India must build a credit history database

The word ‘inclusive’ has been figuring prominently in India’s policy documents for years now but still inequality persists in this country. Among several things that facilitate inclusion, credit is one of the critical factors that can enable the poor to improve their economic status. The Nachiket Mor Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households, which was set up by the Reserve Bank of India in 2013, and CRISIL’s inclusive index report point out that nearly 90% of small businesses have no links with formal financial institutions, only one in two Indians has a savings account and that only one in seven Indians has access to banking credit.

India’s financial inclusion strategy has failed primarily due to information asymmetry: The inability of institutions to gather information about the repayment capacity of a borrower pushed these institutions to be extra cautious in extending credit. Many expected that micro finance schemes would solve this problem by creating social networks. These networks, they hoped, would act as replacements, establishing the link between the users and the institutions by facilitating transmission of information. But this model has inherent flaws. Research by economists Dean Karlan, Xavier Gine and Emily Breza has revealed that there is no difference in the default rates between individual and group liabilities if dynamic incentives are used.

This problem of information asymmetry could be addressed by building credit histories of individuals. Anyway, financial institutions are moving towards digitalisation to improve their efficiency: Data can be captured, stored, retrieved and shared with fewer resources. On its part, the government should plan for a national credit history database for individuals who have the Aadhaar number.

Building such credit histories has several benefits. First, access to credit history would enable micro-finance institutions (MFIs) to determine an individual’s risk type and this would minimise uncertainties and lower the interest rates. Second, it would offer individuals the mobility to switch between institutions. This would induce competition between MFIs and would force them to operate efficiently and offer better products at low interest rates. Third, this would also prevent the client from taking loans from multiple institutions and also put restrictions on loan officers who force clients to take multiple loans, leading them to a debt trap. The Andhra Pradesh micro-finance fiasco would have never happened if such credit histories existed.

Amith Kaushik Tanneru is a second-year MA student at the Jindal School of Government and Public Policy The views expressed by the author are personal