19/08/2014

As the Al Etihad Credit Bureau becomes fully operational there is an ongoing debate as to its efficacy and who the ultimate beneficiaries will be. This debate is partially centred around the assumption that banks will cooperate by providing credit information, thereby lowering the risk faced by the banks. This assumption is flawed. In reality banks are not encouraged in the short run to cooperate with the Credit Bureau. Client information is valuable and companies would love to receive such information from their competitors, but it is against their interest to divulge information about their own clients.

More concretely, banks have two types of clients: good and bad.

Why would a bank want to advertise its good clients to competitors? This flies in the face of the basic tenets of free market capitalism. Client information is one of the most valuable competitive advantages that a company can wish for. Information asymmetries, especially with regards to clients, provide companies with the means to develop a competitive edge which is fiercely protected, exactly what the banks have been doing, delaying the operational launch of the Credit Bureau by four years.

A lending bank would prefer that other banks lend to bad clients so it can be rid of them. If other banks know that a client has a bad credit history they will not lend to them, and the original lending bank will be stuck with the defaulting client.

Does this mean that the vision of the Credit Bureau is flawed? Not at all. Where the public understanding breaks down is about who the main beneficiaries of the Credit Bureau are. The answer is the borrowers. All of them, not just the high-quality ones.

Commentary in the public domain is exalting the perceived fact that “bad” borrowers, who, the rhetoric implies, have been driving up borrowing costs for “good” borrowers, will be exposed and that borrowing costs will be skewed in favour of higher credit grade borrowers and against lower grade borrowers. This oft quoted and completely false idea serves no one other than the banks, and least of all borrowers, who are the main drivers of the economy, be they retail or commercial.

When the borrowing market is opaque then all borrowers suffer, as lack of information leads to an increase in perceived risk.

If a bank doesn’t know the history of a borrower, it will be suspicious if the borrower is leaving their current bank and will then charge higher than market. Worse, borrowers become locked in to their current banks as switching to another which does not have access to their credit history is extremely costly. This gives the current lending bank monopolistic power over the borrower, regardless of classification and all borrowers are deprived of basic financial options. Viewed from a different perspective, if banks are expected to increase interest rates because of access to more information then clearly they have flawed risk assessment policies, as information, good or bad, should never increase interest rates over the scenario of no information. This is Risk Management 101.

Although this analysis at first brush would seem to indicate that the Credit Bureau faces tough challenges, the solution begins with understanding the global best practices role of a credit bureau. A credit bureau does not exist to serve the bank’s interest but rather to protect the end consumer, in this case the borrower. This points to a solution to the Credit Bureau’s challenges.

What is valuable to a borrower is his credit history. When a bank holds a borrower’s credit history hostage it borders on extortion. The first step for making the Credit Bureau an effective institution for the advancement of the UAE’s economy is to enact legislation that firmly assigns ownerships of a borrower’s credit history to its rightful owner: the borrower.

The second step is for the federal Government to make clear to banks that are benefiting from the Government’s explicit and implicit guarantees, that allow the banks access to cheap funding, that such support is dependent on the banks cooperating with the Government. This is similar to the rules in the US for participating in the Federal Deposit Insurance Corporation. Finally, the Credit Bureau should be empowered to fine banks a material amount for breaching its rules. Transforming the banking system from an opaque pricing model to a transparent and efficient one will improve the cost of borrowing, which will in turn help drive the economy.

The bottom line is that the Credit Bureau is in the best interest of the economy and the borrowers, and should be afforded the direct authority to execute its mandate.

Sabah al-Binali was formerly a senior banker at Union National Bank and was vice chairman of Gulf Finance Corporation. He is an active investor and entrepreneurial leader, with a track record of financing, building and growing companies in the Mena region

Sabah al-Binali - The National