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1 ACCESS INNOVATION GROWTH Visa International - Korea Credit Bureau Study Building a sustainable consumer finance industry in Korea : The Role of Credit Bureaus July 2004

2 ACCESS INNOVATION GROWTH Welcome The payments industry in this country has come a long way in a relatively short time. All of us in the industry recognize that there are problems associated with the unsustainably rapid rate of growth in recent years, but as we address these, we should not lose sight of some very real achievements. Korea has established a substantial consumer and business-tobusiness electronic payment system that embraces some of the most technologically advanced features of any market in the world. In the same way that some of these solutions are being adopted in other markets, so we have to continue to learn from other countries how best to manage the future development of our own industry. This report is a contribution by Visa to one of the most pressing challenges facing our industry - the adoption of an efficient credit bureau industry that can serve the interests of all parties in the system. Credit bureaus lie at the heart of sound lending practices and benefit not just lenders but also borrowers offering wider and diversified access to broader segments of consumers. Furthermore, the growth of the overall economy depends largely on lenders' abilities to sustain financing while managing risks efficiently and effectively. As the report details, there is no one solution that fits all markets. Visa's experience in working with members, merchants, regulators and cardholders in more than 150 markets teaches us that while it is immensely valuable to transfer knowledge between markets, solutions have to recognize particular local circumstances. Encouragingly, we have seen real progress in recent months as all parties in the industry have worked together to address close to four million credit delinquent consumers and large credit losses. There is still much to be done, but Visa offers this report as a contribution to the urgent and important discussions that must be had to define and resolve the issues and legitimate concerns of all interested parties in quickly establishing a strong credit bureau industry. We look forward to playing our full part in the discussions that lie ahead. YC Kim Country Manager Korea Visa International If you have any feedback on this publication please apcorpcom@visa.com Visa International Oriental Chemical Building 19F 50, Sokong-Dong, Chung-ku Seoul, Korea

3 ACCESS INNOVATION GROWTH Contents 1 Introduction 1. Introduction 1 2. Executive summary 3 3. The Korean market 7 4. The Role of credit risk management Selected country experiences Recent experiences in establishing bureaus Implications for Korea Direction for Korea Transition considerations Benefits of change Appendix 43 Appendix A - International markets 43 Appendix B - Selected country experiences 45 Appendix C - Glossary 52 Appendix D - List of references 53 Since the country s currency crisis, Korea s economy has experienced a significant influx of both influential business practices and capital. This has resulted in a return to strong GDP growth. A slowdown in global demand in 2000 began to place pressure on Korea s export-driven growth and in response, Korea looked to alternative means to ensure growth momentum. Increasing consumer credit, in particular unsecured, card-based credit emerged as a primary policy option. Both the government and finance industry pursued strategies to grow consumer debt aggressively. However, as consumer credit trended quickly upward, there was a marked increase in delinquent loans. The industry reached a critical point in 2003 as delinquency increased and consumer income fell. LG Card had to seek capital bailouts from parent companies, creditors and the government. Korean regulators reported that the number of consumers classified as credit delinquent 1 had risen to 3.7 million individuals an all-time high. The drivers of Korea s recent credit performance are interdependent and include: Significant industry-focus on the aggressive growth of consumer debt Weak credit risk management practices The absence of credit bureau services Ineffective management of cross-institution limits and exposures due to limited information sharing High growth in unsecured consumer debt as a percentage of consumer income, combined with limited consumer experience in debt management Government promotion of consumer spending on cards through tax incentives 2 A propensity to issue charge cards over credit cards A slowdown in GDP growth driven by slower global demand 1 The law classifies a borrower who has KRW 300,000 overdue for over 90 days as a credit delinquent. Payment becomes overdue if it is not made by the payment date specified on the monthly statement. 2 The Korean government sought to promote consumer debt to respond to a slow down in export led growth (boost private consumption), and reduce tax fraud among merchants. This policy also served to migrate risk away from the weakened corporate sector. 1

4 ACCESS INNOVATION GROWTH 2 Executive summary This document addresses the absence of effective credit bureaus in Korea, and will answer two fundamental questions: How can a Korean credit bureau environment benefit all of its stakeholders? What s needed to facilitate this progression? Credit bureaus collect information about individuals and/or companies from lenders and other sources. A bureau collects this information to provide a consolidated view of an individual or company s credit performance. The information is provided to potential lenders in the form of a credit report and/or credit score, which gives them a better understanding of the borrower s credit history and behavior prior to making a decision. Bureaus add value by connecting the maximum number of lenders with the right levels of information, and provide additional insight from basic information. The basic business model is depicted graphically in illustration 1. Participation Other Non-finance Telcos & Utilities Other Finance Card Monolines Banks Information Providers Illustration 1 Basic credit bureau business model aggregation and supply of information Aggregation and Insight Credit Bureaus Information Users Other Non-finance Telcos & Utilities Other Finance Card Monolines Banks Penetration Korean market Korea has historically operated a fledgling credit information infrastructure consisting of industry associations and intra-sector information sharing. Over the last two years, the private sector has entered the market and accelerated improvements in the information sharing model. Current Korean regulation is not a constraint to effective information sharing, but regulators may be able to play a role in fostering competitor collaboration. The industry shares information on three planes: Mandated information from the financial services sector to the Korea Federation of Banks (KFB) and from there to the credit bureaus Intra-sector information sharing through industry associations or small groups of companies Additional information sourced by credit bureaus from the industry through private commercial contracts A review of the current credit risk management capabilities in Korea, in comparison with international experience, shows that there are significant opportunities for improvement. Implications for Korea International comparisons suggest that Korea s credit reporting market and credit risk management practices are behind the US. Unless Korea improves its present credit reporting infrastructure, it runs the risk of falling behind emerging Asian benchmarks as well. The main roadblock preventing Korea from developing a highly effective bureau industry is the level and quality of information shared among lenders. The Korean regulatory framework requires financial institutions to provide limited information to the KFB: When compared with other countries, and what is required for more effective credit risk management, this mandatory information is clearly insufficient for effective risk management. There is inconsistency in the information available across industry sectors. For example, the larger credit card companies share short-term delinquency information, but this data is not made available to the rest of industry. Bureaus are looking at ways of opening the flow of information by establishing private contracts with lenders. The challenge with this approach is that the type, depth and format of information are subject to private negotiations rather than being agreed industry standards. A combined effort from stakeholders, credit providers, credit bureaus, consumers, and regulators is important for the urgent task implementing key credit bureau capabilities in an acceptably short timeframe. It is important for all parties to work together to manage and accommodate differences in objectives and expectations. 2 3

