Maximizing the Benefits From Credit Reporting

Transcription

1 TRANSUNION WHITE PAPER Maximizing the Benefits From Credit Reporting Michael E. Staten, Take Charge America Endowed Professor Norton School of Family and Consumer Sciences University of Arizona

2 1 Introduction 4 The Special Function Served by Credit Reporting 5 How does Comprehensive Credit Reporting Improve Credit Decision-Making? 8 Benefits That Result From Comprehensive Full-File Reporting Systems 13 Structuring the Credit Reporting System to Maximize Benefits 15 Conclusion Credit bureaus have evolved worldwide in recent decades to reduce the costs of assessing borrower risk. Credit reporting benefits both lenders and consumers, at the same time it increases economic activity. However, some types of reporting systems generate larger benefits than others. The value of a credit reporting system to its host economy depends on the nature and extent of the information collected and shared, as well as on the organizational and ownership structure of the reporting system. This paper provides evidence that a full-file, comprehensive credit reporting system maximizes the economic benefits from credit reporting. It also explains why independent, privately held credit bureaus have been found to provide more complete credit history data and more innovative information products and services for lending decisions. The credit report helps lenders pierce the fog of uncertainty surrounding each new loan applicant. More information about a borrower s past credit history and the handling of existing accounts improves the lender s risk assessment process. The result is a better match of borrowers to loans. Full-file reporting of negative information on borrower delinquencies and positive information on accounts paid as agreed produces the maximum benefits. Simulations illustrate how full-file reporting (especially with widespread lender participation) increases the ability of the shared data to predict borrower risk. Full-file reporting facilitates more accurate prediction of repayment probabilities and encourages repayment by giving consumers a stake in establishing and protecting a good credit reputation. Because full-file reporting increases a lender s ability to recognize borrowers for successful use of credit, it also increases both the availability of credit as well as the likelihood that loans are repaid. When comprehensive data on consumer credit histories is readily available, it significantly reduces the costs to new lenders of entering loan markets, enhances competition and lowers credit prices. This levels the playing field so that new entrants can overcome the advantage of established lenders in reaching creditworthy customers. Broader access to credit made possible by full-file credit reporting systems generates macroeconomic growth advantages for the host countries. Cross-country studies have found that consumer spending is more sensitive to changes in income in countries with less-developed consumer credit markets. Credit markets that make loans accessible to large segments of the population provide a cushion that dampens the impact of household income interruptions, and provides consumers a credit bridge while they look for new employment. Portable credit reputations also increase the mobility of the workforce by reducing the burden on consumers of accepting new jobs in distant locations in response to structural shifts in the economy. In this way, structural economic shifts can cause temporary disruptions without crippling long-term effects. Full-file reporting also can make capital more mobile by supporting the securitization of consumer loan receivables. Comprehensive credit reports and credit scores give investors objective information on the quality of the underlying loan accounts. Armed with this granular information to quantify risk, lenders can tap into the global capital markets to obtain funds for making loans.

3 Securitization has supported enormous growth in credit card, automobile and mortgage lending in the U.S. In addition, comprehensive personal credit reports on small business owners have triggered an expansion in small business lending, especially to relatively risky marginal borrowers who would not otherwise receive credit. But, not all reporting systems produce equivalent benefits. The structure of the reporting system plays a significant role in bringing the benefits to the market. Credit bureaus have evolved as either market-based, privately owned organizations or government controlled public credit registries. A recent study of 129 countries found that credit reporting agencies that distributed a broader range of data and provided legal incentives to ensure the quality of the data were also associated with significantly more private credit. More specifically, the characteristics of credit reporting agencies that are associated with significantly more private credit include 1) distribution (to end users) of both positive and negative data, 2) data from a cross-section of lenders, including banks, retailers, trade creditors, and utilities, 3) five or more years of historical data for borrowers, and 4) data collected for all loans of value above 1percent of per capita income. All of these reporting are hallmarks of full-file reporting. Independent, privately owned credit bureaus produce full-file reporting more often than do public credit registries. The for-profit structure of the typical private credit bureau gives it greater incentive to ensure data accuracy, as well as to collect data from a variety of sources to increase the value of the information it sells. Consequently, the core database assembled and maintained by private credit bureaus is potentially more valuable to both private sector customers and the financial regulators than would be the data assembled by public credit registries. In addition, private credit bureaus also have an incentive to make data products available to a wider variety of end-users than do public credit registries, helping to account for the higher volume of lending in countries with private credit bureaus. These data products include the development of innovative decision tools (e.g., fraud prevention; identity verification and theft prevention; risk scoring models) that help to manage and reduce risk. Neither public credit registries nor industry-sector credit reporting consortiums have comparable incentives to develop a wide array of information products.

4 The sharing of information among lenders regarding borrowers past credit experience is the foundation of modern risk management. Credit bureaus, either publicly run or privately owned, have evolved worldwide in recent decades to formalize the exchange of credit histories and reduce the costs of assessing borrower risk. Credit reporting systems generate benefits to lenders and consumers and increase economic activity. However, some types of systems generate larger benefits than others, depending on the nature and extent of information shared and also on the organizational and ownership structure of the reporting system. This paper will examine the significant economic benefits that are achievable through a well-developed credit reporting system. The paper is organized as follows. Section 1 briefly discusses the economic function of credit bureaus, and their evolution as either market-based, privately owned organizations or government controlled public credit registries. Section 2 explains why information sharing through credit reporting improves credit decisionmaking. The results of several simulations illustrate that broader information sharing (more credit information reported for each borrower; more lenders participating in the sharing) increases the power of the data in predicting borrower risk. Section 3 documents the variety of benefits to consumers, lenders and the economy that can derive from a well-developed credit reporting system. The more comprehensive the credit reporting is, the greater the benefits. Section 4 considers how the organizational structure of a credit reporting system influences the magnitude of the benefits. Recent evidence from cross-country studies suggests that benefits are maximized when privately owned credit bureaus compete in the market to offer information products and decision tools TransUnion LLC All Rights Reserved

