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Credit Bureau Reporting in North American Financial Services Industry

Financial Services Industry is all about risk and return. This is as valid for lenders as it is for investors.

A Lender(or) a Creditor is a person or a financial institution that have provided some financial amount to borrower(s) (customer), which may or may not be backed by a security / asset, based on the policies and business model of the lender. Lender expects to earn the interest income through these lending arrangements. A borrower could be either an Individual or an Organization.

As can be interpreted from above, the underlying framework of the 'Financial Lending' is Risk and Return.

While interest earned can be easily attributed to the 'Return' factor; it is the 'Risk' associated with a lending arrangement (and borrower, ultimately) which impacts the lending behavior of the lender.

To identify the risk associated with a borrower - performance of the borrower on past loans, borrower's payment habits and information about any specific activities which can be of concern are the aspects which a lender is interested in. These key factors about the customer help the lenders forecast / predict the future performance of borrower and assessing the risk associated with the lending arrangement with the specific borrower(s).

With the knowledge of forecasted performance, risk assessed and the risk appetite; a lender can decide what kind of borrower portfolio is manageable and sustainable, and accordingly, a lender can decide to allow or deny loan to an interested party.

The information to help perform risk assessment is invaluable & of enormous importance to finance business. It has to be accurate and a true representation of past behavior of the borrower/customer. Also, of relevance is to remove bias and subjectivity from this analysis and have the analysis done on a comprehensive dataset through Statistics, and ensure that it is standardized, objective and 'acceptable-by-everyone'. Thus, the need of a centralized credit agency managing these aspects, recognized by Government and other Financial Regulators in USA was identified. This led to establishing Credit Reporting Agencies in early 19th Century.

As per the World Bank, the official definition of Credit Bureaus1 is - "A credit bureau is one of the two main types of credit reporting institutions. It collects information from a wide variety of financial and nonfinancial entities, including microfinance institutions and credit card companies, and provides comprehensive consumer credit information with value-added services such as credit scores to private lenders. Credit bureaus are privately owned and privately operated companies. As privately owned commercial enterprises, credit bureaus tend to cater to the information requirements of commercial lenders. Though there is variation in the type and extent of information they collect, credit bureaus generally strive to collect very detailed data on individual clients. They therefore tend to cover smaller loans and often collect information from a wide variety of financial and nonfinancial entities, including retailers, credit card companies, and microfinance institutions. As a result, data collected by credit bureaus are often more comprehensive and better geared to assess and monitor the creditworthiness of individual clients"

These Credit Bureau Agencies collate the financial and personal data of individuals along with other data which could be of relevance to lenders/financing business. As in USA, there is a limit to gather the personal / private information on individuals, only the fields specifically required towards Credit Reporting are collected by these agencies. The same has been detailed out in sections below. This data is processed through pre-defined (obviously well thought off, based on best practices and regression tested) mathematical algorithm to produce an unbiased, near accurate Credit Rating of the individual (or) an Organization. This information is provided on need-basis to the lenders, for use.

This document details out the Credit Reporting process associated with the individual borrowers although at a high level, it touches upon a few aspect of Business / Commercial Entities related reporting.

Credit Bureau Agencies in the USA

·         In USA, Credit Bureau Agencies can be categorized on basis of the data class they are mastering:

o   Consumer level or

o   Business / Commercial Entities level

CreditUnion.jpg

Functions of Credit Bureau Agencies

Aggregation of Data

·         As applicable for any Forecasting Model based on statistical analysis - the broader the sample size, more accurate is the forecasted behavior. The same is applicable in Financial Lending business as well and lenders strive to get correct and accurate information and information from as many sources as possible; so as to avoid or minimize risks.

·         While the sources of data can be enormous and different efforts / costs can be involved in extracting and processing the data, the Credit Bureaus have to identify the data sources which are most trust-worthy, have data on a wide variety of consumer and have been involved in providing credit to the borrower in past. These data sources are also knows as 'Data Furnishers'. 

