mail: antonio.maristrello@fgv.br. Antônio José Maristrello Porto. I am very grateful to Randall S. Thomas
and Hans-Bernd Schäfer, who made comments on previous drafts. I am also grateful to Gustavo Sampaio de
Abreu Ribeiro and Heitor Campos de A. Guimarães for valuable research assistance. Responsibility for errors
rests with the author.
I – Introduction
A noncredit transaction is likely to be less regulated than a credit transaction. For
examples, the regulation of cash retail sales of refrigerators is lighter than the regulation
of such sales made with credit. This article shed some light on the importance of
information in a credit transaction operation. The relation between lenders and
borrowers may be adversely affected by asymmetric information, causing an inefficient
allocation of credit. The inability of lenders to evaluate the real intentions of potential
borrowers may prevent the extension of credit, or force lenders to charge borrowers
higher rates, which in turn may cause adverse selection in the credit market.1
A potential method to reduce asymmetry of information between lenders and borrowers
is the creation of a credit reporting agencies (CRA). 2 In some countries, positive credit
reporting agencies (positive-CRA) and negative credit reporting agencies (negativeCRA)3 are created and maintained by government (public credit registries), by private
institutions (private credit registries), or by both.4
If a CRA may reduce asymmetry of information and thus to foster the credit market,
why do some countries not have a fully functioning one? The aim of this article is to
analyze, from a law and economics point of view, the pros and the cons of the creation
and the implementation of a CRA in any given country. Even though my analysis uses
Brazilian for illustration – a country without a fully functioning positive-CRA yet – as a
model,5 I believe that my analysis is also pertinent for other countries. Moreover, given
See (Stiglitz and Weiss 1981)
In a prefect competitive market, lenders and borrowers would have perfect information. Lenders
would have all the necessary information about borrowers past credit history and, thereafter, could
adjust the price and the limits of a loan in a case by case base. However, borrowers have strong
incentives to fail to disclose information, known to her, that if communicated to the lender would
have made the loan fall through or imputed her more expensive interests’ rates.
3
CRAs may issue reports that “range from simple statements of past defaults or arrears – ‘‘black’’ or
‘‘negative’’ data – to detailed reports on the applicant’s assets and liabilities, guarantees, debt
maturity structure, pattern of repayments, employment and family history – ‘‘white’’ or ‘‘positive’’
data” (Jappelli and Pagano 2002, p. 2022).
4
I acknowledge that the difference between privately and publicly run CRAs is relevant in terms of
functioning rules, level of access, available information etc; however, for our purposes in this paper
– analyzing the impact of such credit information sharing system on asymmetry of information in
the credit market – the nature of who runs the system is less important. For this reason, throughout
this paper I will only distinguish between private and public CRA when relevant.
5
By the end of the eighties there was an intense deregulation of the bank sector in Brazil and the
Real Plan allowed for economic stabilization, which culminated in the rise of foreign banks that
2
1
2
that the desirability of CRAs also depends on the design of such institutions, it is highly
advantageous to compare different institutional designs of CRAs.6
The creation and implementation of a positive-CRA in a country may reduce the
asymmetry of information between lender7 and borrower, and thus, reduce the
transaction costs involved in their transactions, increasing society’s overall wealth.
However, the distribution of these gains to consumers, in terms of lower interest rates,
increases in the amount of available credit, and better credit conditions, will depend
primarily upon the level of competition in the credit market.8
Furthermore, there are political choices that must be made between the benefits of
having more and cheaper credit available under a fully functioning positive-CRA, and
its costs, including the loss of consumer privacy and the costs of having false negative
information9 about individuals appearing in the CRAs. In order to address this issue, I
conduct a survey to try to measure how much privacy Brazilians’ consumers are willing
to give up for better credit conditions.
In Section II, I describe the process of the creation of a positive-CRA, point out why it
is important, and discuss some of its positive and negative sides. In Section III, I
highlight some restrictive features of the positive-CRA, its limits as a credit policy and
its dilemmas. I also briefly discuss how the institutional design of CRA has important
effects on its social desirability. In Section IV, I use an empirical survey to shed further
lights on the link between privacy and better credit conditions for Brazilians’
consumers. Section V contains some concluding remarks.
dominated the technology of the credit analysis. Despite all these facts, Brazil still lacks a fully
functioning CRA. See (Pinheiro and Moura 2001).
6
I will, when necessary, analyze the already established institutional design in other countries and
try to make some corporations.
7
During the text I will use lenders to refer to banks, department stores and small retailers, but will
make differentiation when necessary. This is an important point because the effects of a fully
functioning CRA may be different to each of these creditors.
8
In the absence of competition the interest rate for the good debtor may fall and the interest rate for the
bad debtor may increase. However, the average interest rate will remain the same, if the creditor knows
the quota of bad debtors but not the individual. The efficiency gain in this situation is that a pooling
equilibrium and cross subsidization of bad debtors by good debtors is avoided and that more credits are
given to good and less to bad debtors.
9
By false negative I do not mean only negative information – false past defaults or arrears, rather I
mean all type of false information that was erroneously reported to positive-CRA or processed by it
and that results in worse credit history reports to borrow than her in fact has.
3
II – Positive Consumer Credit Reporting – an overview
It is widely accepted in the microeconomic literature that the phenomenon of
asymmetric information generates a market failure and that its correction usually leads
to a more efficient functioning market.10 In essence, a market with great asymmetry of
information does not work efficiently, e.g. debtors may be subsidized, which leads to
inaccurate prices and wrong quantities in the market, or buyers may be paying more for
goods, or may inefficiently abstain from buying. Thus, at the margin, asymmetries in
the quality, quantity, or method of processing of information between parties prevents
the conclusion of transactions that at first sight would be mutually beneficial.
