Doing Business In India

Discussions by eminent credit experts have highlighted the pure dependence of credit risk assessment on financial statements and payment history. Whereas good business research thrives on ‘Alternate data sources’ then why shouldn’t credit risk assessment incorporate alternate data for a robust model? Whether financial statements are more reliable is debatable point especially in the context of MSMEs (they form the bulk of business enterprises all over the globe). Most developed economies do not insist on audited statements from business owners and in developing economies, we are aware of what happens. The business owner decides what is to be presented….. Yes, payment history is credible and can be used as a source of information but can be misleading if relied solely upon. Credit rating does consider ‘alternate data sources’ but as a product is used for a minuscule segment of the universe. When you consider credit scoring or internal risk assessment processes, invariably ‘alternate data sources’ are disregarded. Moreover, majority of the credit officers are unaware of ‘alternate data sources’ and their relative weight in the risk assessment model. It seems that we all want to follow the system that has been established………….. Are we doing it right?

Dun & Bradstreet (D&B), a leading Business Information company, is continuing a program in India to collect trade payment information from industry participants. What is the rationale of such a program? There are several key issues that figure especially in an operating environment where Credit Bureau referral systems are not fully developed. Moreover this has global implications especially in light of the failure of large corporations all over the world.

Let us first take a look at how does the D&B program work? The program operates as a ’shared information network’ that gives that gives 24 hours online access to payment information on businesses. The trade participants have to provide their receivable information on a monthly basis. In return the trade partner receives free of charge data to reduce risk. Additionally D&B would provide Business reports, for a charge, that would incorporate trade payment data alongwith financial and operational information on the subject business.

This ‘shared information network’ is a private company initiative that does not have explicit regulatory approval in the form of licensing. Licensing is an important criterion in developing markets where any form of monopoly is shunned. But then…….how does it affect the trade participants? Well there could be positive and negative implications……there could be legal liabilities for masked sharing of ‘mutual’ information between trading parties but on the other hand a wider information base will support better credit decisions.

The Credit Information business environment in India can be a perfect example of a developing market that is maturing. In the current scenario, only regulated and licensed credit information entities, those that have been licensed by Reserve Bank of India (RBI) under the Credit Information Companies (Regulation) Act, 2005 are allowed to operate. Presently CIBIL is the only licensed and operating Credit Bureau in India. Last year RBI had called for applications for fresh licenses. Large Global players like Equifax Inc and Experian Ltd had applied in partnership with local financial institutions. Thus the credit information space will see lot of action in the coming months. The Credit Bureaus will collect and share information with specified members that are participants from the financial markets.

Under the licensing arrangements, Credit Bureaus are expected to carry out the following business:
(a) providing credit information to individual and corporate borrowers his/her/its own credit report;
(b) providing data management services to the Credit Institutions who are its members;
(c) collecting, processing, collating and disseminating data/information related to property mortgaged to credit institutions;
(d) collecting, processing, collating and disseminating data/information related to investments made in Securities other than those issued by Central Government; and
(e) any other function as notified by the Reserve Bank from time to time.

What do the Credit Bureaus do? Credit Bureaus collect information on borrowers from the member institutions, process the data on proprietary and advance risk management process and collectively store it for usage by member on demand. Typically the data collected would be on the account performance of the borrower. Account performance will include indicators like number of credit lines the borrower enjoys, current outstanding status of those credit lines, number of credit applications among other information. CIBIL is faced with several disputes on account of deviation and differences in the data on the credit reports. This is the case even when the underlying data comes from established data sources like the banking system.

Currently there are no established data privacy laws prevalent in India. Another tricky issue is that of data ownership. In the financial markets, financial institutions and other licensed entities that are governed by their respective regulatory authorities are prohibited from sharing personal data on customers with some exceptions (e.g. sharing with Credit Bureaus). But for other industries there is no clear law that allows sharing of trade information. In such a scenario, sharing of information without explicit approval from counter party will attract legal cases with civil liability even though proving the guilt will be an onerous task. But the possibility of legal cases will become a deterrent for the trade participants to share information with private networks.

How does the industry gather credit information? The trade finds its novel yet practical ways to address this function. Informal process of reference gathering from local trade players is the most prevalent option. Another way of getting information is through insiders like employees and other vendors. Competitors also form a good option to gather information. These methods are mostly disorganized, are loaded with an element of bias and are conducted in with least technical knowledge.