5 1. The Special Function Served by Credit Reporting The twin threats of adverse selection and moral hazard confront every loan officer examining a new loan application. Adverse selection poses a significant barrier to the entry of new lenders into credit markets. New entrants have no prior experience with local borrowers to draw upon, greatly increasing the difficulty of assessing an applicant s risk. As a result they are likely to attract applications from higher-risk borrowers who have been rejected by established lenders. Information about borrowers past credit experience that is shared across lenders through a credit bureau intermediary can reduce this problem. Moral hazard presents lenders with a different problem. Once a loan is obtained, borrowers have a greater incentive to default when the expected future consequences are low. But, a reputation for past default that is readily communicated to potential lenders can raise those costs, thereby reducing the moral hazard by boosting the borrower s incentive to repay. 1 Credit bureaus facilitate that information sharing. Economist Daniel Klein has observed that the credit bureau has the distinction of being the most standardized and most extensive reputational system humankind has ever known. 2 To the extent that an interest in preserving reputations encourages consumers to alter their behavior, then through the market s evolution of the credit bureau, commerce promotes morality as though it were guided by an invisible hand. 3 The emergence of the credit bureau as an important third-party participant in credit markets institutionalizes the sharing of information and reduces the costs of assessing borrower risk. Economic research has shown that lenders can benefit as a group if they commit to exchanging information about borrowers and create an enforcement mechanism that ensures accuracy of the information shared (Padilla and Pagano, 1997). The third-party credit bureau serves as both the clearinghouse and enforcer. As a result, loan interest rates and loan default rates are lower than in the absence of information sharing. 4 Around the globe, the pooling of borrower credit histories has become commonplace, although much of the reporting infrastructure has been established in just the past three decades. 5 Credit information sharing may take place on a voluntary basis through private credit bureaus that are set up either through lender consortiums or by independent firms. In many countries the information sharing and pooling may be mandatory through Public Credit Registries (PCRs) set up and run by the country s central bank. 6 In some countries, both types of credit bureaus serve the market. Japelli and Pagano (2006) synthesize the results of two detailed cross-country surveys that were conducted to determine the extent of credit reporting and when it originated. One survey covered 49 countries (Japelli and Pagano 2002); the other survey was commissioned by the World Bank and surveyed 77 countries (Miller 2003). Together, the surveys revealed that before 1950 less than 20 percent of surveyed countries had a private credit bureau, and less than 5 percent had a PCR. By 2000, 60 percent of countries surveyed had a private bureau and 50percent of countries had a PCR. Private credit bureaus are usually structured around reciprocal agreements, where furnishers of data (creditors) voluntarily agree to contribute accurate data (usually in prescribed formats) in exchange for access to consolidated reports on potential customers. The level of detail in the report varies widely across countries. The threat that a data furnisher will be denied future access to reports if the furnisher fails to report (or knowingly contributes inaccurate data) is often used to reduce the free-rider problem inherent in sharing. Reported data ranges from a simple statement of current or past delinquencies (negative information) to more detailed statements that itemize account balances, credit limits, and account age, by type of account (positive information). In some countries, credit reports also include information on borrower assets and employment. Because sharing with a PCR is usually compulsory, all lenders are covered, but PCR reporting is typically required only for loans that meet or exceed a certain loan-size threshold. 7 Credit accounts with balances below the threshold are not reported, or may only be reported if seriously delinquent. Frequently, only the borrower s aggregate balances are reported to lenders making inquiries, not the itemized listing of accounts and creditors. Because there is typically credit activity below the PCR loan-size 2008 TransUnion LLC All Rights Reserved 4

6 threshold, private credit bureaus still operate in some countries with PCRs by focusing on the market segment below the PCR threshold. Generally speaking, private credit bureaus offer more detailed information on individual accounts than do PCRs and may merge credit info with other types of data to create valuable information products for lenders. 8 Jappelli and Pagano (2006) summarize the major implications of economic studies of the development of credit reporting and its influence on the functioning of credit markets. The sharing of information among lenders via credit reporting: 1. Facilitates more accurate prediction of repayment probabilities (reducing adverse selection problems) 2. Encourages repayment (reducing moral hazard) 3. Enhances competition (by reducing the costs to new lenders of entering loan markets) 4. Prevents overextension by borrowers as lenders gain a more comprehensive view of borrower credit obligations 2. How does Comprehensive Credit Reporting Improve Credit Decision-Making? Piercing the Fog of Uncertainty The credit report helps lenders pierce the fog of uncertainty surrounding each new loan applicant from the lender s viewpoint. Generally speaking, more information about a borrower s past credit history and the handling of existing accounts improves the lender s risk assessment process. The result is a better match of borrowers to loans. The credit reporting environment varies widely around the world. The difficulty and cost of risk evaluation rises and falls accordingly. Some countries (e.g., United States, Canada, United Kingdom) have credit reporting systems characterized by comprehensive, full-file reporting that yields a credit report for each consumer containing both positive and negative information about a borrower s credit experience across all types of loan products. At the other end of the reporting spectrum are credit reporting systems that produce consumer credit files containing only negative information (delinquencies, chargeoffs, bankruptcies, etc.). Essentially, a consumer in a negativeonly reporting country would have either derogatory information in their credit report or no information at all. The problems for a lender trying to assess the applicant s risk in a negative-only reporting environment are readily apparent. Such credit reports give a lender little or no information for lowerrisk borrowers who use credit responsibly. The lender can not discern the length and breadth of the consumer s past credit experience nor can the lender determine the consumer s current credit obligations. The consumer gets no benefit from handling credit responsibly in the past, and the lender can t tell the extent to which the consumer is burdened with other credit obligations at the time of the application. Only when the file contains some negative information does it help the lender at all. Otherwise, the applicant remains shrouded in a fog of uncertainty. In between the full-file comprehensive reporting systems and the negativeonly systems are a host of intermediate reporting environments that contain some positive information, but not a complete history of a consumer s credit experience. Common examples are reporting systems that evolved from lender consortiums within a particular segment of the industry. For example, banks may have historically participated in the exchange of information within the banking community about their consumer loan experience, but did not share that information with non-bank creditors. Retailer creditors or finance companies may have developed their own sharing arrangements within their segment of the loan market. Within the consortium, lenders would agree to share negative or positive data, or both. However, even with positive data present, a credit report produced by any one consortium would be incomplete, because it would contain the information from lenders in only one segment of the industry. Across all reporting environments, comprehensive, full-file reporting provides the greatest benefit to risk evaluation. The empirical case for the advantages of full-file reporting is relatively recent, but the results are now well established, having been replicated TransUnion LLC All Rights Reserved

7 by researchers several times with different datasets. Barron and Staten (2003) provided a comparative assessment of benefits from reporting environments as part of a World Bank project to explore the role of credit reporting infrastructure in developing economies. Their report offers a set of simulations that demonstrate the benefits of increasingly comprehensive information about a borrower s credit profile. In doing so, they simulate the effects that country-by-country differences in credit reporting have on credit availability and loan performance. One simulation is described below, comparing a reporting environment in which full-file information is available for risk assessment vs. an environment in which only negative information is available. Because credit reports in the U.S. provide the most comprehensive profile of consumer credit histories (full range of negative and positive credit account data, including account balances and percent of credit line utilized for revolving credit accounts) of any credit reporting in the world, they provide a very useful analytical tool for the simulations. By using a large set of credit report data elements from U.S. credit reports to build a predictive credit scoring model, and then removing particular data fields that in other countries are either banned by regulation or unavailable due to limitations in local credit reporting systems, the simulation can identify the reduction in predictive power attributable to the missing information. This technique quantifies in two ways the cost imposed on lenders and consumers by the missing data. First, it reveals the increase in predicted delinquency rates for a group of accepted loans, relative to what lenders can achieve when more information is available about a borrower s credit experience. It also identifies the decrease in the number of loans that can be approved for a given pool of consumer applicants, while maintaining a target delinquency rate. TABLE 1 Effect on Default Rate for Various Approval Rates Target Approval Rate Negative-Only Model Table 1 illustrates the change in predictive power associated with expansion in the information available to the credit scoring models. Under each of the scenarios depicted in the table, the models were used to calculate individual credit scores for each borrower in a sample. Individual borrowers were ranked according to their credit score. The authors then picked various loan approval rates (e.g., 60 percent) and reported the corresponding percent of borrowers who would default (defined as reaching 90 days past due) on their newly opened accounts within two years. To illustrate, at a targeted approval rate of 60 percent (i.e., accept the top 60 percent of all borrowers in the sample), the model built on a negative-only reporting system produced a 3.36 percent default rate among accepted applicants, compared to a 1.95 percent default rate for the full-file model. In other words, the default rate under the negative-only reporting rules is 72 percent higher than if full-file information was available to creditors. Comprehensive, Full-File Model Default Reduction 40% 2.91% 1.15% 153.0% 60% 3.36% 1.95% 72.3% 75% 4.10% 3.09% 32.7% 100% 9.38% 9.38% 0.0% Source: Barron and Staten, 2003 TABLE 2 Effect on Credit Availability for Various Default Rates Target Approval Rate Negative-Only Model Comprehensive, Full-fi le Model Percent Increase with Full-file Model 3% 39.0% 74.8% 47.5% 4% 73.7% 82.9% 11.1% 5% 84.2% 88.9% 5.3% 6% 90.6% 92.8% 2.4% 7% 94.6% 95.6% 1.0% MEAN 100% 100% Source: Barron and Staten, 2003 % of Customers Who Obtain a Loan 2008 TransUnion LLC All Rights Reserved 6

