Know The Doing Business Getting Credit Methodology

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New Delhi (ABC Live): Doing Business Getting Credit Methodology:  Doing Business Claims that It  measures the legal rights of borrowers and lenders with respect to secured transactions through one set of indicators and the reporting of credit information through another. The first set of indicators measures whether certain features that facilitate lending exist within the applicable collateral and bankruptcy laws.

The second set measures the coverage, scope and accessibility of credit information available through credit reporting service providers such as credit bureaus or credit registries (figure 1). The ranking of economies on the ease of getting credit is determined by sorting their distance to frontier scores for getting credit. These scores are the distance to frontier score for the sum of the strength of legal rights index and the depth of credit information index.

Doing Business Getting Credit Methodology: 

LEGAL RIGHTS OF BORROWERS AND LENDERS 

The data on the legal rights of borrowers and lenders are gathered through a questionnaire administered to financial lawyers and verified through analysis of laws and regulations as well as public sources of information on collateral and bankruptcy laws. Questionnaire responses are verified through several rounds of follow-up communication with respondents as well as by contacting third parties and consulting public sources. The questionnaire data are confirmed through teleconference calls or on-site visits in all economies.

Strength of legal rights index

The strength of legal rights index measures the degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and thus facilitate lending . For each economy it is first determined whether a unitary secured transactions system exists. Then two case scenarios, case A and case B, are used to determine how a nonpossessory security interest is created, publicized and enforced according to the law. Special emphasis is given to how the collateral registry operates (if registration of security interests is possible).

The case scenarios involve a secured borrower, company ABC, and a secured lender, BizBank.

In some economies the legal framework for secured transactions will allow only case A or case B (not both) to apply. Both cases examine the same set of legal provisions relating to the use of movable collateral.

Several assumptions about the secured borrower (ABC) and lender (BizBank) are used:

ABC is a domestic limited liability company (or its legal equivalent).

  • ABC has up to 50 employees.
  • ABC has its headquarters and only base of operations in the economy’s largest business city. For 11 economies the data are also collected for the second largest business city.
  • Both ABC and BizBank are 100% domestically owned.

The case scenarios also involve assumptions. In case A, as collateral for the loan, ABC grants BizBank a nonpossessory security interest in one category of movable assets, for example, its machinery or its inventory. ABC wants to keep both possession and ownership of the collateral. In economies where the law does not allow nonpossessory security interests in movable property, ABC and BizBank use a fiduciary transfer-of-title arrangement (or a similar substitute for nonpossessory security interests).

In case B, ABC grants BizBank a business charge, enterprise charge, floating charge or any charge that gives BizBank a security interest over ABC’s combined movable assets (or as much of ABC’s movable assets as possible). ABC keeps ownership and possession of the assets.

The strength of legal rights index covers functional equivalents to security interests in movable assets (such as financial leases and sales with retention of title) only in its first component, to assess how integrated or unified the economy’s legal framework for secured transactions is.

The strength of legal rights index includes 10 aspects related to legal rights in collateral law and 2 aspects in bankruptcy law. A score of 1 is assigned for each of the following features of the laws:

  • The economy has an integrated or unified legal framework for secured transactions that extends to the creation, publicity and enforcement of four functional equivalents to security interests in movable assets: fiduciary transfers of title; financial leases; assignments or transfers of receivables; and sales with retention of title.
  • The law allows a business to grant a nonpossessory security right in a single category of movable assets (such as machinery or inventory), without requiring a specific description of the collateral.
  • The law allows a business to grant a nonpossessory security right in substantially all its movable assets, without requiring a specific description of the collateral.
  • A security right can be given over future or after-acquired assets and extends automatically to the products, proceeds and replacements of the original assets.
  • A general description of debts and obligations is permitted in the collateral agreement and in registration documents, all types of debts and obligations can be secured between the parties, and the collateral agreement can include a maximum amount for which the assets are encumbered.
  • A collateral registry or registration institution for security interests granted over movable property by incorporated and nonincorporated entities is in operation, unified geographically and with an electronic database indexed by debtors’ names.
  • The collateral registry is a notice-based registry—a registry that files only a notice of the existence of a security interest (not the underlying documents) and does not perform a legal review of the transaction. The registry also publicizes functional equivalents to security interests.
  • The collateral registry has modern features such as those that allow secured creditors (or their representatives) to register, search, amend or cancel security interests online.
  • Secured creditors are paid first (for example, before tax claims and employee claims) when a debtor defaults outside an insolvency procedure.
  • Secured creditors are paid first (for example, before tax claims and employee claims) when a business is liquidated.
  • Secured creditors are subject to an automatic stay on enforcement procedures when a debtor enters a court-supervised reorganization procedure, but the law protects secured creditors’ rights by providing clear grounds for relief from the automatic stay (for example, if the movable property is in danger) and setting a time limit for it.
  • The law allows parties to agree in the collateral agreement that the lender may enforce its security right out of court; the law allows public and private auctions and also permits the secured creditor to take the asset in satisfaction of the debt.

