Assessing Infrastructure for Intermediation: Legal Framework ...

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  • Assessing Infrastructure for Intermediation: Legal Framework ...

    1. 1. Assessing Infrastructure for Intermediation: Legal Framework and Credit Information Systems Thorsten Beck
    2. 2. Introduction <ul><li>Infrastructure is set of institutions and rules for functioning of financial system </li></ul><ul><li>Legal infrastructure: laws and their enforcement, corporate governance </li></ul><ul><li>Informational infrastructure: credit information sharing, accounting and auditing rules and practice </li></ul><ul><li>Transactional infrastructure: retail and wholesale payment systems </li></ul>
    3. 3. Legal framework
    4. 4. The Importance of the Legal Framework for the Financial System <ul><li>Financial contracts depend on certainty of legal rights and predictability and speed of their fair and impartial enforcement </li></ul><ul><li>Regulation and supervision of financial system requires legal and regulatory framework </li></ul>
    5. 5. Private Credit and Creditor Rights
    6. 6. Private Credit and contract enforcement
    7. 7. Legal framework - overview <ul><li>Financial sector legislation </li></ul><ul><li>Corporate sector framework </li></ul><ul><li>Collateral and creditor rights </li></ul><ul><li>Insolvency framework </li></ul><ul><li>Judicial system </li></ul>
    8. 8. Legal Framework: Financial Sector Legislation <ul><li>Central Bank, Bank Supervisory Authority Legislation </li></ul><ul><ul><li>Independence, objectives, accountability </li></ul></ul><ul><li>Banking/financial institutions legislation </li></ul><ul><ul><li>From cradle to grave, bank secrecy </li></ul></ul><ul><li>Payment system legislation and regulation </li></ul><ul><ul><li>Finality of payment, zero hour rule </li></ul></ul><ul><li>Anti-money-laundering (AML), Combating the financing of terrorism (CFT) legislation </li></ul><ul><li>Government debt management legislation </li></ul><ul><li>Capital markets legislation </li></ul><ul><li>Insurance sector legislation </li></ul>
    9. 9. Legal Framework: Corporate Sector Framework <ul><li>Company law </li></ul><ul><ul><li>Regime for formation, registration and operation of companies </li></ul></ul><ul><ul><li>Different types of companies (limited liability, joint stock, partnerships etc.) </li></ul></ul><ul><li>Corporate governance </li></ul><ul><ul><li>Relationship between stakeholders of companies </li></ul></ul><ul><ul><ul><li>Directors’ duties </li></ul></ul></ul><ul><ul><ul><li>Shareholder rights </li></ul></ul></ul><ul><ul><ul><li>Audit and accounting practices </li></ul></ul></ul><ul><ul><li>Laws and regulations </li></ul></ul><ul><ul><li>Regulatory agencies enforcing legislation and regulations </li></ul></ul><ul><ul><li>Business culture and practices </li></ul></ul>
    10. 10. Legal Framework: Collateral and Creditor Rights <ul><li>Predictable, transparent and affordable enforcement of unsecured and secured claims outside the insolvency system </li></ul><ul><li>Civil Code, laws on insolvency, land, pledge, mortgages, execution </li></ul><ul><li>Registers for movable and immovable property, registration procedures </li></ul><ul><li>Restrictions on ownership, transfer, pledge </li></ul><ul><li>Loan documentation </li></ul><ul><li>Role of Notary Public </li></ul><ul><li>Court / non-court enforcement procedures </li></ul>
    11. 11. Legal Framework: Insolvency Framework <ul><li>Legal framework for corporate insolvency </li></ul><ul><ul><li>Provide for timely, efficient and impartial resolution </li></ul></ul><ul><ul><li>Maximize value of assets and recoveries </li></ul></ul><ul><ul><li>Efficient liquidation of nonviable and rehabilitation of viable businesses </li></ul></ul><ul><ul><li>Equitable treatment of similarly situated creditors </li></ul></ul><ul><ul><li>Transparent procedure </li></ul></ul><ul><ul><li>Framework for cross-border insolvencies </li></ul></ul><ul><li>Informal out-of-court procedures for work-out </li></ul><ul><li>Institutional framework </li></ul>
    12. 12. Legal Framework: Effective Insolvency and Creditor Rights Systems <ul><li>Principles and Guidelines for Effective Insolvency and Creditor Rights Systems </li></ul><ul><li>Developed in 1999/2000 by WB and other organizations and experts </li></ul><ul><li>35 principles in four areas: </li></ul><ul><ul><li>Creditor rights and enforcement systems </li></ul></ul><ul><ul><li>Corporate insolvency </li></ul></ul><ul><ul><li>Credit risk management, debt recovery and informal enterprise workout practices </li></ul></ul><ul><ul><li>Effective implementation of legal mechanisms </li></ul></ul>
    13. 13. Legal Framework: Judicial System <ul><li>Courts are “slow, corrupt, incompetent and expensive”. </li></ul><ul><li>Judges </li></ul><ul><ul><li>Appointment, dismissal, independence, salaries, promotion </li></ul></ul><ul><li>Infrastructure </li></ul><ul><ul><li>Location of courts, buildings, libraries, computerization, budget, administration </li></ul></ul><ul><li>Procedures </li></ul><ul><ul><li>Code of Civil Procedure, filing fees, appeal procedures, injunctions, case management, allocation of cases, execution of judgments </li></ul></ul><ul><li>Court Officials </li></ul><ul><ul><li>Prosecutors, bailiffs, police, court staff, lawyers, bar associations, discipline </li></ul></ul><ul><li>Arbitration, mediation, specialized courts </li></ul>