8 Next, consider the implications of the two reporting systems for extending credit to deserving borrowers. Suppose the economics of the lender s operation dictate an optimal default rate of 3 percent. Table 2 shows that the negative-only reporting model could approve only 39.8 percent of applicants without exceeding the target default rate. However, under the full-file system, 74.8 percent of applicants could be approved. In other words, for every 10,000 applicants, the full-file system would approve 3,500 deserving borrowers that the negative-only system would have rejected. These results clearly indicate that a credit reporting environment that does not provide comprehensive credit experience on consumers produces either a significant increase in the likelihood that originated loans will default (and consequently higher loan prices) or a significant reduction in the availability of credit. How can this be? The reason for the improved performance of the full-file model is intuitive: when risk assessment tools have less information available to them, creditors have greater difficulty piercing the fog of uncertainty that surrounds new borrowers. Consequently, creditor efforts are less effective at matching loans to borrowers who will repay as agreed. For any pool of approved loans, more of the loans go to borrowers who will default, and more borrowers are rejected who would have repaid. The negative impact on worthy borrowers is greatest for those who are young, have short time on the job or at their residence, have lower incomes, and are generally more financially vulnerable. These are precisely the borrowers for whom the ability to see successful handling of credit on the credit report is most important, to offset attributes that otherwise make them appear to be higher risk. Barron and Staten (2003) also report simulations of credit reporting that is fragmented by the type of lender originating the loan. This occurs frequently around the world in countries where the evolution of credit data repositories was driven by industry affiliation. In several Latin American countries (Brazil, Mexico, Argentina) as well as Japan, banks historically shared information about their customer loan experience and created databases that captured only bank loan experience. Non-bank creditors often were not allowed to draw information from the repository, so pooled their own loan experience to form a separate database. Barron and Staten simulate a segmented reporting system by comparing the fullfile scenario to a reporting system in which only credit experience compiled by retailers was available to a lender. The simulations demonstrated that fragmented reporting also results in significant deterioration of a scoring model s predictive power. A corollary to these findings, and one that can be demonstrated statistically through simulations like the ones described above, is that in any reporting system, the more lenders that report, the better. The intuition follows directly from the results above. Lenders who choose not to report their customers experience, or report only negative information and omit accounts in good standing, impose a predictive drag on the rest of the data. Credit reporting is a good example of an action that produces what economists call externalities. A non-reporting creditor, especially a large one, imposes an external cost on all other creditors, because omission of its data impairs the value of the remaining credit bureau information for everyone. The predictive power of models built with reported data is diminished, and the fog of uncertainty surrounding a given borrower is a little bit greater when lenders know that the consumer may have an account (of unknown size and payment status) with a non-reporting creditor. The simulation approach developed by Barron and Staten has been applied by other researchers to different databases and other reporting environments. A study by Turner (2003) used commercially available scoring models and U.S. data to show the impact of a negative-only reporting environment in which only serious delinquencies (90 days past due or worse) are reported. Powell, Mylenko, Miller and Majnoni (2004) used credit report data from Brazil and Argentina and found dramatic increases in loan acceptance rates resulting from full-file information. Still another study by Turner (2007) used Colombian credit files and a commercial scoring model to show the predictive boost from the availability of full-file information. Although the magnitude of the gain from full-file reporting varies across these studies due to differences in the depth and quality of the information in the respective credit reports across countries, all the studies showed a significant gain to risk assessment when full-file information is used rather than negative-only information TransUnion LLC All Rights Reserved

9 To summarize, all of these simulations show that a comprehensive credit reporting system that expands a lender s ability to recognize borrowers for successful use of credit can produce significant increases in both the availability of credit as well as the likelihood that loans are repaid. The results highlight the distinct tradeoff between 1) limits (regulatory or otherwise) on the collection and use of personal credit histories and 2) making credit available to consumers at reasonable prices. 3. Benefits That Result From Comprehensive, Full-File Reporting Systems As discussed above, full-file credit reporting significantly improves the effectiveness of the risk evaluation process in consumer lending. This section discusses the broader set of benefits to credit markets and the macroeconomy that can be linked back to the detailed information sharing made possible by a well-developed credit reporting system. A. Preventing Delinquencies and Defaults Comprehensive credit reports allow consumers to establish a reputation for handling credit responsibly. To the extent that consumers recognize the link between their credit opportunities and the content of their credit reports, the reporting system has a powerful and beneficial side-effect: it reinforces borrower incentives to manage credit wisely and avoid delinquencies and defaults. In this way, credit reporting improves the performance of the entire market and lowers the costs of making credit available. In competitive credit markets these cost savings translate to lower prices and greater product availability to consumers. 10 An under-appreciated aspect of the reporting of positive credit information is that it allows lenders to be proactive in preventing debt problems, not only in the application phase but also for existing accountholders. Credit reports that take into account the full breadth of a borrower s obligations (as well as past payment history) allow creditors to detect overextension. Because the comprehensive credit reports available in the U.S. give lenders a broad picture of a borrower s changing financial circumstances, credit scoring is used by many U.S. lenders to determine appropriate intervention for borrowers headed for financial trouble, including possible recommendations for credit counseling assistance. 11 In addition, full-file credit reports give financial regulators a valuable tool for assessing the quality of bank assets and compliance with fair lending laws. As part of the regulatory responsibility to ensure safety and soundness of the banking system, bank examiners can inspect samples of loans from a lender s portfolio and use the information from credit reports and credit scores in each loan file to evaluate the lender s underwriting procedures. Loan samples with credit reports and scores can help the examiner determine the quality of the bank s assets and the adequacy of capital. If the comprehensive credit reports available in the United States are so useful for predicting risk, why did the global credit crisis of 2008 begin with soaring default rates in the U.S. subprime mortgage market? The short answer is that while credit reports provide critical input to a risk manager s decision process, they aren t the only tool in the manager s toolbox. Mortgage lenders in the U.S. had multiple tools but used them badly. The credit risk posed by a given loan depends on a variety of factors other than the borrower s skill in handling credit and current level of debt (both of which a full-file credit report helps to measure). Other key factors in determining mortgage loan risk include the size, source and stability of a borrower s income stream; the value of the borrower s assets that could be tapped if income proves insufficient to maintain payments; the value of the loan collateral (the house and property backing the mortgage loan) as an assurance to the lender that all or most of the loan principal could be recovered if foreclosure becomes necessary; and an assessment of economic conditions that could affect all of the above. The art and science of risk management rests on gathering and using information on all of these factors to make accurate estimates about the probability of repayment. Most observers agree that between 2002 and 2007, many mortgage lenders in the U.S. willingly accepted borrowers that credit reports and scores indicated were higher risk. And, over the five-year period, lenders put these borrowers into increasingly risky loan products with terms that made economic sense only if the underlying collateral continued to rise in value. By 2006, the underlying home prices had stopped rising, and in 2007 began a steady downward slide, triggering massive defaults across lender portfolios. While a thorough analysis of how this translated into a global credit crisis is beyond the scope of this paper, it is safe to say that virtually no observers 2008 TransUnion LLC All Rights Reserved 8

