Using credit reference bureaus to boost trade

The client had accumulated huge debts as most of the orders were placed on credit to be repaid after sales.

At his new job, Alex found an application from the same customer amongst other potential customers seeking services on credit terms. He has to make his calculation right.

Minimising the risk of default could mean that Alex, who is already equipped with the credit history of the customer as a defaulter, insists on cash terms.

This could mean losing sale to other competitors who might want to offer credit to this customer.

Alternatively, Alex could ignore the negative information of the customer to supply the order as he could capture the potential customer and boost sales to the company.  

This scenario illustrates what characterises Kenya’s trade credit market.

Just like the lending market before the adoption of credit referencing, there exists serial defaulters; customers who secure services or products on credit, default and switch suppliers to get more credit besides repaying the outstanding debts.

Every time, the term credit referencing is mentioned, what resonates in the mind of many is the dreaded concept of black listing of serial defaulters and the association with commercial banks.

Credit referencing is not limited to banking or the lending market, but is a concept that helps in decision making to reduce the risk of default.

Similar to the lending market, the trade credit market requires sound decision making furnished with adequate history to eradicate any risk of defaults.

This information can be gathered from daily business transactions, but it must be submitted to a credit reference bureau to facilitate easy sharing of information.

There exist two forms of credit referencing; banking and no banking credit referencing.

The banking credit referencing is where banks submit data especially on payment history of their borrowers or customers to a credit reference bureau for sharing amongst themselves. This is a requirement.

To minimise any risk of default in lending, the commercial banks would first check with the bureau on any information on the credit history of the borrower before making decision. In this, the sharing of information is only limited to the banks.

The non banking credit reference on the other hand is a concept that is not been fully exploited as a tool to boost trade credit.

Unlike the banking credit referencing which is a statutory requirement, the non banking referencing is market driven and is not under any regulation by the central bank.

That means that all trade credit providers starting from the utility providers, service providers, suppliers and even manufacturers can submit the information on their customers to a credit bureau without any restrictions.

The credit bureaus already have the system in place to facilitate non banking referencing and what lacks is the initiative to gather and capture the existing information in a bureau for sharing.

Unlike lending transactions which are only accessible to the few, trade credit transaction cuts across all consumers or borrowers since everyone in one way or the other depends on or relies on credit.

As a business, you may have a customer who has never sought any loan facility from a bank and so has no credit history as far as banking referencing is concerned.

Elsewhere, the same customer relies on utilities such as electricity for daily operations which must be paid after consumption or use.

These days with the heightened level of competition that characterises both the service and commodity market, the use of trade credit has emerged a major tool of competition and boosting sales revenue surpassing price cuts and discounts.

Given this, consumer preference has also changed with most consumers preferring use of trade credit to price reduction or discounts.

Consequently ,use of pure cash terms in trade transaction has taken a backseat paving way for trade credit.

Even in trade credit, the level of competition has also increased as customers seek to place orders with suppliers who provide favourable credit terms with relatively strict conditions.

To suppliers or service providers, besides boosting sales and revenue, using trade credit invites risks of default which has a negative effect of profit .

Eliminating such risks requires sound decision making backed with adequate information that gives insights on the customer’s payment history.

But this can only be achieved through credit referencing.

However, due to the information asymmetry that still exists in the trade credit market, a customer who has defaulted on debt repayment on one supplier can still continue to access trade credit from other service providers just by switching suppliers as a ploy to evade repaying the debt.

This is what we observe in Alex’s scenario where one customer switches service providers to evade debt repayment and continue getting further access trade credits.  

Non banking credit referencing comes in to eliminate the information asymmetry where all service providers, utility providers, manufacturers submit the information to a bureau which is then shared amongst trade credit providers.

This would eliminate customers who are defaulters by exposing their credit histories to any service provider willing to offer trade credits as well as reduce the risk of default, bad debts and erosion of capital.

Currently, non banking credit referencing has started amongst tour and travel agencies where all the players submit the data to a bureau for sharing.

Mr Opiyo, is a financial consultant pursuing Chartered Financial Analyst course.