Disruptive T echnologies in the Credit Information Sharing Industry: Developments and Implications FINANCE, COMPETITIVENESS International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non-commercial purposes. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Directors or Executive Directors of the respective institutions of the World Bank Group or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. Because the World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrightsworldbankI T able of Contents TABLE OF CONTENTS I I Acknowledgments III Abbreviations and Acronyms V Executive Summary VII 1. Overview of Credit Information Systems 1 Introduction 1 Credit Reporting Ecosystem 2 Benefits of Credit Information Sharing 3 Credit Information Solutions Offered by the World Bank Group 4 2. Trends and Innovations in Disruptive T echnologies 7 Introduction 7 Proliferation of Big Data 8 Emergence of New T echnologies 10 Risks, Challenges, and Opportunities 12 3. Implications of Disruptive T echnologies on Credit Reporting 17 Evolving Credit Reporting Landscape: Firms 17 Evolving Credit Reporting Landscape: Models, Data Types, Sources, Ownership, and Privacy 19 Evolving Credit Reporting Landscape: Development 26 4. Regulatory and Supervisory Approaches to Fintech 29 Standards for Fintech and Alt Data 30 5. The Role of the World Bank Group 35 6. Conclusions 37 Annex. General Principles for Credit Reporting 39 Endnotes 41DISRUPTIVE TECHNOLOGIES IN THE CREDIT INFORMATION SHARING INDUSTRY: DEVELOPMENTS AND IMPLICATIONS II List of Boxes Box 1: What Is Big Data? 9 Box 2: Potential for Discriminatory Lending 13 Box 3: Risks and Challenges Associated with Big Data and Fintech 14 Box 4: Opportunities Associated with Adoption of Big Data and Fintech 15 Box 5: Alternative Lenders: Kabbage, Amazon, M-Shwari, CapitalFloat, and Pay-As-Y ou-Go Solar Markets 18 Box 6: Alternative Scoring Companies 20 Box 7: Psychometric T estsEntrepreneurial Finance Lab and Creditinfo 22 Box 8: Use of Open Data PlatformsBonify 23 Box 9 Distributed Ledger T echnologies and Biometrics in Credit Reporting 23 Box 10: Biometrics Uganda and India 24 Box 11: Fintech Laws and Regulatory Framework in the European Union, Switzerland, China, and Mexico 32 Box 12: Automated Data Collection in Austria and Rwanda 33 List of Figures Figure 1: Key Participants in a Credit Reporting System 3 Figure 2: Illustration of Structured and Unstructured Data 8 Figure 3: Four Vs of Big Data 9 Figure 4: New T echnologies Used in the Credit Reporting Industry 10 Figure 5: Risks, Challenges, and Opportunities of Using New T echnology in Credit Reporting 12 Figure 6: Types of Data Used for Credit Reporting 21 Figure 7: Countries with Regulatory Sandboxes 29 Figure 8: Guidelines for Policy Makers and Regulators to Address Fin T ech from the Bali Fintech Agenda 31 List of T ables T able 1: Benefits of Credit Information Flow to Different Stakeholders 4 T able 2: IDC Financial Insights Fintech Ranking List 25 T able 3: Potential Development Impact of New Data T echnologies, Products, and Models 27 T able 4: World Bank Groups Role in New Data T echnologies 36ACKNOWLEDGMENTS III Acknowledgments This note is a product of the Financial Inclusion, Infrastructure and Access Unit in the World Bank Groups Finance, Competitiveness and Innovation Global Practice. This discussion note was prepared by Luz Maria Salamina (lead financial sector specialist), Pratibha Chhabra (operations officer), Shalini Sankaranarayan (senior financial sector specialist), and Collen Masunda (financial sector consultant), and the work was carried out with the support of the credit reporting team of lead specialists: Oscar Madeddu, Colin Raymond, Fabrizio Fraboni, and Hung Hoang Ngovandan. The note also benefited from the peer reviewers Matthew Saal (lead financial sector specialist, World Bank Group), Emma Thomas (head of government and public affairs, UK thus they are important for job creation and economic growth. And yet, according to the World Bank Groups SME Finance Forum, 2 65 million or 40 percent of formal micro, small, and medium enterprises (MSMEs) in developing countries have unmet financing needs. The MSME finance gap in developing countries is estimated to be $5.2 trillion or approximately 1.4 times the current level of MSME lending, and women-owned businesses comprise 28 percent of MSMEs and account for 32 percent of the MSME finance gap. Improving access to financial services plays an important role in reducing the worlds poverty levels and increasing shared prosperity. Financial inclusion is aligned with the World Bank Group (WBG) commitment to reduce poverty, increase shared prosperity, and promote sustainable development. Recognizing the transformational potential of financial inclusion for economic development, WBG and partners put forward an ambitious goal of universal financial access by 2020. 3 Credit information systems (CIS) help ensure financial stability by enabling responsible access to finance. They also can play an instrumental role in expanding access to credit and other services on credit to the underserved and unbanked. CIS facilitate lending processes by providing objective information that enables lenders to reduce their portfolio risk, reduce transaction costs, and expand their lending portfolios. By doing so, credit reporting systems enable lenders to expand access to credit to creditworthy borrowers, including individuals with thin credit history, microentrepreneurs, and SMEs. 4 The world is becoming increasingly digitized, and that development has led to an explosion in the different types of data, technologies, and products available. From artificial intelligence to cryptography, rapid advances in digital technology are transforming the financial services landscape, creating opportunities and challengesDISRUPTIVE TECHNOLOGIES IN THE CREDIT INFORMATION SHARING INDUSTRY: DEVELOPMENTS AND IMPLICATIONS VIII for consumers, service providers, and regulators alike. The Bali Fintech Agenda developed by the International Monetary Fund (IMF) and World Bank defines fintech as “the advances in technology that have the potential to transform the provision of financial services spurring the development of new business models, applications, processes, and products. 5 These fintech developments also have implications for the credit reporting industry. The industry itself, the product of years of evolution in response to market needs, has already been gradually adapting and leveraging these new developments to better serve market needs and enable greater financial inclusion. The use of alternative data and the digitalization of consumer and SME finance represent a large opportunity to expand access to finance to unserved and underserved market segments. 