5 Executive summary Executive summary Direction for Korea The development of an enhanced credit bureau structure for Korea must take into account the current market conditions and ensure acceptance from all key stakeholders. This report provides five guiding principles: 1. A commercially viable business model 2. Clear acceptance by all stakeholders Primary Change Agent Regulator Illustration 2 Target changes in Korean capabilities Information Quality Cross-Sector Participation Regulatory Facilitation Industry Sophistication of Lenders Market Forces Bureau Value Added Usage Penetration Efficiency of Infrastructure Operating Environment Ownership Structure Cross-Sector Participation 3. Protection of consumers rights and respect for individual privacy 4. Willingness for change in current industry positions and practices 5. Encouragement of free competition within the regulatory environment We believe that effective progress can be achieved by focusing on four key capabilities: information quality, sophistication of lenders, cross-sector participation and regulatory facilitation. Sophistication of Lenders Regulatory Facilitation Efficiency of Infrastructure Information Quality Market Sophistication Service Capability Bureau Value Added Usage Penetration Value added to economy Illustration 3 Possible transition path for evolution of credit bureau industry Korea 1995 Phase I Phase II Korea Today Time Phase III The adoption of an effective credit bureau is likely to occur in three-phases. The first is most likely to focus on achieving domestic efficiency, international standards and quickly enhancing the quality in the information exchange. We believe initial regulatory assistance can lead to a swift improvement in the quality of information and an increase in cross-sector participation. The second phase is likely to focus on a coordinated industry effort to improve credit risk management capabilities and to ensure that the benefits of increased information are realized. Consumers will also need to be educated on what an improved credit reporting environment means to them. The final phase would be primarily concerned with ensuring the sustained development of the Korean bureau market. Phase I Regulators lead a drive to expand the minimum industry information model bearing in mind the requirements of all stakeholders Phase II Industry commits to implementation of the information model, a prudent credit practices framework and consumer education Phase III Market forces ensure the industry capability continues to evolve without formal coordination from regulators or industry Transition considerations Information model: Expanding the position of positive and negative data is an industry priority. Any interim solution needs to be agreed in the context of longer-term commitments. One way to increase information depth and consistency is to increase the mandatory information provision requirements currently managed by the KFB. Improved cross-sector participation will also be critical. Competitive concerns: All lenders should be granted equal access to credit information on a reciprocal basis. The way this information is captured and the shape it takes when presented to lenders may offer an interim solution to encourage industry collaboration and consistent participation. 4 5

6 Executive summary ACCESS INNOVATION GROWTH Access to credit: As access to credit information improves, the industry must ensure that the economy does not experience a sudden fall in credit availability. Credit risk management (CRM): The industry needs to develop adequate credit risk management capabilities internally that can accommodate changes to the bureau environment. Lenders with the most sophisticated CRM will realize the greatest benefits from improved credit information. However, it is important to note that the prevalence of charge and conventional credit cards in Korea is exacerbating the incidence of delinquency across the industry. Consumer participation: Regulators must balance the demands of individuals rights against the need for effective information sharing. International experience supports the provision of credit information without specific consumer consent when the request is for credit purposes only. However, consumers interests cannot be ignored in the development of such a policy. Options to achieve this include running education programs and involving consumer groups in a consultative process as the industry processes are determined. Industry structure: While there are a number of alternatives that can be considered, we are unaware of a compelling argument that would indicate the current structure is a constraint to competitive market evolution. Benefits of change All industry stakeholders will see significant benefits of an enhanced bureau industry - credit bureaus increase the accuracy of lending decisions, the availability of credit to the economy, and reduce the size and frequency of delinquency. These outcomes ultimately increase the stability and growth of consumption and corporate profitability. Consumers will benefit from: Pricing that more accurately reflects their individual circumstances Improved access to credit, based on a better understanding of their financial position Greater understanding of the need to manage their credit Rewards for enhanced credit behavior over time Lenders will: Be in a better position to measure and price the underlying risk of a given account Increase segment specialization and access the capabilities necessary to lend responsibly to broader risk segments Enhance credit risk management practices in line with leading global practices Bureaus will: Gain access to enhanced information, enabling improved services, increased user demand, improved economies of scale and ultimately more development capital for reinvestment Regulators will: Gain access to more accurate and timely data regarding the state of the consumer finance market Face a reduced likelihood of significant industry delinquencies and the need to bail out or recapitalize domestic lenders Be able to respond to changes and trends more proactively Manage a fundamentally less volatile lending environment 3 The Korean market Korea has historically operated a fledgling credit reporting infrastructure, consisting mainly of industry associations and intra-sector information sharing. Over the last two years, the private sector has entered the market and improved the information sharing model. The two specialist industry players today are National Information & Credit Evaluation (NICE) and Korea Information Service (KIS). There are no known restrictions on new entrants to the credit reporting market. The essential regulatory framework is in place and is currently being reviewed by regulators. The current information model shows that the industry shares information on three planes: 1. Mandated information from the financial services sector to KFB and then to the credit bureaus 2. Intra-sector information sharing through industry associations 3. Additional information sourced by credit bureaus from the industry through private commercial contracts A review of the current capabilities in Korea based on international experiences shows that there is room for improvement. The ongoing credit crisis in the consumer segment has created a sense of urgency, both within the industry and among regulators, to enhance these capabilities in the near term. Today s Korean credit bureau business represents only a minor portion of the credit information industry, although the industry expects significant development in the coming years. Korea s first privately operated credit bureau was established in 2002 andit is only recently that the credit information industry has begun to view a fully functioning credit bureau business as a strategic growth opportunity for both the industry and the economy. Key players The Korean credit bureau environment consists of five major stakeholders: consumers, industry participants (suppliers and buyers of information), industry associations, credit information companies and regulators. 6 7

