Credit Act necessary in defining Kenya’s credit score system

NAIROBI…Top commercial law firm MMC Africa Law has proposed the establishment of a new standalone Credit Act that will define a designated regulator to oversee credit scoring and information sharing for all credit providers operating in the market regardless of their industry.

This comes months after Central Bank of Kenya Governor Patrick Njoroge, during a regional conference on credit information sharing in Nairobi, expressed concern that the differing formulas for reviewing credit scores by the various licensed credit bureaus – Metropol Credit Reference Bureau Limited, CreditInfo Credit Reference Bureau Kenya Limited and Credit Reference Bureau Africa Limited (trading as TransUnion) – was resulting in confusion.

According to Jacqueline Wangui, MMC Africa Law’s Banking & Finance Partner; the announcement by CBK governor on plans to formulate a central server for financial technology firms to facilitate submission of client credit information could potentially spell the end of mobile, online and micro lenders’ woes with high risk loan delinquents and serial defaulters.

“The new model will also address lenders’ apprehensions about credit score consistency across the three main credit bureaus. One other essential safeguard of the proposed credit information central server is to preserve the integrity of credit scoring so that everyone has a number that accurately determines their credit worthiness,” she explained.

Jacqueline however pointed out that the absence of a Credit Act means that some categories of credit providers are not regulated and thus may choose not to actively remit data to the central server.

“This has the potential of undermining the efficacy of the proposed changes. Faced with the challenge, Parliament may elect to legislate a new standalone Credit Act that defines a designated regulator to oversee all credit providers operating in the market regardless of their industry. Alternatively, it may strengthen the authority and rights of the Credit Information Sharing Association of Kenya (CIS) as a self-regulating establishment to improve its enforcement mechanisms across a larger pool of institutions that offer credit,” she said.

A credit score is a numerical expression based on a level analysis of a person’s or institution’s credit files to represent the creditworthiness of the entity. A credit score is primarily based on credit report information typically sourced from credit reference bureaus (CRBs).

The introduction of the CRBs to Kenya’s financial scene was a much-needed solution to the banking crisis of the 1990s which saw the collapse of a number of banks, triggered in part by non-performing loans (NPLs). In the period between 1996 and 1999, the proportion of NPLs grew from 17.7 per cent to 34.2 percent as compared to performing loans, according to data from CBK. A key contributor to the rise in NPLs was the information asymmetry amongst banks, allowing borrowers to migrate freely across banking institutions on the occurrence of a default.

A well-functioning and efficient credit scoring system remains, in Jacqueline’s opinion, an invaluable lever in revamping the credit market and a key determinant of sustained growth for financial institutions.

“Despite the proliferation of banking services, provision of loans to individuals, corporates and industries still constitutes a primary source of income for lending institutions in Kenya. Part of these financial institutions’ elementary lending practices is their evaluation of the creditworthiness of potential debtors prior to granting credit,” MMC Africa Law’s Banking & Finance Partner explained.

She continued on to say: “As the appetite for banking facilities soars, the quality of credit-scoring processes has become imperative. The need to develop a scoring methodology that provides a powerful, empirical and objective way of assessing debtors is vital in the authentication of borrowers’ credit reports.”

To ensure the successful implementation of the proposals made by CBK and that are ultimately meant to revamp the credit market; Jacqueline recommends that CBK ought to engage CIS for a seamless integration of the new model so as to attain high levels of enforcement and compliance across participants.

“The conduct of the credit market on credit scoring and information sharing is split between the CIS and CBK. This is therefore something CBK would need to streamline,” Jacqueline explained.

MMC Africa Law’s Banking & Finance Partner points out that credit information sharing has positively influenced the profit before tax of Kenyan banks.

“Studies have shown that 68 per cent of variability in the banks’ profit before tax was accounted for by credit information sharing through the pulling of reports from the CRBs,” she observed, further noting that according to press briefings by Transunion, in the year 2015, only 150,000 borrowers were blacklisted but with the era of quick money lenders such as mobile loan apps, 350,000 more borrowers are now blacklisted in just over three years, bringing the number of listed defaulters to 500,000.