Getting Credit Methodology
Figure 1 - Do lenders have credit information on entrepreneurs seeking credit? Is the law favorable to borrowers and lenders using movable assets as collateral?
Doing Business measures the legal rights of borrowers and lenders with respect to secured transactions through one set of indicators and the sharing of credit information through another. The first set of indicators measures whether certain features that facilitate lending exist within the applicable collateral and bankruptcy laws. The second set measures the coverage, scope and accessibility of credit information available through credit reporting service providers such as credit bureaus or credit registries (figure 1). The ranking of economies on the ease of getting credit is determined by sorting their distance to frontier scores for getting credit. These scores are the distance to frontier score for the sum of the strength of legal rights index and the depth of credit information index (figure 2).
Figure 2 - Getting credit: collateral rules and credit information
The data on the legal rights of borrowers and lenders are gathered through a questionnaire administered to financial lawyers and verified through analysis of laws and regulations as well as public sources of information on collateral and bankruptcy laws. Questionnaire responses are verified through several rounds of follow-up communication with respondents as well as by contacting third parties and consulting public sources. The questionnaire data are confirmed through teleconference calls or on-site visits in all economies.
Strength of legal rights index
The strength of legal rights index measures the degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and thus facilitate lending (table 1). The index for the first time this year includes 12 components rather than 10. For each economy it is first assessed whether a unitary secured transactions system exists. Then 2 case scenarios, case A and case B, are used to determine how a nonpossessory security interest is created, publicized and enforced according to the law. Special emphasis is given to how the collateral registry operates (if registration of security interests is possible). The case scenarios involve a secured borrower, the incorporated company ABC, and a secured lender, BizBank.
In some economies the legal framework for secured transactions will allow only case A or case B (not both) to apply. Both cases examine the same set of legal provisions relating to the use of movable collateral.
Table 1 What do the getting credit indicators measure?
Several assumptions about the secured borrower (ABC) and lender (BizBank) are used:
- ABC is a domestic, limited liability company.
- ABC has up to 50 employees.
- ABC has its headquarters and only base of operations in the economy’s largest business city. For 11 economies the data are also collected for the second largest business city (see cities list).
- Both ABC and BizBank are 100% domestically owned.
The case scenarios also involve assumptions. In case A, as collateral for the loan, ABC grants BizBank a nonpossessory security interest in one category of movable assets, for example, its machinery or its inventory. ABC wants to keep both possession and ownership of the collateral. In economies where the law does not allow nonpossessory security interests in movable property, ABC and BizBank use a fiduciary transfer-of-title arrangement (or a similar substitute for nonpossessory security interests).
In case B, ABC grants BizBank a business charge, enterprise charge, floating charge or any charge that gives BizBank a security interest over ABC’s combined movable assets (or as much of ABC’s movable assets as possible). ABC keeps ownership and possession of the assets.
The strength of legal rights index covers functional equivalents to security over movable assets (for example, leasing or reservation of title) only in its first component, to assess how integrated or unified the economy’s legal framework for secured transactions is.
The strength of legal rights index includes 10 aspects related to legal rights in collateral law and 2 aspects in bankruptcy law. A score of 1 is assigned for each of the following features of the laws:
- The economy has an integrated or unified legal framework for secured transactions that extends to the creation, publicity and enforcement of 4 functional equivalents to security interests in movable assets: fiduciary transfer of title; financial leases; assignment or transfer of receivables; and sales with retention of title.
- The law allows a business to grant a nonpossessory security right in a single category of movable assets (such as machinery or inventory), without requiring a specific description of the collateral.
- The law allows a business to grant a nonpossessory security right in substantially all its movable assets, without requiring a specific description of the collateral.
- A security right can be given over future or after-acquired assets and extends automatically to the products, proceeds or replacements of the original assets.
- A general description of debts and obligations is permitted in the collateral agreement and in registration documents, all types of debts and obligations can be secured between the parties, and the collateral agreement can include a maximum amount for which the assets are encumbered.
- A collateral registry or registration institution for security interests granted over movable property by incorporated and nonincorporated entities is in operation, unified geographically and with an electronic database indexed by debtors’ names.
- The collateral registry is a notice-based registry—a registry that files only a notice of the existence of a security interest (not the underlying documents) and does not perform a legal review of the transaction. The registry also publicizes functional equivalents to security interests.
- The collateral registry has modern features such as those that allow secured creditors (or their representatives) to register, search, amend or cancel security interests online.
- Secured creditors are paid first (for example, before tax claims and employee claims) when a debtor defaults outside an insolvency procedure.
- Secured creditors are paid first (for example, before tax claims and employee claims) when a business is liquidated.
- Secured creditors are subject to an automatic stay on enforcement procedures when a debtor enters a court-supervised reorganization procedure, but the law protects secured creditors’ rights by providing clear grounds for relief from the automatic stay (for example, if the movable property is in danger) or setting a time limit for it.
- The law allows parties to agree in the collateral agreement that the lender may enforce its security right out of court; the law allows public and private auctions and also permits the secured creditor to take the asset in satisfaction of the debt.
