Implications of cutting consumer loans
Starting on January 1, 2019, consumer loans will have a maximum period limit of 30 months due to a new measure enacted by the Monetary Policy Commission (MPC) of Mongol Bank.
This means that any consumer loans, with the exception of mortgage loans, must not exceed the maximum period limit of 30 months or 2.5 years. This comes on the heels of the decision by the MPC to implement a debt-to-income ratio (DTI) limit for consumer loans. What will this entail for the recovering economy and does it introduce the risk of curbing rising economic activity?
Implementing a maximum term for consumer loans is a key tool for a central bank or banking authority in a country to manage existing debt issues and to prevent future systemic crises. Just a month ago, Turkey’s Banking Regulatory and Supervisory Authority lowered its maximum term limit for consumer loans from 48 months to 36 months. The measure has two key goals, to protect consumers and to shield the financial sector and infrastructure from systemic crises.
In regards to the public, the MPC has made sure that no individuals can bite off more than they can chew. The DTI limit approved in July and set to come into effect at the same time as the maximum term limit, is a significant step towards ensuring that consumers are borrowing within their limits. DTI is calculated by adding up all of an individual’s monthly debt payments and dividing them up by their gross monthly income. The lower the percentage, the better the financial position of the individual. In the absence of a DTI limit, banks have complete authority on who to lend to, which usually results in lending being skewed towards individuals and creates the risk of usury lending. A 70 percent DTI limit being enacted in 2019 means that banks will be incentivized to lend to individuals in a good financial position and gear their lost lending opportunities towards businesses.
The DTI limit and the maximum term limit being imposed together is important as it prevents banks from stretching out loans to absurd periods in order to bypass the DTI limit. According to Mongol Bank, the average period of the majority of consumer loans is 27 months. As a result, this will not have that much of a pronounced effect on existing loans or future consumer loans. It is mainly geared towards preventing banks from attempting to bypass the DTI limit.
In addition, according to N.Urgamalsuvd, head of Monetary Policy Projection at Mongol Bank, the measure is important in an economy that is highly dependent on mining exports and therefore susceptible to boom-bust cycles.
“In order to secure long-term loans, an individual must usually provide proof of guaranteed employment. Our economy is very susceptible to external shock and dependent on mining. When commodity prices drop, which it inevitably will, businesses decrease their investment and production. The first measure taken by a company when production decreases is to lay off employees. The employees who were laid off will have increased risk of defaulting on their loans,” said N.Urgamalsuvd.
Systemically, the two measures are designed to reduce the number of non-performing loans and nudge commercial banks to lend to businesses. This ensures the integrity and stability of the financial sector while also spurring business activity. The less non-performing loans there are in the banking sector, the more that the commercial banks will be willing to supply loans. In addition, it safeguards the system from any single bank or institution derailing the whole sector through irresponsible lending.
Of course, there are some concerns to be had. Specifically, it will affect certain businesses such as car dealerships. Car dealerships usually provide long-term loans on new vehicles and this will significantly undercut their ability to provide such loans to their customers. This will be a big hit to many who have an affinity for purchasing every new model of a car and that is not necessarily a bad thing. Less financing opportunities for big costs such as cars will mean the majority will have to look at purchasing second hand cars or cheaper vehicles. This will likely decrease the huge flux of cash that is spent on importing expensive vehicles, which also positively affects the balance of payments and the trade surplus of Mongolia.
According to Mongol Bank statistics, the number of consumer loans has shot up 40 to 50 percent while lending to businesses has remained relatively the same. In the last decade, household debt as a proportion of GDP has doubled. Increasing household debt can spell impending doom for an economy as was seen in the US housing market crash that caused the 2008 global financial crisis. Irresponsible lending practices and borderline usury practices can eventually lead to a systemic crash. The measures are aimed at preventing such catastrophes.
Those with existing loans and loans approved before January 1, 2019, will not be affected by the measure. While there are some concerns this will curb consumerism, there is an argument to be made that consumerism driven by debt is not good for the long-term prospects of the economy.
There is one major concern that has warranted caution. It is the fact that non-banking financial institutions will not have to abide by these measures as Mongol Bank is only in charge of supervising and regulating the 14 commercial banks. As a result, the Financial Regulatory Commission (FRC) must seriously consider enacting a similar measure in the non-banking sector.
One of the more certain positive takeaways from the measures will be a likely decrease in lending interest rates. Previously, commercial banks competed with each other by stretching out loans or lowering the DTI limit. But with the two measures, banks will have no other way to compete outside of lower interest rates. Overall, starting in 2019, the banking sector is set to become a lot more comprehensive and stable in terms in withstanding shocks.
...One of the more certain positive takeaways from the measures will be a likely
decrease in lending interest rates...