The phenomenon of asymmetric information is particularly important in the credit
market. The nature of credit, which involves a promise of future payment, makes the
identification of the profile and the intentions of a potential borrower a crucial factor for
estimating the probability of repayment. However, in most cases, such information is
not accessible to lenders at a low cost. This asymmetry of information may be
responsible for an inefficient allocation of resources with the possibility to generate a
process of adverse selection in the credit market.
In many countries, especially developing countries, the lack of tools (or their
malfunction) to reduce the asymmetry of information in the credit market may result in
an equilibrium that would imply higher prices, less credit available, and shorter time
limits on credit than would be the case in a scenario of perfect information.11
Traditionally financial institutions try to counteract this asymmetry of information by
investing significant resources in the study of potential debtors’ business plans and
estimated cash flows and by increasing collateral requirements. However, this strategy
is extremely costly and imprecise, thus making loans too expensive to undertake.12
However, the problems caused by asymmetric information extend beyond the stage of
credit contract formation. Even once a loan is made, the inability of lenders to control
The role played by information in markets has been the focus of a theoretical economic literature
in which the works of Jaffe and Russel (1976) and Stiglitz and Weiss (1981) are the main
references.
11
This one of the possible scenarios and depends crucially on the amount of information available to
creditors. If, for example, the creditors know the quota of bad debtors and of failing credits, then the price
may not be higher in the average. There will be less credit to good and more credit to bad debtors. As
good creditors use credit more efficiently this will result in a social loss.
12
(Galindo e Miller, p.3)
4
10
borrowers’ actions after they obtain a loan may create moral hazard problems if
borrowers adopt behaviors that increase their risk of default (e.g. taking out additional
new loans at the same time). Thus, the asymmetry of information between lenders and
borrowers with respect to the quality of the profile of the borrowers and the risk of
default prevents the market of reaching a socially efficient equilibrium, leading to
restricted credit or very high borrowing rates.13
This possible inefficient equilibrium leads market forces, or politicians, to decide to
create and operate a mechanism that allows lenders (and borrows) to overcome
informational asymmetries. A common organizational arrangement that sometimes is
created by market forces and sometimes by state policies is a credit reporting agency.14
It is an institutional response to the problem of asymmetric information in credit
markets that tends to be easier to establish than other alternatives, such as, changing
complicated regulatory frameworks.15
I will use the term credit reporting agencies (CRA) to refer to any private or public
organization that collects positive and negative information on individuals (consumers)
and businesses in a country. I am especially interested in a CRA that works with
positive data – a positive-CRA – because Brazil, which already has a fully functioning
negative-CRA,16 is considering the idea of implementing a fully functioning positiveCRA.
To try to confront this problem, on May the 19, 2009, the Brazilian House of Representatives
approved the bill 836-E of 2003, which dealt with the establishment of the Positive Consumer
Credit Reporting as one measure that would enhance the development of the credit market in
Brazil. This bill was vetoed by President Lula that in the next day enacted the Provisory Measure
518 of 12/30/2010. The Provisory Measure 518 created the positive-CRA, but did not regulate it.
On May the 09, 2011, the Brazilian House of Representatives approved the Provisory Measure 518.
On May the 18, 2011, the senate amended the Provisory Measure that was named bill 12/11 that is
a new attempt to create and regulate a positive-CRA in Brazil
14
As pointed by Olegario: “The term “bureau” is used primarily in the U.S. and Canada: elsewhere,
the term “registry” is also uses. Although “credit bureau” technically refers to any non-profit or forprofit private organization that collects information on individuals and businesses, in the U.S. the
term is used almost exclusively in connection with consumer rather than business credit” … “In the
U.S., the history of credit bureaus differs significantly from that of business-to-businesses creditreporting agencies”(Olegario 2002, p.6-7).
15
(Galindo e Miller, 2001, pp.14 and 15)
16
For a survey of all types of negative-CRAs in Brazil and the way they work, see (First_Initiative
2006).
5
13
One of the reasons to create a CRA is that consumer loan default represents a major
share of the cost of capital in the credit market, and therefore in the country. A positiveCRA and a negative-CRA may be desirable because the current system of consumers’
databases (if available) is unable to distinguish between the “good” and the “bad”
payers. Thus, lenders end up raising interest rates for all consumers to compensate for
the default of some debtors. That is, the “good payers” subsidize for the “bad payers.”
Accordingly, while a negative-CRA collects and compiles information about borrowers
past defaults, or arrears, a positive-CRA collects and compiles positive credit
information about borrowers. It handles data concerning not only to the delay or default,
but also to the timely payment of obligations by the borrowers. Thus, any “negative”
information concerning earlier defaults or delays could be analyzed together with
“positive” data about regular timely payments. A positive-CRA would provide therefore
a more complete picture of the credit history of each individual and complement the
information collected by negative-CRAs. The idea is that positive-CRA may provide
more complete information to the lenders about the financial performance of the
borrowers, beginning at the time of their inscription in the system.17 In countries where
just negative-CRAs exist, the implementation of a positive-CRA could improve the
selection of borrowers by the lenders.
An idea first introduced by (Pagano and Jappelli 1993) is that CRAs in general – either
only with negative, or positive, information or both – help reduce adverse selection by
improving the overall pool of borrowers to lenders. This occurs because once credit
information about all customers is publicly available, financial institutions can access
the quality of non-local potential customers and lend to them with the same level of
safet as they do with their local clients. As a result of this, the overall default rate for all
loans tends to fall. However, Pagano and Jappelli also note that the net effect of this
information spreading on overall lending is ambiguous, since the net effect of the
implied increase in lending to new “safe” borrowers minus the possible reduction in
lending to risky types is not easily calculated and would depend on further variables
related to the lending market in scrutiny.
This is similar to the way insurance companies use historical data of a prospective insured, or a
potential employer uses past information about a potential employee.