·         In the U.S., following are typical Data Furnishers for Credit Bureau Agencies

Information / Data Type

Data Furnishers

Description

Personal Information (Name, Date of Birth, Social Security Number, Address) - Initial

Social Security Administration (SSA)

·         Typically, SSA office is the initial source of information for Credit Bureaus on individuals

·         This information is used by Credit bureaus to create a record for an individual using SSN, Name and DOB

·         However, on a stand-alone basis, this information is not of much use to Credit Bureaus as there is no financial information, payments habit here which can help prediction of future performance of an individual financially

Personal Information (Name, Date of Birth, Social Security Number, Address) - On-going

 

Financial Information (loan amount, duration credit taken for, payment behavior, missed payments etc.)

·         Creditors

·         Lenders (Registered Financial Institution)

·         Utilities (Electricity, Gas, Water) Companies

·         Renter Companies

·         Debt Collection Agencies (credit bureaus)

·         These data furnishers are the ones with whom the individuals have been in financial agreement or transaction in past or an on-going basis

·         These data furnishers provide some key information to credit Bureaus like:

o    Payment Rating and Payment History of the Customer

o    Loan/Credit Amount

o    Credit Utilization

o    Total Duration of Loan

o    Amount Paid

o    Balance on Loan

o    Delinquency (non-payment /payment misses) on account

o    Any derogatory action (like charge-off of loan, forceful repossession of asset etc.)

o    Ongoing Bankruptcy

Other Information of relevance

·         Social Security Administration (SSA)

·         Civil Courts (i.e. public records)

·         This information is used by Credit bureaus to consider changes to an individual's record in case of SSN, Name and DOB change

·         Public Access to Court Records (PACER) and Bankruptcy  courts give any information pertaining to filing of Bankruptcy by an individual to Credit Bureaus

·         These two sources can often provide information regarding Death of a consumer


Format for Data Acquisition

·         Due to the varied sources and to have a standard format for these Data Furnishers to report data; Credit Bureaus have laid down specified formats of Reporting. The formats being currently used are:

o   Metro

o   Metro 2

·         Metro 2 Credit Reporting guidelines and standards are the latest and most widely used format in which Data Furnishers provide their data to Credit Bureaus Agencies. It has been clearly defined in Credit Resource Guide and the same is updated on an annual basis to address common issues and any new updates. Use of these format(s) by the data furnishers ensures avoidance of inaccuracies in credit reporting, incorrect results and credit scores for individuals / consumers. 

·         Generally, data furnishers are supposed to generate the Metro 2 Credit Report every month accurately reflecting the activities of consumers with respect to their debt obligations and submit to Credit Bureaus.

 

Processing of Data

·         Credit Bureaus process the data through the set (internal) automated program to read the file and extract the data. Data about the specific individual from different data furnishers is compiled and ran through a standard pre-defined algorithm (proprietary to Credit Bureaus), the end result which is the generation of "Credit Score".

·         Typically, weighted average of these factors is considered for Credit Score calculation:

Captured below is a pictorial of typical factors considered in credit assessment of an individual

CreditScore.jpg

Figure 1: Factors used in Credit Score Calculation

Circulation of Credit Score and Other Credit Information

·         This resultant information computed by Credit Bureaus is available to requestors on a need basis.

·         Usually, the lenders who have been approached by consumer for a loan get a written consent from consumer for doing a 'hard inquiry' on their credit. Upon getting consumer's consent; the financing companies request this data from Credit Bureaus by passing on specific details of consumer including Name, SSN, and Address.

·         Individuals / consumers are also entitled to a free copy of their Credit Report from all Credit Bureaus (except Innovis) on an annual basis.

 

Other Aspects of Credit Bureau Reporting

This section enlists some of the other aspects related to the Credit Bureau Reporting which are of equal importance towards ensuring fair practices in Credit Bureau reporting industry and towards addressing consumer grievances.

