Credit Reporting in Russia: Challenges and Opportunities

Summary. Credit history is an integral part of U.S. business practice and many U.S. companies who are new to the Russian market may want to know how to obtain reliable and accurate credit information about Russian companies and individuals. While performing a credit check is a routine task in the U.S., it is not a simple undertaking in Russia.

Finding and evaluating information on a potential business partner, not to mention credit history data, may be rather challenging. Many Russian companies are wary of providing information about their business, especially sensitive financial and credit data. Even if such information is available, it is usually submitted upon request, and can't be found in open sources (such as in business directories, or on the internet). The lack of publicly available credit history information complicates business and commerce activities. However, commercial companies and the Russian financial community are increasingly recognizing that this is a problem, and alternative laws for the establishment of credit bureaus are being discussed. Currently, only consumer credit bureaus are under the microscope, whereas companies themselves remain on the sideline. Problems of credit history data availability, current and proposed laws and existing alternative sources of credit information are discussed in this report. The report is broken down into the following parts:

• The Current Status of Credit Reporting in Russia
• Post-Soviet Business Practices
• Credit Information Disclosure Requirements - Laws and Regulations
• Available Sources of Credit Information.

The Current Status of Credit Reporting in Russia

1. The banking system, insurance industry, consumer goods distributors, government agencies and various other organizations are all in need of accurate credit reporting. The core question that creditors want to have answered is whether a borrower is willing and able to fulfill their obligations. Naturally, an evaluation of past performance, combined with an analysis of current credit standing and creditworthiness, helps to answer that question. Good past performance (i.e. credit history which reflects paying habits, etc.) also can help consumers and businesses claim lower interest rates and overall better credit terms. There is no doubt that credit history information is one of the key elements of the market economy and effective supplier - consumer relations.

2. Availability of information on the borrower's credit history and paying habits helps creditors to estimate the credit risk and make a final credit decision. However, in Russia, such information is not yet a matter of open exchange between relevant parties. It is impossible to legally purchase a credit history of a company or an individual. There are almost no mechanisms for the legal and systematic accumulation of such data for a wide range of economic agents. The result of this situation is that banks are less willing to take credit risks, because there is a lack of information for a careful risk-assessment. Because of the risk-averse nature of the banking industry, decisions on whether to extend credit often require analyses based upon a large body of industry-specific comparative payment and credit data, company-specific performance, etc. Therefore, a lot of good small and medium companies either do not qualify for credit, or cannot attract credit on reasonable terms. The result is that the economy is not getting enough financing and growth is slower than would otherwise be possible. Moreover, even if information is available, there is no guarantee that it is accurate. Therefore, in the absence of any government action to create a framework for the accumulation and exchange of this crucial information, businesses have to rely upon personal ties, information provided by their partners (and thusly, not independently verified), informal channels and other sources. This complicates the process, making it less objective and narrowing the circle of potential partners, buyers and suppliers.

Post-Soviet Business Practices

3. The difficulty in obtaining credit history information in Russia lies in the fact that there is no system for the accumulation of such data, even though it is widely known that access to accurate and reliable information is vital for the success of any business undertaking. Clear rules of accumulation, analysis and distribution of sensitive business data are needed in Russia in order to assure that the needs of the developing economy are met - rules that simultaneously support public confidence as well as ensure reasonable fairness to all involved parties. Information (including not only credit history information, but also data on a company's capital, operating costs and main shareholders) should be properly evaluated in order to establish its accuracy, relevancy and honesty. Honesty is key because without that factor no information is useful (for example, it is easy to make a company's accounts receivable twice bigger, thus distorting credit analysis data, and so forth). In the post-Soviet Russia a widely applied principle of business conduct is that everything that is not formally prohibited is allowed. This principle is a cause of a 70-year long gap, which broke historical continuity and eliminated moral rules of business conduct. Moreover, the importance and sensitive nature of credit information (especially when it contains personal data) stipulates not only a need for concord in the society on fair principles and rules of its use (respecting individual freedom), but also requires that confidence exists among all parties that these rules would be strictly adhered to and that any disputes could be settled through the court system.

4. All the aforementioned facts and statements are obvious, but it is nevertheless important to point out that, in post-Soviet Russia, many aspects of business still remain upside-down. An important problem in contemporary Russia is the lack of trust between people and, in a broader sense, between society and all levels of the administration. This becomes apparent, for example, in tax avoidance; companies and individuals are not willing to disclose revenues and pay all their taxes, not only because the tax burden is perceived to be too high, but, more importantly, because many people don't believe that their taxes will be used effectively and therefore don't have a sense of responsibility for what happens in society. During Soviet times, the political elite (which transformed into political and economic elite) became used to suppressing individuality (and society as a whole), and people became used to neglecting the regime and disregarding its words and actions. A change of thinking has not fully occurred yet and the aforementioned phenomena of the post-Soviet mentality are, in many ways, still in place. It is interesting to note that renaissance of principles of normal business conduct in Russia may be observed between members of historical confessions, like Jewish or Russian orthodox. There, entrepreneurs are constrained not only by external legal restrictions, but also by inner moral categories.

