The question of what credit reporting model will be available to lenders in making their consumer credit decisions is itself one of the most important credit risk decisions to face Australia in more than 20 years.
It is a question that will be determined over the coming months, following a review of the Privacy Act by the Australian Law Reform Commission.
The issue of credit reporting standards takes on added significance now that it is clear that the credit cycle has turned.
Readers may recall in an article in The Sheet a few weeks ago bankruptcy (a clear proxy for overall credit quality) was shown to be increasing and, increasingly often, the reason provided by those filing for bankruptcy is excessive use of credit.
(See 'Missing the point in the credit reporting debate' from August 7).
The earlier article put forward a definition of more responsible lending as: lending that produces outcomes indicating that the credit decision was responsible and reasonable given the information that was available at the time.
I suggested then that the only way this would be achieved was via a holistic solution, a model that included better controls over:
1. The content of the credit file - a more complete financial picture to be available for credit assessment.
2. Increased controls, monitoring, and independent oversight of data input and access.
3. Mechanisms that put significant pressure on lenders to actually use credit file information for improving credit decisions.
Contrary to some initial reporting, the credit industry is uniting behind a model that includes these key elements. One of the most commonly agreed aspects is the need for an iron-clad means of ensuring the American model is not the basis of the new Australian model, because Australia does not want the outcome of that model.
The following comparison chart will hopefully shed light on how that can be achieved, and how lessons learned from experience elsewhere can be used to deliver a better solution here.
20070906 HartmanTab1
There are very important differences between what is generally being proposed and models in place elsewhere and a different model will deliver a different outcome.
The model being proposed is structured precisely to deliver more responsible lending.
Credit providers agree that there needs to be an effective means of independent oversight to ensure that everyone plays by the rules.
It is also important to look at one more alternative, one that attempts to deliver an improvement on today, but relies heavily on restricting the breadth of content as protection from the outcomes of an American type model.
At the risk of offending some who have worked long and hard on this issue for years, this "limited data" model was developed primarily as a politically sellable alternative.
Today this model is not widely supported by lenders because it will not deliver the holistic mix of elements required to enable and ensure more responsible lending.
In fact, such a model is potentially 'dangerous' because of the unfounded expectations it can set.
The very limited amount of additional data will not support better decisions, and so far that model provides no assurance mechanisms for better control of data quality, content or use.
The expectation of better lending is highly unlikely to be delivered. At best, little or no change to lending practices will occur and Australia will continue on its current path to much higher bankruptcies and bad debts.
And there is real potential that this model could lull some into a false sense of security, creating the illusion of this data being substantially more predictive of risk outcomes when it is not.
It takes a clear picture of a borrower's financial situation to make a good lending decision.
Today, though it is completely legal to obtain all of the information needed, there simply is no practical means of doing so. With a limited additional data model, and no more effective controls over data quality, access or use, we will not have any improvement.
To suggest that it is better to prevent all lenders from gaining a practical means of gathering the necessary information to make more responsible lending decisions, is tantamount to arguing that it is better that all credit decisions be impaired for fear that a small few might misuse the information (even when severe penalties for doing so would be there as a prevention).
The most common alternative proposed by lenders is to construct, via a code of conduct, a holistic approach to improve the breadth and quality of content, to better control access and to use new means to make it unprofitable to take an increasingly aggressive credit risk position.
Some suggest that this can't be done within the confines of the Privacy Act review - that it would cut across too many legal boundaries. I don't accept that.
The Australian Law Reform Commission has a huge responsibility in reviewing the Privacy Act and, in particular, the elements relating to credit information.
Its job is made all the more challenging because understanding how the three aspects (content, access and use) interact is not common knowledge, or even attainable simply via research.
It takes years to acquire an understanding of the intricacies of consumer credit management and that knowledge is not something that is often shared with those outside of the industry.
However, if the majority of interested parties could work together and reach an agreed holistic approach to reform, something that is clearly a practical solution to an increasingly serious and difficult issue, I have every confidence in Professor Les McCrimmon and the Attorney General's office being able to structure new principlesbased regulation that would enable such an approach to be delivered - perhaps via a code of conduct and subject to full independent oversight.
The question right now is whether the interested parties will find a workable solution, or whether the review will become stuck, and choose to prescribe a limiting set of rules based on what is perceived to be the least offensive option, but one that will not provide the elements needed to address the very real challenges of the turn in the credit cycle.