10 have identified credit reporting as the source of the problem. It would be closer to the truth to say that lenders chose to ignore the information they had on borrower risk (for a variety of reasons), and bet that continued home price appreciation would insulate them from losses due to borrower payment problems. 12 B. Enhanced Competition Because it dramatically reduces the cost of assessing the risk of new borrowers, credit report information encourages entry by new lenders and greater competition. A significant obstacle to new entry into an established loan market is the prospect that the only customers interested in the new lender s product are the ones who have been rejected by other lenders because of their higher risk. This problem of adverse selection can sharply limit the number of competitors in a market, especially if information on borrowers past credit experience is costly to obtain. Credit report information lowers those costs. The more detailed the credit history available to new entrants, the more competitive will be the market for new loans. The massive new entry into the U.S. bank credit card market beginning in the late 1980s provides a compelling example of how credit report data facilitates rapid entry into new geographic markets. Through the late 1970s, most credit cardholders in the U.S. acquired their cards through their local financial institutions, often by picking up applications at a branch. Choice was limited to issuers who happened to offer a credit card product through a local bank or other financial institution. Customers in smaller towns had fewer choices than residents of large cities. Few banks issued credit cards to customers outside their charter state. Because local institutions faced little threat of entry, there was little variance in either credit card prices or product features (Knittel and Stango 2003). All of this began to change by the midto-late 1980s. A key court decision in 1978 gave banks the ability to launch national credit card marketing programs without being constrained by cross-state differences in the legal limits on pricing. 13 The nationwide availability of detailed credit histories for potential cardholder prospects made it possible for companies to enter new geographic markets. Established, full-service banks with credit card programs began national marketing campaigns. Over the course of the next decade the opportunity to market credit cards nationally through the mail, without a network of brick and mortar branches, spawned the entry of branchless, monoline credit card specialists. Beginning in 1985 and continuing through the early 1990s, retailers and manufacturers (e.g., Sears (Discover card), General Motors, AT&T and General Electric) also began introducing their own co-branded bank credit cards as unique alternatives to the traditional Visa and MasterCard products being offered by established banks. These entrants combined data about existing customers of their corporate affiliates with information from credit reports and other external sources to identify and reach likely prospects. Entry often occurred with astounding speed. 14 The use of credit report data to prescreen borrowers and target desirable prospects provided the jet fuel for an acceleration in card offerings and competition. 15 The wave of new entrants to the credit card market put increasing downward pressure on the finance charge rate and annual fees charged by existing issuers. Incumbent credit card issuers saw attrition escalate, particularly among their lower-risk customers. 16 Competitors knew no geographic boundaries and their offers reached consumer mailboxes from thousands of miles away. Knittel and Stango (2003) found that the flood of new entrants eventually broke what had been a pattern of tacit price collusion among incumbent banks for over a decade. All of this was possible because credit bureau data could be used to assess the risk of potential new customers, negating some of the advantages of the incumbent issuers. The ability of new entrants to use personal information to establish and cultivate relationships with customers thousands of miles away has transformed the competitive landscape for credit cards in the United States, injecting intense price and service competition into a market that had not been historically noted for either. 17 New entrants not only triggered a dramatic reduction in credit card pricing, but also substantially broadened access to the bank credit card product to millions of higher-risk households. 18 The largest increases in card ownership occurred in the lower income segments of the population TransUnion LLC All Rights Reserved

11 Table 3 compares the number of generalpurpose credit cards owned per thousand people in the United States verses eight countries in the European Union. Ownership rates are vastly higher in the United States. Although cultural differences across country borders surely explain some of the variation in card ownership in Table 3 it is hard to avoid the conclusion that the presence of more detailed credit histories in the United States is a powerful contributor to the substantially higher rate of credit card ownership. The rankings of countries by card ownership strongly resemble the rankings by the amount of detail in credit bureau reports. This is all the more significant because unsecured, revolving lines of credit are significantly higher risk than secured loans due to the lack of collateral and the lender s exposure in the untapped line of credit. Quite literally, the borrower s reputation (past and future) is the lender s assurance that the loan will be repaid. Comprehensive credit reports hold their greatest value for lenders assessing borrower risk for this type of product. A report on the global credit card industry prepared in 2001 by Morgan Stanley Dean Witter Equity Research confirms this conclusion regarding the impact of the credit reporting environment as a boon or impediment to new entrants. Of the United Kingdom, the Morgan Stanley report had this to say: Barriers to entry are low and new companies are still entering. U.K. credit bureaus have access to almost as much data as do those in the United States, allowing companies to launch targeted direct mail campaigns. 19 Their assessment of competitive conditions and entry prospects in other European countries contrasts sharply. For example, France is a difficult market to crack. In addition to a cartel-like organization that controls the nation s merchant terminal structure, [l]ack of a central credit bureau in the country is another hindrance, since the credit information made available through the Banque de France is limited to negative or so-called black data. This information is held for only one year. The report s authors write that while Italy is an open market, [t]he biggest obstacle to new entrants TABLE 3 Credit Card Ownership, 1997 (per 1000 people in population) is the lack of a centralized credit bureau. They note that [n]ew entrants in Spain s revolving credit market face some challenges. The lack of availability of credit information on consumers is one problem, as the country does not have centralized credit bureaus to collect and exchange credit information. 20 Credit cards are not the only credit product to exhibit the effects of cross-country differences in the availability of credit Country Superpremium + Premium Corporate Standard Total United States U.K Belgium Netherlands Spain Sweden Germany Italy France Source: Thomas et al, 2002, p 212. TABLE 4 Home Ownership Rates Among Younger Borrowers Country % Home ownership Among Population Aged Average % Downpayment, United States United Kingdom Spain France Italy Germany Source: Chiuri and Jappelli, TransUnion LLC All Rights Reserved 10

