One view of credit is that it represents spending future money or unearned money to acquire goods and services needed today. Credit availers should be aware that lenders will try to ensure that the money lent will be within what can actually be earned or sourced by the borrower. Suppliers of credit will evaluate the borrower’s capacity and willingness to generate the future revenues that will pay off the debt.
To get a loan approval from whichever source, like banks, credit cooperatives, microfinance institutions, credit-card companies and other financial intermediaries, the borrower will be assessed based on available records, whether good or bad. Positive credit information will be gathered on good past performance such as, but not limited to, information on timely payments and meeting promises made. Lenders also take a look at negative credit performance of the borrower such as late payments or non-payments.
In other words, it is most likely that the borrower will be evaluated based on some historical record. If the subject does not have any credit history, is opaque and difficult to read, accessing the desired loan becomes a challenge. The technical term is information asymmetry, a situation in which one party in a transaction has more superior information compared to another. Simply put, what one knows about the other is not necessarily the same as what the other knows about himself. And the creditor is looking to solve the asymmetry by aiming for congruence.
External finance sources need adequate information to facilitate decision-making. This includes quantitative and qualitative information such as financial statements, business results, forecasts, business plans, state of competition, etc. The creditor checks one important parameter, the borrower’s character that can only be built on reputation and good standing. With this awareness, the borrower’s task is to ensure that there is enough information that will make it easier for the creditor to make a positive assessment and judgment.
In this environment, one’s financial footprint becomes essential. A financial footprint represents a trail of someone’s financial transactions that another entity aims to follow, just like looking for footprints of where you’ve been. Since having a financial footprint will lead to a better credit assessment, one must knowingly and deliberately build it with care.
The following is one useful taxology of what constitutes a financial footprint. First is personal credit, which includes credit history of the principal consisting of credit cards, home mortgages, payment of utilities and legal records. The financial record of the enterprise and the principal must be well kept and this includes financial statements like income (revenues less expenses) statement, balance sheet, cash flow statement and auditor’s notes. Another category is trade data, which includes verification of borrower’s performance and dealings, like past financial institution dealing, key suppliers, industry and competition data, customer records, etc. Finally, there is an emerging set of alternative data such as online web transactions, website and the social media (Facebook, Twitter, Linkedin and the like). Social media is getting to become a powerful tool to unlock one’s history.
Borrowers, especially in the SME sector, should take on this task proactively by improving their financial and information literacy. If necessary, they could seek the requisite training for this from relevant public and private sector providers. Developing a financial footprint cannot be left to chance and is primarily the responsibility of the one whose footprint is being taken. By taking this perspective, the principal will assume more responsibility for his affairs and cannot blame other parties who are definitely aiming to trace the financial footprint.
Of course, the providers are very interested in getting the information through an improved credit reporting system. The better the system and processes are for gathering this data, the better the risks of credit are mitigated. It is here where the credit infrastructure build-up will play an important role. Credit will enable households to fund needs for its comfortable existence and to consume or acquire necessary assets for shelter and transport. Credit will provide businessmen and entrepreneurs funds that will help them sustain and grow with the opportunities available. Credit will make the economy grow and prosper, and it will be facilitated not just by the provider improving the credit infrastructure, but also by the borrowers themselves being keenly aware of the importance of building a reliable record toward a positive financial footprint.
Benel D. Lagua is executive vice president at the Development Bank of the Philippines. He is an active FINEX member and a longtime advocate of risk-based lending for SMEs. The views expressed herein are his own and do not necessarily reflect the opinion of his office as well as FINEX.