The purpose of the study was to examine the effect of credit reference bureaus on profitability of commercial banks in Kenya. The study adopted a causal comparative descriptive research design and used secondary data for analysis. The target population consisted of 44 commercial banks in Kenya. The study concludes that credit reference bureau services assist in reducing the incidence of non-performing loans and hence in improving the bank profitability. This is made possible through the reduction of transaction costs, enhanced information sharing, reduced loan loss and delinquency, and enhanced credit evaluation practices due to credit reference bureau services are used. The study recommends that banks should continue to utilize the credit reference bureau services as it enhances their profitability. The service lowers the risks involved in identifying suitable clients that the bank can advance loans to. Further studies should incorporate measures of GDP as they greatly affect profitability and also determine client perception on CRB.
1.1 Background of the Study
According to Cavelaars and Passenier (2012), until the 1960s obtaining a loan required a face-to-face application procedure with a bank employee in whom one had to explain the purpose of the loan and demonstrate one’s creditworthiness. Over time, the development of credit bureaus and credit scoring models enabled banks to obtain information about individual consumer’s credit records even though they had no prior relationship with them. Therefore credit referencing not only helps lower transaction costs but also facilitate distant transactions such as, for instance, e-finance or internet transactions and banking.
There has been dramatic increase in competition in traditional and non-traditional institutions in the financial services industry with a decline in consumer loyalty Paswan, Spears, Hasty & Ganesh, (2004). Lending based on hard-information may outperform lending based on relationship-based soft-information, especially in long-distance situations Cavelaars&Passenier, (2012). However, information sharing occasioned by credit reference bureaus has led to increased competition among banks resulting in a decline in monopoly rents for banks, to the benefit of the bank’s customers and society as a whole. Lenders use credit reference databases in order to evaluate a consumer’s credit application and his/her creditworthiness.
According to Idun and Aboagye (2014) in a Ghanaian study recommends encouraging a more competitive banking system with more innovative products tailored toward mobilization of savings and investment to growth induced sectors of the economy. Thus as the credit reference practices get firm foothold in the financial industry, credit data can be used for various ends. Importantly, such data have been considered to promote transparency and reduce the information advantage that a lender has over its existing clients, which in turn could lead both to lower prices offered to consumers and greater access to credit. Since information is very vital for the efficient functioning of the credit markets Ferretti, (2006), existence of asymmetric information between borrowers and lenders poses problems of bad debts, moral hazard and adverse selection.