12 histories. Economists have found that home ownership rates among younger households vary substantially across developed countries, and the reason is linked to differences in credit reporting (Chiuri and Jappelli 2002). A study of home ownership rates in 14 countries (including eleven EU countries, Canada, the United States, and Australia) found that the cross-country variance in the required downpayment for a mortgage loan is a key determinant of differences in the timing of home purchase (Table 4). In particular, the authors cited the amount of information available in consumer credit report files as a key factor, noting substantial variance in file content across the sampled countries. Lenders in the United States, Canada, and the United Kingdom can require less collateral (i.e., a lower down payment) as a hedge against the likelihood of default because borrower credit histories are more complete. These countries are among the leaders in terms of home ownership among younger households. In contrast, in countries where the exchange of credit history data is far more limited (e.g., France, Italy and Spain) down payments are higher and the degree of home ownership among younger households is significantly lower. The lesson from these international examples is that the availability of detailed personal credit history data can facilitate the movement of lending markets from collateral-based lending to information-based lending. This benefits borrowers at all stages of life who have fewer assets to pledge as security for loans. At the same time, full-file credit reporting gives financial institution regulators the information tools they need to encourage prudent lending and prevent over-extension. C. Increased Mobility of the Workforce The availability of comprehensive and timely credit report data contributes to the mobility of both labor and capital in the U.S. economy. As a result, credit reporting is arguably one of the key elements of the U.S. infrastructure that underpins the remarkable productivity growth of the past 15 years. 21 Credit bureaus in the U.S. are good examples of institutions that facilitate the flow of both labor and capital to more valuable uses. Portable credit reputations give consumers greater mobility. There is less risk associated with severing old relationships and starting new ones, because objective information is available that helps U.S. residents to establish and build trust in new locations more quickly. From a labor market perspective, because the credit reporting system has increased the mobility of the U.S. population, structural shifts within the economy can cause temporary disruptions without crippling long-term effects. In contrast, more restrictive credit reporting laws in Europe prevent consumers in the EU from taking full advantage of their complete credit histories. The fact that credit information is not mobile restricts the mobility of consumers, especially across borders, because of the resulting difficulty of obtaining credit from new institutions. As a result, consumer lending in Europe tends to be concentrated among a few major banks in each country, each of which has its own large customer databases. 22 European consumers, although they outnumber their U.S. counterparts, have access to one-third less credit as a percentage of Gross Domestic Product (Morgan Stanley Research, 2001). D. Increased Mobility of Capital A well developed credit reporting system also makes capital more mobile. Securitization of consumer loans is a prime example. Comprehensive credit reporting allows investors in securities backed by credit card, automobile and residential mortgage receivables to cut through the fog of uncertainty to better evaluate the underlying accounts. Borrower credit risk scores and account performance data are used by analysts to rate the quality of the securitized receivables, which facilitates appropriate pricing of the asset-backed securities. The transparency of risk in individual loans enables creditors to document and pool loans of similar risk and sell them to investors. As a result, the securitization process brings huge amounts of loanable funds into consumer and mortgage credit markets, making credit cheaper and more readily available. Indeed, the liquidity crisis can in part be tied to the fact that after securitization, the link to borrower credit information was lost, creating a vacuum of updated credit information on the secondary market the industry is currently working to address this gap, in hopes that increased transparency will improve investor confidence and liquidity. 23 The enormous growth in the U.S. credit card market during the 1990s was fueled by the influx of loanable funds made possible through securitization. At the end of 1990, there were $1 billion of securitized credit card balances in the United States, less than 1 percent of all outstanding card balances. By the end TransUnion LLC All Rights Reserved

13 of 2007, securitized receivables comprised 46 percent of over $960 billion in revolving credit outstanding. According to Richard C. Drason, associate director at ratings agency Fitch IBCA, securitization of credit card receivables played a major role for smaller players, for players just getting into the business, and for regional players trying to grow nationally. It gave them access to cheaper funds that they might not have been able to obtain. 24 Securitization has been especially helpful to non-depository credit card companies that did not have access to consumer deposits to use to make card loans. Again, the European Union provides a contrast. Cross-border competition has benefited the corporate lending market over the past decade, but consumer loan markets remain fragmented. 25 Conversion to a common currency within the European Union has not been enough to remove persistent cross-border differences in consumer loan interest rates. Adjustments to changing market interest rates are faster in some countries but lag far behind in other countries. Economists have concluded that to lower the cost of consumer loans it will be necessary to encourage cross-border penetration by retail lenders to bring loan rates into closer alignment across countries. Of course, as was noted above, one of the impediments to cross-border consumer lending to some countries is the lack of information about borrowers, a direct result of lack of harmonization of credit reporting rules across EU countries. Another area in which credit reporting has facilitated the influx of new capital in the U.S. is the financing of small business startups. Here again, the ready availability and comprehensive nature of U.S. credit reports has given American small business formation a unique advantage. According to the National Federation of Independent Businesses, seven out of ten small-business owners start their businesses with less than $20, By the early 1990s, credit analysts had determined that personal credit reports for small business owners and partners were highly predictive of the success of the business. Commercial scorecards for evaluating small business loans were introduced to the market in Subsequent research found that the adoption of small business credit scoring expanded the volume of loans, and caused a net increase in lending to relatively risky marginal borrowers who would not otherwise receive credit (Berger, Frame and Miller, 2005). This result mirrors findings discussed previously regarding the positive benefits of credit scoring for credit availability in consumer markets. E. Credit Availability and Economic Resiliency Consumer credit allows households to transfer consumption from periods where household income is high to periods where income is low. This is particularly important for householders early in the life-cycle (ranging in age from the early 20s though their 40s) when the demand for housing, durable goods and education is relatively high, and incomes are relatively low but expected to rise over time. But, it is also important for households weathering temporary income disruptions or unexpected expense shocks. Because the comprehensive content of U.S. credit reports has allowed creditors to extend loans and establish lines of credit for a much wider segment of the population, compared to other countries, tens of millions of U.S. households have access to a credit bridge that can sustain them through temporary disruptions and declines in incomes. The availability of consumer credit to bridge income disruptions has important macro-economic implications. Crosscountry studies have found that credit availability and consumption fluctuations are linked. Consumer spending is more sensitive to changes in income in countries with less-developed consumer credit markets, especially during periods of tighter credit constraints (Bacchetta and Gerlach, 1997). Credit markets that make loans accessible to large segments of the population provide a cushion that neutralizes the macroeconomic drag associated with temporary declines in income, lowering the risk of outright recession and reducing the magnitude of downturns when they do occur (Kreuger and Perri, 2002). These studies imply that the United States and other countries with comprehensive credit reporting systems enjoy a macroeconomic growth advantage as a consequence of welldeveloped consumer credit markets. The intuition is straightforward. Detailed personal credit history data gives lenders confidence in assessing the risk associated with new borrowers. It allows lenders to design and price products to meet the credit needs of previously underserved populations. Because of the underlying credit reporting network, U.S. consumers can get credit, insurance and a host of other financial services based on their individual credit records, not their family name or how long they have known 2008 TransUnion LLC All Rights Reserved 12