5. Continuing with the tax avoidance example, tax avoidance necessitates that a company have two sets of accounting books - one for the tax authorities and one for the management, and so forth. Once started, the string of lies forms a vicious cycle, which is extremely hard to break (NOTE: of course, not every business or individual is involved in tax avoidance or similar illegal activities, but the degree of prevalence of this problem is such that it strongly affects the overall situation). Certainly, there are strong reasons to believe that credit reporting in Russia has to deal with the problem of a lack of trust and confidence. This issue is especially important, because credit is based on mutual trust and responsibility. Currently, getting complete and accurate credit history information is more of an uncommon challenge than a routine operation. In addition to the problems of a persistent Soviet mentality, the legal framework is insufficient. Existing laws do not fully address the need of the developing economy for an up-to-date credit reporting system.

6. However, there are signs that Russian businesses are prepared to deal with the problem. According to Inna Danilchenko, project manager at Dun & Bradstreet Nord (located in St. Petersburg, Russia), the volume of orders for business information reports has increased manifold in the past three years, indicating a gradual change of business practices. Interestingly, some companies are wary of disclosing information about themselves, even when such information is public and is available from other sources. Another observation is that a company that is unwilling to submit information about itself is oftentimes a user of such information about others. The reasons for non-disclosure of information (although it is quite obvious that transparency is beneficial for business) can be disputed and they are in no way easily identifiable, but it is likely that fear and a lack of confidence are at the basis of this "secretive" business mentality.

Credit Information Disclosure Requirements - Laws and Regulations

7. Russia has quite strict laws regulating disclosure and the protection of information. Although there is no law specifically regarding credit bureaus, other laws essentially cover the issue.

More specifically, those laws are: The Civil Code The Law on Banks and Banking Activities The Law on Information and Protection of Information The Law on State Secrets The Law on Joint-Stock Companies The Law on Closed Joint-Stock Companies The Law on State Registration of Legal Entities The Law on Registration of Immovable Property The Labor Code Some Presidential Decrees

8. There are some issues not covered in existing laws. For example, it is not always clear which information about companies and individuals is confidential, and existing laws don't facilitate the exchange of important business information. There are, however, various initiatives to enact laws, such as a law on information of a personal nature, a law on commercial secrets, professional secrets, credit bureaus, and others. When and which laws will be enacted remains an open question. There is a strong interest and even some pressure from the Russian and international financial community to enact laws which would allow the effective functioning of credit information resources, such as credit bureaus. However, whatever the actual substance of the new laws will be, the creation of a credit reporting system and databases in Russia will certainly take many years.

9. The existing draft laws only address issues of the establishment of consumer credit bureaus; commercial credit bureaus are not being actively discussed. It also remains to be seen who would be allowed to use credit information. In Russia, a lot of information is considered to be commercial or bank secrets. For example, as to credit bureaus, banks are, by law, not allowed to disclose any information about the accounts of their clients. This is a very important hurdle for the development of credit bureaus since information can be submitted only upon the written consent of a client. Although the financial community is definitely interested in seeing the range of potential users extended to include insurance companies, telecommunication service providers, leasing companies and other creditors, the discussed laws, when adopted, may only provide for the banks. It is also unclear whether banks would be obliged to provide confidential information about consumers to the credit bureaus, or if this would be done only upon the consent of the consumer. Naturally, there is interest among market participants to see several credit bureaus competing with each other (leading to increased quality of service) rather than one government-operated credit bureau. However, it still remains to be seen what the legislative choice will be.

10. The effort to create the first Russian private consumer credit bureau is being carried out by Delta Capital, the management company of the U.S.- ussia Investment Fund. The planned consumer credit bureau may expand its coverage at later stages to contain commercial clients. According to Ms. Hurley, vice-President of Delta Capital Management Inc., the Bureau will be modeled after Western concepts, but take into account Russian specifics. The Bureau will unite several prominent banks with wide retail credit clientele bases. In the absence of a law that would allow banks to contribute data to the credit bureau, the banks will include a clause into credit agreements with customers that confidential information about a loan may be disclosed to the credit bureau. This information will be submitted to the databank of the Bureau and every bank that would have a contract would have access to the credit histories of their consumers. Since the information will be confidential, only authorized banks (those which signed contracts with the Bureau) will be able to access consumer credit information. Whether or not insurance companies and other creditors will be allowed to access the database depends on the law, which is yet to be adopted. Files will be updated on a monthly basis, thus assuring that credit reports contained in the database are always current. The database will mostly include Moscow-based consumers during the first stages. Certainly, it will take at least one to two years before the track record of any consumer is meaningful for making credit decisions. However, banks do need this critical information on consumer credit history, just as consumers need easier access to credit and better terms, so the initiative to launch the Bureau is well-timed and is demanded by market participants.

