What ails credit infrastructure in India?

With higher disposable income and a subsequent increase in consumption, Indians are borrowing more and more. The life-styles of families have improved and they do not mind going to a bank anymore to maintain this high standards. While banks are very excited at the prospect that this new development offers, they are still not sure of the quality of credit information they have. The best information that lenders have is the statement of earnings of the head of the family member, and a metric loan amount/value is used to determine the credit worthiness of the customer. This creates a lot of information asymmetry and causes the problem of adverse selection as it is assumed that only people with bad credit worthiness approach the bank in the first place. There is no way for the bank to determine whether the individual approaching it has taken loans from other banks as well, whether he has defaulted on those payments, whether he has declared bankruptcy in the past few years and other important issues. This increases the chances of default and malpractices like recovery agent. With stricter laws on recovery, banks become circumspect in giving the loans and if at all they do, they do it at higher rates, justifying the risk, leading to the problem of lemons, where only people with a bad credit history take loans at such high rates, whereas individual with high credit worthiness just step out of the market, further escalating the risk of defaults for the banks.
Is increasing CIBIL’s coverage the answer?
For most part ‘yes’, but with a catch. Increase in CIBIL’s coverage in terms of depth and reach would solve many problems for the banks and other lending institutes:
a) Increased reach would provide the banks access to a larger portion of the population, without any additional risk. The banks can now significantly increase the asset side of their balance sheet, leading to higher interest income and profits.
b) Increased depth would remove the information asymmetry resulting in faster loan approvals for individuals and better risk management for the banks. Additionally this would remove certain socio-political biases that emanate from such a lack of information, where bank managers use demographic variable like caste, color and race, among others to determine the credit worthiness of an individual, depriving many people of their dreams of an improved life-style.
c) The banks can now use objective financial metrics and with reasonable level of accuracy determine the credit worthiness of an individual. This would be a great tool for active risk management.
d) The banks can ask for more innovative collaterals, as it would now have access to full investments of the individual.
One question to ask is that why did the US banks fail in the presence of such information. And the short answer here is greed. The banks can use this information to draw fancy models and indulge in dangerous practices like sub-prime lending, among others. The key here would be regulation and self-regulation. Whether that would happen: my guess is as good as yours!