14 their banker. In addition, they can rent apartments, purchase cell phones and cable television service, and rent automobiles without either large deposits or an established relationship with the service provider, all because their reputation for paying as agreed is documented through their credit reports Structuring the Credit Reporting System to Maximize Benefits As discussed in Section 1, credit reporting systems around the world have taken on a variety of organizational forms, ranging from public credit registries to private consortiums of lenders in specific segments of the industry, to private, independent credit reporting agencies. In some countries, two or more of these organizational structures co-exist. An important question is whether the market structure of the credit reporting system has a significant impact on the magnitude of the system s benefits to consumers, lenders and the macroeconomy. Both theory and emerging empirical evidence suggests that it does. A recent study by Djankov, et al (2007) conducted a detailed examination of the credit reporting systems of creditor rights in 129 countries. The authors found that countries with stronger creditor rights and greater information sharing through credit bureaus (public or private) also had more private lending as a percent of country Gross Domestic Product. Interestingly, the authors also found that credit reporting agencies (public or private) that distributed a broader range of data and provided legal incentives to ensure the quality of the data were also associated with significantly more private credit. More specifically, the following characteristics of credit reporting agencies appeared in countries with greater amounts of private credit: 1) distribution (to end users) of both positive and negative data, 2) data from a cross-section of lenders, including retailers, trade creditors, and utilities, in addition to financial institutions, 3) five or more years of historical data for borrowers, and 4) data collected for all loans of value above 1 percent of per capita income. 29 Of course, these attributes of a reporting system represent a more precise description of what has been characterized in this paper as full-file reporting. Another recent study obtained even more specific results regarding the differential impact of public vs private credit reporting agencies on private lending activity. Analyzing credit reporting in 65 countries, Turner and Varghese (2007) found that broader coverage of credit-eligible adults by full-file, private credit bureaus increased private sector lending as a percent of GDP, holding other factors constant. In the case of 100 percent coverage of credit-eligible adults, private sector lending rose by 60 percent. 30 This result is quite consistent with the findings of the simulations described in Section 2. Full-file reporting from a broad cross-section of lenders in an economy gives risk scoring models their greatest predictive power, which can translate into greater access to credit for consumers. Why do private credit bureaus produce full-file reporting more often than public credit registries? Most of the reason appears to stem from differing missions. Public credit registries have typically been established to aid in the supervision of financial institutions to ensure safety, soundness and stability of the banking system. In contrast, private credit bureaus are set up in response to market signals that indicate a commercial opportunity to lower the costs of risk assessment and provide decision tools to lenders. In addition, the for-profit structure of the typical private credit bureau creates incentives to continuously monitor and improve the quality and scope of information provided to lenders, incentives that a publicly owned credit registry can t easily duplicate. These different missions lead to different actions by the two types of reporting agencies. Private credit bureaus have greater incentive to ensure data accuracy, as it directly affects the value and price of the information products they sell to lenders. A credit bureau with a reputation for file errors will suffer lost sales in a competitive market as creditors shift their business to vendors that establish a reputation for greater reliability. Moreover, in some countries with private credit bureaus, consumers have the right to inspect the information about them in credit bureau files, and demand reinvestigation of alleged inaccuracies. This gives credit bureaus an additional incentive to invest in procedures that promote accuracy. A mandatory re-verification process is costly for both bureaus and creditors. Like the automaker that must reimburse dealers for warranty work to repair defective vehicles, both creditors and the bureaus would like to reduce the costs they would be required to incur if a consumer alleges TransUnion LLC All Rights Reserved

15 an error. Consequently, bureaus will invest in reporting and updating procedures that eliminate most errors. Public credit registries have no such incentives. To increase the value of the information they sell, private credit bureaus also have market-based incentives to collect data from a variety of sources not just regulated financial institutions when such data can improve the usefulness of their information products for lenders. Powell, et al (2004) found in their crosscountry study that while PCRs may compel regulated institutions to supply data, they rarely seem to include data supplied voluntarily from other sources. 31 Of the 57 PCRs surveyed, only three indicated that they received any data on a voluntary basis. The authors concluded that creditors apparently do not wish to divulge sensitive customer financial data to the government on a voluntary basis. In contrast, without the legal authority to compel reporting, private credit bureaus necessarily must seek out and engage potential furnishers of data to convince them to report. To build their core database of data on credit experience, private credit bureaus seek useful (predictive) data from a wide variety of sources, such as retailers, leasing firms, non-regulated financial institutions, other firms that possess credit or payment-related data on consumers (e.g., landlords, cell-phone providers), public courts and other public databases. Powell, et al (2004) also found that the large majority of PCRs provided access to their data only to the regulated financial institutions that were compelled to report data. As a result, not only are nonreporting financial institutions denied any access to the data but also small businesses, non-financial businesses that provide credit, and insurance firms do not typically have access to the data. 32 This is likely an important reason behind the observation that PCRs generate lower volumes of private lending, relative to private credit bureaus. In contrast to the closed-group practices of many PCRs, the opportunity to expand market share provides a powerful financial incentive for a private credit bureau to sell credit reports and data products to a broad cross-section of firms that make credit-related decisions. 33 Similarly, private credit bureaus operating in competitive markets have incentives to develop new decision tools (e.g., fraud prevention; identity verification and theft prevention; risk scoring tools) that help to manage and reduce risk, and therefore provide value to lenders. Powell, et al (2004) confirm that private credit bureaus typically offer more detailed information to customers and a wider range of information products and services to aid decision-making. As a case in point, the three major credit reporting agencies in the United States have been driven by competitive pressures to produce a wide array of innovative decision tools and scoring products to assist lenders. Examples of scoring products developed by the decision analysis units of U.S. credit bureaus include models to 1) determine how much to increase the limit on credit card accounts; 2) approve authorizations of new credit card purchases at the point of sale; 3) monitor credit card account transactions for possible fraudulent activity (including identity theft); 4) predict account attrition so that lenders can take steps to recruit and keep loyal customers; 5) initiate collection strategies on delinquent accounts, set their tone and predict dollar recoveries; 6) select potential new customers for receipt of pre-approved invitations to apply for credit; and 7) identify existing customers who may respond favorably to the cross-selling of other products. Neither public credit registries nor industry-sector consortiums have comparable incentives to develop such an array of products TransUnion LLC All Rights Reserved 14

16 5. Conclusions Comprehensive, full-file credit reporting provided by private credit bureaus such as those observed in the United States, Canada and the United Kingdom has benefited the residents of those countries by facilitating greater access to credit and financial services, especially for traditionally underserved populations. The depth and breadth of information in the credit reports produced by a full-file reporting system have supported the development of sophisticated statistical scoring tools. In countries with well-developed credit reporting systems, credit decisions are increasingly based on factual data regarding a borrower s own past payment history. Credit scoring has replaced face-to-face attempts to evaluate character and capacity (common a generation ago) with a more equitable (and less invasive) assessment based on documented prior behavior. At the same time credit scoring has improved the accuracy and speed of lending decisions. Readily available and comprehensive data on consumer credit histories has significantly enhanced competition and lowered credit prices by making it possible for lenders to compete for customers nationally, by enabling businesses other than financial institutions to begin offering competitive financial products and services, and by leveling the playing field so that new entrants can overcome the advantage of established lenders in assessing new customers. Comprehensive credit reporting systems have also generated macroeconomic growth advantages for their host countries, including greater resistance to household income interruptions and greater mobility for both labor and capital. But, not all reporting systems produce equivalent benefits; the structure of the reporting system plays a significant role in bringing the benefits to the market. Generally speaking, recent research has shown that private credit bureaus are associated with more comprehensive credit files on borrowers and more innovative decision tools for lenders.