7 The Korean market The Korean market More than 5,000 financial institutions currently provide mandated credit data to KFB Consumers Industry Participants Industry Associations Credit Information Companies Regulators Illustration 4 Korean credit information structure Retail Bank Korea Federation of Banks (KFB) Credit Inquiry Business Ministry of Finance & Economy (MOFE) Card Company Korea Non-Bank Financing Association Industry participants mostly include financial institutions such as retail banks, other banking institutions, credit card companies, consumer finance companies, and insurance companies. A number of nonfinancial institutions such as department stores with merchant credit and mobile service providers with customers bill payment histories also actively participate in this market. At present, these institutions share only limited information with the credit bureau industry. This has been identified as one of the key industry challenges that needs to be overcome. The industry associations collect mandatory information from their members. The most influential is the Korea Federation of Banks (KFB), a non-profit, industry-owned organization. More than 5,000 financial institutions in Korea report the regulatory mandated minimum set of credit information to the KFB, including data on personal CONSUMERS Consumer Finance Credit Investigation Business Financial Supervisory Service (FSS) Telco Korea Association of Information & Telecommunication Others Others Debt Collection Business Financial Supervisory Commission (FSC) details, credit transactions and credit delinquency. This data is made available to the participating financial institutions as well as to private credit bureaus with the credit bureau industry currently relying heavily on this data set. With the exception of the Korea Non-Bank Financing Association (KNFA) and the Korea Association of Information & Telecommunications (KAIT), industry associations do not actively participate in the collection of credit information. The KNFA only collects credit card usage information on consumers who hold four or more credit cards. The KAIT collects payment default information on fixed line, wireless, Internet access, and cable TV services. While there are six companies licensed to operate credit bureaus, only National Information & Credit Evaluation (NICE) and Korea Information Service (KIS) currently operate consumer credit bureaus. NICE and There is a basic mandated set of credit data that the financial services sector has to provide to KFB. KIS are the most active participants in the industry. KIS launched Korea s first credit bureau, KIS CB, in February 2002 and started its first credit bureau service in May It had 48 data-sharing member institutions by the end of NICE followed shortly afterwards, starting its first credit bureau service in November 2002, and has developed the largest number of data sharing member institutions, with 111 by the end of In April 2004, Kookmin Bank, LG Card, Samsung Card, Woori Finance Holdings and Seoul Guarantee Insurance signed an agreement to open a joint credit bureau. Although the deal remains subject to government approval, it represents a move toward greater intra-sector information sharing. This is positive for the long term stability of Korean credit markets and helps address the information sharing barriers that have existed to date between card companies and banks. However, to be more effective and to fully address weaknesses within today s system, the bureau needs to provide equal access to consistent information for all lenders and require lenders to provide credit information in exchange for access to bureau information. Information framework The Korean credit bureau industry has two different levels of information sharing. The government regulates the first level, which ensures the collection of basic information. All financial institutions are obliged to provide required credit information to the KFB on a regular basis. At the second level, private credit bureaus collect additional information from financial and non-financial institutions based on commercial contracts. The private credit bureaus aggregate these two complementary sources to improve the completeness of information. All regulated lending institutions are required to report three types of basic credit information to the KFB: personal identification, credit transactions and credit delinquencies. Credit transaction information includes only the borrower s current status (total amount and date). It does not show the borrower s payment behavior, credit limits or other positive information. The delinquency information only indicates whether or not the borrower is categorized as a credit delinquent under the current regulation. The law classifies a borrower who has KRW 300,000 overdue for over 90 days as credit delinquent. This basic data consists of both positive and negative information but lacks substantial detail in either category. 8 9

8 The Korean market The Korean market Identification Information Name Address Citizen ID number The existence of a Citizen ID number facilitates fast, cost-effective matching Financial Institutions Korea Federation of 1 Banks (KFB) 2 Credit Bureaus Credit Transaction Information Illustration 5 Mandatory information reported to the KFB Current status of loan & guarantee Date opened Total amount Status of bank & credit card account Open / Close status Current status of credit card cash advance Total amount Delinquency Information Credit Delinquent status Credit delinquency Payment guarantee delinquency Public record delinquency (e.g. tax) Disturbance of financial system (e.g. fraud) To supplement information collected by the KFB, private credit bureaus develop commercial contracts with industry participants to build more comprehensive credit information databases. Under these private arrangements, the credit bureaus share more detailed information including transaction information and short-term (less than 90 days) delinquency information with Limited Positive Information (e.g. no payment history, no existing credit limit) Limited Negative Information (e.g. no short-term delinquency information) banks and other lenders. The major contributors to this information sharing among non-financial institutions are department stores with large merchant credit accounts. Unfortunately their default/delinquency information is only collected by the private credit bureaus, not the KFB. This is shown in Illustration 6. Illustration 6 Credit bureau information flow Non-Financial Institutions While the additional information submitted by non-financial institutions augments the information that the credit bureaus provide, its uncoordinated nature represents one of the major stumbling blocks in the development of credit bureau services in Korea. Some other challenges of note are: By the end of 2003, NICE had 161 participating member institutions, of which 111 were data sharing members. KIS had 85 participating member institutions, of which 48 were data sharing members. More importantly, their data sharing members were not reporting the same sets of data, and most of the data reported was negative information. 3 4 Individual Contracts Individual Contracts As the collected data sets are based on commercial arrangements, the actual data points collected are proprietary, preventing this study from accurately evaluating the effectiveness of cross-sector information sharing today. The five major credit card issuers in Korea have had minimal participation with regard to sharing information, particularly on short-term delinquencies. A successful credit information industry is based on fairness, standardization, accuracy and reciprocity. While there has been substantial progress made by credit bureaus and the industry, as long as selective participation and data sharing exists, overall industry effectiveness will be compromised

9 The Korean market The Korean market With the increased need for adequate credit reporting mechanisms, regulators are in the process of strengthening the current regulations Regulatory framework The Usage and Protection of Credit Information Act (the Credit Information Act) ensures fair usage of credit information and protection of privacy. The current Credit Information Act has three main sections that are relevant to the credit bureau environment: Collection, investigation and processing of credit information Distribution, usage and management of credit information Consumer protection The Credit Information Act was written before the emergence of credit bureaus in Korea. Since then, the government has recognized a need for responding to the current credit delinquency problem. The Ministry of Finance and Economy (MOFE) has identified specific areas for improvement, such as credit delinquency regulations and the credit bureau environment, enabling the credit bureaus to gather more comprehensive information. The credit delinquency Ownership Structure Operating Environment Cross-Sector Participation Regulatory Facilitation Information Quality Service Capability Bureau Value Added regulation will be abolished in two years, which means lenders will independently manage credit delinquent status. This is the case in many countries around the world. The government will help the credit bureaus gain access to a wider range of information. An example of this is the Korea Labor Welfare Corporation s (employment information) commitment to providing relevant information. Introducing the capability models Throughout the course of this paper, we will draw comparisons between the credit information industries of Korea and selected countries. Korea will be compared in greater detail to three specific countries: the US, Singapore and Australia. Each provides lessons and insight from international experience. We have developed a Credit Information Industry Capability Model, utilizing a spider analysis framework to describe the relative basic characteristics of each country s credit bureau capabilities. Service Capability Market Sophistication Considers the inherent capabilities of the credit bureau service providers across basic data capture and provision through bureau services and into high end value added credit services Illustrates the sophistication of lending practices, the efficiency of the industry infrastructure and the extent to which bureau services are utilized to support lending decisions within financial services and other industries These models, based on secondary market research, do not attempt to isolate specific service providers. Instead, they provide a broad look at industry capabilities against service capabilities, the operating environment and market sophistication. Each is a function of its underlying dimensions as described in the table below: Capability Service Capability Market Sophistication Operating Environment Dimension Information Quality Bureau Value Added User Penetration Infrastructure Efficiency Characteristics Assessments of each country are made through qualitative judgments when comparing observations of key markets across the Americas, Europe and Asia. It is important to note that regulatory facilitation does not equate to the level of regulator participation. Also, ownership structure does not imply that private ownership is superior to public ownership. Lender 1 Credit decisioning and monitoring based on simple tracking, no scoring and Sophistication predictive analysis 4 Extensive use of credit data and business rules in debt origination, maintenance and collection Regulatory Facilitation Ownership Structures Cross Sector Participation Illustration 8 Capabilities dimensions and characteristics 1 Limited coverage, accuracy, matching, long and infrequent data refresh, no positive data. 4 Extensive data set, full information, frequent refresh, error capture and correction capabilities 1 Simple products, basic data aggregation, no additional information 4 Value services, predictive models and scores, strong integration capabilities with user systems 1 No additional services beyond credit assessment information 4 Substantial product and service expansion (e.g. marketing, consulting, collections) 1 Limited usage within financials service with little or no additional sector application 4 Broad industry usage across all credit providers, consumer self assessment and management 1 No automated data transfer, limited integration between players, limited use of technology 4 Multi party integration, dominance of technology based access and integration, host to host 1 Unclear policies, heavy data restriction and privacy bias, volatile standards 4 Well defined policies, active industry dialogue and facilitation, consistency, and market dialogue 1 Heavy government ownership, competition restrictions, partisan government investment 4 Strong private sector drive entrepreneurialism, free competition, specialized government role 1 Little or no co-ordination in collecting and reporting across sectors, different access rules 4 High levels of cross industry collaboration, standard data architecture and quality framework Sophistication of Lenders Efficiency of Infrastructure Market Sophistication User Penetration Operating Environment Reflects the tone of the regulatory environment (e.g. persuasive, facilitative, reactive), the role of ownership in industry participation, and the degree to which collaborative decision making and information sharing occurs across industry sectors Illustration 7 Country capability model 12 13

