Innovation in data management: Improvements for consumer financial records in Chile
Over-indebtedness is a real problem for the country’s finance. In Chile, as in many other countries in South America, citizens are highly indebted, where 50% of them spend more than 25% of their income on debt services, and this is more seen in poor people¹ (CMF, 2019).
In early January 2020, the Chilean Government launched a new project aiming to create a system like the Credit Report Agencies (CRA) which exist in many countries in order to improve this problem and hence have a public system with credit records for all citizens.
Despite this advance, this new mechanism has several challenges. First, creating a public registry of indebtedness in charge of a third party has the risk of fraud, like Equifax’s case in 2017. Another issue is that consumers have to review their data in their reports periodically to fix any wrong information.
However, there are some data innovations to address these challenges. One opportunity is to change the innate form of operation of the sector through a “Distributed Ledger Technology”. A decentralized system of credit report would positively impact Chilean consumers (and the Government) because it could solve the problem of a bad use of information and consumers would not need to review their reports and be a link between the provider institution and the CRA.
As we know, innovations have issues, especially in their implementation. In this case, this new technology has an inherent challenge for stakeholders, which is to understand and believe in the new mechanism. Besides this, the cost of a new technology and its implementation is high, and privacy issues also matter.
The report will be divided into the following form. First, the sector background. Second, the challenges, opportunities, and impacts that the innovation has on the sector. In the third part, implementation issues will be explained, ending with a brief conclusion.
Background
Chile, like many other undeveloped countries, has over-indebted citizens. Many of the causes of this problem is access to formal credits and hence to better opportunities. In 2017, debt to financial retailers was 37% and to informal systems 7% (Central Bank, 2017). Additionally, consumers do not know their financial information. 17,3% of household debt is outside the debtor’s record (CMF, 2020); hence, citizens do not have easy access to it.
Despite the Government’s attempts (through the Ministry of Finance and Economy) to try to fix this problem, until now, there are only two systems of commercial information². However, these systems contain negative information (unpaid loans) and only give access to formal banks.
In early 2020, these ministries launched a project that creates a new system to consolidate all the financial information of consumers, like the credit reports managed by CRAs in many countries, but the Chilean system will be in charge of a public institution, the Financial Market Commission (CMF).
The goals for this system were mentioned in CMF (2019) such as “People are the holders of their financial information … Entities are due to individuals and should advocate the provision of adequate standards of service in terms of efficiency and safety, ensuring their reputational integrity with a long-term look”. Also, the Commission mentioned, “It is critical for efficiency and financial stability that the industry has more and better information. An information system with greater coverage and scope is required”.
Challenges and Opportunities
Challenges
The previous section described the background behind why the Chilean Government wants to have a consolidated system of information through a public agency. But there are some challenges to it.
First, when a third party is collecting the data, many problems related to fraud and inadequate use of consumer information may arise.
“A third part (an Agency) is in charge to collect information about the consumer (or people). Hence, only because of this, many risks appear, like fraud and bad use of the information because people do not know exactly what they do with this information and who is looking at it” (Goharshady et al. 2018). Also, Goldman Sachs (2016) explains that “In many parts of the world, corruption can lead to counterfeiting or alteration of official records. Similarly, a malicious actor might attempt to selectively alter or destroy records, for example a cyber-hacker changing payment records or trades between parties”. Similarly, Xu et al. (2018) stresses that “The ability of credit-scoring organizations to collect, use and share individual’s personal data is not constrained”.
Chile did not avoid this type of fraud. For example, in 2019, and in 2018 the “State Bank” and the “Commercial Information Directory (DICOM)” had some stolen information.
Second, with this system, consumers must review and fix their information periodically because of in many cases, agencies collect wrong information about them. Additionally, many young people appear with no financial history because they do not have a previous credit. Still, they probably have new types of financial information in their electronic devices. Hence, this system of credit reports can harm all these people to acquire some new financial products.
In this context, Goharshady. et al. (2018) affirms that “Reports stored by different CRAs can be inconsistent or contradictory. Moreover, it is estimated that as many as a third of all credit reports might contain errors that can lead to denial of access to credit”. Also, Goldman Sachs (2016) mentions that “In any transaction involving two or more parties, the same transaction is typically entered separately by each party into that organization’s own independent systems. In each organization, the transaction works its way through middle-office and back-office systems — at which point errors can create the need for costly reconciliation processes with significant manual intervention”³.
Opportunities to address these Challenges
Having seen the challenges that a consolidated system has, this section will provide opportunities to improve the system’s issues through “Blockchain” technology. Some examples of Blockchain apps are in Appendix 1.
Rodriguez (2018) explains Blockchain like “As the name states, it is a sequence of blocks or groups of transactions that are chained together and distributed among the users”.
Hence, the challenges explained above could be driven by a decentralized trustworthy system that helps Chilean consumers to be connected to financial stakeholders, because this new system allows consumers to be the owner of their information, managing and sharing it with the institutions that they want. In other words, there is not a public agency in charge of collecting information of all consumers and then sharing it with the institutions that are allowed to receive this information.