17 1 Another variation on the moral hazard problem occurs when a borrower obtains credit from multiple sources. Each additional loan adds to total debt (relative to income) and so raises the probability of default, not only on the new loan but for all other existing loans. If lenders are unaware of the multiple loans, and do not take countermeasures, borrowers are more likely to overextend (Bizer and DeMarzo, 1992). Exchange of information about a borrower s existing loans helps lenders to curb the problem. 2 Klein (1992), p Klein (1992), p The benefits from information sharing are even larger in countries that have mobile and diverse populations. The intuition is straightforward. A mobile and both economically/culturally diverse borrower pool reduces the likelihood that a lender s own experience will be sufficient to gauge the risk of a new applicant. This is one reason why countries with greater resident mobility (e.g., Canada, Japan, Australia, United States) have more extensive private credit-reporting activity, as measured by number of credit reports per capita. (Pagano and Japelli, 1993). 5 Miller (2003), pp Jappelli and Pagano (2003 and 2006) find that Public Credit Registries are more likely to evolve in countries where private arrangements have not yet arisen, and where creditor rights are poorly protected by the legal system. 7 For example, Miller (2003) reported the smallest loan size required to be reported to the PCR in the following countries (as of 1999, in US$): France, $81,558; Spain, $6,450; Mexico, $21,424; Brazil, $25, Readers interested in more detailed international comparisons can refer to excellent work contained in Miller (2003). As part of a World Bank effort to encourage the growth of a credit reporting infrastructure in developing countries, Miller organized a symposium held in 2000 that commissioned new theoretical and descriptive work on credit reporting around the world. The resulting collection of papers is the most comprehensive description of the global credit reporting system to date. 9 The simulation results linking broader credit availability to the degree of credit information-sharing have been corroborated through cross-country studies. Japelli and Pagano (2002) found that the volume of consumer and mortgage lending in a country rises as a direct result of greater information sharing within a country s credit reporting system. 10 The incentive to preserve a reputation for reliable payment can be quite powerful. A project sponsored by the Inter-American Development Bank and edited by Pagano (2001) offers some extraordinary insights on this point. Six case studies depict how retail credit markets in six Latin American countries have evolved institutions, including unique forms of information-sharing across various types of transactions, to curb excessive default rates that have hampered consumer and small business lending. Collectively they provide a fascinating set of examples and anecdotes that illustrate how credit market institutions arise to deal with adverse selection and especially moral hazard. 11 For examples see: Demery, Why Risk Managers Expect More, 1998, pp 34-35; Adler, 2002; Lucas, Score Updates, 2002, pp That bet looked smart in 2003 and 2004 while home prices (and lender profits) were soaring, but ultimately turned out to be a bad one as prices collapsed and bank capital evaporated as lenders covered the resulting losses. The question of why regulators failed to take earlier and more aggressive action is interesting, but beyond the scope of this paper. It was not for lack of information on borrower credit profiles or the growing risk of a home price bubble. Indeed the debate over how to prevent a similar credit crisis in the future will likely focus on the how much the government should become involved in limiting the risk-taking behavior that borrowers and lenders are otherwise willing to accept. 13 Marquette National Bank of Minneapolis v. First of Omaha Service Corp., 439 U.S. 299, 310 (1978). 14 Following its introduction in 1992, the General Motors MasterCard product established 2 million accounts and more than $500 million of balances in its first 60 days on the market, making it the most successful credit card launch in U.S. history. See Dickson, (1992), p The annual number of direct mail credit card solicitations soared from 1 billion in 1989 to 2.4 billion in 1994 (Stango 2000). Staten and Cate (2003) provide a case study of MBNA Corporation, the large monoline credit card issuer that was among the top three bank credit card issuers in the United States until its acquisition by Bank of America in The study offers a detailed description of how a large national credit card issuer utilizes credit report data, externally acquired demographic information, and data about the existing customers of its corporate affiliates to successfully target millions of profitable customers throughout the United States via direct mail and telephone solicitations. 16 For a description of the attrition pressures that eventually led to steep rate cuts by incumbent issuers see Hilder and Pae, (1991) at B1; Spiro (1991), at 104; Pae, (1992) at B1; Credit Card News (1992). 17 One card industry executive remarked in 1998, Ten years ago, credit cards were an under-marketed business. Issuers are now more sophisticated in their approach to underwriting, pricing and targeting offers at consumers. The entry of a lot of powerful marketers like AT&T and General Motors woke people up and made them realize they were not as aggressive as they could be. See Lucas (1998) pp Source: The Profitability of Credit Card Operations of Depository Institutions, an annual report by the Board of Governors of the Federal Reserve System, submitted to the U.S. Congress pursuant to Section 8 of the Fair Credit and Charge Card Disclosure Act of The report also notes that credit card interest rates fell sharply from mid-1991 through early 1994 after being relatively stable for most of the previous twenty years. (p. 6) The decline in the average most common interest rate on issuer credit card plans between 1991 and 1994 was 244 basis points. 19 Posner (2001), p Posner (2001), pp 75, 78-79, 81, Economic studies have found that the proliferation of computer and information technology was associated with the productivity surge in the United States during the 1990s (Gust and Marquez, 2002). However, what was remarkable about this development was that the same factors were available worldwide, but for the most part we did not witness similar productivity growth elsewhere. Economists who study productivity growth increasingly point to the U.S. institutions that promote efficiency in labor and capital markets as the secret to the flexibility and resiliency of the U.S. economy. 22 A 2000 report from the U.S. based consulting firm The Tower Group found that in Europe consumer financial services are provided by one-tenth the number of institutions that serve U.S. households, despite the fact that the pan-european market has almost one and one-half times as many households. In France, the EU country with some of the strictest financial privacy laws that restrict personal data transfers, seven banks control more than 96% of banking assets. In particular, French law does not permit positive credit reporting. Consequently, unless a borrower has had past payment difficulties, he has no credit history at all. See Kitchenman, (2000). 23 To be sure, unexpected losses in securitized mortgage loan receivables were at the heart of the financial contagion that caused global credit markets to freeze in the third quarter of The procedures and contracts used to package and re-package mortgage-backed securities for sale in secondary markets appear to be a prime suspect in creating uncertainty about who was responsible for underlying losses, and the size of those losses. Commercial rating agencies that evaluate the quality of asset-backed securities appear responsible as well for accepting large fees from issuers of securities in exchange for high ratings, without careful scrutiny of the underlying assets using information (like credit scores and property valuation data) that was readily available. For more on this last point see U.S. House of Representatives, Committee on Oversight and Government Reform, Hearing on Credit Rating Agencies and the Financial Crisis, October 22, More direct oversight of the securitization market is likely in store, but precisely because the securitization process is so valuable in making huge quantities of investor funds available to loan markets. 24 Punch, (1998). 25 This discussion draws on two papers: Heinemann and Schuler (2001) and European Credit Research Institute (2002). 26 National Federation of Independent Businesses < Small businesses represent over 99 percent of all employers in the United States, create 80 percent of all new jobs, and account for about 38 percent of Gross Domestic Product. 27 Fair Isaac Co. introduced its Small Business Scoring System in 1995 in a joint effort with Philadelphia-based Risk Management Association (formerly Robert Morris Associates, or RMA), a trade association of lenders. See, Mester, 1997, p A benefit not to be overlooked is the remarkable speed at which these credit-related decisions can take place in a market with access to comprehensive credit reports. Even very significant decisions about financing college tuition or a new home are often made in a matter of minutes, instead of days or weeks as is the case in many other countries, because credit history data is readily accessible. The variety and speed of such services are unheard of in most other countries where restrictive laws and market practices prevent credit bureaus from storing sufficient information on consumer borrowing and payment behavior to support rapid and accurate decision-making. 29 Djankov, et al (2007), p Turner and Varghese (2007), p Powell, et al (2004), p Powell, et al (2004), p A host of market-driven contracts govern the provision of data to private credit bureaus and the purchase of data products from the bureaus. As noted in Section 1, private credit bureaus are usually structured around reciprocal agreements in which furnishers of data agree to contribute in exchange for the right to purchase consolidated reports on potential customers. References Adler, Jane. Two Faces of the Card Market, Collections and Credit Risk, 7, No 10, Oct. 2002, pp Barron, John M. and Michael E. Staten, The Value of Comprehensive Credit Reports: Lessons from the U.S. Experience, in Margaret Miller, ed., Credit Reporting Systems and the International Economy, MIT Press, 2003, pp Berger, Allen N., W. Scott Frame, and Nathan H. Miller, Credit Scoring and the Availability, Price and Risk of Small Business Credit, Journal of Money, Credit and Banking, vol. 37, No. 2 April 2005, pp Bizer, David S. and Peter M. Demarzo, Sequential Banking, Journal of Political Economy, 100, no. 1, February 1992, pp Citibank Leads an Exodus from Higher Interest Rates, Credit Card News, May 1, Chiuri, Maria Concetta and Tullio Jappelli, Financial Market Imperfections and Home Ownership: A Comparative Study, manuscript, Department of Economics, Universita di Salerno, Demery, Paul, Why Risk Managers Expect More, Credit Card Management, 10th Anniversary Issue, May, 1998, pp Dickson, Martin, Record Take-Up for GM Card, Financial Times, Nov. 17, 1992, p 26. Djankov, Simeon, Caralee McLeish, and Andrei Shleifer, Private Credit in 129 Countries, Journal of Financial Economics, Vol 84, 2007, pp European Credit Research Institute, Consumer Credit Rates in the Eurozone: Evidence on the Emergence of a Single Retail Banking Market, European Credit Research Institute Research Report No. 2, Jan Fickenscher, Lisa, Credit Bureaus Move Against Lenders that Withhold Info, American Banker, December 30, 1999, p TransUnion LLC All Rights Reserved

