Submission to the Portfolio Committee on Finance on Indebtedness
It is important to differentiate between access to finance, indebtedness, and over-indebtedness. The public perception of the extent of over-indebtedness is strongly influenced by the attention that even isolated cases of extreme over-indebtedness elicit. It is critical to assess indebtedness and over-indebtedness based upon representative national statistics in order to form a balanced view.
The MFRC has done extensive work on levels of debt, predatory lending and related issues. Our investigations include
An external assessment of the effectiveness of the MFRC’s regulatory mechanisms was conducted by the IRIS Institute of the University of Maryland in 2001.
A research project that was conducted jointly by the University of Cape Town (DPRU) and a consulting firm, ECI, on indebtedness and loan utilisation. The research was conducted at the end of 2000 and was based on the 1995 Income and Expenditure Survey, the October household surveys and an analysis of the reports from a number of other research projects related to this topic.
In December 2002 the MFRC mandated the HSRC to follow up on this previous work, with a further project consisting of a comparison of the 1995 and 2000 Income and Expenditure Surveys (produced by Statistics South Africa), in respect of trends in indebtedness, nature of debt, savings profiles and vulnerability of borrowers.
We analysed a 2001 paper by Reza Daniels (who was also involved in both the UCT and the HSRC projects) entitled "Modelling Vulnerability to Over-Indebtedness among Urban Indebted Households in South Africa".
During 2003 the MFRC mandated research on the interface between HIV/Aids and indebtedness (with the focus on micro-lending) and on the purposes for which people borrow from micro-lenders. These projects have both been concluded and the reports are available.
We further have gained detailed insight into the levels of indebtedness through "reckless lending investigations" in which we have been engaged since the end of 2002. Each such investigation covers a sample of the borrowers of one lender, and takes account all the debts (as well as insurance premiums) of each borrower, as reflected in the NLR, the credit bureaux data and bank statement repayments. Although only 6 such investigations have been completed (a further 9 are in progress), these include some of the largest lenders and the findings are thus significant.
We also did extensive research into international experience with over-indebtedness (and reckless lending) and the regulatory approaches thereto.
The most notable in respect of regulatory approaches are:-
A statement by John Hawke (Comptroller of the Currency) to the US Congressional Hearings on predatory lending and the guidelines issued by the Office of Thrift Supervision and Federal Reserve. The overall approach is one of identifying specific predatory practices (that requires regulation) while stressing the need not to introduce overly restrictive legislation which may result in the marginalization of high risk clients, the reduction in access to finance and increased abuse by unregulated operators;
A Fitch-IBCA assessment of the impact of payday lending and indebtedness on the Japanese society, and the regulatory response thereto.
The latest EU proposals on regulation of consumer credit, in which regulatory mechanisms against over-indebtedness was a major consideration.
Two United Kingdom reports, one on "loan sharks" and another on over-indebtedness, and the regulatory proposals that are being considered;
There are a number of statistical and economical studies in the EU on the problems of over-indebtednesds, including: (a) Statistical study of the problem of Consumer Indebtedness: for the Commission of the European Communities, Directorate-General for Health & Consumer Protection; (b) Working Paper from the Department of Economics, Stockholm School of Economics, on the relationship between indebtedness and unemployment,(c) The final report from an analysis across different EU member states of ‘the prevention and treatment of personal problems related to consumer addiction, personal purchasing habits and overindebtedness" ,
Other international studies include (a) A report on indebtedness amongst Hong Kong police officers, (b) a chapter on the New Zealand review of consumer credit legislation, and (c) a US study on predatory lending.
The extent of indebtedness and over-indebtedness
The following conclusions are based upon HSRC’s analysis of the 1995 and 2000 National Income & Expenditure Surveys (administered by Stats SA).
The level of indebtedness was lower in 2000 than in 1995 for all income groups except for the poorest 3 income groups. This does not mean that there is less of a problem of over-indebtedness in 2000 than in 1995, but does contest the notion of ‘general’ or ‘endemic’ over-indebtedness". The decrease in the average indebtedness levels is caused primarily by the fact that the access to finance increased substantially – the percentage of the population has some or the other form of debt increased by 31% between 1995 and 2000. Yet, there are still large sections of the population without debt, varying from 88% and 82% for the lowest income groups, to between 37% and 52% for ‘middle income groups’.
