[VIEWPOINT]Credit Amnesty Is Counterproductive

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[VIEWPOINT]Credit Amnesty Is Counterproductive

Earlier this month, the Korea Federation of Banks deleted from its computer network the bad credit rating records of 1.08 million people after they paid off all their debts. The Financial Supervisory Service announced that it would inspect relevant financial institutions to ensure that they do not retain their own credit records.

These moves follow a meeting on April 3 in which the ruling Millennium Democratic Party and the government decided to wipe clear the records of many former credit delinquents to allow more people to borrow from financial institutions with greater ease. The step has been welcomed by the general public and the press.

Bad credit rating holders, in this case, means those with bad records in the federation's electronic network. As the government has apparently figured, the easiest way to reduce this number is simply to erase the records themselves. This is an expedient but rough-and-ready method which demonstrates profound ignorance of basic economic principles and shortsighted policy that will eventually lead to the burgeoning of bad credit ratings among borrowers rather than reducing them. This kind of poor policy reminds me of the evils of the government-controlled financial system of the past.

It is necessary for us to think about why the credit recording system was implemented in the first place. It is already well known that credit risk management is central to the money lending business. At the heart of credit risk management is forecasting the borrowers' default ratio.

In other words, the core of risk management is not to deny loans to individuals and companies which show any possibility of defaulting, but to estimate what proportion of borrowers will make good on their loans. The credit rating system is an essential tool in forecasting the default ratio.

Credit records make it possible for banks to lend money to companies which do not have optimal credit status but meet certain criteria - for these firms, the banks will often increase the interest on the loan to balance the extra risk. In lending money to individuals it is more difficult for the banks to get precise information on the borrowers' credit history and it costs more money than it does in the case of companies. That's why the banks usually make a "yes" or "no" decision when it considers loan applications from individuals, without adjusting interest rates.

The government's "credit amnesty" policy is the killer of this credit risk management because it degrades the efficiency of the risk management system.

The factors necessary for forecasting the default ratio, enumerated by order of importance, are the reputation of the money borrower, his income, debt-to-property ratio, stability of income and collateral. In the history of money-lending, the reputation of the borrower has always been at the core - and to assess this, there have always been records of arrears. It is even more important in a country like Korea where banks usually don't keep payback records.

If we delete the records of arrears through this so-called "credit amnesty," clever banks will either curtail money-lending to individuals for whom it is difficult to get credit history information or increase their interest rates. Individuals will have to depend more on private lending and the cutthroat interest rates they pay will increase bankruptcies..

If a bank keeps lending money as before to individuals for whom they cannot trace a credit history, the possibility of producing a bad credit record is higher than before because the bank may have loaned to someone who will again default, creating a new black mark.

This kind of vicious circle, contrary to government expectations, will increase the number of bad creditors. It is senseless for the government to think that banks will make more loans just because bad records have been erased. For politicians and officials to tell the Financial Supervisory Service to investigate and punish financial institutions which hold on to their credit records is also senseless.


The writer is a director of A.T. Kearney Consulting.

by Chu Jin-hyung

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