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The Free-Flow Of Credit Information Has Big Impact On Credit Markets And The U.S. Economy

Cost of credit is reduced

A more accurate and complete picture of creditworthiness reduces the risk of lending, and therefore, reduces the cost of credit. Moreover, customers can shop for the best loan rates among many lenders, since they know that the same credit information about them will be available to all lenders, and not just the financial institution that they have done business with in the past. This enhances competition among lenders and drives rates down. These benefits require knowledge of personal information. As law professor Fred Cate stated, lending is now "based on creditworthiness, not who you know."

More credit is extended

Greater availability of information allows the pool of potential borrowers to increase because lenders can make better decisions. According to Mitchell Petersen and Raghuram Rajan of the Kellogg Graduate School of Management, Northwestern University and the Graduate School of Business, University of Chicago, respectively: "The ability to collect and process large amounts of information about potential borrowers has dramatically expanded where and how banks can lend. For example, Automatic Loan Machines now offer loans on the spot to anyone who has a reasonable credit history, regardless of whom they banked with in the past."

The wide availability of consistent and accurate information has enabled loans of similar credit quality to be packaged and sold to investors as asset-backed securities. The free-flow of information allows investors to judge with greater confidence the riskiness and potential return of their investment. The secondary mortgage market is the prime
example of how successful secondary markets can be in providing liquidity, spreading the risk among a large pool of investors, and lowering the price of home loans. Walter Kitchenman, of the Tower Group, estimates that the U.S. secondary mortgage market has resulted in a full two-percentage point reduction in the price of mortgages in the U.S. relative to other countries.

The same result is now occurring in secondary markets for automobile loans and credit card receivables. In fact, over 50 percent of all revolving credit and over 30 percent of all non-mortgage consumer credit - $436 billion - is held widely by investors in pools of securitized assets.

The availability of information allows financial institutions to make better decisions before extending credit, and thereby helps to lower potential losses. Institutions also have a better ability to catch fraudulent activity, and when loans do go bad, have a better chance of recovery.

Bank regulators also have greater information available to be able to judge the financial condition of the lender, to evaluate the consistency of credit decisions being made, and to evaluate trends in lending. According to law professor Fred Cate, "[S]tandardized data makes it possible to identify unusual transactions and accounts easily, evaluate the risks associated with different portfolios, and compare institutions and portfolios." This transparency and free-flow of information all serves to make the U.S. economic system stronger.

The availability of information allows lenders to specialize in the delivery of certain products. Without good information, the risk of focusing in any one area may be too great. The advantages of specialized lenders is that they can provide better rates and terms since they know the market better than other, more diversified lenders.