10 The Korean market The Korean market Korea capability model The first application of the capability model framework is for the Korean credit information environment. Despite the relative youth of Korean credit bureaus, they are seeking to move beyond simple information collection and distribution. They are aggressively seeking to expand their reach and breadth. Ownership Structure Operating Environment Cross-Sector Participation Sophistication of Lenders Regulatory Facilitation Efficiency of Infrastructure Market Sophistication Illustration 9 Korea credit bureau capability model Service Capability Information Quality Bureau Value Added Usage Penetration Key considerations for the Korean market To date, bureaus have faced considerable reluctance by the various players in the financial and non-financial sectors to share quality information. Most of the existing information is negative and does not capture short-term consumer behavior. It is important to note that the Big Five credit card issuers in Korea have taken a valuable step in sharing information among themselves that is more detailed than required by the KFB reporting, such as increased detail on shorter-term delinquency information. There is an opportunity to realize greater benefits for all industry participants by increasing this sharing. This information could be made available to all industry participants with a requirement that they reciprocate the exchange. Local players continue to pursue improved bureau services, including capabilities in scoring, either through internal skills or partnerships. The current bureaus are based on valueadded services, including debt collection and credit solutions. The sector is well serviced, maturing and competitive, but core gaps lie in the depth and breadth of risk advisories or consulting-type services. There is fair coverage of the financial services sector through the KFB and the credit bureaus. The commercial credit bureaus are now in the process of opening up to the non-financial sectors. The general network and infrastructure within Korea is excellent when compared with global standards. Korea quickly established an electronic infrastructure for the capture and exchange of information. Bureaus can support online and host-to-host communication today, but tape-based exchange for mandatory industry reporting still occurs between the KFB and the private bureaus. The relative youth of credit information services combined with historically lax risk management practices and limited demand for information, indicate lender sophistication must increase substantially. While some lenders have developed sophisticated capabilities in recent years, the industry as a whole fell significantly short of best practice The current structure lacks an inclusive view of all sectors. Although bureaus will continue to close cross-sector participation gaps, international evidence suggests the prevalence of sector- based sharing is substantially reducing the value of credit bureau services. User penetration trends will move closer to international levels over time as credit bureaus continue to expand their sources of data aggressively. Ownership structures are unregulated. There are currently six licensed players in the market, two of which have made substantial investments. Bureaus have little to no effect on industry association decision-making. The regulatory framework would benefit from increased clarity and enhancement on areas such as the type of information reported. In the absence of significant market participation, regulators may seek to facilitate the industry's evolution in Korea

11 ACCESS INNOVATION GROWTH The role of credit risk management 4 The role of credit risk management Credit Risk Management (CRM) is the practice of understanding and managing the risk a business incurs in extending credit. Without effective CRM practices, lenders are significantly less likely to realize benefits from credit bureaus. The CRM process consists of three key components: 1. Portfolio Planning allows a lender to estimate and plan risk exposures and expected returns at the portfolio level. 2. Portfolio Acquisition describes the processes and procedures banks use to capture loan applications, decide whether to accept them, and how to establish price. 3. Portfolio Maintenance allows lenders to track changes in the risk profile of a portfolio over time and to take actions to ensure both risk and return levels are meeting expectations. Korea has the opportunity to increase the returns it realizes from CRM. More prudent portfolio planning could have constrained the aggressive acquisition strategies pursued since1999. Loose application of credit policies and limitations around available credit decision processes and tools, particularly during the initial phases of the recent growth cycle, contributed heavily to recent significant increases in delinquencies. However, the capabilities that exist today are, on average, a substantial improvement over where they were in With concerns regarding the quality of credit portfolios driving a slowdown in the acquisition activities of lenders, portfolio maintenance is expected to remain a core focus of Korean lenders for the foreseeable future. CRM is an essential core competency for lenders. It should influence sales and customer strategies, helping determine by which risk segments a lender is willing to pursue. It requires specific business processes and procedures to ensure that lending decisions adequately consider and price for risk. The CRM process The CRM process consists of three key steps: Portfolio planning: Allows a lender to estimate and plan risk exposures and expected returns at the portfolio level. The portfolio level is a summary of loan information across categories such as customers, segments and product types and is used to project performance and direct changes in sales strategies. Portfolio acquisition: This encompasses the processes and procedures banks use to capture a loan application, decide whether to accept the application and how to price loans that are accepted Portfolio maintenance: Allows lenders to track changes in the risk profile of a portfolio over time. By tracking the borrowing activity of their customers, both on their own products and those held with other lenders, an institution can monitor changes in its overall risk exposure and take proactive measures to reduce risk where necessary. CRM practices in Korea Portfolio planning: Characteristics of current practices in Korea give rise to the following issues for consideration: - Risk management could be better integrated with the management of the business as a whole. Although lenders typically conduct regular analysis and reporting of the lending portfolio, there are opportunities to improve the quality of this information and the links between portfolio analysis and business decisions - Increasing the proportion of consumer loans determined by using credit scores rather than by judgmental decisions, would improve the consistency and comparability of risk data - Better integration of risk within card businesses would almost certainly have led to a faster contraction of aggressive marketing activity in the face of deteriorating credit performance. Portfolio acquisition: Loose adherence to credit policies and limits, particularly during the initial phases of the recent growth cycle, contributed heavily to recent industry issues. A key consideration when evaluating the effectiveness of acquisition capabilities within a market is the performance lag, because default activity typically trails lending decisions by 12 to 24 months. Current industry discussions should take into consideration: - Current capabilities are generally a substantial improvement over those in place at the beginning of Although credit scoring, including utilizing both bureau attributes and bureau scores, is a widely accepted practice, a key challenge is the consistency with which credit scores are applied. - Korea has historically had a significant volume of loans determined through manual exception processes rather than credit scores. There are opportunities to increase the proportion of automated decisions which could reduce costs and increase the consistency of decisions. - The proportion of institutions working with major international vendors and advisors on scoring is increasing. A number of domestic banks are already using and/or developing technologies from leading international vendors such as Experian and Fair Isaac. - Risk-based pricing is commonly applied. A Korean consumer today can easily access products and services with different interest rates based on their risk rating