    14. 14. Legal framework: Cross-country comparisons <ul><li>Doing Business database; case study approach: </li></ul><ul><ul><li>Claim equals twice country’s income per capita, creditor (plaintiff) is 100% right, judicial process, which ends in favor of creditor: </li></ul></ul><ul><ul><ul><li>Number of procedures legally required between the parties </li></ul></ul></ul><ul><ul><ul><li>Time (days) spent in dispute resolution until payment </li></ul></ul></ul><ul><ul><ul><li>Cost (fees, duties etc.) of going through the court procedure, relative to debt value </li></ul></ul></ul><ul><ul><li>Transfer of land and building in a peri-urban area of the country’s most populous city, 50 times income per capita. </li></ul></ul><ul><ul><ul><li>Number of procedures legally required to register property </li></ul></ul></ul><ul><ul><ul><li>Time (days) spent in completing procedures </li></ul></ul></ul><ul><ul><ul><li>Cost (taxes, fees, duties etc.) relative to property, only official costs </li></ul></ul></ul><ul><ul><li>Insolvency: time (in days), cost (as percentage of estate) and recovery rate (cents on the dollar) </li></ul></ul>
    15. 15. Legal framework: Cross-country comparisons Source: Doing Business project, http:ru.worldbank.orgdoingbusiness
    16. 16. Credit information systems
    17. 17. The Role of Credit Reporting Systems in Financial Markets <ul><li>Reduce asymmetric information between borrowers and lenders </li></ul><ul><li>Allow lenders to more accurately evaluate risk and avoid adverse selection </li></ul><ul><li>Strengthen incentives for borrowers to repay, reducing moral hazard </li></ul><ul><ul><li>Increase the cost of default </li></ul></ul><ul><ul><li>Provide an incentive for good borrowers: Reputation Collateral </li></ul></ul><ul><li>Increase competitiveness, reduce segmentation </li></ul>
    18. 18. Private Credit and Credit Information Sharing
    19. 19. Credit information systems - overview <ul><li>Institutions and sources of information </li></ul><ul><li>Public vs. private registries </li></ul><ul><li>Elements of a robust credit registry system </li></ul>
    20. 20. Financial Information Infrastructure: Primary Institutions & Sources of Data <ul><li>Consumer Credit Reporting Firms & Registries </li></ul><ul><li>Commercial Credit Reporting Firms & Registries </li></ul><ul><li>Corporate Registries </li></ul><ul><li>Ratings Firms </li></ul><ul><li>Microfinance Credit Bureaus </li></ul><ul><li>Industry Specific Databases (insurance, property management, utilities, cell phones, agricultural commodities, etc.) </li></ul><ul><li>Other Public Data (public databases, Chambers of Commerce / Better Business Bureau, media) </li></ul>
    21. 21. Information in credit reports <ul><li>The heart of the credit report is the detailed payment history it provides </li></ul><ul><ul><li>Positive payment history empowers good borrowers, creates reputation collateral </li></ul></ul><ul><ul><li>Negative payment data encourages honoring obligations </li></ul></ul><ul><ul><li>Lender Account No. Date Opened & Credit Limit & Payment </li></ul></ul><ul><ul><li> Date Reported Past Due History </li></ul></ul><ul><ul><li>B of A XXXX 1-1-2000 $5,000 30 day - 1 </li></ul></ul><ul><ul><li>6-1-2004 $0 </li></ul></ul>
    22. 22. Public vs. Private Credit Registries
    23. 23. Advantages and Shortcomings of Public Credit Registries <ul><li>Advantages </li></ul><ul><li>Public credit registries can compel banks to report, especially important in economies with concentrated financial systems </li></ul><ul><li>Public credit registries can operate where the legal environment is inhospitable for private ventures </li></ul><ul><li>Public credit registries may engender additional confidence, depending on country experiences </li></ul><ul><li>Public credit registries provide data for bank supervision </li></ul><ul><li>Shortcomings: </li></ul><ul><li>Data sources and distribution of data are more limited for private credit registries </li></ul><ul><li>Public credit registries have fewer resources (staff, funding, technology) </li></ul><ul><li>Public credit registries do not offer value-added services such as credit scoring </li></ul><ul><li>Public credit registries offer limited consumer attention </li></ul>
    24. 24. Elements of a Robust Credit Reporting System <ul><li>Providers and users of credit data </li></ul><ul><li>Institutional arrangements </li></ul><ul><li>Quality of the data collected </li></ul><ul><li>Quality of the data distributed </li></ul><ul><li>Legal framework for credit reporting </li></ul><ul><li>Regulatory framework for credit reports </li></ul><ul><li>Use of credit information for bank supervision </li></ul><ul><li>Consumer outreach & education </li></ul>
