Access to finance for the informal sector

In developing countries like Bangladesh, much of the population is employed in the informal sector. Most of the self-employed as farmers, household-based entrepreneurs with small retail shops, street vendors, artisanal manufacturers, or other service providers are in informal sector. These small enterprises in don’t have not documented source and even no steady source of income. Moreover, poor households are lacking collateral—or the right type of collateral, or the proper legal documentation—against which financial institution (FI) can secure credit. Lenders often lack the necessary information to assess the creditworthiness of potential customers, including a lack of reliable and unique identification for individuals and businesses. As a consequence, many MSMEs remain out of bank credit.

The alternate option is to lend against credit report (CR) of these informal business enterprises. CR can at least supplement the physical collateral with reputational collateral. There are some lenders come up with credit to traders against collateral of sales documents without physical collaterals. CR can reduce information asymmetry, thus reducing default rates, which in turn should result in lower average interest rates, enhanced competition in the credit market, and ultimately increased access to credit. Through CR information and the tools derived from it (e.g. credit scores), creditors can better predict future repayment prospects based on a debtor’s past and current payment behaviour and level of indebtedness, among other factors.

Credit reporting service providers (CRSPs) can perform the crucial functions of gathering and distributing reliable credit information, improving creditor protection, and strengthening credit market. CR commonly contain business registration or incorporation number, firm name and taxpayer identification number (TIN) to identify a firm, firm’s physical address, the names of the firm’s owners and legal entity identifiers. It may also include additional identifiers such as the date of a firm’s registration, its field of business activity, activity statuses and the legal form of ownership.

CR addresses a fundamental problem of credit markets such as: asymmetric information between borrowers and lenders, which may lead to adverse selection, credit rationing, and moral hazard problems.  The availability of such data can help potential lenders to assess past borrower behaviour and to extend credit to small firms. A recent study shows that credit reporting is associated with the improved availability of credit and lower credit costs, especially for opaque firms such as SMEs and those operating in economies with weak legal environments.

One of the Doing Business studies revealed data from CRSPs in 190 economies and identified four elements that contribute to improving the quality and scope of credit reporting for MSMEs. These four elements are: (1) identifying MSME borrowers to link them to the credit data available to CRSPs; (2) integrating alternative sources of data—in addition to banks and regulated financial institutions—in credit reporting; (3) expanding the types of information available on MSMEs, including their field of activity, financial standing, and financial and non-financial obligations; and (4) customizing specific products that target the MSME sector.

CRSPs face several obstacles when linking credit data to the relevant SME. First, CRSPs receive identification information—such as the firm’s taxpayer identification number or corporate registration and incorporation number—directly from the lender, which has obtained this information from the MSME.

The preparation of CR to increase access to finance for SMEs presents unique challenges. The first principle of the World Bank’s General Principles for Credit Reporting is that “credit reporting systems should have relevant, accurate, timely and sufficient data—including positive—collected on a systematic basis from all reliable, appropriate and available sources.” It is more challenging to properly identify and collect adequate financial and credit data on SMEs compared to larger firms. The sufficient collection of data is essential to ensure that CRSPs produce comprehensive credit reports on MSMEs.

Depending on the legal and regulatory framework of an economy and the availability of public data from different sources, CRSPs are not always able to cross-check the accuracy of the identification data against databases administered by the respective public agencies.

SME identification numbers such as BIN, TIN etc due to closure and re-opening of a firm under a different name is very important information. Some of these small entrepreneurs are reluctance to register their enterprises with appropriate authorities due to avoid the formalities and don’t foresee any advantage of registration. These authorities are unable to collect data on the history of those MSMEs.

