Proposal to cut cost of credit is not good enough, critics say

The cost of credit is high, but is a big cut in interest rates the way to go? Angelique Ardé reports on mixed responses to draft regulations proposing significantly lower interest rates.

The gover nment wants to slash interest rates on personal loans by about eight percentage points, and wants you to pay about three percentage points less in interest on your credit card and store card debt. But there has been a mixed response to the proposal, which is in draft regulations on limiting the interest rates and fees charged in terms of the National Credit Act (NCA).

Some say the regulations do not go far enough to help the poor, who pay the most for credit, while others say there is no rational basis for how the rates will be capped.

The regulations propose cutting the maximum interest rate that applies to unsecured credit transactions (personal loans) by 7.9 percentage points and cutting the maximum interest rate that applies to revolving credit facilities (overdrafts, credit card debt and store card debt) by 2.9 percentage points.

Deborah Solomon, a debt counsellor from online debt counselling portal DCI, says the cuts are “not good enough”.

She says the proposals show that the Department of Trade and Industry (DTI) realises that credit providers’ profit margins are too high and that reckless lending and reckless borrowing are rampant in the credit market. In light of this, Solomon says it’s a concern that the DTI has proposed only slight relief for consumers who take out small, short-term loans (up to R8 000 over six months). Currently, these loans can attract a maximum interest rate of five percent a month. The regulations propose that the maximum rate changes to five percent for the first loan and three percent for subsequent loans in a calendar year.

Not only is this “ridiculously high”, but Solomon says consumers experience the worst abuses when taking out microloans. “They start with a loan of, say, R2 000. After they’ve paid two or three instalments, the credit provider offers the consumer another loan, and what started out as a small loan becomes an ever-growing debt. In this way, the loan is used as a revolving credit facility, at five percent a month, or 60 percent a year.”

Lowering the interest rate will not address the “rolling” of loans, she says. It will also not address the interest charged on credit life insurance linked to loans, or the fact that credit providers charge the maximum service fees and loan initiation fees, all of which affect lowerincome consumers, she says.

Joan Fubbs, the chairperson of the portfolio committee on trade and industry, says the draft regulations on limiting interest are an essential piece of legislation, because preventing borrowers from becoming ensnared by unscrupulous lenders and stemming reckless borrowing will ensure the social stability of the country.

During engagements on amendments to the NCA, the high cost of credit was identified as contributing to the high level of indebtedness.

But Anton Alberts, the Freedom Front Plus’s Member of Parliament on the portfolio committee on trade and industry, says the cost of credit does not inhibit borrowers. “When people are in trouble, they go into debt, irrespective of what it costs, because they’re fighting to survive. People are obtaining credit to cover their living expenses, which is very dangerous – like a Greece scenario.”

The cost of credit can’t be looked at in isolation, he says. It must be viewed in the context of the energy crisis and the high cost of doing business in South Africa. These and other factors destroy jobs and force consumers to use credit to survive.

Geordin Hill-Lewis, the Democratic Alliance’s MP on the portfolio committee, says the proposals are “not pro-poor”. He says it is disappointing that the formula used to calculate the maximum interest rates on unsecured credit has been retained (see the table, above).

“This [way of calculating the maximum interest rate] makes it difficult for consumers to predict if they will be able to pay when the repo rate goes up. Consumers think that, when the repo rate goes up by one percent, so too does the cost of credit. But on unsecured credit, it goes up almost two percent.”

Hill-Lewis says he has a problem with a formula that has an exponential, as opposed to a direct, relationship with the repo rate. “Why not use a simple formula like the one used to calculate the maximum interest on a home loan?”

Stephen Logan, the

chief executive of Fair Credit, a nonprofit company that lobbies for fair credit, says he favours a simple formula. “The reality is that most consumers are financially illiterate.”

Consumers fail to distinguish between different types of credit and, consequently, don’t use credit appropriately, Logan says.

“We have consumers using unsecured and short-term loans to buy cars and renovate homes. The poorest consumers rarely access cheaper types of credit, such as home loans, and end up using unsecured and short-term loans, thereby paying the most,” he says.

Logan says he broadly supports the regulations, because the cost of credit is too high. “But a lot more needs to be done to improve access to the right types of credit,” he says.

The NCA has failed to level the playing field and help consumers access cheaper for ms of credit. Short-ter m loans are expensive unsecured loans. There is little if any justification for the vast difference in cost between what the NCA defines as a short-term loan and an unsecured loan, he says.

Before the NCA, the banks were careful to avoid taking advantage of exemptions under the Usury Act, but after the NCA effectively legitimised expensive loans, they piled in, Logan says.

Hennie Ferreira, the chief executive of MicroFinance South Africa (MFSA), says the regulations will adversely affect the turnovers of microlenders by up to 24 percent.

“Credit policy is not businessfriendly, and this has an adverse impact on consumers. By making credit cheaper, you do not improve access to credit for high-risk consumers. The opposite happens. You make it more affordable for people with security and low risk. Price is a reflection of risk. If credit is too cheap, you can’t provide for writeoffs. You have to price for risk and the cost of doing business.”

The draft regulations will be perceived as a win politically, but they will force people who are financially excluded to use “underground” (unregistered) lenders, he says.

The MFSA has requested a meeting with the DTI.

For a fuller version of this article, go to www.persfin.co.za