The index ranges from 0 to 12, with higher scores indicating that collateral and bankruptcy laws are better designed to expand access to credit.

Reforms

The strength of legal rights index tracks changes related to secured transactions and insolvency every year. Depending on the impact on the data, certain changes are classified as reforms and listed in the summaries of Doing Business reforms in 2016/2017 section of the report in order to acknowledge the implementation of significant changes. Reforms are divided in two types: those that make it easier to do business and those changes that make it more difficult to do business. The strength of legal rights index uses the following criteria to recognize a reform.

All changes in laws and regulations that have any impact on the economy’s score on the existence of a secured transaction legal framework which regulates the creation, publicity and enforcement of nonpossessory security interests and their functional equivalents. Each year, new laws and amendments are evaluated to see if they facilitate obtaining credit by small and medium enterprises, allowing for maximum flexibility in the choice of assets which can be used as collateral. Guidelines, model rules, principles, recommendations and case law are excluded.

Reforms impacting the strength of legal rights index include amendments to or the introduction of a secured transactions act, insolvency code, or civil code as well as the establishment or modernization of any of the features of a collateral registry as measured by the indicators. For example, introducing a law which provides for a collateral registry and actually establishing that collateral registry—which is geographically centralized, unified for all types of movable assets and for both incorporated and non-incorporated entities searchable by debtor’s name—would represent a reform with a 1-point increase and would therefore be acknowledged in the report.

CREDIT INFORMATION

The data on the reporting of credit information are built in two stages. First, banking supervision authorities and public information sources are surveyed to confirm the presence of a credit reporting service provider, such as a credit bureau or credit registry. Second, when applicable, a detailed questionnaire on the credit bureau’s or credit registry’s structure, laws and associated rules is administered to the entity itself. Questionnaire responses are verified through several rounds of follow-up communication with respondents as well as by contacting third parties and consulting public sources. The questionnaire data are confirmed through teleconference calls or on-site visits in all economies.

Depth of credit information index

The depth of credit information index measures rules and practices affecting the coverage, scope and accessibility of credit information available through either a credit bureau or a credit registry. A score of 1 is assigned for each of the following eight features of the credit bureau or credit registry (or both):

  • Data on firms and individuals are distributed.
  • Both positive credit information (for example, original loan amounts, outstanding loan amounts and a pattern of on-time repayments) and negative information (for example, late payments and the number and amount of defaults) are distributed.
  • Data from retailers or utility companies are distributed in addition to data from financial institutions.
  • At least two years of historical data are distributed. Credit bureaus and registries that erase data on defaults as soon as they are repaid or distribute negative information more than 10 years after defaults are repaid receive a score of 0 for this component.
  • Data on loan amounts below 1% of income per capita are distributed.
  • By law, borrowers have the right to access their data in the largest credit bureau or registry in the economy. Credit bureaus and registries that charge more than 1% of income per capita for borrowers to inspect their data receive a score of 0 for this component.
  • Banks and other financial institutions have online access to the credit information (for example, through a web interface, a system-to-system connection or both).
  • Bureau or registry credit scores are offered as a value added service to help banks and other financial institutions assess the creditworthiness of borrowers.

The index ranges from 0 to 8, with higher values indicating the availability of more credit information, from either a credit bureau or a credit registry, to facilitate lending decisions. If the credit bureau or registry is not operational or covers less than 5% of the adult population, the score on the depth of credit information index is 0.