12 The role of credit risk management ACCESS INNOVATION GROWTH - Critically, given the current quality of industry information available through bureaus, lenders are taking greater risk in pricing down perceived lower risk customers, than comparable decisions made by banks in full reporting environments. Portfolio maintenance: Portfolio maintenance is expected to remain a core focus of Korean lenders for the foreseeable future. - Given significant risk and delinquency levels within the current lending environment, combined with a high penetration of unsecured debt to GDP, new lending volumes in Korea have slowed dramatically. - The core focus of domestic lenders is to contain delinquency and increase the quality of existing portfolios. - The lack of consistent and detailed term-based delinquency information from credit bureaus dramatically reduces the ability of institutions to estimate effectively their share of total customer delinquency. - The absence of relevant transaction information means banks are severely constrained in recognizing behavioral warning signs for debt held with other banks before delinquency occurs. 5 Selected country experiences In the US: Sophisticated credit bureaus provide decision support to lenders Federal policy has encouraged lenders to make credit available to a broad segment of the US population. The result has been a dramatic increase in access to credit, particularly for those in lower income groups. A well developed credit bureau industry with highly sophisticated capabilities has become one of the leading providers of solutions and advice to local industries across the world. In Singapore: Regulatory facilitation and industry participation have played important roles in speeding up the establishment of a credit bureau. Although relatively new and currently collecting and distributing relatively limited information, the Singapore credit bureau is, however, more expansive than the existing Korean model. The bureau is responding to demands by the industry and plans to include customer credit limits for each card and the extent to which each are utilized. The Australian market: Represents a developed economy with a sophisticated lending environment. Places significant limitations on what bureaus can collect and distribute, due largely to concerns over individual privacy. Is a negative (delinquency-based) credit reporting environment. Information regarding positive credit transaction activity and behavior may not be collected or distributed. Faces limitations regarding the sophistication of risk-based pricing and product options which is in a large part due to the lack of sufficient industry level (positive) credit information

13 Selected country experiences Selected country experiences The US market has high capabilities in bureau services and is one of the leading providers of solutions and services to local industries across the world Credit bureaus in the US The US is generally regarded as the most developed credit information market in the world and as such we have not provided a capability model. The key considerations for the American market are: The market has matured to grow the data set to include information from the financial and non-financial sectors. There are now fewer instances of institutions not providing information to the all the credit bureaus The market has high capabilities in bureau services and is one of the leading providers of solutions and services to local industries across the world. Credit management and consulting services are highly developed in this market. Credit reports and credit scores have become part of the decision-making process in the market for financial and non-financial credit providers. The infrastructure is mature and proven and there is extensive use of electronic information exchange with a high degree of integration between the bureaus and users. There is substantial lender sophistication. Risk-based pricing is a common feature for most consumer products. Many institutions also employ advanced delinquency prediction models. There is significant cross-sector participation, with players from the financial and non-financial sectors. Credit reports are now being used by consumers and non-lending institutions. Ownership structure is unregulated, but the market has stabilized with three key bureau players and one scoring specialist. The regulatory framework has undergone substantial revision over the years, especially with the introduction of the Fair and Accurate Credit Reporting Act. This is supplemented by an active and consultative approach with consumer groups. Credit bureaus in Singapore The key considerations of the Singapore market are: The Singapore credit information market and infrastructure are relatively new. Having been established in partnership with Dun & Bradstreet and Baycorp, it is able to draw upon global experience. The current capabilities are limited to reporting on information collected from the members. There are currently minimal value-added services provided by the credit bureau. The credit reports will be used by all the members of the Association of Banks, Singapore; including ABN-Amro, American Express, Citibank, DBS, HSBC, Maybank, OCBC. Standard Chartered and UOB. Regulators played a substantial role in driving the progress of the Singaporean market Ownership Structure Operating Environment Cross-Sector Participation Illustration 10 Capability model - Singapore Regulatory Facilitation Information Quality Market Sophistication Service Capability Bureau Value Added Sophisticationi Usage of Lenders Penetration Efficiency of Infrastructure The financial markets are building up key capabilities in risk management, though the non-financial segment has yet to utilize credit management services significantly. The current model splits financial and non-financial sector participation, thereby inherently limiting cross-sector sharing. This issue may be addressed by mergers, but could also be contractually addressed Ownership structures are unregulated, with the market having two players, both in the private sector. The Monetary Authority of Singapore has undertaken substantial regulatory facilitation to ensure the implementation of the credit bureau and maintains an active role in the bureau s development. Credit bureaus in Australia The key features of the Australian market are: The information model only allows for negative information, a function of tight credit information legislation. The established history of the market and the sophistication of its players have led to the availability of advanced bureau services, notwithstanding the limitations imposed on data collection. A vibrant value-added service market exists through bureau providers, additional service specialists, such as Collections House and Legal Co. Extensive consulting and technology services are also accessed through international players including Experian and Fair Isaac to close domestic gaps. Baycorp Advantage, Australia s major consumer credit bureau, has a diversified client base of banks, specialist financial services, telecommunications, retailers, mortgage specialists and insurance companies. Direct consumer usage is facilitated but has not been a focus. The historical dominance of Baycorp as the major consumer credit bureau has enabled sustained investments in a wellintegrated technology platform that has captured a high proportion of industry volumes. Some limitations exist regarding the sophistication and prevalence of riskbased pricing and product options from lenders. This is partially a function of insufficient information and partially due to market practices

