Australia's credit rating system is failing both borrowers and lenders. Many borrowers are unaware of their own credit scores and our research shows they have trouble applying for suitable loans. Lenders are also struggling with too little information, causing them to extend loans to those they shouldn't and restrict loans to worthy borrowers.
Under the new credit reporting regime, both lenders and borrowers will have access to more data, such as monthly payment histories on loans and credit cards. This will help consumers understand their own creditworthiness, improve their credit scores and shop around for lower interest rates.
The new data will arm banks and other lenders to make better lending decisions. But it should also level the playing field by giving new entrants more information, helping them to compete with the established lenders.
My research with Luke Deer examined loan applications to SocietyOne. This is a peer-to-peer lending marketplace that specialises in unsecured personal loans.
Borrowers are only accepted onto the SocietyOne platform if their credit scores can be verified. Substantial "underwriting" is required to ensure borrowers are of sufficient credit quality.
A borrower may report only part of their true financial situation – for example, by sharing information from only one of multiple accounts. Without an accurate picture of creditworthiness, lenders could be extending loans to borrowers that should be rejected, and others might not receive loans they should qualify for.
This is where the new credit reporting regime comes in – there will be much more data. In addition to monthly payment histories, there will be red flags on any missed payments of more than 14 days. The current system only flags missed payments of more than 60 days or bankruptcies only.
The shift towards comprehensive credit reporting should reduce the time required to underwrite loans and allow loans to be priced more efficiently. This is in part because it will reduce the risk of lending to people who are risky borrowers, and so will lower costs.
Australia has lagged other developed countries in adopting positive credit reporting. Up to this point, the large banks have had a significant informational advantage over new entrants. Because many of us have accounts with the larger banks, they simply had access to information that other lenders don't.
This will partially eliminate the need for costly processes in loan underwriting. But prior experience from an over-reliance on credit scores in the United States shows that careful assessment of borrowers remains vital.
Comprehensive credit reporting should lead to, in aggregate, lower borrowing rates for lower-risk individuals and incentives for higher-risk individuals to improve their position. However, it remains to be seen whether this will lead to a greater degree of exclusion or predatory loans for riskier borrowers.