The Soviet Union and, then, Russia have always been fertile ground for informal lending by friends and family. People loaned money to others they knew and trusted. Then there was the not-so-friendly loan-sharking, in which people loaned money because they knew they would get it back – no matter what, and with interest.

Now that Russian banks are being forced to act honorably and lend money for business as well as personal needs, the banking industry is faced with a unique problem: Citizens here do not have the type of verifiable credit histories needed by banks to grant loans.

The obstacles between potential borrowers and banks’ cash vaults are many.

Andrei Bergmann knows the situation first hand. The 39 year-old, middle-class sales manager with a Moscow IT firm had his loan application turned down recently by a bank because he lacked a credit history. His argument that friends who had provided him with financing in the past would testify to his creditworthiness fell on deaf ears.

The bank wanted documented records of previous borrowings, preferably from financial institutions. He had never borrowed from a bank before, he said, stressing that that’s what friends are for.

In the past, Bergmann explained to The Russia Journal, one simply needed to approach a well-to-do comrade who, after listening sympathetically, would dip into his cash savings for the requested loan.

"In most cases, such loans are granted as a gentleman’s agreement – deals finalized simply by a handshake, without any written evidence but with a verbal promise to return the money at a certain date in the future," he said.

In a random poll of more than 80 people conducted in May by The Russia Journal at Moscow’s Okhotny Ryad shopping mall – frequented by people from many different social backgrounds – 85 percent of those surveyed did not know what the term "credit history" meant. Many people still take it as an insult when banks or lenders ask about their creditworthiness.

According to State Duma deputies and financial experts calling for the formation of a credit bureau – an agency to help monitor the creditworthiness of potential clients – the requirement of having a verifiable credit history has created a dilemma for both borrowers and lenders.

Most wage earners in need of financing to improve their situations are relatively young and, therefore, have never had to borrow money before, leaving them without any credit history. Members of the older generation who have borrowed in the past did so in a nontraditional banking environment, thus leaving them to the same fate.

Commercial banks are also in a difficult position, unable to fully investigate potential clients’ credit-history stories.

The result, according to experts, is that banks in Russia today use different methodologies – from crude guessing to complex individually drafted schemes – to assess creditworthiness. That means most lending deals are either made blindly or based on an intuition that the person on the other side of the bank counter is a good risk.

Lending in the dark

In the absence of a national credit bureau, extremely detailed loan applications are a prerequisite for granting loans, said Valery Torkhov, Avangard Bank deputy chairman. "We’re able to crosscheck some of these facts using application-scoring techniques as well as our connections in the banking community."

He said this verification system is effective, though not completely error-free, in the overall assessment of clients’ creditworthiness. "Consequently, there are cases of bad loans or those requiring adjustment after they’ve been granted," he said.

Natalya Nikolayeva, vice president in charge of regulatory relations at Citibank Russia – an affiliate of the U.S.-based Citibank group, which serves corporate and private clients in Moscow – said her bank evaluates the creditworthiness of potential clients based on data they supply and other checks.

Alfa Bank has moved even further to set up a risk-management department to carry out analyses and creditworthiness scoring of potential borrowers. This system, along with the scoring principles used in client-creditworthiness evaluation, is confidential, said Oleg Tumanov, the bank’s deputy CEO.

"For our own clients, we have files with their credit histories, while information on new clients’ creditworthiness is collected from all possible sources – from rating and information agencies, publicly accessed financial statements, interviews with managers, the mass media and our business partners," he said. "This system is quite effective, as our bad loans represented less that 1 percent of the total lending portfolio in 2002, and no debt was written off."

BIN Bank runs a conservative lending policy based on its own complex method of evaluation of potential clients, taking into account their financial status, qualification level of management, credit histories and the business environment under which they operate, said Alexei Guskov, BIN’s senior vice president.

However, though a positive credit history is important, it is not a decisive factor in many cases, Guskov said. "Similarly, a negative credit history does not necessarily mean such clients should never be granted loans," he added. "Therefore, it’s very important to analyze all the factors that led to the failure to repay the loans in the past."

A credit bureau would be an ideal cure for issues of delinquency if it were to gather information on clients that consciously refuse to repay loans – that is, when the failure to repay was not motivated by entrepreneurial risks but was the result of theft and/or fraud, Guskov said.

Michel Perhirin, Raiffeisenbank’s managing board chairman, said his bank has a reliable credit-scoring system, specifically worked out on the basis of the bank’s global know-how, for evaluating potential clients’ creditworthiness.

"We’ve also installed special software for customer prescreening at all dealerships cooperating with us on car-loan programs and at our own call centers as well. This was done to enable dealerships to prescreen clients looking for car loans, as well as our operators in the call center for both car- and consumer-loan programs," he added.

So far, the level of efficiency of this method has proven to be around 95 percent, he added.

The call for a credit bureau

Though most banks’ CEOs contacted by The Russia Journal claimed high efficiency rates for their individually drafted client assessment- and credit-eligibility scoring systems, leading banking experts – from both private and government circles – are calling for the creation of a credit bureau that would harmonize the procedures into a single set of rules.

They said the Russian financial market needs a credit bureau, like the Equifax, Experian and TransUnion credit-reporting agencies in the United States or other similar organizations in France, Canada and Mexico, which pool clients’ credit histories from participating banks and then disseminate them on request to banks whenever people apply for new loans.

Natalya Grigoreyeva, director of the retail-credit department at MDM Bank, said she welcomes the idea of a credit bureau, noting that such a one-spot pool of information would be vital for lending operations. She said that MDM Bank would participate in such an agency if appropriate conditions are set up for it to function efficiently.

