Opinion: China’s Economy Will Need Credit Scores and Well-Regulated Lenders
“Storm Clouds Are brewing for the Global Economy” the headline of the World Bank’s January 2019 Global Economic Prospects report says presaging tougher times ahead. International trade and investment have softened. Trade tensions remain elevated. In addition, risks are growing that growth could be even weaker than anticipated. With trade under pressure and the Chinese economy transitioning from investment-led to consumption-led growth, there are big expectations on the Chinese consumer.
Yet consumers are reining in their spending with lower car sales and slowing sales of consumer goods. Against this backdrop we are convinced, a well-functioning consumer finance regulatory framework will play the most significant role in stimulating economic development through consumption. According a historical comparison of the transition to consumption between 1941 and 1961, annual consumer spending in the United States for housing and cars more than tripled, in constant dollars. To buy these goods, many households relied on credit. By 1949, 49% of new cars, 54% of used cars, 54% of refrigerators, and 46% of TVs were being sold on credit. The history of consumer credit in the U.S. is that it drove consumption and hence gross domestic product (GDP), perhaps in can do the same in China.
There are a number of strategic issues for the industry that, once realized, could lead to a greater protection of consumers’ rights and safe and stable development of consumer finance delivered by licensed CFCs delivering greater GDP growth. This article will address three such issues, comprehensive regulation of all lenders regardless of form, the importance of a credit bureau to financial infrastructure, and finally the need for more cost-effective funding.
The first issue is the need for comprehensive and consistent regulation of all providers of consumer finance, regardless of their legal form. Trust is a prerequisite for a successful economy and a well-functioning financial services industry and that trust comes from a well-regulated industry.
Given the increasingly digital environment for financial products and services and the potential for digitalization to support greater financial inclusion and inclusive growth, the need for effective financial consumer protection is more important than ever. China is emerging as the world’s fintech market leader. With high levels of mobile penetration, China is already the world’s largest and most developed retail e-commerce market, and these digitally knowledgeably Chinese consumers are embracing fintech offerings, they must not be disappointed and lose faith in these new and innovative approaches.
Globally there have been attempts at light touch regulation for fintech providers but this has often ended badly. So whilst regulation ought not to stifle innovation policies, and approaches developed by financial consumer protection authorities should evolve and adapt in line with the environment, its core focus should be preserving trust by offering consumer protection through appropriate regulation and supervision.
Supervision needs also to be with a competent and experienced body. The CBIRC is an impressive and professional regulator and to ensure consistency they should be charged with supervision of all consumer finance providers.
The next strategic issue is the widespread availability of accurate credit information to ensure lending decisions are made on appropriate basis.
Credit bureaus are essential elements of the financial infrastructure.
Technology has allowed lenders to move from a subjective assessment to automated processes based on quantitative models. This shift to automation has allowed credit to become cheaper and much more widely available thus increasing financial inclusion. Credit bureaus are critical in helping lenders make faster and more accurate credit decisions. Credit histories not only provide necessary input for automated credit underwriting, but also allow borrowers to take their credit history from one financial institution to another, thereby making lending markets more competitive and, in the end, more affordable. Companies need a well-functioning credit bureau infrastructure.
The introduction of credit scoring in the 1950s in the United States — coupled with the automation of workflow and credit underwriting — played a key role in the rapid rise of consumer lending. Credit bureaus are characterized by economies of scale, and coordination among creditors is critical for operations to start up. In many cases, the strong support of supervisors as well as the willingness of government to provide easy access to public databases, are critical to enable credit bureau establishment.
With a proper credit bureau infrastructure people can get loans faster. Scores can be delivered almost instantaneously, helping lenders speed up loan approvals. Today many credit decisions can be made within minutes. Decisions are fairer. Using credit scoring, lenders can focus only on the facts related to credit risk, rather than subjective judgment. More credit is available. Lenders who use credit scoring can approve more loans, because credit scoring gives them more precise information on which to base credit decisions. It allows lenders to identify individuals who are likely to perform well in the future, even though their credit report shows past problems. Even people whose scores are lower than a lender’s cut-off for “automatic approval” benefit from scoring. Finally interest rates are lower overall. With more credit available, the cost of credit for borrowers decreases. Automated credit processes, including credit scoring, make the credit granting process more efficient and less costly for lenders, who in turn have passed savings on to their customers. And by controlling credit losses using scoring, lenders can make rates lower overall.
So in China it is imperative that all lenders contribute to the credit bureau and equally all lenders have access to the data so that credit can be provided responsibly, more widely available and at a lower cost. Of course legislation should carefully balance the ability of creditors to share information with the individual’s right for privacy and provide necessary protections on accuracy.
Finally the issue of funding. Most providers of consumer finance are not banks and so the must finance the loans they make from something other than customer deposits. This means resorting to the wholesale money market, the capital market and other providers of finance.
To ensure financial stability lenders need to have a robust, diversified and cost effective funding base. Studies of other countries highlight the importance of capital market funding for nonbank providers of consumer loans and we think it will be in the interest of all stakeholders to see the development of deep and liquid capital markets in China, especially for consumer finance funding. This will provide diversification and lower costs that can be passed on to consumers. The asset-backed securities market in China is currently heavily restricted and many participants consider there would be merit in allowing further issuance by consumer finance players for all types of loans, always within an effective regulatory framework. This step will be essential if the Chinese consumer finance market is to provide the scale of support to consumption that occurred in the United States on its journey to being a consumption led economy.
China is shifting its growth model to one relying more on consumption and less on investment. It is also urbanizing, aging and experiencing dynamic technological change. The history of other markets highlights the crucial role consumer finance plays in such a transition. With some adjustments consumer finance can help the Chinese consumer drive growth and enrich their lives.
Mel Carvill is a member of PPF Group’s top executive team and a member of the board of directors of Home Credit B.V.
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