Credit rating is equally important for both businesses and individuals. Financial institutions provide a credit rating to an individual or a business depending on their past financial history.
Banks and financial institutions providing loans consider the credit rating or credit score to assess the creditworthiness of someone. It acts as a reference point for the financial institutions to assess the amount of risk there is in sanctioning a loan to someone. The higher the credit rating, the lower risk there is of the borrower not returning the loan.
Flaws in the Credit Rating System
The credit rating system today is flawed. It mostly favours people with a strong financial background, allowing them to borrow huge sums for lower interest rates while cutting out those who are actually in need.
For example, a fresh university graduate or someone with a weak financial background may not have any credit history to calculate the credit score. This would make them ineligible for lower interest rates and higher loans.
Looking at the problem from the other end of the spectrum, it’s also easy to note that borrowers can outsmart banks when taking loans. The 2008 financial crisis happened due to the lack of transparency in the process of assessing borrower’s identity and financial records. It was possible for anyone to take any amount of loan without ever having to explain whether or not they can pay it back.
Security is another factor for credit rating entities. They store every bit of the financial history of millions of people. A hack into their system can compromise highly sensitive financial information about their customers. In 2018, hackers stole the personal information of more than 144 million Americans by hacking into the servers of the multinational credit rating agency Equifax.
Blockchain solution for credit rating
- Reputation-based credit
Blockchain can help people keep a record of their reputation in terms of their responsibility, shopping habits, social behaviour, reliability, social impact, and other such factors. This can act as a metric for banks to assess a person’s chances of paying back the money they borrow.
Digital identities on blockchain can act as a single source of all information about anyone. Financial entities can rest assured that the information a potential borrower provides is legitimate. They can then assess the information to provide a loan to them.
Blockchains are immutable ledgers. When records are stored on a blockchain, they cannot be hacked, stolen, or tampered with. Hacking incidents such as that of Equifax can be easily prevented. People can create their own identities on a decentralised ledger that they themselves are accountable for. There will not be a centralised repository of records that hackers will be able to target. Any attempt to steal personal information from each individual would be a highly expensive affair.
- Universally accepted credit rating
Blockchains are borderless systems. When credit rating agencies rely on blockchain-based identities and reputation recorded a borderless ledger, the world can have better standards for universally accepted credit ratings so financial institutions from anywhere in the world can assess anyone’s creditworthiness.
Blockchain is still proving its efficient use cases to the world. And the startups in the credit rating industry have already started using blockchain to create a better system for storing records and calculating credit scores. The use of blockchain in a credit system is also said to help the unbanked population receive loans. With time, we may see more applications of blockchain in the credit and financial industry.