1. 1 Assessing Infrastructure for Intermediation: Legal Framework and Credit Information Systems Thorsten Beck

2. 2 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

3. 3 Legal framework

4. 4 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

5. 5 Private Credit and Creditor Rights

6. 6 Private Credit and contract enforcement

7. 7 Legal framework - overview Financial sector legislation Corporate sector framework Collateral and creditor rights Insolvency framework Judicial system

8. 8 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

9. 9 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

10. 10 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

11. 11 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

12. 12 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

13. 13 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

14. 14 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)

15. 15 Legal framework: Cross-country comparisons Source: Doing Business project, http:\\rru.worldbank.org\doingbusiness

16. 16 Credit information systems

17. 17 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

18. 18 Private Credit and Credit Information Sharing

19. 19 Credit information systems - overview Institutions and sources of information Public vs. private registries Elements of a robust credit registry system

20. 20 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)

21. 21 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 Account No. Date Opened &Credit Limit & Payment Date ReportedPast Due History B of AXXXX1-1-2000$5,000 30 day - 1 6-1-2004$0

22. 22 Public vs. Private Credit Registries

23. 23 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

24. 24 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

25. 25 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.)

26. 26 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?

27. 27 Institutional Arrangements for Private Credit Registries

28. 28 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

29. 29 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

30. 30 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

31. 31 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

32. 32 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?

33. 33 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

34. 34 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.)