6
17
Some positive sides of a positive-CRA
Nonetheless, in principle, the establishment of a positive-CRA may enable a reduction
in per-loan costs, thereby opening up new lending opportunities and greater access to
credit for some borrowers. This is because when an individual cannot demonstrate her
commitment to pay its debts (e.g. through collateral), and there is a large asymmetry of
information about their ability to pay, the lenders must rely on inferences about the
likelihood of default. With a more comprehensive database on the historical profile of
consumers, financial institutions may make fewer demands (e.g. lower initial payment,
less collateral, lower interest rates etc.) so that those consumers with good credit history
have better access to credit lines. Provided with more information, lenders can better
differentiate the risks of potential debtors and offer credit terms in balance with those
risks. This may allow financial institutions to identify more easily borrowers with good
credit history and charge them interest rates more consistent with their levels of risk.
This improved differentiation between “good” and “bad” payers, in turn, may provide a
mitigation of the problem of adverse selection in the credit market. In addition, the
closer and more accurate supervision of borrowers credit history creates a new kind of
collateral – “reputation” collateral, which in turn can help reduce both the problems of
adverse selection and moral hazard in credit markets to the extent that borrowers now
have a higher stake in maintaining their “positive” evaluation.18,19
Individuals with lower economic means often cannot prove they have a steady source of
income or that they own property to use as collateral. A positive-CRA helps people with
lower levels of income to signal in a credible and objective manner their historical
ability and willingness to repay their obligations. Thus, the credit history can be
understood as a “good” on which the State assigns a property right, 20 causing the
individual to value it even more. In short, a positive-CRA transforms information into a
(Galindo e Miller, p.3)
We must acknowledge, however, that even though a system with positive credit information
helps to mitigate the moral hazard, an even better system to this end would also make public
information about the overall credit extended to each borrower, thus allowing each potential
debtor to easily access the level of indebtedness of each potential borrower. This is important since
a borrower’s default risk depends on how much of his income is devoted to the payment of debt. If
this information is not made available to potential lenders, the borrowers will have an incentive to
over-borrow, thus lowering his ability to pay past debts.
20
Nowadays, specific creditors own this right. If the individual is a client in a specific bank, this
bank owns his or hers rights, only the bank have information – the individual knows, but cannot
use it because cannot prove it – over historical ability and willing to repay of the individual.
7
18
19
commodity that can be “appraised, bought, and sold” by the market (Olegario 2002, p.89), and also transfers to borrowers a title of property over their credit history. The
creation of a title of property over individual credit history is a good by itself and gives
borrowers incentives to take care of their property so that it may be used in a more
efficient way.21 It is not an exaggeration to infer that a title over individuals’ credit
history is a measure that creates wealth. Furthermore, if the future access to credit is
valuable to the borrower, then she will have an additional incentive not to default on a
loan contract because it will damage her future credit. Thus, besides providing the
lender with the necessary information to measure risks more precisely, a positive-CRA
provides additional incentives for borrowers to use their credit more responsibly. This
should also mitigate the problem of moral hazard, since consumers will have greater
incentives not to engage in behavior that increases their probability of default.22
This point deserves further elaboration. Contrary to Jappelli and Pagano 2006, I argue
that the disciplinary effect of CRAs arises not only from the sharing of negative
information, but it is also strengthened by the disclosure of positive information.
Jappelli and Pagano claim that a “high-quality borrower will not be concerned about his
default being reported to outside banks if they are also told that he is a high-quality
client.”23 However insightful, I believe this analysis neglects an important additional
point. The sharing of “positive”, in addition to “negative”, data gives the borrower a
greater interest in maintaining his positive image. One default only might be enough to
stain someone’s image or credit scoring in the short run. In addition, as mentioned
above, the sharing of positive information about one’s credit history works as an
endowment for the person. So, given the fact that most people tend to weigh losses
more heavily than gains (loss aversion), the idea of losing such endowment (that is, a
positive image in face of potential debtors) would to provide further disciplinary
incentive on borrowers, not less.
For a more elaborated explanation on how a title of property protected by the State may
stimulate the efficient use of a resource see (Hardin 1968).
22
It should be noted that in countries where there is not a well-developed system of consumer
credit reporting, lenders might make the mistake of lending to borrowers who already have other
debts (loans) that undertake substantial portion of their income. These errors result in higher costs
of credit. Another way of seen the importance of positive-CRAs is highlighted by Galindo and Miller:
“Credit registries which collect standardized historical data on borrowers can create a new kind of
collateral—reputation collateral—which can help both in reducing problems of adverse selection
and moral hazard” (Galindo and Miller 2001, p.3).
23
Jappelli and Pagano 2006 p. 11.
8
21
When analyzing which groups might benefit more from such a credit information
sharing system, there is evidence in other countries that shows that younger individuals
are a class of borrowers who can greatly benefit from the existence of a positive-CRA
(Staten and Cate 2003). At this point it is important to emphasize that the Brazilian bill,
for example, provides for the inclusion in the positive-CRA of consumer’s payments of
their power bill, water bill, telephone bill, gas bill, etc. This is important because
younger individuals, or those who have not had prior access to credit, might be able to
create a positive credit history through prompt payment of these bills.
Another group that would benefit from a positive-CRA is small businesses. These firms
are perhaps the segment of the credit market where the negative impact of asymmetric
information is most evident. First, the vast majority of small businesses don’t have
independent analysis criteria available either through ratings firms or stock and bond
prices. Second, small businesses are very diverse group, thus it is extremely difficult for
lenders to identify clear criteria that could constitute successful predictors of default or
serve to quantity risk. Further complicating matters, many small business owners
mingle their personal finances with those of their company, experience excessive
economic volatility, suffer from poor accounting techniques and engage in widespread
tax evasion24. All of these negative factors can be addressed, or have their negative
effect mitigated, by the use of credit scoring techniques.