D&B’s Trade Exchange Program prima facie is an important move in the right direction. With trade payment information details the quality of Business Credit information will improve considerably. The quality of risk scores will improve. But there are some serious challenges that it will face.
1. The basic hesitation of private businesses to share information.
2. The credibility of the information that is being provided. It is common knowledge that Account Receivables seldom reconcile between trading partners.
3. Retribution by warring parties. The result would be that the credit report of one partner would deteriorate and that could harm its business prospects.
4. Payment delays could be on account of other differences such quality issues
5. There are legal issues in sharing mutual information. Account Receivable information is not proprietary to one party. Unless there are definite agreements in between trade partners that clearly spell the ownership of the data.
6. Additional cost in using business information reports.

“Building Databases @ ur cost“. Effectively D&B attempts to build databases at the cost of the Trade partners. The implied usage of data is in the Business Information reports that it primarily produces. On the other hand we have Credit Bureaus that are spending crores of rupees to gather data and on substantial license fees.

What is the alternative? Credible information from Credit Bureaus would be a good answer. But currently they have a limited scope of operation and are primarily focused in the financial markets.

The other option can be a central repository that stores all trade payment information. This would ensure the credibility and correctness of information that is stored. The information can be accessed by all licensed users for a minimal charge.

The third option will be of professional firms that provide specialised services in the Account Receivable management vertical. For example IBD’s AR management solutions. IBD is a professional services firm involved in risk management.

IBD’s AR management solution adopts proactive processes such as “Dynamic Credit Limit Setting” whereby the organization incorporates the system of ‘know your customer (KYC)’ and will set credit limits based on events. The advantage is that you gather current and credible information on your trade partners. More importantly you continue to respectthe trade relationship that your business has built and nurtured over years.

Vivek Parti, CEO, India Business Database.com, Risk Management and Forensic Company

In these uncertain times where there is a complete stagnation of business growth and slowdown of payments, managing credit worthiness by Small Business owners is a difficult ORDEAL. Make sure you aren’t labeled a ‘bad credit’. You can do this by maintaining a good credit score. It’s simple…….. make timely payments of credit accounts that are regularly reported to credit bureaus, settle open derogatory listings and start making payments on other credit lines inorder to reprove credit worthiness.

The good question is “Where is the money?”. Now before you go around looking for the ‘money‘ bear in mind what the credit bureaus are looking for while scoring your credit accounts:

Payment history weighs heavily in your credit score. Consistently paying your installments on time has a positive influence on the score. Collection accounts and bankruptcy filings are also taken into consideration when analyzing your payment history.

Total debt vis-a-vis total available credit. If your credit limits are maxed out, you will be considered a poor credit risk, because it appears that you are struggling to pay off the debt you have already incurred.

Length of positive credit history, where the longer you maintain accounts in good standing, the better your score will be.

Mix of types of credit and its maturity period has an impact on the credit scores.

The number of new credit applications recently completed has a bearing on the credit score. Applying for too much new credit in a short time period makes indicates that you could be credit risk, as you may be desperately trying to keep your head above water.

Additionally your neighbourhood friendly banker (who has now turned horrific!!) looks for Corporate Intelligence on your business. He is making sure that your current performance will not affect your future repayment capacity. Businesses with negative credit listings, such as delinquent accounts, must establish new positive credit lines to try to counterbalance the negative impact of their delinquent items.

Now the most important question of all “Where is the money?”. Well there are various sources for revenue generation. If you happen to be in the US and are part of the erstwhile blue chip corporations…having gone bust, then you have the US treasury that will infuse billions of tax payer’s money. If you happen to be in India and are part of the farmer community, then the government would show its largesse and waive your loans or if you happen to be the global flag bearer of any industry (Corporate Fraud or Financial misstatements not withstanding) you will be provided assistance to keep your business afloat.

Any other category, sorry….you need to brave it all by yourself. You chose to be an entrepreneurship over being a worker or a farmer. You are heavily outnumbered in the populist scheme of things.

Vivek Parti, CEO, India Business Database.com, Risk Management and Forensic Company

In times of uncertainty and regression, the one thing that is dear to all businesses is the credit that they extend to their customers. The function becomes critical to SMEs who have limited resources.

The one question that needs to be answered is: While assessing a BUSINESS PARTNER for its Credit & Operational Risk, what elements would you consider in the following business functions?