Bangladesh has National Identification Number (NID), which was a voter ID initially and now used as NID. It has many incorrect information and all the citizens are yet to cover under this program. Using NID and correctly mentioned name in it can also help to identify a firm correctly. CRSPs can link the credit files of proprietors or directors with credit obtained in the MSME’s name may reduces the probability of incorrect firm identification. By this time, Bangladesh government curtailed many services for citizens without NID. Now no citizen can open Bank account without NID. The property law has been changed and no person can own property without Tax Identity Number (TIN). Other individual identifiers used by CRSPs include the borrower’s place and date of birth, their profession and the names of their parents and spouse. The telephone department, social clubs and even some business conglomerates of goods and service are maintaining data base of customers. CRSPs can easily check authentication from Election Commission and Tax department and these business houses.

Private and public entities that extend credit to MSMEs have payment information that can help other parties to assess a firm’s creditworthiness.

The most common creditors in the developed markets for small firms include commercial banks, other non-bank financial institutions and credit card issuers. Even for SMEs that do not have a traditional banking relationship, real-sector companies (such as suppliers that provide trade credit) and non-financial creditors (such as retailers and utility providers) can provide valuable information on a firm’s repayment history, allowing potential lenders to assess their creditworthiness. In many countries, some entities also collect and compile court judgment data and sell them to CRSPs to complement the data collected under reciprocity arrangements. These “non-traditional” sources of data—such as data on payments associated with finance corporations and retailers—bolster information on thin-file clients who are not typically covered by banks and other regulated financial institutions.

CRSPs also report credit information from utility providers in 59 economies. The majority of these are in Latin America and the Caribbean and the OECD high-income economies.

In the United States, DTE Energy—an electricity and natural gas company—began fully reporting customer payment data to three major credit bureaus—Experian, Equifax and Innovis—in August 2006. DTE customers with no prior credit history (8.1 per cent of the total) gained either a credit file or a credit score31 simply by making their monthly DTE billpayments. Within six months DTE had 80,000 fewer accounts in arrears. In the United Arab Emirates, the credit bureau “Emcredit” signed an agreement with the Dubai Electricity and Water Authority and began exchanging data in 2013. The utility provider shares a list of those customers with accounts more than 90 days overdue with the CRSP and can access the CRSP’s bounced check repository. Creditinfo Guyana, the country’s first credit bureau, began collecting data from Guyana Water Inc. and other alternative dataproviders shortly after its launch in 2015 and expanded the CRSP’s coverage from 2.4 per cent of adult population in May 2015 to 16.4 per cent in January 2016.

Around the world, 113 of the 190 economies covered by the Doing Business database have at least one CRSP that reports repayment histories from finance corporations and leasing companies. The OECD high income group has the highest proportion of such economies (88 per cent) while Sub-Saharan Africa has the lowest (33 per cent). Leasing and credit reporting can help to facilitate greater SME financing, even in the absence of well developed institutions. In Romania, 29.6 per cent of SMEs used leasing as a source for financing economic activities (the credit bureau, Biroul de Credit, receives leasing data from 25 finance corporations), followed by self-financing (64.4 per cent) and bank loans (51.1 per cent). In Tanzania, the credit bureau “Creditinfo” expanded the “Creditors Network”—an alliance of creditors that share information about their customers’ payment behaviors—to include vehicle leasing and rental companies; its coverage increased from 0.6 per cent of the adult population in 2014 to 6.2 per cent in 2017. In Taiwan, China, the Joint Credit Information Center (JCIC) released the “R04 Finance Leasing Information” in February 2014—a mechanism that takes data from the finance leasing association and reports on entrepreneurs’ leasing transaction information to other potential lenders.

Bangladesh may formulate policies to use these sources to in credit reporting systems. There may be even legal framework like some other some economies to allow the sharing of information from non-traditional sources and authorised CRSPs to prepare CR for MSMEs.

Bangladesh has few credits rating companies but the CR is not effective for financing of SME because of formats of report and also acceptability to financial institutions. The CR should be mandatary for accepting as replace of mortgage under legal framework in order to finance MSMEs.

The writer is a legal legal economist. He can be contacted at mssiddiqui2035@gmail.com