Available Sources of Credit Information

11. Reputable banks always base their credit decisions on official documents from a company. Therefore, companies that have to rely on banks for financing are forced to take their business out of the shadow. Larger companies in Russia that realize the effect of transparency on a company's value and credit rating and have the resources to implement it, follow a set of strategies aiming at disclosing information about their businesses. The strategies include the implementation of international accounting standards, the adaptation of corporate governance codes, the hiring of independent directors and so forth. The Federal Commission for Securities and Markets requires the disclosure of information. By law, all open-stock companies are required to publish their annual reports and submit information to the FCSM. Information about old and new stock and bond issues can be viewed on a specially created official web site of FCSM: http://disclosure.fcsm.ru (currently in Russian only). Smaller companies in Russia still rely on retained earnings for business expansion. A significant portion of their business is oftentimes in a shadow. For such companies, bank credit is hardly available.

12. Since there are currently no credit bureaus, banks prefer to work with borrowers who maintain accounts with them. In fact, many banks reject credit if a potential borrower doesn't agree to maintain an account with the bank. Banks have also to rely on borrowers to submit all the required information. Typically, this information includes:

• A list of outstanding loans (the list should include information on where funds were borrowed, the schedule of repayment, etc.);
• Liens on assets;
• Confirmation from tax authorities every quarter that charters of the company were not amended during the past three months (tax authorities are responsible for the registration of newly established companies and for the registration of amendments in statutory documents);
• Documents confirming repayment of previous loans;
• All legal documents (charters, powers of attorney, financial statements, etc.);
• Documents confirming ownership of property and real estate to be pledged;
• Other documents.

13. The list of documents is usually so extensive, and takes so much time to compile, that many companies employ a special staff, responsible for handling bank documentation and bank relations. Naturally, small and medium companies (SMEs) are at a disadvantage in this respect, as they are not able to put in as much of the time and effort required to obtain all the documents. The problems of SMEs are complemented by a lack of liquid collateral, less professional accounting and higher interest rates. On the other hand, for the banks, it is difficult to effectively tap into SME market segment, because anks want to be fully protected by pledged assets (usually of a value far exceeding the amount of the loan). Due to the lack of accurate credit history information, banks are not in a position to assume risks based on credit rating, a company's reputation and a careful project analysis.

14. The sole source of official information about a company (if it's not a joint-stock company) in Russia is the State Statistical Committee (Goskomstat). All companies are obliged to submit their financial statements (upon approval of the tax authorities) to Goskomstat. If a company is a joint-stock company, it is also obliged to disclose certain information to the Federal Commission on Securities and Markets. The problem is that Goskomstat is very slow in processing information, so the information, when finally processed, may not reflect the true state of the company. Moreover, some companies fail to submit reports to Goskomstat on a regular basis. This happens particularly often (according to Inna Danilchenko from Dun & Bradstreet Nord) when a year isn't particularly successful for a company and it experienced losses, diminished sales, etc. In either case, no credit information is provided to Goskomstat, so there is no way to evaluate the credit history of a company (not to mention of an individual) on the basis of official statistics.

15. The quarterly financial documentation, which is filed with Goskomstat, contains officially stipulated forms, such as the balance sheet, the profit and loss statement and some others. It also contains a description of accounts payable and accounts receivable of the organization. This form discloses the total amount of accounts payable and receivable with respect to every debtor and creditor and any arrears. However, this form is often not submitted to Goskomstat and, even if it is submitted, by the time it is processed and available, it is not up-to-date. Bankers say that up-to-date and relevant descriptions of accounts payable and receivable can be received only from a company directly upon request. Although it is not a commercial secret according to Russian law, such information is not available through any public source of information. Moreover, a form compiled on a certain date does not give any indication of the track record of a company's paying habits.

16. Recognizing the fact that, due to the current legal environment, there is no way to collect credit information about a company, unless it is submitted on a voluntary basis, Dun & Bradstreet launched an initiative called the Creditors Club. Through Industrial Creditors Clubs, participants can share information on the fulfillment of credit contracts by their debtors. Companies that signed a Participant Agreement with DNB provide overdue payment data on their debtors on a monthly basis. This information is then calculated by DNB and placed in the system as aggregate debts of each debtor to the particular Club (currently there are clubs of Pharmaceuticals and Food creditors). The website (www.creditnet.ru) does not disclose the source of the information. Information collected through the Industrial Creditors Clubs may later be used for the establishment of a national credit bureau of commercial clients (not individuals).

17. U.S. Government Contact

For more information, you may also contact Igor Yegorov, BISNIS Representative in Northwest Russia Tel.: 7 (812) 326 2585 Fax: 7 (812) 326 2561 E-mail: igor.yegorov@mail.doc.gov