14 Selected country experiences ACCESS INNOVATION GROWTH Some limitations exist regarding the sophistication and prevalence of riskbased pricing and product options from lenders Faced with a low participation hurdle (only negative data), private bureaus have expanded the network of information suppliers. Ownership structures are unregulated and there is no public registry. The private market has seen progressively more entrants. Privacy legislation has placed significant constraints on the industry information model, with limited regulatory activity to change industry structure or function. Operating Environment Ownership Structure Cross-Sector Participation Regulatory Facilitation Sophistication of Lenders Illustration 11 Capability model - Australia Source: Company websites, media Efficiency of Infrastructure Information Quality Market Sophistication Case study conclusions Service Capability Bureau Value Added Usage Penetration The US has evolved from a fragmented lender market. The historical lack of a dominant group of lenders reduced competitive resistance to information sharing. The sophistication observed in the US market has been achieved over a significant period of time, enabled through substantial and sustained investment from private bureaus. The US market benefits significantly from a facilitative regulatory environment. The time required to establish a functional credit bureau industry has shortened. Emerging markets are benefiting from increased international experience and precedents. The typical Asian experience is the result of regulatory action. It is critical that regulators establish a sufficient minimum standard from which the industry will continue to grow. Heavily engaging industry input and participation can generate sustainable momentum for change and reduce the likelihood of regression to old practices. In contrast, the Australian experience highlights the potential impact of restrictive regulation. Despite the presence of sophisticated domestic and international lenders and historically strong CRM practices, the Australian market forfeits much of the benefits of bureau services. As a result, the Australian market has produced a relatively stable and low risk delinquency record at the expense of pricing flexibility, product choice, risk-adjusted credit returns and restricted access to credit for lower income consumer segments. 6 Recent experiences in establishing bureaus The emerging credit reporting markets have leveraged technology and skills transfer to jumpstart their own markets through partnerships and other arrangements. Hong Kong experience indicates: Crisis levels of both delinquency and bankruptcies led to a sudden increase in the willingness of lenders and other stakeholders to pursue positive reporting. The establishment of the Hong Kong bureau was a consultative process with regulators gathering views from all stakeholders banks, consumer associations, other interest groups and the bureau service provider. Since the introduction of positive information sharing, charge-offs and bankruptcies have begun to fall. Recent regional experience indicates that credit bureaus are increasingly a core part of Asian economies development, with regulators and industry working together to drive rapid change. In support of the selected country case studies, this report documents the establishment of credit bureau industries within other countries. The Hong Kong commentary outlines the perspectives of a lender that managed its bank s transition from the negative reporting environment to the positive information exchange executed today. The India analysis outlines the experience of a bureau chief executive in establishing India s first private credit bureau. The report also outlines the Thailand experience in the Appendix. This provides the perspective of a regulator who played an extensive role in the evolution of the Thai credit information industry. Perspectives from Hong Kong Hong Kong s move to positive information sharing a banker s perspective Context In mid-2003, positive credit information sharing was introduced with a privately owned bureau. Hong Kong had historically shared 'blacklists' of borrowers capturing delinquency, bankruptcies or legal judgments filed against them. However, the crisis levels of both delinquency and bankruptcies experienced in recent years led to a sudden increase in the willingness of lenders and other stakeholders to pursue positive reporting. The commentary below outlines the experience of an undisclosed Accenture client. The client is a large lender and provides insights from that perspective

15 Recent experiences in establishing bureaus Recent experiences in establishing bureaus Hong Kong lenders were primarily concerned with their information rights and obligations under the new system Access to the credit bureau is restricted to new applications and serious delinquents in the first two years Participant concerns The primary concerns of lenders related to the definition of the industry information framework and the rights and obligations of industry participants in enabling it. Some of the key questions for lenders were: Who would contribute data to the bureau? Who would have access to this data? Under what conditions would access be granted? Lenders were concerned that other players could delay their data contribution and/or unfairly gain access to the information provided. As net providers of information, larger lenders faced greater relative exposures to inconsistency and voiced the loudest concerns. The secondary concern related to how well information rights and obligations would be policed, particularly as TransUnion (the local credit bureau) had profit incentives to release data. A final, industry-level concern was to ensure that the market avoided an immediate and broad-based credit squeeze. Once lenders could validate borrowers across industry credit lines, a general concern emerged that a large proportion of customers would be downgraded and subsequently their access to credit reduced. Since no one knew the size of the debt problem in Hong Kong, the impact of such a squeeze on the broader economy was unknown. The process The establishment of the Hong Kong bureau was a consultative process with regulators synthesizing views from all stakeholders banks, consumer associations, other interest groups and TransUnion. Regulators sought to police the system through both mandatory obligations and guidelines for participants. In response to the threat of a possible credit squeeze, the Hong Kong Monetary Authority (HKMA) established some simple rules. For the first two years under a positive reporting framework, institutions would only be able to request customers bureau data if a customer approached a lender requesting a new line of credit, or a lender had good reason to believe a customer was experiencing payment difficulties (e.g., seriously delinquent or had proactively asked for debt restructuring). Thus banks cannot check the bureau records of existing customers who do not request new credit or exhibit signs of serious delinquency. As a result, portfolio scans to measure the overall health of a loan book will not be allowed until The results The overall transition was relatively smooth with no major problems. A credit crunch has not occurred Charge-offs and bankruptcies have begun to fall Although lenders experienced dramatic falls in loan approval rates, the best lenders targeted a return to previous levels or higher within six to nine months There is evidence of some increased balance transfer activity, although levels are not exceptionally high Some sub-prime lenders have targeted debt consolidation with moderate success Increasing risk-based pricing is apparent, however, a prevalence of upward movement may be beginning to emerge There is no clear evidence to date that any one player has profitably advanced its competitive position as a result of the bureau Smaller players may be deriving greater relative benefit from the bureau - new application volume is material relative to existing assets. Insights from the Hong Kong experience Some of the concerns that may reduce the willingness of existing players to share credit information include: Lenders may be reluctant to disclose the extent of deterioration in existing portfolios due to competitive or valuation concerns. More effective lenders may be concerned that regulators will force sharing of debts to underpin weaker bank performance. Competition may be enhanced as more sophisticated global players, who use bureaus as a key information source, may seek to exploit skill and experience gaps by entering the market and/or importing superior capabilities and resources to capture market share from domestic players. Other considerations for Korea include: Limiting access to existing customer information for two years has not eliminated the threat of a credit squeeze - it has probably only delayed it. Increased information and pricing flexibility are allowing lenders to access segments traditionally serviced by unregulated lenders. Positive bureaus know actual debt to income ratios and limits to income levels. Key lessons learned The best credit risk managers will realize the greatest benefits from increased information sharing. Lenders shift from competing on the size and depth of their credit information databases to the depth and accuracy of the insights they can draw from this information. Best practice will include the ability to tie these credit insights to marketing and portfolio management actions at the customer and account levels. The best lenders will be able to increase or decrease their exposures over time based on changes in customers and market circumstances