“This system contributes to reduce fraud and increase trust with increased security and increasing transparency and efficiency in multi-party transactions” (Goldman Sachs. 2016). Also, Xu et al. (2018) affirms that “Thanks to the “trustless” proof mechanism running on miners across networks, users can trust the system of the public ledger stored worldwide on many different nodes maintained by “miner-accountants” as opposed to having to establish and maintain trust with a transaction counter-party or a third-party intermediary”. And Goharshady et al. (2018) stresses that “ This system stores the credit report data in an encrypted format, using asymmetrical encryption, in a series of smart contracts. The encryption is such that only the owner and creator of a record, or anyone who they authorize by providing the relevant private key, can decrypt it”.
Additionally, this new mechanism helps consumers to have always the right information in their reports, avoiding to fix it by themselves and be a link between the provider institution and the CRA. “Wrong information provided by an institution can be traced back to their originator who in turn has the ability to fix them”… “erroneous data added by an institution can always be fixed by the same institution” (Goharshady et al. 2018). Besides that, Xu et.al (2018) affirms that “Thanks to the consensus mechanism enforced by the blockchain, only the confirmed data and transactions can be recorded in a new block and appended to the main chain”.
Impacts in the sector
A distributed ledger technology could help the Chilean Government with its goals related to the creation of a credit report system for its citizens. In one part, this system gives consumers a form to collect their financial information in a secure and decentralized form, where they are the owner of their data and able to decide with which institution they want to share it. Hence, problems like fraud or identification will be avoided.
In addition, it allows citizens to have knowledge of their financial information, a matter that helps to reduce indebtedness and asymmetry of information, a real problem that many underdeveloped countries have. Additionally, they do not need to waste time in reviewing their reports and being a link between the provider institution and the CRA, because enterprises can fix the errors.
Issues
There are several issues that a technological system has to handle. “A first step is creating a more user-friendly interface, especially one that abstracts away the underlying cryptography” (Goharshady et al. 2018). In the same issue, Goldman Sachs (2016) affirms that “To gain widespread adoption, we believe technical standards will be needed to ensure similar technical implementations across industries — particularly in cases where multiple blockchains need to interoperate with each other. In other words, the system needs to achieve that creditors and borrowers feel comfortable with this new approach to credit reporting and also to believe in it”. Given that, it is necessary to take into account social issues, like access to technologies that permit the use of a blockchain system and technology literacy.
Likewise, there exist some issues with the time and cost of implementation. “Mass adoption by most institutions may take longer due to the slow evolution of networks with many participants” (Furche et al. 2017). And Berndsen (2016) stresses that “The adoption will be gradual. Interoperability between existing systems and blockchain implementations is needed to make sure that the current settlement and custody activities can continue at all times”.
Additionally, some technical problems may appear because technological innovation changes over time. Hence, it is essential to be aware of new systems and ideas for better performance, like high-speed technology and privacy issues.
Conclusion
Over-indebtedness is an important problem in Chile. The Ministries of Finance and Economy have tried to solve this issue for several years, concluding that a consolidated information system can be a useful mechanism. In January 2020 they launched a project that sought to create a public credit reporting agency such as the CRAs that exist in other parts of the world. Their goals were that citizens could know their financial information and also, that they can share it with financial institutions to lower the information asymmetries that exist in this market.
The report deals with two challenges that this project entails. On the one hand, the lack of decentralization leads to possible fraud and bad use of information. The second problem is related to the periodical review that consumers must carry out in search of errors. Then, it was explained that a potential opportunity of innovation might be to use a decentralized system such as the “Distributed Ledger Technology” where the consumer becomes the owner of its information.
The impact of the Blockchain system on the Government and consumers is to provide a mechanism that allows consumers to know their financial information safely and privately. Consequently, they can make better financial choices and decide with whom they share their data. This could also reduce the asymmetries of information that exist in the market. Finally, the report addressed some issues that this new system could entail. One of them is the credibility of all stakeholders in the system to achieve the block operations. Others are the high cost of the implementation, the creation of a user-friendly interface and possible problems of technological changes inherent to the system.
Footnotes
[1] People who earn less than 470 AUS a month, have a debt of 20,2% of their income.
[2] The information contained in the Debtors’ Statement is updated once a month through the consolidated debt information in file R04. Banks can access the full debtor registration and thus have access to the debtors’ obligations information with other banks. The Commercial Information Bulletin (BIC), is a repository of economic, financial, banking or commercial information, managed by the Chamber of Commerce of Santiago A.G. (CCS).
[3] In many social media this matter appears. For example: https://www.brookings.edu/research/the-real-problem-with-credit-reports-is-the-astounding-number-of-errors/ and https://bloom.co/blog/how-decentralized-credit-scores-address-the-global-millennial-credit-crisis/.
Appendices
Appendix 1
In this context, some platforms have appeared to solve the centralization problem in the field of shared data like Bloom, Monedha and Chlu. Also, in other contexts exist DataWallet, Medicalchain, and BitShares.
References
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