In Lithuania, for example, both a credit bureau and a credit registry operate. Both distribute data on firms and individuals (a score of 1). Although the credit registry does not distribute data on on-time repayments, the credit bureau distributes full positive and negative credit information (a score of 1). While the credit registry does not distribute data from retailers or utilities, the credit bureau does (a score of 1). Both distribute at least two years of historical data (a score of 1). Although the credit registry has a threshold of €290, the credit bureau distributes data on loans of any value (a score of 1). Borrowers have the right to access their data in both the credit bureau and the credit registry free of charge once a year (a score of 1). Both entities provide data users access to databases through a web interface (a score of 1). Although the credit registry does not provide credit scores, the credit bureau does (a score of 1). Adding these numbers gives Lithuania a score of 8 on the depth of credit information index.

Credit bureau coverage

Credit bureau coverage reports the number of individuals and firms listed in a credit bureau’s database as of January 1, 2017, with information on their borrowing history within the past five years, plus the number of individuals and firms that have had no borrowing history in the past five years but for which a lender requested a credit report from the bureau in the period between January 2, 2016, and January 1, 2017. The number is expressed as a percentage of the adult population (the population age 15 and above in 2016 according to the World Bank’s World Development Indicators). A credit bureau is defined as a private firm or nonprofit organization that maintains a database on the creditworthiness of borrowers (individuals or firms) in the financial system and facilitates the exchange of credit information among creditors. (Many credit bureaus support banking and overall financial supervision activities in practice, though this is not their primary objective.) Credit investigative bureaus that do not directly facilitate information exchange among banks and other financial institutions are not considered. If no credit bureau operates, the coverage value is 0.0%.

Credit registry coverage

Credit registry coverage reports the number of individuals and firms listed in a credit registry’s database as of January 1, 2017, with information on their borrowing history within the past five years, plus the number of individuals and firms that have had no borrowing history in the past five years but for which a lender requested a credit report from the registry in the period between January 2, 2016, and January 1, 2017. The number is expressed as a percentage of the adult population (the population age 15 and above in 2016 according to the World Bank’s World Development Indicators). A credit registry is defined as a database managed by the public sector, usually by the central bank or the superintendent of banks, that collects information on the creditworthiness of borrowers (individuals or firms) in the financial system and facilitates the exchange of credit information among banks and other regulated financial institutions (while their primary objective is to assist banking supervision). If no credit registry operates, the coverage value is 0.0%.

Reforms

The depth of credit information index tracks changes related to the coverage, scope and accessibility of credit information available through either a credit bureau or a credit registry every year. Depending on the impact on the data, certain changes are classified as reforms and listed in the summaries of Doing Business reforms in 2016/2017 section of the report in order to acknowledge the implementation of significant changes. Reforms are divided into two types: those that make it easier to do business and those changes that make it more difficult to do business. The credit information index uses three criteria to recognize a reform.

First, all changes in laws, regulations and practices that have any impact on the economy’s score on the credit information index are classified as reforms. Examples of reforms impacting the index include measures to distribute positive credit data in addition to negative data, the distribution of credit data from utilities or retailers or the introduction of credit scores as a value-added service. Any change that improves the score of a given economy in any of the eight features of the index is considered a reform. Some reforms can have an impact in more than one feature. For example, the introduction of a new credit bureau covering more than 5% of the adult population that distributes information on firms and individuals, as well as positive and negative data and provides online access to data users, represents a 3 point increase in the index. In contrast, the introduction of legislation that guarantees borrowers’ rights to access their data in the largest credit bureau or registry in the economy represents a reform with a 1 point increase in the index.

Second, changes that increase the coverage of the largest credit bureau or registry in an economy above 5% of the adult population may also be classified as reforms. According to the getting credit methodology, if the credit bureau or registry is not operational or covers less than 5% of the adult population, the score on the depth of credit information index is 0. The impact of the reform will depend on the characteristics of the economy’s credit reporting system as it relates to the eight features of the index. Expanded coverage that does not reach 5% of the adult population is not classified as a reform but the impact is still reflected on the most updated statistics.

Third, occasionally the credit information index will acknowledge legislative changes with no current impact on the data as reforms. This option is typically reserved to legislative changes of exceptional magnitude, such as the introduction of laws allowing the operation of credit bureaus or laws on personal data protection.

The data details on getting credit can be found for each economy at http://www.doingbusiness.org. The initial methodology was developed by Djankov, McLiesh and Shleifer (2007) and is adopted here with minor changes.

Source : Doing Business Getting Credit Methodology