Paper

A Decomposition of Screening and Incentive Effects in Credit Information Systems

How do credit bureaus help in screening borrowers?
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This paper decomposes the effect of a credit information system, or credit bureau, into two distinct effects: a screening effect and an incentive effect.

The paper:

  • Develops a model that illustrates how credit information systems mitigate both adverse selection and moral hazard problems in credit markets through screening and incentive effects;
  • Uses the model to make predictions about the effect of a credit information system on default rates and portfolio composition.

The model:

  • Considers a borrowing pool characterized by a set of borrowers, indexed in order of a uniformly distributed level of initial productive assets observable to all lenders;
  • Regards both informal and formal sectors as potential sources of loans;
  • Considers two kinds of borrowers those with a lower rate of time preference and those with a higher time preference.

The model states that:

  • The screening effect of the credit bureau is the direct change in lender profits resulting from the ability to screen impatient borrowers from the portfolio;
  • The incentive effect is that fewer impatient borrowers will risk taking multiple loans as their chances of being detected increase;
  • The screening effect and the incentive effect are two distinct and positive effects of information sharing via credit bureaus.

The paper concludes that the fact that credit information systems can both lower default rates and lead to greater inclusiveness of low-income borrowers within a microfinance network has important policy implications for development practitioners.

About this Publication

By McIntosh, C., Wydick, B.
Published