Gehan Gunasekara: Credit tests need close examination

Photo / Supplied

Opinion

The news that everyone in New Zealand is to be given an individual score for credit reliability should come as no surprise.

After all, from primary school onwards even children are now accustomed to being told whether they have not achieved, achieved or achieved with merit. There is no reason why adults should be treated any differently as far as their credit rating is concerned.

Credit reporting agencies such as Veda Advantage (formerly Baycorp) already give individuals - that is, anyone who has ever applied for credit - a ranking, and the move to a more detailed numeric system is, by itself, hardly a cause for concern.

The devil is in the detail however, and in the implementation of the revised format. It is difficult to see how it can work under existing restrictions in the Privacy Act and the Credit Reporting Privacy Code that currently governs the sector.

These rules allow the reporting of only certain types of information regarding individuals. For the most part, these include negative matters such as whether the individual has defaulted, or other matters such as the number of times credit has been applied for.

The credit industry, though, would like to move towards comprehensive credit reporting so that fuller details of an applicant's financial profile can be made known to a prospective creditor.

Certainly it is difficult to resist demands - seemingly reasonable - for access to information such as whether credit applications were approved, what type they were, who the loan was with, what the credit limit was and whether the account is still open. Moves towards stricter identity verification with driver's licence checks built in is also sensible, as identity fraud is a growing problem here as it is overseas.

On the one hand it is unlikely that even these details will suffice to enable the construction of a meaningful scoring system such as that proposed. For example, information such as an individual's income level and their repayment history would be of value, as would perhaps other risk factors such as their health and insurance status.

Indeed the provision of a scoring system requires the use of sometimes complex algorithms. The algorithm, however, is only as good as the inputs fed into it. The more inputs used, the greater will be the predictability of the credit risk an individual poses.

It is clear that this is a slippery slope that will in time lead to the collection of a potentially unlimited quantity of personal information.

On the other hand, a move towards comprehensive reporting also poses a challenge to privacy authorities and individuals alike. Current law entitles individuals to request copies of their credit reports free of charge, and the relatively small amount of detail that is now contained enables easy verification should an error occur, such as a default that is incorrectly recorded.

However, as ever more detail is gathered, errors will inevitably occur. More troublingly, it may become difficult - if not impossible - for individuals to verify the inputs, as much of the information will be commercially sensitive to its providers.

Finally, in the interests of transparency, individuals should be able to find out how the algorithms themselves are employed, but here again commercial considerations are likely to be a barrier.

It is also worth pointing out that, in the United States where comprehensive credit reporting exists, more informed decision-making as to whether individuals should be granted credit has not prevented those who are overstretched from being given credit.

Indeed the converse has occurred, as evidenced by the sub-prime mortgage crisis of recent times. Reputable agencies may take a scoring system seriously, but loan sharks invariably will not. The most likely scenario, unfortunately, is that a certain segment of society will be disenfranchised from obtaining credit, thereby driving them to ever more desperate measures.

Rather than rewarding those with a good credit history, it seems likely that a system of comprehensive credit reporting will instead enable the targeting of those who are good credit risks to obtain further credit.

This may boost the profits of lenders, but will do little for society at large in reducing its indebtedness.

In New Zealand, it is as well that those who monitor our credit rating are themselves under the scrutiny of the Privacy Commissioner. The privacy authorities here and in Australia are conducting a review of credit reporting, and we await the outcome with interest.

* Gehan Gunasekara researches privacy law at the University of Auckland Business School.