Gabriel Davel
Mistaken remedies are no cure for the precarious credit market.
THE South African credit market is in a precarious position and consumers are in for a rough ride. Fairly dramatic and damaging fallout seems inevitable. Unfortunately, there seems to be a limited understanding of the causes of the problem, while many of the steps the Department of Trade and Industry is taking can only make matters worse, both for consumers and for the financial system.
The statistics paint an alarming picture: over the past five years, the quarterly credit disbursed for mortgages decreased 29%, while unsecured loans increased 190%. There is about R250bn in arrears on all personal debt in SA — R180bn on credit agreements only — and 48% of South African consumers have impaired credit records.
Predatory credit practices are largely to blame for this situation.
Nearly every one of the major lenders participated enthusiastically in the lending frenzy over the past few years, in a frantic competition to load their clients with as much debt as possible.
Although the bulk of the blame must lie with the grantors of credit, policy blunders over the past few years have aggravated the situation. The most costly of the blunders has been the failure to amend the rules that govern emolument attachment orders (“garnishee orders”), despite numerous submissions and proposals. This contributed to the stress that led to the Marikana tragedy and prevented overindebtedness from being addressed effectively.
At present, the Department of Trade and Industry and the National Credit Regulator are circulating a range of proposals for new legislation and regulations on consumer credit. With very few exceptions, these changes will make matters worse rather than better. Most of the proposals seem designed to serve political objectives or special pressure groups, with little relation to the underlying causes of the problem.
The most damaging of the department’s proposals are the ones to remove large amounts of consumer information from credit bureaus’ records.
This simply means that the information that credit providers require to identify consumers who are unable to meet their repayments or have a history of default will be removed from the records.
Lenders’ ability to identify clients with bad payment histories will be reduced. Bank credit risk models and scorecards will be undermined and banks’ risk will increase.
Overindebted clients will become more overindebted, either to registered credit providers or to loan sharks.
Unfortunately, clients with good payment profiles will be equally punished as there will be no way to differentiate between good clients and bad payers.
The small and medium-sized enterprises (SMEs) will not escape the negative effects as the credit profile of an SME owner is an
‘Nearly every major lender participated enthusiastically in the lending frenzy over the past few years’
important component of an SME credit assessment. Responsible clients and SMEs will receive less credit and they will have to pay higher interest rates.
Apart from these changes, the department and the National Credit Regulator are also introducing a broad range of further amendments, to different aspects of the regulatory structure.
This includes ill-conceived lending prescriptions and ad hoc instructions on permissible legal action when clients default. It also includes damaging changes to the debt-counselling payment system, with high risk to consumers and the banking system.
There is little doubt of the negative effects of these measures.
Without going into all of the technical dynamics, the following outcomes can be expected:
Debt problems will get worse, particularly for the working class and low-income consumers, who are most affected by the debt spiral and are most likely to take on even more debt;
Interest rates will increase, even for lowrisk consumers, who will be lumped into the same pot as bad payers and will have to bear the cost of increased defaults;
The cost of legal debt collection will increase; and
Clients’ access to redress will be significantly weakened.
These factors will also reduce SME finance and increase SME interest rates. And the risk of bank failure will increase.
We will all be worse off and the financial system will be at greater risk.
However, it is important to address the root causes of the reckless credit growth taking place in SA and the cycle of increasing overindebtedness. This would imply that the incentives that lead to this type of lending have to be corrected.
The following issues are at the core of the problem. First, a modification to the present interest limits in order to remove the preferential treatment of unsecured loans and equalise the unsecured loan and credit card limits, at least for larger loans.
This will remove a major incentive for the present growth in unsecured lending.
Second, to introduce fundamental changes to the rules on emolument attachment orders, in order to protect the income of low-income consumers.
This could include an upper limit on the amount and term of deductions, as well as limits on payment terms for credit contracts, for example limiting interest on judgment debt to the statutory rate.
Such changes to the rules should also include protection to the priority categories of debt, such as debt-counselling payments or mortgage debt.
Last, to clarify the rules that govern reckless lending and strengthen the courts’ powers to restructure debt and write down reckless loans.
The priority in legal reform should be on effective penalties against abusive lending practices and the effective protection of consumer incomes.
We should at all costs avoid interventions that undermine our credit market infrastructure and avoid mechanisms that create perverse incentives.
The measures that the Department of Trade and Industry is proposing hold serious risks for the financial sector.
Internationally, there is an expectation of continued uncertainty and instability in global financial markets.
Domestically, we face pressure from inflation, exchange-rate weakness and a current account deficit, with an increasing potential for the Reserve Bank’s to increase its repo rate in the foreseeable future.
We will then face the prospect of highly indebted consumers being hit with increased interest rates and higher debt payments — on top of the high unemployment rate.
This can lead only to increased defaults and escalating losses in the banking sector.
With the removal of credit bureau information, the banking sector will have limited ability to predict or manage the level of risk, as result of weakened scorecards and risk models.
The combination of external financial pressures and a weakened credit system will create risks that will be very difficult to manage effectively.
The outcomes of such a scenario could be severe for a very broad segment of South African society but will, as usual, be most damaging to the weak and the vulnerable.