BIN’s Guskov calls the plan to create the bureau timely, rational and positive. "If the agency does really accumulate data on non-creditworthy clients or the actual people behind delinquent organizations, then it will be highly demanded by the market," he added.

Alfa Bank’s Tumanov said the creation of a credit bureau is one of the most important directions of the on-going banking reform. Tumanov further argued that one of the reasons for the underperformance in the sector is the lack of reliable information, forcing banks to use all sources of information – from the mass media, analytic reports and even rumors – to evaluate credit risk.

"Getting reliable information is even more important for banks when we turn to lending to midsize businesses as opposed to large borrowers, where it is easier to find the necessary information," he said.

Small and medium-sized business is a huge market for lending, and this segment, which has a potential exceeding $5 billion, is currently undercredited, experts say. The availability of better information would enable banks to expand their loan portfolios primarily into this market segment, Tumanov said.

Avangard’s Torkhov also sees the creation of a credit bureau in a positive way. "We at Avangard Bank are eagerly waiting for the appearance of a credit bureau because, as one of a small number of Russian issuers of credit cards, such an agency will be highly useful for us in effectively assessing credit activity," he said.

Raiffeisenbank’s Perhirin said the credit bureau will serve as an instrument to trigger development of the consumer-loans market, which eventually will lead to a reduction of financing rates and facilitate the whole process of granting and getting loans by reducing the number of documents required by lenders.

However, Perhirin warned that proper legislation and other necessary regulatory measures should be enacted to protect the interests of all parties involved in the process so as to "leave no chance for data leakage or violations of borrowers’ rights."

"In the short-term perspective, though, no miracles will happen," he said, "and getting a proper database launched and in place will take time."

Nearly all CEOs have serious misgivings on the safety of disclosed data, consequences of unauthorized leakage to third parties and other pitfalls that might arise in the future in connection with the bureau’s functions.

Specifically, Guskov cautioned that there is an ethical side of this issue. For instance, someone blacklisted once might be left in the situation for eternity. "Even in the Criminal Code, there is the principle of the statute of limitations, which limits the period in which someone is liable to prosecution for a crime committed," he said. "Also, there is the fear that such data could be leaked to the press or elsewhere."

Other CEOs note that this fear has a well-founded basis in Russia’s recent past. During the Soviet years, Russians became extremely protective of their privacy and financial status, primarily to avoid any kind of communist reprisals because no one was supposed to have money. This has resulted in greater levels of privacy for individuals than in Western countries, where banks and credit-card companies can access the financial histories of customers at the touch of a button.

Government undecided on issue

Though the government has long realized the need for a credit bureau on the domestic financial market, bureaucracy, conflicting legislation and interdepartmental wrangling have thwarted its initiatives. For instance, there are two drafts of the bill on the issue – one from the State Duma and the other jointly drafted by the Economic Development and Trade Ministry and the Central Bank of Russia. They differ only on the scope of information they say should be disclosed and penalties for unauthorized disclosure.

The last hitch in getting the official plan approved occurred in March. Pavel Medvedev, the State Duma’s Banking Committee deputy chairman, had said at a banking forum that the Duma has sent the bills back to the Cabinet for approval. Then, Georgy Luntovsky, a Central Bank deputy chairman, added that CBR experts – who are expected to play a major role in the project – have yet to work out how to exchange information on pooled credit histories between banks. He also noted that there is no official consensus on whether the bureau should be government-owned or run by an independent corporate entity.

While Citibank’s Nikolayeva blames the slow pace of the official action on the lack of adequate lobbying power from interested groups to push the legislation through, Alfa Bank’s Tumanov says he doesn’t see anything wrong with this slow pace. "It’s always better to think through an important issue of this nature than to make quick decisions, where any mistake might harm both borrowers and lending institutions," he said.

Taking private initiative

However, not all market players are prepared to wait until the government’s slow pace achieves results, as shown by Delta Capital Management (DCM), which announced in April that it would soon set up a private credit bureau to help facilitate financial operations in Russia.

"We are considering setting up a credit bureau, and the main issue at the moment is how best to organize it so that it’s accepted by the local financial market," said James Cook, DCM senior vice president in charge of the Delta Financial Group. DCM is the investment of arm of the U.S.-Russia Investment Fund, which manages $400 million granted by the U.S. government for investments in Russia.

"The banking confidentiality law prevents financial institutions from disseminating clients’ information to third parties, and we need to find a way to reconcile this law with the requirement to share clients’ credit histories in the credit bureau," said Nikolai Shitov, CEO of DeltaCredit Bank, an affiliate of DCM.

Kirill Dmitriev, a U.S.-educated financial expert with several years of working experience in Western capital markets before relocating to Russia to work as an investment manager for DCM, attributes the slow pace of the government to ignorance of the huge benefits that come with such bureaus in the West.

"The creation of this bureau will prevent banks from lending to clients blindly, or based on limited knowledge of their credit histories," he said. "To the clients, it will shorten the time spent on considering loan applications from three months in some Russian banks and 14 days at DeltaCredit to just two to three days."

CEOs divided over ownership

Most CEOs of commercial banks said they do not care who eventually owns the bureau, provided it plays the role it is supposed to. A few show preferences for either government-owned or privately run agencies.

However, BIN’s Guskov was emphatic that the bureau should be state-owned and heavily fortified by legislation. "If financial institutions are legally mandated to supply the needed information, as opposed to just given proposals for voluntary disclosure, and there is an effective governmental control over the entire process, then the bureau will work efficiently," Guskov said. Otherwise, little will be achieved, he added.

Torkhov noted that his bank recognizes the need for sharing credit-history information through the bureau as a necessary condition for its effective functioning. "We are ready to share essential credit history information on the condition that bank secrecy will not be violated."