As a result of changes introduced this year, the first component of the index replaces one relating to legal limitations on who can participate in a security agreement. Two components were added, on what type of collateral registry operates in the economy and on how it operates. The scoring now penalizes economies for not having an automatic stay on enforcement during reorganization procedures so as to ensure that a viable business can continue to operate. And the index takes into account new elements relating to out-of-court enforcement procedures (such as the types of auctions allowed).
The index ranges from 0 to 12, with higher scores indicating that collateral and bankruptcy laws are better designed to expand access to credit.
The data on the sharing of credit information are built in 2 stages. First, banking supervision authorities and public information sources are surveyed to confirm the presence of a credit reporting service provider, such as a credit bureau or credit registry. Second, when applicable, a detailed questionnaire on the credit bureau’s or credit registry’s structure, laws and associated rules is administered to the entity itself. Questionnaire responses are verified through several rounds of follow-up communication with respondents as well as by contacting third parties and consulting public sources. The questionnaire data are confirmed through teleconference calls or on-site visits in all economies.
Depth of credit information index
The depth of credit information index measures rules and practices affecting the coverage, scope and accessibility of credit information available through either a credit bureau or a credit registry. A score of 1 is assigned for each of the following 8 features of the credit bureau or credit registry (or both):
- Data on both firms and individuals are distributed.
- Both positive credit information (for example, original loan amounts, outstanding loan amounts and a pattern of on-time repayments) and negative information (for example, late payments and the number and amount of defaults) are distributed.
- Data from retailers and utility companies are distributed in addition to data from financial institutions.
- At least 2 years of historical data are distributed. Credit bureaus and registries that distribute more than 10 years of negative data or erase data on defaults as soon as they are repaid obtain a score of 0 for this component (1).
- Data on loan amounts below 1% of income per capita are distributed.
- By law, borrowers have the right to access their data in the largest credit bureau or registry in the economy. Credit bureaus and registries that charge more than 1% of income per capita for borrowers to inspect their data obtain a score of 0 for this component (2).
- Data users can access borrowers’ credit information online (for example, through an online platform, a system-to-system connection or both) (3).
- Bureau or registry credit scores are offered as a value added service to help data users assess the creditworthiness of borrowers (4).
Previously the depth of credit information index covered only the first 6 features listed above. The index ranges from 0 to 8, with higher values indicating the availability of more credit information, from either a credit bureau or a credit registry, to facilitate lending decisions. If the credit bureau or registry is not operational or covers less than 5% of the adult population, the score on the depth of credit information index is 0.
In Lithuania, for example, both a credit bureau and a credit registry operate. Both distribute data on firms and individuals (a score of 1). Both distribute positive and negative information (a score of 1). Although the credit registry does not distribute data from retailers or utilities, the credit bureau does (a score of 1). Both distribute at least 2 years of historical data (a score of 1). Although the credit registry has a threshold of 1,000 litai, the credit bureau distributes data on loans of any value (a score of 1). Borrowers have the right to access their data in both the credit bureau and the credit registry free of charge once a year (a score of 1). Both entities provide data users access to databases through an online platform (a score of 1). Although the credit registry does not provide credit scores, the credit bureau does (a score of 1). Adding these numbers gives Lithuania a score of 8 on the depth of credit information index.
Credit bureau coverage
Credit bureau coverage reports the number of individuals and firms listed in a credit bureau’s database as of January 1, 2014, with information on their borrowing history from the past 5 years. The number is expressed as a percentage of the adult population (the population age 15 and above in 2013 according to the World Bank’s World Development Indicators). A credit bureau is defined as a private firm or nonprofit organization that maintains a database on the creditworthiness of borrowers (individuals or firms) in the financial system and facilitates the exchange of credit information among creditors. (Many credit bureaus support banking and overall financial supervision activities in practice, though this is not their primary objective.) Credit investigative bureaus and credit reporting firms that do not directly facilitate information exchange among banks and other financial institutions are not considered. If no credit bureau operates, the coverage value is 0.0%.
Credit registry coverage
Credit registry coverage reports the number of individuals and firms listed in a credit registry’s database as of January 1, 2014, with information on their borrowing history from the past 5 years. The number is expressed as a percentage of the adult population (the population age 15 and above in 2013 according to the World Bank’s World Development Indicators). A credit registry is defined as a database managed by the public sector, usually by the central bank or the superintendent of banks, that primarily assists banking supervision while at the same time facilitating the exchange of credit information among banks and other regulated financial institutions. If no registry operates, the coverage value is 0.0%.
The initial methodology was developed by Djankov, McLiesh and Shleifer (2007) and is adopted here with minor changes.
1- This component is revised in Doing Business 2015. The previous methodology assigned a point if more than 2 years of historical data were distributed. Similarly, credit bureaus and registries that erased data on defaults as soon as they were repaid obtained a score of 0.
2- This component is revised in Doing Business 2015. The previous methodology assigned a point if borrowers have the right by law to access their data in the largest credit bureau or registry in the economy.
3- This component is new in Doing Business 2015.
4- This component is new in Doing Business 2015.