16 Implications for Korea ACCESS INNOVATION GROWTH 7 Implications for Korea International comparisons clearly indicate that the Korean credit reporting market and CRM practices are behind the US and will fall behind Asian benchmarks without immediate improvement. The crisis experienced by the credit card industry, combined with increasing levels of industry and regulator focus on credit bureaus, suggest a high probability of change in the near- to medium-term. Although bureaus will continue to close cross-sector participation gaps,, international evidence suggests the prevalence of sector-based sharing is substantially reducing the value of credit bureau services. In the absence of significant market participation, regulators may choose to hasten industry evolution in Korea. A coordinated effort by the various stakeholders is important to create urgently required key capabilities in an acceptable timeframe. A natural amount of tension will continue to exist in the market as stakeholders pursue different objectives. The crisis currently being experienced by the credit card industry, combined with increasing levels of industry and regulator focus on credit bureaus, suggests a high probability of change in the near- to mediumterm. The Korean credit bureau capability model clearly indicates an opportunity for the industry and/or regulators to take a more aggressive role in the development of the domestic environment. However, the Korean market presents unique characteristics and needs that must be considered from the perspective of all stakeholders. Large incumbents are expected to have reservations in the sharing of positive information due to fears of increased competition for the most attractive customer segments. Lenders have moved from a focus on simple growth through increasing the number of cardholders, to debt monitoring and maintenance. During the growth phase in household credit, there were no active credit bureaus that could have assisted in the credit assessment process. The KFB was the only industry source for credit information. The level of information provided solely by the KFB is insufficient to drive a world-class credit assessment process. KIS and NICE entered the credit bureau market in 2002 at a time when the industry was already seeing evidence of an emerging KW - trillion delinquency crisis. As recovery and delinquency management efforts intensified, credit originations and the use of credit reports as a means of determining credit card applications were no longer industry priorities. The immediate problem shifted to debt management and the sharing of delinquency information, particularly maintaining track of consumer borrowing from multiple sources. As a result, the current demand from industry is focused on information and tools that enable lenders to monitor changes in portfolio credit quality proactively over time. This is possible only with participation by all the major players in the consumer credit market, including financial and non-financial sectors Household Debt Growth Matured credit market with improved credit discipline Obtain relevant consumer information Prevent poaching of high value customers Retain competitive information Credit Industry Growth phase with easy consumer credit from multiple sources Credit recovery and delinquency management phase KIS and NICE enter the Credit Bureau business Drive industry to an acceptable standard Ensure adherence to regulations and policies Meet social and national obligations Preserve role of industry associations Regulators Stakeholder Expectations Consumers Ensure credit decisioning is fair and correct Ability to identify and correct errors Capability to better manage individual credit worthiness Ensure fairer pricing and improved access to credit Illustration 13 Household debt Source: 2003, Household Credit Trend - Bank of Korea Credit Bureau Ease the sourcing of credit information Seek open competition and commercial pricing Financially viable business and operating model Illustration 12 Stakeholder expectations 26 27

17 Implications for Korea ACCESS INNOVATION GROWTH 2.46 Q Illustration 14 Number of delinquencies Q # of delinquencies - MM Source: 2003, Household Credit Trend - Bank of Korea Consumers' exuberance and relative inexperience with personal debt have contributed to the severity of the current problems. The success of the credit information industry is dependent on lenders providing and using information. Korea Australia Singapore USA Very High Illustration 15 Comparison of information models Q Extent of participation in the credit reporting market With more than 5,000 contributing lending institutions, the KFB has a very broad coverage of financial information providers, and thereby consumers. Comparing global experience with Korea, we see substantial gaps in the quality of information. Private credit bureaus have sought to close the gaps in information depth by forging commercial contracts with lenders. These contracts allow the bureaus to collect more detailed and timely information. The difficulty with this contracting-based approach is that a lack of consistency emerges regarding what is collected, when it is collected, who has access to the information and on what conditions it can be accessed. This can undermine both lender and borrower confidence in the fairness and utility of the system. A comparative analysis of the Korean information framework with the US, Singapore and Australia is provided below. Depth of information shared with credit bureaus Bank Non-Bank FI Other Negative Positive High Moderate Low None 8 Direction for Korea The industry must take into account the current market conditions and ensure acceptance from all key stakeholders Five guiding principles are proposed for the industry to adopt during the transition phase: 1. A commercially viable business model 2. Clear acceptance by all stakeholders 3. Protection of consumer rights and respect for individual privacy 4. Willingness for change in current industry positions and practices 5. A regulatory environment that encourages free competition By mapping current market capabilities to international best practice we believe that by focusing on four key priorities the Korean credit reporting market will see an overall improvement in credit decision making: 1. Information quality 2. Sophistication of lenders 3. Cross-sector participation 4. Regulatory facilitation Market forces are likely to ensure that other key components of the industry capability set will continue to develop at a sufficient pace. A definitive direction for the industry is unlikely to emerge without substantial stakeholder dialogue. There is little doubt within the research or financial industry that full-scale credit information sharing offers significant benefits to all stakeholders as a homogenous group. However, in seeking to promote change, one key challenge must be addressed: significant uncertainty exists regarding how the benefits are shared across - and particularly within - stakeholder groups. The value sharing that unfolds in any given market will be a function of both the model that is chosen and the transition path utilized to reach it. We suggest two approaches to these challenges: We have defined guiding principles that can be used to initiate and facilitate debate. We have presented a target capability model for discussion to provide clear direction on the possible focus, priority and general quantum of change. We have not defined the target model beyond a capability model level of detail. This allows for significant debate and consideration of value-sharing implications of these decisions

18 Direction for Korea Direction for Korea Korea credit bureaus industry guiding principles Commercially viable: The business model for the credit bureau must be commercially viable for all players. Pricing must be market driven and be fair to the participants. In the long-term, market forces determine how the industry information model expands.. Benefits statements: For the credit bureau market to mature, all players in the industry must be made aware, and be convinced of, the benefits. Regulatory guidance could be a tool to aid this process, but the market must be allowed a substantial role in defining optimal sharing of the incremental value created. Consumer rights: Consumer education and involvement is an essential element in gaining acceptance of an effective credit bureau. Acceptance of change: All stakeholders must be willing to accept change in their current positions. Consumers must be willing to accept an increase in the amount of credit information available to lenders, in order to be able to access fairer pricing. Current industry players have, over time, acquired a competitive advantage at substantial cost and effort by building substantial customer databases and developing insights. Changes in the credit bureau business model must recognize the value of these assets and the impact of delivering the proposed changes on these values. Competition and regulatory encouragement: There must be positive regulation and encouragement to facilitate a competitive base environment from which to grow. At the same time, it is important that market forces are allowed to shape the industry structure and ownership patterns to best suit market demands without undue regulatory interference. Improving Korea s credit risk management We are suggesting a three-part focus strategy to maximize the impact of change efforts. Utilize regulatory facilitation to promote industry cooperation on information quality and cross sector participation Pursue an industry-led program to increase the sophistication of lenders and borrows Allow market forces to drive outward pressure on the remaining capabilities. Of the nine capability areas, it is information quality and cross-sector participation that will contribute most to the effectiveness of a bureau service in improving industry credit decisions. By increasing the number of lenders contributing information and the quality of information they contribute, many of the other variables will follow an outward expansion through market forces. Target Korean Capability Model Changes Primary Change Agent Regulator Illustration 16 Key changes in capabilities Information Quality Cross Sector Participation Regulatory Facilitation Industry Sophistication of Lenders Market Forces Bureau Value Added Usage Penetration Efficiency of Infrastructure Operating Environment Ownership Structure Cross Sector Participation There are a number of industry dimensions that correlate with the dimensions targeted by the focus strategy: Two maturing bureaus service the Korean industry with at least one potential new participant. Faced with an expanded data set, private bureaus will be in a position to enhance the quality of reports provided and provide insight drawn from the information. Private credit bureaus will ensure bureau and value-added services continue to evolve at a sufficient pace in order to maintain domestic effectiveness and international parity. Sophistication of Lenders Regulatory Facilitation Efficiency of Infrastructure Information Quality Market Sophistication Service Capability Bureau Value Added Usage Penetration The improved quality of bureau services and marketing will lead to increased penetration as more lenders, telecommunication companies, insurance companies and trade financiers begin to utilize an expanded product range. Increased usage will lead to economies of scale, enhanced pricing, increased profits and re-investment, and, as a consequence, enhanced infrastructure efficiency