A further question that regulators must confront is whether to use positive-CRA’s to
engage in credit scoring of the individuals registered on their files. The creation of a
positive-CRA can be accompanied by positive-CRA using risk analysis on the available
data of the borrower. When positive-CRAs rate (potential) borrowers based on their
credit history, they can employ statistical models to produce and sell credit scoring
services.25 The choice of the variables that will compose the statistical model in many
cases is regulated by the legislature or the judiciary. In the case of the Brazilian Draft
Law, the regulator required the disclosure of the variables used in the risk analysis, so
that the positive-CRA must make public the information it considered in its scoring
system. Such regulation is important for transparency and social control of the
24
25
Galindo e Miller, p.3
See (Jappelli and Pagano 2002, p.2022).
9
evaluation methods.26 This risk analysis aims to replace other mechanisms of compiling
information about the profile and paying capacity of consumers (such as interviews,
credit forms etc.) with a more accurate method based on documented historical
consumer behavior. By numerically ranking (potential) borrowers, statistical models
used in credit scoring are an important mechanism to help lenders in many credit
markets, and the tools of credit scoring are now expanding their influence over lenders’
decisions in mortgage and small business loan markets.27 In fact, in some countries,
such as the United States, information models are used for making lists of consumers or
companies that are granted pre-approved credit lines (prescreening). By providing fast
and cheap access to information about the historical profile and behavior of debtors, the
databases will enable better monitoring of the activities of consumers after the loan has
been granted. Greater monitoring, in principle, tends to mitigate the problem of moral
hazard mentioned above.
The experience of specific countries has also shown that the existence of a complete
reporting about the payment history of consumers is especially important for those
sectors of the population with lower levels of income. For example, a comparison in the
United States between access to unsecured credit between the 1970’s, a decade in which
there was a major reform in the consumer credit reporting system and the year of 2001,
found a growth of almost 70% for the lowest one fifty of the population and 30% for the
second fifth of lower levels of income, respectively, in face of a growth of
approximately 10% for the remaining three fifths having higher levels of income.28
Thus, a system of consumer credit reporting seems to improve access to credit and
reduce firms’ financial constraints, while also allowing lower economic classes and
younger consumers to have more and better access to credit, insurance and other
financial services. Such access would be based only on their historical bill paying
profiles, and not based on ownership of assets that could serve as collateral, or on prior
credit relationships, as occurs with consumers with higher levels of income.
There is the possibility, however, of a marked desire to use variables in the statistical model of
evaluation of credit scoring that may go against social desire and the legislature or the judiciary will
have to intervene in this issue.
27
See (Galindo and Miller 2001, p.2).
28
See (Staten and Cate 2003).
10
26
Some negative sides of a positive-CRA
Some critics have argued those modern credit scoring models applied today are biased
against minorities and women. In certain cultures the argument goes, minorities are
more likely to take loans and to take trade credit from community groups and local
members that provide credit based on borrowers’ "character" (a cultural idea), rather
than on any other indicators of credit worthiness control. 29 These local loans tend not to
be reported to positive-CRAs, thus create no credit history. Positive- CRAs may be also
biased against women. As it is true in some countries, women tend to be a coadjutant in
the financial lives of the couple. In these countries, usually most of the credit history of
the couple is constructed in the husband’s name.30
To protect against such biases, a positive-CRA should expressly provide rules for the
information stored in the credit registries. The regulator ex ante, or the judiciary ex post,
must supervise what type of information is collected by the positive-CRA. In the case of
the Brazilian Draft Law, the regulator determined that the information collected, stored
and processed in positive-CRAs should be objective, clear, accurate and easily
understood. It also forbid collection of any information that does not have a direct
relationship with risk analysis of the debtor, including social and ethnic origin, health
and sexual orientation, political, religious, and personal beliefs. This type of regulation
is necessary to avoid discrimination against minorities and woman. Furthermore, the
use of any information by the positive-CRAs for other purposes than credit risk analysis
(e.g. marketing, direct mail, search marketing etc.) should be permitted only after the
express authorization of the registered consumer. Respecting these and other
restrictions, potential lenders could use the information to complement other data that
they already have about the reliability of the potential borrower to make decisions about
borrowers` financial stability and their consequent ability and willingness to repay the
debt. As an example, such information may be used to make decisions about loan
granting, price, deadline, and other credit conditions.
Furthermore, the overlap of mechanisms between a full functioning positive-CRA and
other systems that partially collect and provide positive credit consumer history needs to
be critically discussed. A positive-CRA may complement and refine an existing system
For a deep explanation and more examples on how positive-CRA may contain hidden biases
against minorities and women, see (Olegario 2002, p.40-41)
30
See note 29
11
29
of credit information. For example, the Credit Information System of the Brazilian
Central Bank (Sistema de Informações de Crédito do Banco Central – “SCR”) is a tool
for supervision of the banking sector The SCR is one of the main instruments used by
the Central Bank to monitor the credit portfolios of financial institutions. It also gathers
data on borrowers’ credit behavior with regard to their obligations incurred in the
financial system, which is filed monthly by the financial institutions. Only customers
whose total obligations are equal to, or greater than, R$ 5,000.00 (~ US$ 2,500.00) are
identified.31 With this limit, the SCR does not reach the financial arrangements of the
classes C, D, and E32. This weakness of the system may be alleviated by a positiveCRA. The SCR does not fully function as a positive-CRA; its main function is to assist
banking supervision activities. Although its main function is to assist in banking
supervision, SCR provides some positive credit information to the market. It provides
borrowers’ credit history information to the regulated financial institutions that feed its
database, but not to other financial institutions that do not provide data to SCR. In
situations like this, a fully functioning positive-CRA could offer these services to the
credit market as a whole, so that all lenders would have access to this information.33
The next section focuses on both existing analyses and new insights into a cost benefit
analysis of positive-CRA.
III – Limiting Features of Consumer Credit Reporting
The creation of a fully functioning CRA may generate two types of effects. The first
effect, as mentioned above, is that it reduces the asymmetry of information between
lenders and borrowers with a consequent positive impact on adverse selection and moral
hazard on credit markets. The second effect could be to invigorate competition between
lenders, reducing the rents that financial institutions could otherwise extract from their
See (First_Initiative 2006, p.12).
