Information Asymmetries: Investopedia defines Information Asymmetry as a situation where, ‘one party has more or better information than the other.’ Affected economic transactions include buyer vs seller, loan borrower vs bank, insurance client vs insurer, patient vs doctor and employee vs employer principal agency problem. Information asymmetries allow reward for specialized skills. Drawbacks include fraud as parties with superior information cheat or abuse their counterparties or when distorted risk pricing lead to inefficient market failures. Adverse selection and moral hazard are the two types of asymmetric information.
The Adverse Selection Problem
Britannica defines adverse selection as a market process in which buyers or sellers of a product or service can use their private knowledge of the risk factors involved in the transaction to maximize their outcomes, at the expense of the other parties to the transaction.’
Risky borrowers may refuse to disclose their other loans or previous defaults on loans from relatives, business credit or other banks to loan underwriting officers.
Smokers or people with pre-existing conditions may not inform their health insurers thereby hiding the full cost of insuring them.
Consequently, insurance legal agreements are uberrimae fidei contracts which require parties to have utmost good faith during disclosure.
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Insurers from countries with less legal restrictions may prefer cherry picking and cream skimming to only insure minimal risk clients.
The Moral Hazard Problem
Investopedia defines moral hazard as the risk that a party has not entered a contract in good faith or has provided misleading information about its assets, liabilities, or credit capacity.
It could also be, ‘a party has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.’
Alternatively, ‘a party lacks the incentive to guard against a financial risk due to being protected from any potential consequences’.
Loan borrowers for instance divert funds from the investment they contracted if they think the bank cannot recover from them if they default.
Credit Reference Bureaus, Credit Registries and Over Indebtedness Problem.
The World Bank defines credit bureaus (private owned) and credit registries (government owned) as credit reporting institutions which collect information from a wide variety of financial and nonfinancial entities, including microfinance institutions and credit card companies, and provides comprehensive consumer credit information with value-added services such as credit scores to private lenders.’
They enable financial intermediation by lowering adverse selection and moral hazard risks, reducing default risk, improving credit access and lower interest rates for lower risk borrowers.
In addition, they help build credit history ‘reputational collateral’ especially by Micro and Small Enterprises and new to bank consumer loan clients who may not have collateral like title deeds, logbooks, cash cover, equities, or treasury bonds to secure loans.
They help reduce over indebtedness by promoting a healthy “credit culture” by incentivizing responsible borrowing characterized by absence of excessive debt and high prompt loan repayment rates.
An over indebted household is defined by the European Commission to be, ‘one whose existing and foreseeable resources are insufficient to meet its financial commitments without lowering its living standards, which has both social and policy implications if this means reducing them below what is regarded as the minimum acceptable in the country concerned’.
A ‘’FICO Score’’ for Every African &’’SME Rating’’ for Every African Business
The three major CRBs in America (Equifax, Experian, TransUnion) avail Fair Isaac Corporation (FICO) scores for borrowers.
The weight of key deterministic variables for FICO Scores includes the history of loan repayment (kept promise to pay) at 35 percent, value of debts owed 30 percent, duration of credit history 15 percent, new credit 10 percent and credit types levered 10 percent.
FICO scores range credit risk from 800-850 (exceptionally low), 740-799 (very good), 670-739 (good), 580-669 (fair) and 300-579 (poor).
Also Read: African Countries Can’t Resolve Their Debt Crisis Under a System Rigged Against Them
The search for a continentally acknowledged ‘’Africa’s FICO Score’’ for every African consumer and SME Rating for every African startup, Micro, Small and Medium Enterprises as well as corporates remain a mirage.
Its clear credit scores, MSME ratings and self-sovereign economic identities will be pivotal in unlocking the promise of Africa Continental Free Trade Area. This will help grow intra Africa trade from 15 percent to the over 60 percent in EU and USMCA by reducing information asymmetries and transaction costs between counterparties.
Africa’s Low Credit Reference Bureau Coverage and Bank Credit to Private Sector
Growing CRB coverage to 100% of adults and MSMEs is a worthwhile investment critical for growing domestic credit to over 100 percent of GDP and thereby maturing the credit markets and financial sector development in Africa.
Roping in negative and positive data of banks, telcos; saccos; MFIs; digital lenders; embedded finance big techs, fintech, student university and TVET loans, and landlords rents payment data is paramount if Africa is to deepen CRBs depth and ratchet up credit volume to over 100 percent of GDP.
CRB coverage for Kenya is low at 36.4 percent of adults as contrasted with its credit to private sector by banks at 31.6 percent of GDP.
South Africa’s CRB coverage of 66.5 percent has unlocked growth of credit to MSMEs by banks to 57.6 percent of GDP below Mauritius 67, Tunisia 62, and Morocco 58 percent of GDP.
African countries with very low credit percent of GDP ratios includes Sierra Leone with 3.2, South Sudan 5.2, Equatorial Guinea 5.9, DRC 11.8, Madagascar 17, and Mozambique at 18.
Region wise credit percent of GDP range from World at 94, Euro Area 79, Eastern and Southern Africa 35, LDCs 32, MENA 30, Sub Saharan Africa 28, Western and Central Africa at 18 percent.
Best practice benchmark countries include Hong Kong, South Korea, Denmark, Sweden, Australia, Japan, and UK with 100 percent CRB coverage and high credit to private sector by banks percent of GDP at 249, 195, 176, 147, 128, 127, 122 and 119, respectively.
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