19 Direction for Korea ACCESS INNOVATION GROWTH Potential transition paths We believe regulatory involvement will facilitate expansion of information quality and cross-sector participation. Accelerated market-led change is unlikely: Korea is characterized by a large number of parties with potentially conflicting expectations and a history of moderate or limited coordination. International experience does not indicate a strong role for regulators in enhancing CRM practices. The sophistication of CRM practices within a given market is a function of the capabilities of its individual Value added to economy Illustration 17 Industry transition path Korea 1995 Phase I Phase II Korea Today Time Phase III participants. We contend that market forces are the most appropriate mechanisms to drive the evolutionary process in this area. Any attempt by regulators to develop or define the appropriate actions in this space is unlikely to accommodate the unique needs of all lenders, and will subsequently result in ineffective averaging and constraints. By enhancing the industry information model, regulators will create an environment wherein CRM becomes the primary means of competition. Market forces will drive lenders to invest in its development. Phase I Regulators lead a drive to expand the minimum industry information model bearing in mind the requirements of all stakeholders Phase II Industry commits to implementation of the information model, a prudent credit practices framework and consumer education Phase III Market forces ensure the industry capability continues to evolve without formal coordination from regulators or industry 9 Transition considerations As the industry evolves, a number of issues need to be addressed: Expanding positive and negative data provision is an industry priority. The format in which this information is presented may offer interim solutions to encourage industry collaboration and ultimately consistent participation. However, any interim solutions should be agreed in the context of longer-term commitments. International experience supports the provision of credit information without consumer consent when the request is for credit purposes only. As in established in other markets, opting rights for consumers can be utilized to address other issues such as the use of credit information for direct marketing. The benefits of a credit reporting market will not be realized by the industry unless the participants develop adequate credit risk management capabilities that accommodate changes in the bureau environment. Consumers will need to be constantly engaged in this process. This may include running education programs and involving consumer groups in a consultative process while the industry determines its politics in adopting a comprehensive credit management regime. Information model - Keys to success The information model defines, at a high level, the type and flow of information across the value chain as it moves from raw, transactional data, through to credit reports and scores. It is at the core of creating an effective credit information market. The regulator may choose to aid the industry in overcoming barriers to collaboration. International experience suggests that defining the what, who, how and why of information exchange removes one of the single greatest barriers to collaboration, and ultimately, to progress. The information framework is the only component of the capability model that requires consistent compliance of all market participants. Enhancement of the negative and positive information reported by the industry can substantially enhance the value of bureau services. This change can be brought about either through regulatory mandate or by industry consensus. Given the lack of consistency within the industry and the underlying urgency of the current crisis, a better option may be for the regulator to take a lead role in defining this framework. The current regulatory framework already utilizes a minimum mandatory reporting requirement. The low levels of credit information available to lenders can lead to sub-optimal credit decisions. The challenge that remains for the Korean market is to define the 32 33

20 Transition considerations Transition considerations The information model should explore options in sourcing data and presenting it along with appropriate credit scores, while giving consumers options with their personal privacy. appropriate depth of information that lenders should be sharing. We do not recommend that lenders share all the available data regarding borrowers, but we do propose that increasing the depth of information will increase the effectiveness of lending decisions. As an example, without information regarding the total credit limits a borrower can access across all lenders, the borrower s historical utilization of these limits and his/her transaction behavior, it is very difficult for lenders to effectively estimate the true risk of lending. One immediate means to increase information depth and consistency is to increase the mandatory information provision requirements currently managed by the KFB. If Korean regulators were to increase the depth of information lenders were required to provide to the KFB, it would both increase the effectiveness of lender credit decisions B C D X and capitalize on the existing regulatory infrastructure. Once the minimum sharing requirements are increased, credit bureaus could continue to maintain their role in identifying which additional data can provide meaningful insights to users and structure contracts to promote its provision and application in the lending process. This proposition is outlined below: Cross-sector participation and full information sharing are critical to the credit information business model. The current industry structure is dominated by the KFB as the major aggregator of the mandated information from the financial services sector. By virtue of this requirement, if we ignore the adequacy of the current minimum reporting requirement, financial services sector participation is excellent: it is the inconsistency beyond mandatory information requirements that causes problems. A X B C The proportion of information that lenders in Korea currently exchange The minimum information Korean lenders should exchange to realize a significant uplift in performance and enable effective CRM and a stable lending industry The gap regulatory facilitation can seek to close whilst acknowledging competitive concerns The information that credit bureaus continue to seek in private contracts to improve results Competitive concerns All lenders should be granted equal access to credit bureau information on the principle of reciprocity. While ensuring the participation of all the players in the industry, the business model must recognize the value and importance of acquired transactional information. The current Korean regulatory framework mandates contributions by financial institutions and we see no reason to repeal this requirement. The regulatory mandate could be expanded to include non-finance companies although market forces are likely to be sufficient to effect this. Accenture research has not uncovered any compelling reasons to restrict access to credit information for any specific party other than reciprocity. The reciprocity principle is a vital mechanism to enable market forces to accelerate involvement in the development of bureaus. By requiring all users of information first to become providers of information, the growth in users of bureau services will underwrite the growth in suppliers of information. 100 % Negative data Positive data Aggregate and Audit Some interim measures to encourage this provision of information may facilitate collaboration by more reluctant lenders. In a new market where no one player has established an information or insight advantage over any other, the ideal solution would be to report all the information that is collected, but this is more difficult in an established market where larger players hold information advantages. Full disclosure is a requirement to achieve an effective system, however a phased approach may be considered to facilitate cooperation during a transition period. One option would be to consolidate the information that is reported by lenders into summary level credit reports as an interim measure. Individual account-level information could potentially be masked from the market without seriously limiting its usefulness to the credit decision. This would allow a transition period for participants, while providing the industry access to some of the benefits of information sharing sooner than would normally be the case. It is critical that any interim measure be used only as a mechanism to allow lenders to move into the new environment. Credit Scoring Credit Report X % A D 100 percent of the credit information that could possibly be collected about consumers Cross sector data Mandated data points Collect all data points from industry Ensure accuracy Scoring performed using all available data Credit report with agreed fields Credit Score Illustration 18 Adding value through improved data sourcing Illustration 19 Information model 34 35