“The Brazilian Economic Classification Criterion (CCEB) is an instrument of economic
segmentation that uses a survey of household characteristics to differentiate the population. The
criterion assigns points according to each household characteristic and performs the sum of these
points. In the sequence, there is a match between the test score ranges and levels of economic
status defined by A1, A2, B1, B2, C1 C2, D, E” – Source ABEP. (http://www.abep.org/novo/). Last
accessed 04/07/2011.
33
For a complete survey of the many types of negative and positive credit reporting system
available in Brazil and their functioning and coverage see (First_Initiative 2006)
12
31
32
customers.34 The Brazilian Draft Law assumes that the creation of a positive-CRA is an
additional measure to enhance credit market competition and that this is one of the most
important characteristics of the creation of a fully functional positive-CRA.
By reducing the cost of evaluating the risks of consumers, a database of “positive” and
“negative” information reduces the barriers in the credit market, facilitating the entry of
new competitors. The fact that the credit registries do not have such historical “positive”
information acts as an entry barrier because gathering this kind of information from
potential new costumers, that is, people who do not yet have any kind of relation with
potential entrants, can be extremely costly. To the extent that the incumbent financial
institutions already possess such information from their customers, they hold an
“information monopoly” on the information they possess about their customers, and
because of the resulting high entry costs for other lenders, they are able to extract rents
from their customers. In this system, without the implementation of consumer credit
reporting, potential entrants do not have access to important information. Therefore,
they cannot offer financial products and services at competitive prices and conditions.
Indeed, the potential to increase competition is one of the most important factors for an
effective reduction of credit prices because even reducing the costs of evaluating the
risk of consumers and increasing the availability of such data at a lower cost does not,
by itself, determine that the cost savings will necessarily be passed on to consumers.
This will only incur as a result of increased competition in the provision of credit.35
This point deserves further qualification. Even if we acknowledge that the lack of
positive information about borrowers indeed constitutes a barrier to entry in the
financial sector, this may not be the only barrier. In fact, it may not even be the most
important one. Given this, it might be the case that the creation of positive CRAs will
not reduce sufficiently the barriers to entry to foster a higher level of competition in the
sector so that the prices of loans to costumers fall. However, we cannot resolve this
issue solely from theory as it is ultimately an empirical question.
Another relevant issue regarding a positive-CRA is the question of why incumbent
financial institutions have not created a similar private system? One possible answer is
34
35
See (Padilla and Pagano 1997, p. 206)
See (Stiglitz and Weiss 1981) and (Pagano and Jappelli 1993)
13
that the financial information that financial institutions already hold about their
customers provides them with such a “similar system.” Given this, one might argue that
the creation of positive-CRA would conflict with the existing private arrangements.
There are other possible answers to the question of why incumbent financial institutions
have not created a similar private system. First, the financial institutions hold all
relevant information about borrowers so the creation of positive CRA wouldn’t change
much for them.36 Second, one might argue that the private sector still has not created
such system because it would constitute a form of “public good.” Consequently, its
creators would not be able to individually benefit from its creation, which, in turn,
would dilute individual incentives to create such system in the first place.37
Furthermore, even if a positive-CRA can provide a more efficient equilibrium in the
credit market, there are other obstacles to its creation. Regulators need to determine if
borrowers must sign an authorization to be conscripted into a positive-CRAs – an opt in
clause, or if borrowers must require withdraw from the registry – an opt out clause.38
Another option for regulators is to allow borrowers to choose to disclose their entire
history or just their risk analysis. In fact, there is an incentive for most consumers to
allow the disclosure both their history and risk analysis. First, those consumers with an
excellent payment history would have a strong incentive to allow his or her inclusion on
the credit registries, because they could, therefore, be differentiated from consumers
with “worst” history, and thus have access to more credit at better conditions. In turn,
those consumers with very good, but not great, historical records would also realize that
they would be better off if they allow their inclusion because, in the same way, they
could differentiate themselves from consumers with an average history. Following this
reasoning, the consumers with average history also have incentives to allow her
inclusion, and so on, so that only those consumers with a “bad” history do not allow his
or her inclusion, because they would gain nothing from doing it. These last consumers
This may be an exaggeration. The creation of a positive-CRA may reduce entry barriers and be a
good in itself.
37
But it seems relatively easy to private agents to create a system that could prevent others from
accessing it and then charging the members for the use, thus preventing the system to hold the
characteristics of a public good.
38
The Brazilian draft law approved by the House of Representatives regulated this issue with an
opt in clause. Brazilians’ borrowers must sign in an authorization in order to be scripted in the
positive credit registry.
14
36
are only differentiated from consumers with a “very bad” history by the fact that,
perhaps, these already are enrolled in the existing negative-CRAs, in the case of Brazil
in the Sistema de Proteção ao Crédito – SPC or SERASA.39 Thus, the device that makes
the inclusion in the credit registries a voluntary registration can actually become
mandatory. Even if in theory it seems to give the borrower the option, in practice it
ultimately forces him to sign up or be qualified as a holder of a “bad” payment history.40
If the regulator sets as the default option the opt in clause, and borrowers need to give
their consent to be included in the positive-CRA’ database, the regulator will also need
to analyze what would be the consequences of the positive-CRA for those consumers
with a payment history better than “bad”, that do not enroll in the positive-CRA’s
database. These borrowers, in principle, would be confused with those borrowers with a
“bad” history, since they would not have strong incentives to enroll.41 The fact is that
those borrowers that did not enroll in the credit reporting, in principle, would bear the
worst credit conditions (i.e. higher interest rates, shorter deadlines, and fewer resources
available).
To understand how SPC and SERASA work see (First_Initiative 2006, p.12).
“Conventional rational-choice theory is challenged from the opposite direction by game theory.
