With a Digital Economy, You Dont Need the Equifaxs of the World

In the USA, we rely on credit bureaus to help us assess consumer and business credit risk.

A 150 years ago, the person that granted credit was your town grocer.  He knew everyone that lived in the village or city, and he knew who was a good risk or bad. For example, family men with jobs were good, single men visiting bars not so good.  He also knew how to give credit to people that had seasonality to their cash flow.  When strangers started to move to cities, this era of making business judgments on our personal knowledge ended.

Today, for businesses, every sale made by a company of any reasonable size that is done on some extended payment terms is a credit decision.   All businesses grant credit to their customers in the form of payment terms. In order to do this, they develop credit limits and must manage how much they can have outstanding to a customer at any one time.  See Even Sellers must manage Credit Risk like Banks

The Financial crisis of 2008 did wonders for damaging reputations of credit bureaus, but little else.  After the Financial recession of 2008, when credit agencies were telling us Mortgage Backed securities were a good credit risk, we knew the system was flawed but was the best we had for an analog world. Even in court challenges, the credit bureaus won. When a Federal Appeals Court ruled that credit agencies weren’t responsible for overrating mortgage backed securities, I knew this somehow was a game changer.  Why?  Because no one can solely rely on rating agencies to assess risk.

Now Congress, specifically US congressman McHenry, is proposing legislation that the IRS provide API access for income verification for consumer and small business borrowers. Okay, well, we know if the FBI can be hacked, so too can the IRS (and Equifax, etc.).  It is a step in the right direction to help facilitate small business and consumer lending with a trusted party (or at least if we dont trust the IRS, we believe in their powers).  Now while this provides real-time information on income, in the B2B world it still doesn’t totally address why the traditional models need improved.

As I stated before, the current credit bureaus suffer from a lack of real-time information, adverse selection, and very incomplete credit files, especially on private companies. But in Latin America, with countries like Brazil and Mexico leading the way, they are both reducing their shadow economy by implementing einvoicing requirements with the central tax authorities and in the process, creating a store of valuable data.

How so?  The Government is involved in every transaction twice – first at the time of shipment and than during receipt/payment by the customer. For example, Kellogg’s Brazilian subsidiary sells to a grocery chain. They must create documents of what they are selling and register with the government. The Government will validate back to Kellogg. Kelloggs can’t ship unless they have this document and that is for every single shipment. This is all done electronically. Now you receive your validated document from the government, you ship your goods, you send that invoice in advance of the goods and print out and put on the truck to prove it is a valid shipment. Your customer gets that invoice electronically in advance and immediately sends back to the Government to let them know the invoice is valid to pay. Once you accept the goods, you accept liability to pay tax.

Not only does this tighten the tax process, it provides a treasure trove of data the Dun & Bradstreets or Eulers could never touch. Perhaps these Governments need to start thinking about open APIs and creating access to enable credit decisioning to be done with more real-time and quality data.

Now that is a game changer for credit risk assessment.

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First Voice

  1. Dr. Herbert Broens, Germany:

    Very good article. The same is valid for Europe.

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