Financials
Distribution
Goodwill
Clients
Vendors
Human Resources
Sales & Marketing
Goodwill

I asked this question to various industry professionals and academicians, the responses were:

Demissew Ejara, Associate Professor of Finance at University of New Haven “I think the list contains appropriate variables to spot operational risk. For credit risk, you should look at financial conditions and character or more specifically the five C’s of credit.”

Brian McGuinness,Vice President at Business Lenders, LLC “I always start with the 5 C’s. After that look at industry risk & concentration of sales.”

The five C’s of credit are Character (Integrity), Capacity (Sufficient cash flow to service the obligation), Capital, Collateral (Assets) and Conditions (partner’s condition and the condition of the economy).

William Martin, Sales/Relationship Manager: NBFIs at JP Morgan PLC “You are looking at 2 different elements: credit and operational risk. Each has different constituent elements but as we are seeing in current markets, operational risk can impact on credit risk and force companies out of business. When looking at credit risk, I used to consider:
History: how long has the company been in existence? How has it grown? What changes have there been?
Management: Who? Experience? Length of time in position?
Product: What is it? What is the competition, demand?
Buyers: Who? How many? Bargaining power?
Suppliers: Who? How many? Bargaining power?
Terms of Trade: What are they? Have they changed?
Turnover/Revenues: How has this changed?
Margins: Rising/falling?
Debt/Ability to obtain credit: Can they do this? Who are their bankers? How much debt have they got out?
I would count goodwill as “reputation” – an intangible asset, but one that can mean almost more than the company put together (think of Coca Cola, for example – what value does its brand have?). Media contact – tricky. This is about managing perceptions and those who are good at it can reap great rewards. Operational Risk is the risk of loss arising through fraud, unauthorised activities, error, omission, inefficiency, systems failure or from external events. It is inherent to every business organisation and covers a wide spectrum of issues. Operational risk can arise from a number of causes, including but not limited to:
Fraudulent and other external criminal activities.
Breakdowns in processes and procedures due to human error, misjudgement or malice.
Terrorist attacks.
System failure or non-availability.
In certain parts of the world, vulnerability to natural disasters.
Failure of buyers/suppliers.
Regulatory events.
Political events.
In short, operational risk arises from people, processes, systems and external events. The trick is assessing the impact of an event happening and then its likelihood. this is more of an art than a science!! Different businesses will be subject to different risks in different countries (and even different parts of the same country if, for example, one part of the country is prone to flooding).

There were some who saw the funny side of the serious question, Mohit Mehta, Director at Investment Bank “If you are CEO of a leading business risk assessment company. Please tell us how you would do this?”

In my view, it is important to follow the 5 C’s but more important would be to implement a system of Corporate Intelligence in your work flow. A robust internal credit system coupled with an efficient Corporate Intelligence system would provide the desired response to a deteriorating credit position of the businesses.

Vivek Parti, CEO, India Business Database.com, Business Credit Information Company

Indian Government has taken a number of steps to minimize the impact of the global financial crisis on the Indian economy. But, is Credit Crunch the only reason why the economy falters? Introducing credit into the system maybe short term measures that would provide immediate impetus, good for stock markets, but for sustained growth we need structural and systematic changes and corrections.

The Government of India and Reserve Bank of India are trying to introduce changes that would address these maladies. These include:

1. Additional plan expenditure upto Rs. 200,000 mn. in the current year mainly for critical rural, infrastructure and social security schemes.
2. An across-the-board cut of 4% in ad-valorem Cenvat rate except for petroleum products.
3. Measures to support exports, housing, Micro, Small & Medium Enterprises (MSME) and textile sectors.
4. India Infrastructure Finance Company Ltd to raise Rs. 100,000 mn. to refinance bank lending for infrastructure projects.
5. Monetary, credit and fiscal Policy- External Commercial Borrowing (ECB):
(a) The ‘all-in-cost’ ceilings on such borrowing would be removed, under the approval route of Reserve Bank of India (RBI);
(b) To facilitate access to funds for the housing sector, the ‘development of integrated townships’ would be permitted as an eligible end-use of the ECB, under the approval route of RBI;
(c) NBFCs, dealing exclusively with infrastructure financing, would be permitted to access ECB from multilateral or bilateral financial institutions, under the approval route of RBI.
(d) In order to give a boost to the corporate bond market, FII investment limit in rupee denominated corporate bonds in India would be increased from US $ 6 bn to US $ 15 bn.
6. Credit flow to the economy:
(a) An SPV to provide liquidity support against investment grade paper to Non Banking Finance Companies (NBFCs) upto Rs.250,000 mn.
(b) An arrangement with leading Public Sector Banks to provide a line of credit to NBFCs specifically for purchase of commercial vehicles.
(c) Credit targets of Public Sector Banks are being revised upward.
(d) Guarantee cover under Credit Guarantee Scheme for micro and small enterprises on loans upto 85% for credit facility upto Rs. 0.5 mn. This will benefit about 84 per cent of the total number of accounts accorded guarantee cover.
7. State Governments will be allowed to raise in the current financial year additional market borrowings of 0.5% of their Gross State Domestic Product, amounting to about Rs 300,000 mn, for capital expenditures.
8. Exports:
(a) Taking into account the fact that the rupee has appreciated nearly four per cent against the dollar since November 2008, it has been decided to restore DEPB rates to those prevailing prior to November 2008. In order to provide predictability and stability of regime in the short term for future contracts, the DEPB Scheme would be extended till 31.12.2009.
(b) Duty drawback benefits on certain items.
(c) EXIM Bank has obtained from RBI a line of credit of Rs.50,000 mn and will provide pre-shipment and post-shipment credit, in rupees or dollars, to Indian exporters at competitive rates.
9. To counter recessionary trends:
(a) Exemptions from CVD on TMT bars and structurals, and from CVD and Special CVD on cement, which were given to contain inflation, are being withdrawn. Full exemption from basic customs duty on zinc and ferro alloys, which was also provided to contain inflation, is being similarly withdrawn.
(b) To release land for low income and middle income housing schemes.
(c) States will be provided assistance for the purchase of buses for their urban transport systems.
(d) Accelerated depreciation of 50% will be provided for commercial vehicles to be purchased on or after 1.1.2009 upto 31.03.09.

One area that the Government needs to look at very closely is the quality of credit that is being extended. In its enthusiasm they should not over extend and end up with another round of credit waivers in the near future (or is this the political far sightedness…who knows). This is a distinct possibility. The road to recovery is long since the global economies are still trying to figure out their bearings.

Vivek Parti, CEO, India Business Database.com, Business Credit Information Company

SEC, the US regulator has issued an investigation report on the working of the leading rating agencies. The report raises questions on the working of the agencies on several critical operations. Rating agencies did not have adequate staff to handle the flow of assignments thus hampering the timeliness of the surveillance efforts. There was conflict of interest where in analytical managers were assigned the task of generating business and negotiating for the fee amount thus putting a question mark on the credibility of the ratings. Maintaining market share was a major consideration while devising rating methodology for risk assessment. Deatiled article can be read by clicking this link.

But from the Indian perspective a similar experience is also possible since all three rating agencies are principal owners of the leading Indian Rating agencies, CRISIL is owned by Standard & Poor, Moody’s has share in ICRA and Fitch has an independent operation.

Credit Profiling is set to become a reality in India with the licensing of Credit Bureaus. Moreover, CIBIL has already become operational and a number of banking and financial companies are downloading credit histories on prospective borrowers. Credit Bureaus are a boon for the financial markets but in some cases can turn out to be ugly for the borrowers. There are cases when lenders or other utility companies may charge the borrowers/ users account with charges that are unjustified. These charges may be contested with the company but if they remain unpaid would show as a negative mark on the credit history that is recorded with the Credit Bureaus. Thus it is imperative for the borrower/ user to be careful while making their transactions. Further reading on this topic can be done at ‘Callitout.com‘

Applying for Credit Information Bureau in India

With the new thinking of the government to allow only 5% FDI in this sector has made some of the leading Credit Information companies to rethink their India strategy.

India does need world-class Credit Information Bureaus to make its financial markets more efficient and transparent in its operations. Data with Credit Information Bureaus will be sensitive in nature. Thus ownership should be wide spread with latest technology orientation.

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What are Credit Reports?

Credit Reports are information report on the credit history of the subject as maintained by credit reporting companies. The information contained in the Credit Report may be categorized as Business Information, Borrowing Accounts, Financial Performance, Inquiries and Negative items. These Credit Reports would be used by prospective lenders or trading partners inorder to develop healthy business relationships.

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How do Credit Scores Help?

Scores provide an objective view of the associated credit risk. Making use of credit scores in the process of business transactions assists in:

• Faster processing of transactions
• Fairer decison-making process
• Reduction in weightage of earlier credit problems.

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