Traditional economics generally assumed (except when speculating about cartel behavior, and in a
few other examples) that people made decisions without considering other people’s reactions. If
the price of some product falls, consumers buy more without worrying that by doing so they may
cause the price to rise again. The reason they do not worry is that the effect of each consumer’s
decision on the price is likely to be negligible (the consumer is a “price taker”), while the costs to
the consumers of coordinating their action would be prohibitive… Federal law forbids colleges to
disclose a student’s transcript to a prospective employer or another educational institution without
the student’s permission. Such permission is almost never refused. Game theory can help us see
why without our having to assume hyperrationality. If no student gave permission, an employer
considering a job application from a college student would assume that the student had average
grades – what else could he assume? Students with above-average grades would be hurt by this
assumption, so they would begin giving permission to their schools to release their transcripts.
Eventually all students with grades above the midpoint would grant such permission. So now when
an employer received an application from a student who had not released his transcript, the
employer would assume that the student was in the middle of the lower half of the grade-point
distribution, because everyone in the upper half would have revealed his grades. So every student
in the third quartile (that is, in the upper half of the lower half of the grade distribution) would be
disadvantaged by nondisclosure and would reveal his grades. Eventually only the student with the
very lowest grades would have nothing to gain from disclosure – and his failure to disclose would
reveal his rank as unerringly as if he had disclosed it. Simple game theory thus shows why the law
protecting the privacy of transcripts has been ineffective. The example illustrates what game
theorists call a “pooling equilibrium,” in which (in contrast to a “separating equilibrium”) strategic
behavior prevents people with different preferences from acing differently. The reasoning process
required to achieve a pooling equilibrium in the student-transcript case is not so elaborate as to
require hyperrationality” (Posner 2007).
41
This is one type of false-negative that will be discussed below.
15
39
40
This point deserves attention because, in practice, some borrowers, even with a “good”
history of payment, might not enroll in the credit reporting, even if it would generate
future net benefits. In fact, people usually have, for different reasons, a tendency to
maintain their current situation (status quo bias).42 This can occur, for example, because
of a mere lack of attention resulting in bad choices. Especially in situations where the
benefits may not be clear (as in the case of enrolling in credit reporting) people can
simply opt not to choose one option that, theoretically, would bring them a greater
expected net benefit.
Accordingly, a possible regulatory alternative would be that individuals are
automatically enrolled in the positive-CRA and their risk analysis disclosure unless they
affirmatively choose not to be – an opt out clause. That is, regardless of any
authorization, the borrower would already be enrolled in the positive-CRA and her risk
analysis disseminated for the financial institutions interested. The borrower would have
the choice to be excluded of the credit registries and of the risk analysis, but she should
expressly communicate her choice to the positive-CRA or to any governmental
authority. This should be made possible in a quick, easy, and free manner. This scenario
would tend to reduce the number of borrowers with “good” history that are not enrolled
in the credit reporting and enable better credit conditions to this class of consumers. As
well by keeping for the consumer the option to be excluded from credit reporting at a
low cost, it would maintain their right to privacy.
Another point that deserves attention in a proposal to create a positive-CRA is the
assumption that the correction of the asymmetry of information will promote a more
efficient equilibrium in the credit market of the country. It should be recalled that a
market is composed of many elements that form an intricate network of causalities.
Repositioning any of its elements may not ensure efficiency in the resulting new
equilibrium.43
See (Samuelson and Zeckhauser 1988).
This concept is linked to the “Theory of Second Best”, which, briefly, assumes that in a system
with several variables, for some reason, one (or several) of these variables can not take the value
for that the outcome imagined as “best” option be observed. This theory assumes that in some
situations, for the “second best” option be achieved it would be necessary for other variables, other
than the first, assume different values from those that would be needed to obtain the “first best
option.” See, (Lipsey and Lancaster 1956).
16
42
43
CRAs will impact informal lending and retail shops. This is important since both
players might be excluded from the information sharing system created by the CRAs
and, thus, not benefit from the mitigation in the asymmetry of information and other
advantages abovementioned. To counter this limitation, a CRAs’ system can be
institutionally designed to provide access by such important players to credit
information disclosures. In addition, adding such players to the credit sharing system
could also benefit the financial institutions. A requirement that informal lending and
retail shops provide information about their customers could reduce the asymmetry of
information for the whole market. This is more important when the share of informal
lending is bigger relative to the overall level of lending in the country, as is the case of
most developing countries. As for retail shops, their inclusion is likely to benefit more
developed countries with high levels of consumer debt, as is the case of the United
States.
There is a possible conflict between the creation of a positive-CRA and personal
privacy. When we lose part of our privacy, do we also lose fractions of our integrity, or
personhood, or honor, or dignity, or liberty, or humanity? “The concept of privacy,”
writes Whitman, “is very embarrassingly difficult to define.”44 The creation and
implementation of a positive-CRA implies that merchants, banks and other types of
creditors will be allowed to access the credit record of their customers. 45 For these
customers, who may have never failed to pay their debts, isn’t it a violation of privacy?
People from different countries, or even from different parts of the same country, may
profoundly disagree over this aspect of the protection of consumer data.46
Although I recognize the importance of the debate that surrounds the concept of
privacy, I do not have the intention – or pretension – to define the meaning of the
concept of privacy. I just want to call the attention to the complexity of the debate. For
44
See (Whitman 2004, p. 1153)
Banks and other types of creditors will be allowed to access and will have the obligation to inform the
financial characteristics of their customers to the positive-CRA.
46
It is widely debated in “privacy” literature that individuals from different countries – i.e. United States,
France, Germany, and others – have different feelings about the concept of privacy and about how the
government must treat or regulate consumer credit reporting and other consumer data. See
(Whitman2004). In the Brazilian case, due to the continental size of the country and diversity of people’s
culture, individuals from different parts of the country may have very different opinions about credit
reporting and other consumer data, and may differently take advantage or disadvantage of the creation
and implementation of positive-CRA.