    25. 25. Providers and users of credit data <ul><li>Commercial Banks and other regulated financial institutions (credit card issuers, insurance firms, automobile finance companies, mortgage lenders/guarantors) </li></ul><ul><li>Retailers (appliance retailers, other stores) </li></ul><ul><li>Firms providing business-to-business credit, trade credit </li></ul><ul><li>Microfinance institutions </li></ul><ul><li>Other businesses which provide goods or services on credit (utilities, cell phone providers, agribusiness, etc.) </li></ul>
    26. 26. Providers and users of credit data <ul><li>What is the financial market structure? </li></ul><ul><ul><li>How concentrated is the banking / financial sector? </li></ul></ul><ul><li>What are the main financial sector products? </li></ul><ul><ul><li>Are banks lending to a broad spectrum of the population? Do they offer varied products & services? </li></ul></ul><ul><li>What are the most important non-bank sources of finance? How are these changing? </li></ul><ul><li>In the real sectors of the economy, what are the most important sources of financial services and credit? Are there special industry credit services? </li></ul><ul><li>What role does microfinance play? </li></ul>
    27. 27. Institutional Arrangements for Private Credit Registries
    28. 28. Quality of the Data Collected <ul><li>Collect both positive & negative information </li></ul><ul><li>Maintain data for a reasonable time frame – 5 years minimum </li></ul><ul><ul><li>Do not delete negative data when debt is repaid </li></ul></ul><ul><ul><li>Data should be inaccessible after a certain amount of time </li></ul></ul><ul><li>Credit reports should not include highly sensitive information such as political or religious affiliation, etc…. </li></ul><ul><li>Other identifying information, such as gender, should be evaluated more carefully </li></ul>
    29. 29. Quality of the Data Distributed <ul><li>Integrity and transparency are paramount </li></ul><ul><ul><li>Special standing of any group, including owners or government, will discourage participation </li></ul></ul><ul><li>Open system preferable, reciprocity not necessary </li></ul><ul><li>Access to more detailed information preferable </li></ul><ul><ul><li>Loans described individually, not aggregates </li></ul></ul><ul><ul><li>Institutions providing credit identified </li></ul></ul><ul><li>Restrictions to prevent “cherry-picking” </li></ul><ul><li>Distribution reflects privacy considerations </li></ul>
    30. 30. Legal framework for credit reporting <ul><li>Legal framework should encourage information sharing among lenders </li></ul><ul><ul><li>Provide legal clarity regarding acceptable information sharing practices </li></ul></ul><ul><li>Consideration of privacy issues important </li></ul><ul><ul><li>Broad privacy or data protection laws may unduly limit credit reporting – balance privacy with economic impact of limiting access to data </li></ul></ul><ul><li>Competition policy aspects of credit information </li></ul>
    31. 31. Legal framework for credit reporting: Consumer protection <ul><li>Borrowers should have access to their own data </li></ul><ul><li>Notice of adverse actions based on report </li></ul><ul><li>Record who has accessed data as part of report </li></ul><ul><li>Consumer-friendly procedures in place to challenge erroneous information in reasonable time frame </li></ul><ul><li>Clearly established privacy policy </li></ul>
    32. 32. Regulatory framework for credit reporting <ul><li>Regulatory framework usually weaker than legal framework in developing countries </li></ul><ul><li>Regulatory framework with enforcement </li></ul><ul><ul><li>Can, and do, regulators effectively enforce laws and regulations, via: </li></ul></ul><ul><ul><ul><li>Audits </li></ul></ul></ul><ul><ul><ul><li>Lawsuits </li></ul></ul></ul><ul><ul><ul><li>Fines </li></ul></ul></ul><ul><ul><ul><li>Reviewing industry codes of conduct </li></ul></ul></ul><ul><ul><li>Do consumers have the ability to bring complaints outside the judicial system? </li></ul></ul>
    33. 33. Use of credit information for bank supervision <ul><li>Supervisors include financial institutions’ use of credit information as part of inspections, both on- and off-site </li></ul><ul><li>Use data from PCRs to identify large problem borrowers, to fine-tune regulations and in analytical work to identify risk-categories of borrowers </li></ul><ul><li>Require publicly (government) owned financial institutions to provide data to legitimate credit reporting firms, associations </li></ul><ul><li>Encourage all financial institutions to participate in credit reporting </li></ul>
    34. 34. Consumer Outreach and Education <ul><li>Readily available information on managing credit and on the rights & responsibilities of borrowers regarding credit reporting </li></ul><ul><ul><li>Printed materials at appropriate level, language (internet, banks, retailers, government offices can all provide access) </li></ul></ul><ul><ul><li>Radio or television public service ads </li></ul></ul><ul><li>Role of industry in providing consumer assistance </li></ul><ul><li>Outreach to lenders on importance of credit information </li></ul><ul><li>Outreach to other interested parties (judges, microfinance institutions, etc.) </li></ul>

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