Assessing Infrastructure for
Intermediation: Legal Framework
and Credit Information Systems
Thorsten Beck
1
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
2
Legal framework
3
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
4
0.00
0.50
1.00
1.50
2.00
Private Credit and Creditor Rights
0
2
4
6
Creditor Rights Index
8
10
5
0.00
0.50
1.00
1.50
2.00
Private Credit and contract
enforcement
0
500
1000
Days to Enforce a Contract
1500
6
Legal framework - overview

Financial sector legislation

Corporate sector framework

Collateral and creditor rights

Insolvency framework

Judicial system
7
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
8
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
9
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 10
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
11
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
12
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
13
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)
14
Legal framework:
Cross-country comparisons
South Africa
South Africa
M alawi
M alawi
Tanzania
Tanzania
Zambia
Zambia
Zimbabwe
Zimbabwe
M ozambique
M ozambique
0
100
200
300
400
500
600
600
700
800
Days to Recover Debt Outside Insolvency
Source: Doing Business project, http:\\rru.worldbank.org\doingbusiness
900
1000
1100
1200
1300
1400
Days to Resolve Insolvency
15
1500
Credit information
systems
16
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
17
0.00
0.50
1.00
1.50
2.00
Private Credit and Credit Information
Sharing
0
2
4
Credit Information Index
6
18
Credit information systems overview

Institutions and sources of information

Public vs. private registries

Elements of a robust credit registry
system
19
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)
20
Information in credit reports

The heart of the credit report is the detailed
payment history it provides
 Positive payment history empowers good
borrowers, creates reputation collateral
 Negative payment data encourages honoring
obligations
Lender
B of A
Account No.
XXXX
Date Opened &
Date Reported
1-1-2000
6-1-2004
Credit Limit &
Past Due
$5,000
$0
Payment
History
30 day - 1
21
Public vs. Private Credit Registries
Feature
Public
Private
Purpose
Bank supervision &
credit checks for
lenders
Supervised
institutions (banks)
Yes
Credit checks for lenders
Yes
In some cases
In some countries
No
No charge or
minimal charge
Government
Regulation
Yes
Source of
information
Participation
mandatory?
Positive Info?
Minimum loan
size
Fee for service
Basis for
operations
Varied sources (banks,
retailers, telecoms)
No
Contract
22
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
23
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
24
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.)
25
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?
26
Institutional Arrangements for
Private Credit Registries
Institutional
Type
Private firm w/ no
bank ownership
Private firm w/ bank
ownership
Bank association
Chamber of
Commerce
Commercial & credit
insurance firms
Industry-specific
databases
Pros
Cons
All types of data,
independence
All types of data,
Special access to
bank data
Access to bank data,
integrity
Retail & non-bank
data, broad cover,
historical record
In-depth data on
commercial sector
In-depth data on
single sector
No automatic access
to data
Independence may
be questioned
Only bank data, only
bank access
No bank data,
Limited funds for
modernization
Limited coverage,
High cost per entry
Lmtd. Scope – can’t
cross -check data 27
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
28
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
29
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
30
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
31
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?
32
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
33
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.)
34