17
45
the purpose of this article I will treat privacy, like Stigler has done, as a matter of public
policy.47 The creation of a positive-CRA is a policy choice that directly affects the
acquisition and control of information about people. It is essentially the government
trying to regulate the amount of information that each individual discloses in order to be
part of society, and by compelling personal disclosure such regulation, at least
theoretically, weakens individual privacy protection.
In addition to the attendant loss of privacy that individuals may incur, there are costs
suffered by individuals that have false negative information about them appearing in a
positive-CRA. A public policy that creates a positive-CRA must acknowledge that
information about individuals is frequently claimed to be mistaken or misused.48 The
major problem in this situation is that an individual that has false negative information
inserted to his credit history may value the correction of this error much more than the
positive-CRA organization would be willing to spend to correct it.
IV – Examining Privacy Costs
Positive-CRA versus Privacy
In this final section, I used an empirical approach to try to better understand the link
between privacy and better credit conditions for Brazilians’ consumers.
To begin with, let’s assume a perfect world in which a positive-CRA provides a more
efficient equilibrium in the credit market, so that more and cheaper credit is available in
the market. If this could happen, how much privacy are individuals willing to give up
for these better credit conditions? This is the empirical question that this exercise will
try to answer.
Survey
A sample of 447 subjects participated in the study.49 Their average age was 34 years, the
youngest being 18 years old and the oldest 74 years old. 56,28% of the subjects were
See (Stigler 1980)
See (Stigler 1980, p.624-625)
49
The survey was applied from December 9 to 15 of 2010.
47
48
18
from class A and B, and 41,93% of subjects were from class C. There were no class E
individuals in the sample.50
The survey instrument collected the following demographic details on the subjects:
gender; age; occupation; and years of school. The survey instrument was comprised of
33 questions with different number of alternatives in each question. Subjects were
recruited from visitors at two different shopping malls in city of Rio de Janeiro. We
analyzed the results of the survey’s questions to provide some indications on the
subjects’ preferences. We also made tables and charts to help to evaluate these results.
Questions Asked and Information Collected
While a large amount of information was gathered, we summarize only the most
important pieces in this paper. In the materials below, we first state the question asked
and then summarize the information collected. First, questions 22 and 23 we measure if
the Brazilian consumer were informed of the creation and the characteristic of the
positive-CRA. In question 22 the survey instrument asked the following question to the
subject: In Brazil we have the negative-CRA, which is a public record of bad credit
reputation. In other words, if a consumer does not pay his debts his name is registered in
the record. Did you know that? 99.95% of the subjects answered they knew about the
negative-CRA.
The next question asked to the subject: The Brazilian government has created a
positive-CRA, which is different from the negative-CRA: instead of listing only
consumers who did not pay their bills, the new registry will list all consumers and
classify them as a "great", "good" or "regular" payer. The new registry will be consulted
by financial institutions every time the consumer attempts to take a loan. Did you know
or ever heard about it? Only 43% of the subjects had already heard about positiveCRA.
Table 1 below summarizes this information.
________________________________________________________________________________
Descriptive Data. Table 1
Table 1 presents descriptive statistic. It describes answer
from questions 22 and 23.
50
See note 32
19
Yes
No
Question 22
Number
%
444 99,55%
2
0,45%
Question 23
Number
%
192 43,05%
254 56,95%
The charts below summarize the questions asked and information collected in questions
24, 25, 26 and 28. The answers to question 24 – show that 58% of the subjects prefer
privacy over easier and cheaper credit. In response to question 25, 62,19% of the
subjects said they would not take the risk of being classified in a wrong category (i.e.,
instead of being classified as excellent you are classified as good payer) in order to have
better access to cheaper credit. Question 26 responses indicate that more than 86% of
the subjects believe that consumers should be consulted before having their name
included (registered) in the positive-CRA. In other words, inclusion should not be an
automatic – opt in clause. This result indicates that the protection of privacy has a
clearly high correlation with the desire to not having one’s name included in a positiveCRA without giving consent.
We next asked in question 28, if the subject preferred
the positive-CRA to be under the control of a
government branch, or under the control of a private
institution. We found that 58% preferred a public one.
We can infer that the fear of the loss of privacy makes
the subject more confident in having their data collect
by, and distributed by, the government rather than
with a private company.
Our next set of questions focused on borrowing
behavior. Although more than 80% of the respondents think that credit is a positive
thing to have (question 16), and more than 70% of the subjects think it is easy to get
20
credit (question 13), 77,4% of the subjects gave for not borrowing money in the last 12
months (question 11). The three main reasons for subjects not borrow money in the last
12 months were: the lack of need, the fear of getting in debt and the high costs of
borrowing (question 12). The chart below illustrates the breakout of the responses.
We can link the result in question 24. If people think they do not need money, why
would they give up some privacy or risk being wrongly classified by the positive-CRA?
In this case, respondents that do not need a loan are unwilling to sacrifice their privacy
in order to be registered by the positive-CRA.
Moreover, the results discussed above can be related to the income of the class that the
subject belongs. If the subject belongs to the higher class, it will be easier to her to have
access to credit and this will make it less important to be registered with a positive-CRA
with the resulting loss of privacy.
Econometric Analysis
In this section, I use regression analysis in an effort to determine how subjects with
different demographic details and characteristics (age, gender, and years of education)
reacted with privacy losses. Recall from the previous section that there are two
questions that address directly to privacy: question 25, which examined the tradeoff
between access to cheaper credit and the risk of incorrect information being created at a
positive-CRA, and question 26, which asked about whether consumers should be
automatically included in a positive-CRA or have to opt in. We tested to find out if age,
gender, and years of education were statistically significant determinants of how
respondents answered these questions.
