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Your loan repayment history matters!
Pankaj Anup Toppo, Outlook Money
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January 17, 2008

This party's been on for the last seven years, and what a party it has been! The industrial slowdown of the late 1990s had pulled down demand and left banks flush with funds. So they turned to consumers to grow their lending business. The effort bore fruit.

Consumers lapped up loans that were available to them at hitherto unseen low interest rates. For example, 16.4 per cent of consumers went for a loan of ticket size above Rs 25 lakh (Rs 2.5 million) in 2004-05, as compared to 10.8 per cent in 2003-04, a jump of almost 52 per cent. The party was truly on.

Back then, almost anyone could enter. Banks fell over themselves to acquire customers for all kinds of loans -- home, car, personal, or credit card. As more people borrowed, banks were aggressive in calling people to the party.

Since October 2004, the Reserve Bank of India [Get Quote], which is entrusted with the job of policing the party, sensed the revelry might get out of hand. So, it slowly started sucking out some of the cash lying with the banks.

Today, the music's still playing but the rules are tighter. So, if you are feeling left out, there's still time to join in. Just remember, entry now depends on whether banks see you as a merry reveller or a troublemaker.

"The issue is more of over-leveraging, especially among customers towards the lower end of the curve," says Pralay Mondal, country head (retail assets and credit cards), HDFC Bank [Get Quote].

Rising number of delinquencies and litigation against banks have forced banks to become choosy about who they lend to. "Today we are looking at customers who have some past credit history, or who fit into our credit scores," says Rajiv Sabharwal, head (retail assets and rural finance), ICICI Bank [Get Quote].

That should make it somewhat more difficult for individuals with lower incomes with no credit history to borrow.

Says Mondal: "We are witnessing a little bit of correction in the market. This was due anyway and would be good for the industry in the long run. The issue has not reached a boiling point."

Apart from the banks' own methods, now they have Credit Information Bureau (India) (Cibil) to fall back on. Earlier, Cibil was not of much help because only delinquent cases were referred to it. But, now it is actively involved in preparing credit scores for all borrowers.

In November 2007, Cibil and TransUnion, a global leader in credit and information management, together launched the first generic credit score of a borrower depending on his repayment record. At present, the scores will be available only to member companies and banks. However, it is expected that, eventually, borrowers, too, will be able to get their score.

It is possible to negotiate a loan rate a bit at present. As the market evolves, you could flaunt a good score to demand even lower rates and take the hit if your credit rating is low. But remember, your score is being calculated today. So what can you do to keep it high?

Party theme

A credit score is a number between 300 and 900 that sums up a customer's credit record. It is inversely related with the risk of a borrower defaulting on repayment for more than 91 days. However, as of now you cannot have your own credit score like your counterparts in the US, who have their score given by Fair Issac & Company (FICO).

Says Cibil chairman S. Santhanakrishnan: "Once the RBI guidelines are issued, the procedure for consumers to access the reports will be announced. The guidelines are expected soon." In the US, a FICO score of 700 and more is considered excellent.

Whether you are in the thick of the party or will be hanging out in the fringes will depend on a number of factors. The Cibil model for calculating the credit score uses credit behaviour information. While some of the factors are proprietary, the bulk of the score is made up of credit utilisation (how much credit you are using), defaults (whether your repayments are due, and by how long and how much), number of inquiries (are you applying for additional credit lines), and trade attributes (age of your credit lines, their type, and the mix).

Entry pass

If you are a first-time borrower, you will not have a credit score. "As the score measures a customer on his/her credit performance, its necessary that the customer has a credit history of at least six months to be scored," says Santhanakrishnan. There are mixed reactions within the banking industry towards the new score developed by Cibil.

Says Mondal: "We will have to see how the new credit score simplifies the loan approval process. Banks may do a pilot run to see whether the new score is in line with their own. I hope these scores will help banks make more informed decisions." Sabharwal of ICICI Bank is more forthcoming.

"What score a bank gives will also depend on the inputs received from Cibil. Any extra information helps make better and quicker decisions," says Sabharwal.

Revel by the rules

Sabharwal points out the advantages of a good score: "You will be required to furnish fewer credit documents, the turnaround time for your proposal will be faster, and you would also get a lower rate of interest." However, you will still have to comply with the KYC norms.

Banks typically treat a particular case as a bad credit profile if the person has willingly not repaid the loan and is also not showing any inclination to do so. So, make sure you have a clean payment history. And, you will be able to build one only if you repay all your loans well on time.

"The length of credit history could also be important. Older accounts are generally better. So borrowers should be judicious about closing old accounts and opening new ones," says Santhanakrishnan.

Maintain a reasonable utilisation rate. The more you owe compared to your limit, the more the chances of your credit score being lower.

"So, remember not to shop for credit too much. Having too many accounts, or many recent requests for credit could indicate too much hunger to borrow and impact the score negatively," says Santhanakrishnan. And, certainly, do not borrow so much that you over-leverage yourself and have a tough time paying back.

Last but not the least -- be disciplined about your finances. The most important thing about the score is that it will factor in how you manage all your lines of credit.

"This makes the score even more useful as the same score will indicate the creditworthiness of an individual across multiple financial institutions and products," Santhanakrishnan.

So, if you are already using a credit line, make sure you pay the dues on time and if you happen to be a first-time borrower, never over-leverage yourself.

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