Kenya’s microfinance industry is split into two sets of institutions, with the major differentiator being whether or not they are regulated. One set is made up of deposit-taking MFIs (DTMs) that are regulated by the Central Bank and operate within the stipulations of the Micro Finance Act (Standard Media July 8th 2014).
According to Jappelli ; Pagano (2010) Credit Information Sharing is the exchange of information on client financial histories. Sharing of credit information can make an important contribution to the development of the financial system which is an important determinant of economic growth (Doblas.M;Minetti, 2009). Credit scores have immense benefits to the customers who include both lenders and borrowers. Debtors are able to negotiate with lenders on better terms and conditions. Highly rated borrowers with good credit history can convincingly negotiate for lower interest rates or even waiver of collateral.
The major function of commercial banks in the economy is financial intermediation. According to Gregory (2010) though the size of financial institutions vary from country to country, microfinances mostly constitute the second largest financial intermediary after commercial Banks. The process involves channeling excess funds from the suppliers to the households experiencing deficits in funds commonly referred to as borrowers. This encompasses the lending activity and loan portfolio of Microfinances. Though the loan portfolio is the predominant source of income for these deposit taking Microfinances in terms of interest income, it is also a contributing factor in causing their collapse due to exposure to credit risk (Kimasar;Kwasira, 2014).
The past decade has seen tremendous growth in the financial industry in many developing countries like Kenya. Despite this growth, many Microfinances have continued to be plagued by problems arising from poor quality credit management. This has led to the rise in cost of credit in form of higher interest rates. According to the Kenya Credit Information Sharing
Initiative (KCISI) (2013), when there is no credit information sharing, lenders mistake good risks for bad ones and vice versa. This leaves financial institutions with risky loan portfolios making interest rates to rise over time. When this happens, there is a strong incentive on the part of borrowers to divert huge amounts of the loan funds to riskier projects with high returns since low risk projects cannot yield enough returns to compensate for the high interests. Unfortunately, most of these risky projects fail leading to more defaults.
According to Greuning ; Bratanovic (2006) credit risk is the single most cause of Microfinances and banks failures and therefore prudence in its management is critical to the survival of vast majority of financial institutions. To overcome this problem, microfinances in different parts of the world sought to establish some mechanisms that would enable them to better screen borrowers thus significantly improving the Loan portfolio’s performance. This has been institutionalized in the form of Credit Reference Bureaus (CRBs). Armstrong (2008) observed that the existence of credit registries is associated with increased lending volume, growth of consumer lending, improved access to financing and a more stable banking sector.
Utilization of Credit Information Sharing (CIS) has seen an increase in its use since its inception. A report by the World Bank (2009) indicates that institutionalized information sharing through private bureaus or public credit registers is utilized in more than 100 countries in the world. A research by Hunt (2012) shows that over 3 million credit reports in the USA are issued daily. Mishkin (2008) notes that developing and transition economies utilize credit registries or have fostered credit bureaus in order to boost credit growth. Introduction of credit information sharing initiative was aimed at cushioning lender form financial distress resulting from borrowers not meeting their financial obligations. Non-performing loans (NPLs) are as a result of an inability by a borrower to repay a granted credit when it falls due.Houston & Lin (2010) show that information sharing information is a mechanism that reduce adverse selection by improving the pool of borrowers, the knowledge of applicants? characteristics and therefore improve microfinance efficiency in the allocation of credit.
Based on some case studies, Olweny & Shipho, (2011) points out that credit information sharing plays a key role in improving the efficiency of financial institutions by reducing loan processing costs as well as time required to process loan applications. Lin &Song, (2012) show that information sharing institutions; through their incentive effects on curtailing imprudent behavior of borrowers are also valuable in addressing moral hazard problems. In addition, they show that information sharing helps reduce average interest rates and information rent that banks can otherwise extract from their clients, reduce or even eliminate the information advantage of larger size financial institutions and therefore should enhance credit market completion (kusa & okoth, 2013).