21
Equation question 25:
Q25 = C + aQ7sav + bQ11 + cQ13e + dQ15cw + eQ15pwn + fQ15pw + gQ17 + hQ27
Label
Q25
Q7sav
Q11
Q13e
Q15cw
Q15pwn
Q15pw
Q17
Q27
Parameter
C
a
b
c
d
e
f
g
h
Meaning
Consumer (subject) will not want to take the risk of being incorrectly
classified
Consumer (subject) has savings
Consumer (subject) borrowed money in the last 12 months
Consumer (subject) thinks it is already easy to borrow money
Consumer (subject) will certainly borrow money in the next 12 months
Consumer (subject) will not probably borrow money in the next 12 months
Consumer (subject) will probably borrow money in the next 12 months
Consumer (subject) had a credit request denied
Consumer (subject) wants to be part of Positive-CRA
Value
0.526
0.231
-0.14
0.789
-0.468
-0.084
-0.210
-0.150
-0.012
Prob.
0.000
0.000
0.016
0.082
0.000
0.068
0.022
0.004
0.025
Equation question 26
Q26 = C + aQ15cwn + bQ15cw + cQ15pwn + dQ15pw + eQ31
Label
Q26
Q15cwn
Q15cw
Q15pwn
Q15pw
Q31
Parameter
C
a
b
c
d
e
Meaning
Consumers (subject) thinks they have to be asked prior to be included in
Positive-CRA
Consumer (subject) will certainly not borrow money in the next 12 months
Consumer (subject) will certainly borrow money in the next 12 months
Consumer (subject) will not probably borrow money in the next 12 months
Consumer (subject) will probably borrow money in the next 12 months
Consumer (subject) had already been registered in negative-CRA
Value
0.999
-0.089
-0.378
-0.145
-0.352
0.002
Prob.
0.000
0.000
0.010
0.082
0.000
0.001
22
The results show that if the subject has savings,51 this raises the probability by 23,1%
that subject will not want to take the risk of being incorrectly classified. In other words,
the subject does not want to be registered at a positive-CRA, and may not want one to
even be created if they cannot opt out. Furthermore, if it is already easy to the subject –
in their own perception – to borrow money52, this increases the probability in 7,8% that
she will not want to take the risk of being incorrectly classified. Here again, these
subjects do not want to be registered at a positive-CRA nor even want the creation of a
positive-CRA.
Conversely, if the subject borrowed money in the last 12 months53, this raises the
probability by 13,9% that she would like to have access to cheaper money and therefore
is more willing to take the risk of being incorrectly classified. If the subject thinks she
will certainly borrow money in next 12 months,54 this raises the probability by 46,7%
that she will want to take the risk of being incorrectly classified. In a third variation, we
find that if a person already had a credit request denied55 then they are more likely to be
interested in cheaper credit which lowers the probability by 14,9% that the subject
wants to take the risk of being incorrectly classified. All these coefficients are
significant at the 10% level and the majority of them are significant at 5% level.
In the second set of regressions, we examined the issue of opt in versus opt out
provisions for the positive-CRA. The results showed that if the subject had already
been registered in a negative-CRA,56 then this increases the probability by less than 1%
that she will want an opt out positive-CRA.
Question 7: “Do you have a…”. Answers: 85.46% have checking account; 82.77% have saving
account; 83.67% have credit card; and 46.76% have store/supermarket card.
52
Question 13: “For you, getting access to credit is…” Answers: 2.47% of subjects think it is Very
hard; 17.94% Hard; 59,87%Easy; 12.11%Very easy; and 7.62% do not know.
53
Question 11: “Did you borrow money in the last 12 months? It can be a loan, a purchase
installment plan, a house financing plan or any other kind of borrowing”. Answers: 22.6% said Yes,
while 77.4% said No.
54
Question 15: “Thinking about the next 12 months, would you say…”Answers: 43.18% of subjects
certainly will; 44.07% probably will; 8.28% probably will not; 2.46% certainly will not; and 2.01%
do not know they will take a loan.
55
Question 17: “Have you ever have a loan request denied?”. Answers: 26.17% answered
affirmatively, whereas 73.83%, negatively.
56
This inference – good debtor – is based on the answers of questions 13 (showed above) and 31.
Question 31: “Have you ever had your name included in Negative-CRA?” Answers: 34.4% of
subjects said Yes, while 65.6% did not.
23
51
For all the other tested variables the probabilities were negative. For example, if the
subject is not sure she will borrow money in the next 12 months, this raises the
probability by 37,8% that she prefers an opt in positive-CRA.
Similarly if the subject thinks she will probably not borrow money in the next 12
months, this raises the probability by 35,1% that she prefers an opt in positive-CRA.
These results generally indicate that subjects prefer an opt in positive-CRA. The results
also indicate that privacy is more important than positive-CRA even thought it could be
beneficial to all. The coefficients are all significant at the 1% level.
V – Conclusion
The issues discussed herein are important and do not have simple answers. Moreover,
empirical research on the impact of credit reporting agencies on credit markets is scarce.
However, the few comprehensive empirical studies available suggest not only a growth
and international diffusion of CRAs, but also that the existence of credit registries has a
significant positive impact over the amount of credit available in a given economy
(relative to GNP) and a negative impact on defaults.57 The positive impact of CRAs was
identified regardless of the significant heterogeneity in the operating rules of the CRAs
in different countries.
Standardized data about the historical profile of borrowers, in principle, may help
reduce costs for the granting of credit. However, this measure alone is likely to be
insufficient to allow and encourage the development of the credit market in a country.
Its positive impact will depend on the increase of competition in the sector. Even though
the creation and the implementation of the positive credit registry may reduce the
barriers to entry in the credit market, this may be insufficient to strengthen competition
among lenders in a way that guarantees that consumers will face lower interest rates,
that there will be an increase in the amount of available credit and overall better credit
conditions. Even though a positive credit registry may bring all improvements in the
57
See (Jappelli and Pagano, 1999) and (Galindo e Miller, 2001)
24
credit market that the theory highlights, there may be other costs it creates, such as
taking away some privacy rights for those included in it.
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