 

Fair Credit Reporting Act (FCRA) and Fair and Accurate Credit Transactions Act (FACTA)

The guiding principles for the Credit Bureau Agencies and the data furnishers in USA towards consumer protections, acceptable practices and general rules are laid down by different acts and laws like:

·         Fair Credit Reporting Act (FCRA)

·         Fair and Accurate Credit Transactions Act (FACTA)

·         Fair Credit Billing Act (FCBA) and

·         Regulation B

There are two regulatory bodies formed by government to ensure that Credit Reporting Agencies and data furnishers are adhering to the above mentioned guidelines / acts and practices. These are:

·         Federal Trade Commission (FTC)

·         Office of the Controller of the Currency (OCC)  - specific to banks

 

The key principles through which all of the agencies / theories work are:

·         Accuracy and fairness of credit reporting

·         Reporting based on reasonable procedures which are fair, objective and equitable to the consumer

·         Utmost regard to be given to the aspects of confidentiality, accuracy, relevancy, and proper utilization of consumer information

 

Consumer Rights

It is recommended for consumers to review their credit reports on a regular basis or at least once every year.

·         Individuals are entitled to receive the Credit Bureau Report from Experian, Equifax and Transunion for free on an annual basis.

·         Apart from this, individuals have access to a lot of free websites which provide Credit Score information. These websites can be a good source for individuals to keep a watch on their credit score and any credit related alerts.

In case of any issue identified in their credit reports or any clarification required, individuals have the right to approach Credit Bureaus and seek clarification or raise dispute and get the correction done.

 

Credit dispute

There are different modes through which consumer can raise a Credit Dispute in case of any issues observed:

1)      Consumer can approach the Credit bureaus for getting clarification and raising dispute to get correction done

2)      Through external systems like e-Oscar, AUD or websites showing Credit scores like CreditKarma, Creditsesame, TrueCredit etc.

 

Typically, these credit disputes take a long time (2-3 months on an average and sometimes even 6 months!) towards resolution. A detailed follow-up is involved with the data furnisher and Credit Bureaus towards this. There are many instances where a consumer has sued the data furnisher or Credit Bureau upon identification of any inaccuracy in data or incorrect reporting of Credit Scores.

These lawsuits and very tedious and can prove costly for all the parties involve, so essentially, prevention is better than cure in these cases. This implies that, regular monitoring of Credit information is a key necessity from individual's perspective, to highlight any discrepancy as early as possible and get it corrected before any further impact happens due to this.


Skip Tracing

Skip tracing refers to gathering information about whereabouts of any consumer missing from a long time. Usually, the financing companies opt for skip tracing when they are not able to establish contact with a non-paying consumer through different means like:

·         Field Visit (leading to identification that consumer can no more be found on the addresses known)

·         Correspondences (leading to Return Email)

·         Phone calls (leading to no response or wrong phone numbers)


Many financial organizations take pro-active measures to keep the consumer information (home address, work address, home phone, cell phone, work phone and other details) up-to-date in their system of records. This avoids unpleasant scenarios like:-

·         Consumer skipping without making payments leading to charge-off of the account or

·         Consumer skipping while the asset couldn't be recovered / repossessed due to non-payment


Skip tracing services are a lucrative additional stream of revenue to Credit Bureaus who are gathering consumer data from multiple sources and thus creating a huge repository on individual's information.

Upon getting a skip trace request for specific individuals, Credit Bureaus can dig their databases and provide information regarding recent most addresses, phone numbers reported for the given consumers from other data furnishers. Having this 'probable' information on consumer's whereabouts can be helpful for Financing companies to "trace" the non-paying consumer and eventually secure their loaned asset or recover dues leading to minimization of losses.

Conclusion

Consumer credit information is not only a good tool to assess the credit worthiness of an individual; however, it also plays a significant role towards finalization of interest rates and other contract terms.  The credit reporting business is equally beneficial for Credit Bureau Agencies as well as financing organizations consuming the resulting information that can accordingly treat the consumer per the Credit History details and minimize the risk associated with the financing arrangement. Usually, the financing organizations consuming this credit information are also the data furnishers. Its benefits are not just limited to the Credit Bureau Agencies but for also Consumers with good credit history. Having Credit reports available and accessible to potential lenders; benefits consumers with better credit rating to easily avail loans at lesser interest rates. This benefit may have been lost without the existence of Credit Bureau Agencies

By having robust information-extraction and information-processing systems, financing companies stand to gain a lot in terms of better credit information which can help them take correct decisions and avoid potential credit disputes. 


References

1.       World Bank Definition of Credit Reporting Bureaus - http://www.worldbank.org/en/publication/gfdr/background/credit-bureau.

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