18 Fishelson-Holstine, Hollis Credit Scoring s Role in Increasing Homeownership for Underserved Populations, in Building Assets, Building Credit, edited by Nicolas P. Retsinas and Eric S. Belsky, Brookings Institution Press, 2005, pp Global Growth, Local Challenge, Morgan Stanley Research, Mar. 21, Gust, Christopher and Jaime Marquez, International Comparisons of Productivity Growth: The Role of Information Technology and Regulatory Practices, International Finance Discussion Papers, No. 727, Board of Governors of the Federal Reserve System, May Heinemann, Friedrich and Martin Schuler, Integration Benefits on EU Retail Credit Markets Evidence from Interest Rate Pass-through, manuscript, Zentrum fur Europaische Wirtschanftsforschung, Mannheim, Germany, Nov. 2001, available at Hilder, David B. and Peter Pae, Rivalry Rages Among Big Credit Cards, The Wall Sreet Journal, May 3, 1991, at B1 Japelli, Tullio and Marco Pagano, Information Sharing, Lending and Defaults: Cross-country Evidence, Journal of Banking and Finance, Vol 26, No. 10 October 2002, pp Japelli, Tullio and Marco Pagano, The Role and Effects of Credit Information Sharing, in The Economics of Consumer Credit, edited by Guiseppe Bertola, Richard Disney and Charles Grant, The MIT Press, 2006, pp The Profitability of Credit Card Operations of Depository Institutions, Board of Governors of the Federal Reserve System, Jun Punch, Linda, The Legacy of Card Bonds, Credit Card Management 10th Anniversary Issue, May 1998, pp Spiro, Leah Nathans, How AT&T Skimmed the Cream Off the Credit-Card Market, Business Week, Dec. 16, 1991, at 104. Staten, Michael E. and Fred H. Cate, The Impact of Opt-In Privacy Rules on Retail Credit Markets: A Case Study of MBNA, 52 Duke Law Journal No. 4, 2003, pp Thomas, Lyn C., David B. Edelman, and Jonathan N. Crook, Credit Scoring and its Applications, Society for Industrial and Applied Mathematics, Philadelphia, Turner, Michael A., The Fair Credit Reporting Act: Access, Efficiency and Opportunity, Washington, DC. The National Chamber Foundation, June Turner, Michael and Robin Varghese, Economic Fairness Through Smarter Lending Chapel Hill, NC: Political and Economic Research Council, October U.S. House of Representatives, Committee on Oversight and Government Reform, Hearing on Credit Rating Agencies and the Financial Crisis, October 22, Kitchenman, Walter F., The European Union Directive on Privacy as a Barrier to Trade, The Tower Group, Klein, Daniel B., Promise Keeping in the Great Society: A Model of Credit Information Sharing, Economics and Politics, Vol. 4, No. 2, July 1992, pp Knittel, Christopher R. and Victor Stango, Price Ceilings as Focal Points for Tacit Collusion: Evidence from Credit Cards, American Economic Review, Vol. 93, no. 5, December 2003, pp Kreuger, Dirk and Fabrizio Perri, Does Income Inequality Lead to Consumption Inequality? Evidence and Theory, National Bureau of Economic Research Working Paper #W9202, Sep Lucas, Peter, Marketing s Long and Winding Road, Credit Card Management 10th Anniversary Edition, May 1998, pp Lucas, Peter, Score Updates, Collections and Credit Risk, Vol. 7, No 10; Oct. 2002, pp Mester, Loretta J., What s the Point of Scoring? Business Review, Federal Reserve Bank of Philadelphia, September-October, 1997, pp Miller, Margaret J., Credit Reporting Systems Around the Globe: The State of the Art in Public Credit Registries and Private Credit Reporting Firms, in Credit Reporting Systems and the International Economy, edited by Margaret J. Miller, The MIT Press, 2003, pp Morgan Stanley Research, Global Growth, Local Challenge, March 21, Padilla, Jorge A. and Marco Pagano, Edogenous Communication Among Lenders and Entrepreneurial Incentives, The Review of Financial Studies, Spring, 1997, Vol 10, No. 1 pp Pagano, Marco, editor, Defusing Default, 2001, Inter-American Development Bank and Johns Hopkins Press. Pagano, Marco and Tullio Jappelli, Information Sharing in Credit Markets, Journal of Finance, Dec. 1993, pp Pae, Peter, Success of AT&T's Universal Card Puts Pressure on Big Banks to Reduce Rates, The Wall Street Journal, Feb. 4, 1992, at B1 Posner, Kenneth A., Athina Meehan and Geula Daniel, Industry Report: Global Credit Cards, Morgan Stanley Dean Witter Equity Research, Mar. 21, 2001, pp 75, 78-79, 81, 83. Powell, Andrew, Nataliya Mylenko, Margaret Miller and Giovanni Majnoni, Improving Credit Information, Bank Regulation and Supervision: On the Role and Design of Public Credit Registries, (World Bank Policy Research Working Paper Series, no. 3443, November 2004) 2008 TransUnion LLC All Rights Reserved 17

19 Under legal rules that permit full-file, comprehensive credit reporting, the core database assembled and maintained by private credit bureaus is potentially more valuable to both private sector customers and financial regulators than would be the data assembled by public credit registries. Consequently, independent, privately-owned credit bureaus can more effectively increase credit availability, lower credit prices and partner with financial regulators to prevent over-extension and manage systemic risk. The information contained in this White Paper is not intended as and in no way constitutes legal guidance and/or advice of any nature from TransUnion, nor is anything contained herein a guarantee that your fraud and identity management program will be compliant with Red Flag Regulations. TransUnion makes no warranties of any kind concerning the information provided in this White Paper. You must consult your own legal counsel or compliance advisor to determine whether your fraud and identity management programs will enable your organization to meet your compliance obligations associated with Red Flag Regulations TransUnion LLC All Rights Reserved No part of this publication may be reproduced or distributed in any form or by any means, electronic or otherwise, now known or hereafter developed, including, but not limited to, the Internet, without the explicit prior written consent from TransUnion LLC. Requests for permission to reproduce or distribute any part of, or all of, this publication should be mailed to: Law Department TransUnion 555 West Adams Chicago, Illinois The T logo, TransUnion, and other trademarks, service marks, and logos (the Trademarks ) used in this publication are registered or unregistered Trademarks of TransUnion LLC, or their respective owners. Trademarks may not be used for any purpose whatsoever without the express written permission of the Trademark owner TransUnion LLC All Rights Reserved 555 West Adams Street Chicago, Illinois USA transunion.com/business 2008 TransUnion LLC All Rights Reserved 18