6 A rapidly growing crop of technology- focused consumer and SME lenders and analytics providers (“fintechs”) are putting the use of consumer and SME digital data, customer needs, and advanced analytics at the center of their business models, setting forth new blueprints for disrupting conventional consumer and SME lending. The credit reporting industry has always provided cutting-edge technology, and innovation remains at the core of its business. Most of the traditional providers of credit reporting systems are in fact listed as top-ranking fintechs. Yet the spread of new credit providers and the proliferation of potentially credit-relevant data from nontraditional sources put pressure on this ability to innovate as well as on the core business model of aggregating credit data from financial service providers. Principle 4 of the G20 High-Level Principles on Digital Financial Inclusion recognizes the role that financial information infrastructure and services play in expanding the safe, reliable, and low-cost provision of digital financial services, particularly for underserved rural areas. Specifically, it advocates for the establishment and responsible use of flexible, dynamic credit reporting systems modeled on best practices as outlined by the International Committee on Credit Reporting (ICCR). It also encourages the use of innovative data sources in CISs, such as data on utility payments, mobile airtime purchases, data on digital wallet or e-money accounts, and e-commerce transactions, keeping in mind consumer data protection and privacy rules as well as consumer identification systems. 7 Within this context, this note analyzes the evolution of CISs, including the emergence of new technologies that use alternative data in credit decisioning and the opportunities and risks associated with these trends. This paper also predicts the potential development effect of these disruptive technologies and proposes a role for the World Bank Group in leveraging these technologies to promote inclusion and stability.1. OVERVIEW OF CREDIT INFORMATION SYSTEMS 1 Overview of Credit Information Systems 1. Introduction Well-functioning financial markets contribute to sustainable growth and economic development, because they typically provide an efficient mechanism for evaluating risk and return to investment, and then managing and allocating risk. Financial infrastructure is a core part of all financial systems. The quality of financial infrastructure determines the efficiency of intermediationthe ability of lenders to evaluate risk and of consumers to obtain credit, insurance, and other financial products at competitive terms. Credit reporting is a vital part of a countrys financial infrastructure and is an activity of public interest. 8 Comprehensive credit reporting systems contribute to increased financial inclusion, responsible finance, and financial stability. Credit reporting addresses a fundamental problem of credit markets: asymmetric information between borrowers and lenders, which may lead to adverse selection, credit rationing, and moral hazard problems. Regulators and financial market participants therefore increasingly recognize the value of credit reporting systems (CRSs) to improve credit risk evaluation and overall credit portfolio management, to enhance financial supervision and financial sector stability, and as a tool to enhance access to credit. According to the World Banks Doing Business 2018, 9 approximately 134 countries of 183 countries surveyed had either a credit bureau or a credit registry at the end of 2016. The credit reporting industry has experienced unprecedented growth since 2000, especially in emerging markets. This growth was driven by several factors: High growth of retail credit in emerging markets. Between 1985 and 1995, unfavorable macroeconomic environments and structural restrictions in credit markets in emerging economies constrained credit growth. With the rapid increase in the provision of credit as well as entrance of new types of lenders in the retail credit market, the need for credit information and for streamlining lending processes grew, leading to the establishment of CRSs and greater demand for these types of reforms. Broad reforms stemming from the financial crisis. The 2008 financial crisis provided major impetus for broad reform efforts at the national level as authorities in developed and emerging markets realized the need for strengthening and improving financial infrastructure, including CRSs. The introduction and rollout of the Basel III accords, which raised the capital provisioning requirements forDISRUPTIVE TECHNOLOGIES IN THE CREDIT INFORMATION SHARING INDUSTRY: DEVELOPMENTS AND IMPLICATIONS 2 banks, also underlined the need for more stringent risk assessment and management frameworks. That need, in turn, has motivated an interest in developing or reforming credit registries to collect credit data that can support both micro and macro prudential supervision and regulation. Innovation in the credit reporting space. Since they first emerged, credit bureaus have always leveraged new technologies and innovations to improve efficiency, lower the cost of financing, increase the speed of service, and improve the quality of the information provided to the users of these services. In other words, the credit information sharing space is no stranger to disruption. The earliest disruption in credit markets can be traced to the 1950s, with the introduction of credit scoring and the automation of workflow and credit underwriting processes by CRS providers. During the 1970s, the industry harnessed the power of mainframe computers and databases to process, organize, and report on credit data and realized tremendous operating efficiencies that enabled them to process data faster and attract more business. Automated lending solutions. Given the volume of decisions often required to manage a typical credit retail portfolio (such as grant or reject facility, over-limit authorization, cross-sell or up-sell strategies, and past due action required), lenders in developed credit markets have turned to automation to maintain efficiency. However, raw data in the form of a credit report can be extremely difficult to integrate into such systems. For more than 30 years, credit bureaus have been providing automated lending solutions that eliminate the need for tedious manual sorting of paper and electronic files and that reduce the costs associated with such processing. Hub-and-spoke solutions. Another key innovation in the credit reporting space was the development of hub-and-spoke solutions. With the improvements in database management software and the decreasing costs of storing and processing dataas well as the decreasing costs of hardwarecredit information service providers introduced hub and spoke models, which leveraged economies of scale and increased the level of security in using a single solution to serve multiple markets. Markets with