The consumer credit market depends on the exchange of personal information among market participants. Credit bureaus are the primary repositories of this information, and in recent years they have gathered a vast amount of data on creditworthiness of individuals. Currently Europe as well as the United States are planning large-scale overhauls of their regimes of information sharing in consumer credit markets. In Europe, a new proposal for a directive on consumer credit is discussed, whereas in the US, key provisions of the Fair Credit Reporting Act are expiring by the end of 2003.
Until recently, however, there has been little independent research on the far-reaching implications of privacy regulations in consumer credit markets. There has also been little quantitative analysis of the effects of differing regulatory environments on both credit reporting agencies and the efficiency of the consumer credit market. The present study fills that gap by analysing the economic effects associated with different financial privacy regimes. The US are contrasted with the European Union (with Germany, Great Britain and France as reference countries) to analyse the differences in the privacy regimes and their effects on consumer credit markets. There are less privacy regulations in the US and credit bureaus compete on a nationwide scale. In the EU, on the other hand, data protection and credit reporting schemes differ from one country to another. Americans enjoy broad access to credit, but this is correlated with greater indebtedness, whereas in the EU, credit markets are thinner and households are in general less indebted.
One of the major research questions is whether more stringent data protection regulations inhibit the distribution of credit reports in consumer credit markets. This, in turn, could result in reduced access to credit, less integrated markets and increasing consumer credit risk (measured by the household debt-service burden). With the Financial Privacy Index (FPI) developed in this study, it is possible to quantify data protection regimes. The indices show that the US grants less data protection than the reviewed EU members. Using this index, it is possible to identify the effects of data protection on information distribution, access to credit, consumer indebtedness and consumer credit risk.
The international comparison shows that countries with higher data protection exhibit lower information allocation. However, growing data protection in individual countries is correlated with increased information allocation. It is shown that the more credit reports are sold the higher is the access to credit. This is associated with greater consumer indebtedness and higher consumer credit risk. Among other factors, the latter is due to the fact that access is broadened and marginally less creditworthy households are entering the market.
The policy implications are the following. To increase access to credit and to expand the integration of the consumer credit markets in the EU, cross-border dissemination of credit reports should be facilitated by a standardisation of European credit reporting systems. The proposal for a new directive on consumer credit provides a chance for such harmonisation. At the same time, however, this exchange has to be transparent to consumers – this is of the utmost importance for the trust in consumer credit markets.
Moreover, the European Commission should ensure that the current Data Protection Directive is equally and quickly transposed in the member countries. A new directive directed specifically to the exchange of credit information would only increase regulatory uncertainty and introduce another round of extended and unequal transposition efforts by member countries. In addition, the European Commission should develop a transparent evaluation mechanism for reviewing the transposition and operation of the current Data Protection Directive.
In the US, where the Fair Credit Reporting Act is currently discussed, policy-makers should ensure that the national standards in credit reporting are kept in place. To some extend, the US faces the same problems as Europe. If states are allowed to design their own regulations for information sharing regimes, these regimes will almost certainly differ and therefore reduce scale and scope effects in the credit reporting industry. Credit reporting markets are based upon networks and these networks exhibit peculiarities that should be taken into consideration before applying regulations. The present study also describes the competition in such markets.
A unified system of credit reporting in Europe is likely to result in broader access to consumer credit. And cross-border credit, which is still in its infancy in Europe, may also increase. However, with the broader access seems to come increasing consumer credit risk, as the analysis of the present study suggests. Intensified competition in consumer credit markets is certainly increasing the quality of services and decreasing prices in the long run, but currently Europe does not seem to have adequate instruments in place to monitor the development of the market. Therefore, the EU also needs common definitions and procedures of bankruptcy and over-indebtedness of households to effectively monitor these developments.