Credit Score: An alternative to traditional collateral for accessing credit

IN traditional banking, collateral has long been a prerequisite when seeking credit. It serves as a safety net for lenders, providing reassurance that in the event of a borrower’s failure to repay the credit as per the agreed-upon schedule, there is tangible security in the form of collateral.

However, this requirement has excluded many individuals from accessing credit from financial institutions due to their lack of collateral.

As a result, many people have been forced to turn to loan sharks, who charge astronomical interest rates, leading to higher default rates and perpetuating a cycle of financial instability.

Fortunately, an alternative solution has gained traction in recent years—an individual’s credit score, obtained from a credit reference bureau, can serve as collateral.

A credit score is a numerical representation of an individual’s creditworthiness based on their credit history and financial behaviour.

It gives lenders confidence that the borrower will repay the loan based on their past financial track record. Recognizing the significance of credit scores, most banks have shifted their lending practices to incorporate the score as a primary factor in determining creditworthiness.

In Tanzania, the Bank of Tanzania (BoT) has mandated commercial banks and other financial institutions to obtain credit references from authorized credit reference bureaus.

This move aims to reduce non-performing loans, promote responsible lending, and ensure that borrowers are assessed based on their credit history rather than solely relying on collateral. How to build good credit score Building a good credit score has become crucial for individuals seeking credit.

Here are some key factors to consider when looking to establish a solid credit history: First, always ensure timely repayments: Making loan repayments on time is essential in building a positive credit history.

Consistent and punctual repayments demonstrate reliability and financial responsibility. As discussed in last week’s article, digital loans from Mobile Network Operators (MNOs) are also part of credit score; ontime repayment of these loans is essential to ensure a good credit score. Second, utilize the credit once you have the opportunity.

For individuals and businesses, debt is always cheaper finance than equity. Utilize the available credit opportunity to build your credit score. It is vital to utilize credit only when necessary and in a position to service it.

Third, the longer the credit history, the better the score. Building up the score with small digital loans when necessary is crucial.

The length of an individual’s credit history plays a significant role in determining their creditworthiness.

A more extended credit history allows lenders to assess the borrower’s past financial behaviour more accurately.

Finally, monitoring one’s credit report regularly is important to identify any errors or discrepancies that may negatively impact the credit score. Sometimes the payment can be late because of factors beyond your capacity, and the credit score system will not recognize that.

Reporting inaccuracies to the credit reference bureau can help rectify any issues promptly. By focusing on these key aspects, individuals can proactively work towards improving their credit scores and increasing their chances of accessing credit without the need for traditional collateral. The shift towards credit scores as an alternative to collateral has proven to be a game-changer for many individuals previously excluded from formal credit channels.

It has opened doors to financial opportunities and empowered individuals to pursue their goals without being burdened by the constraints of collateral-based lending.

Furthermore, the utilization of credit scores has broader societal implications. By promoting financial inclusion, individuals marginalized from accessing credit can now invest in their businesses, pursue education, or meet emergency expenses without falling into the clutches of loan sharks.

This, in turn, contributes to economic growth and stability, as creditworthy individuals can contribute to the development of various sectors.

While credit scores have undoubtedly brought about positive changes in the lending landscape, borrowers must exercise financial prudence. Access to credit should be seen as a means to enhance one’s financial standing rather than a license to accumulate unnecessary debt.

Responsible borrowing and diligent repayment practices are important in maintaining a healthy credit score and ensuring long-term financial well-being.

Moreover, the adoption of credit scores as an alternative to traditional collateral has also prompted a shift in the mindset of lenders.

They are now placing greater emphasis on a borrower’s creditworthiness rather than solely relying on the presence of collateral. This shift promotes a more holistic evaluation of an individual’s financial profile, taking into account their ability to manage credit responsibly.

Financial literacy programs and initiatives are crucial in ensuring that individuals understand the importance of credit scores and how to navigate the lending landscape effectively.

Furthermore, credit reference bureaus need to operate with transparency and accuracy.

These institutions are pivotal in maintaining reliable credit information and generating accurate credit scores. Regular audits and strict adherence to data privacy and protection protocols are crucial to maintaining trust in the credit scoring system.

Therefore, using credit scores as an alternative to traditional collateral has revolutionized the lending industry, providing opportunities for individuals previously excluded from accessing credit.

By building a solid credit history and maintaining responsible financial habits, individuals can improve their credit scores and gain access to credit facilities without needing tangible collateral.

This shift towards creditbased lending promotes financial inclusion, stimulates economic growth, and empowers individuals to pursue their aspirations.

However, borrowers must exercise financial prudence and understand the responsibilities of borrowing.

Likewise, regulatory bodies and credit reference bureaus must ensure the accuracy and transparency of credit information to maintain the integrity of the credit scoring system. With these measures in place, credit scores can continue to serve as a reliable and effective alternative to traditional collateral, promoting a fair and inclusive lending landscape for all.

Author: Godsaviour Christopher is A PhD. Candidate at the University of Agder, Norway and a researcher at the Centre for Banking and Financial Services Research (CBFSR) at UDBS. (godsaviourchristopher@ gmail.com and +255753218577).