To get a more accurate indication of the level of over-indebtedness, HSRC compared the number of people whose ‘consumption debt ratio’ exceeded 20% between 1995 and 2000. These statistics indicate that there is cause for concern, with somewhere between 10% and 20% of people with debt potentially having a problem. It also indicates that the biggest concern should be with the lowest income groups, and maybe also with the higher middle income groups.
However, the same statistics indicate that the percentage of people that found themselves in this category (consumption debt > 20% of income), have decreased for most of the income groups. The majority of people thus appear to have improved their ability to manage their debt.
The opposite is true for the poorest four categories (households earning less than R20,000 per year) – in everyone of these categories this percentage has increased.
The ‘consumption debt ratio’ for the higher income groups are the highest, at 29% and 38% for households earning above R75,000 and R150,000 respectively. Given that consumption debt includes vehicle finance, this would skew the ration at these higher income levels and these high ratios may thus not necessarily be a cause for concern. It is also worth remembering that these same income groups reduced their ‘consumption debt ratio’ between 1995 and 2000 and that the percentage of higher income households for whom this ratio exceeded 20% reduced between 1995 and 2000. For these groups, the indebtedness position thus improved between 1995 and 2000.
In a recent survey by Finmark Trust (amongst urban households), consumers’ perceptions on their level of indebtedness were assessed. Except for two lower middle income groups, the majority of consumers in most income groups indicated that that their level of debt decreased over the last 12 months.
The level of indebtedness in of the lower income groups is cause for concern. Many different indicators all point to there being increased financial stress at the lowest income groups. In the lowest income groups, average indebtedness increased as did the percentage of people that have a consumption debt ration of above 20%.
The trends in judgements and summonses have been used by certain researchers to arrive at some rather extreme conclusions with respect to the levels of over-indebtedness. These have at least to be treated with caution – and some of these conclusions may be invalid.
Firstly, there has actually been a downward trend in the number of judgements and summonses for individuals since 1999. Although there appears to be a reversal in trend since the first quarter in 2002, which may be related to the impact of Persal and of the failure of Saambou and Unibank. The trend reversal may well have to do with specific industry developments, rather than a reflection of "very high levels of over-indebtedness".
The researchers appears to have given no consideration to the increase in the number of people that are credit active, in interpreting the data on judgements and summonses. Stats SA’s Income and Expenditure data indicate that between 1995 and 2000 the number of people that accessed credit increased by 1.8 million people, representing a 134% increase. It is thus entirely reasonable that the number of people with judgements and summonses would also have increased, and this does not necessarily indicate a "crisis with over-indebtedness".
The numbers of judgements is a relatively weak indicator for the level of over-indebtedness. There are other indicators that are much more relevant, which we assessed elsewhere.
Causes of over-indebtedness
Per the MFRC’s reckless lending investigations, retail debts and micro-loans are the two biggest categories of debt at 38% and 36% respectively. However, mortgages, other bank debt and insurance premiums also play a role in over-indebted situations (mortgages make an 11% contribution to financial commitments and insurance a 15% contribution). The level of insurance repayments for this market segment is surprisingly high and may well be indicative of over-insurance or inappropriate products being provided.
In many of the extreme cases it appears that hire purchase payments, micro-loan repayments or mortgage payments which are high relative to the consumer’s income, cause the borrower to be placed in a vulnerable position. Due either to unplanned expenditure or to an increasing inability to meet living expenses, the borrowers then start or increase their micro-lending and debt, resulting in a ‘debt cycle’.
The aggregate annual disbursements of all micro-lenders is approximately R13.5 bn and the aggregate loan book in the micro-lending sector is R16.2 bn. One month cash loans amounts to some R3.9 bn in annual loan disbursements , with an underlying loan book in the order of R1.3 bn. This contrasts with a total consumer credit market estimated at R362bn (64bn without mortgages), of which micro-loans consist approximately 4% (and one month loans 0.4%). The magnitudes of other types of consumer debt (included in the total above) are roughly as follows: outstanding balances on lease finance of approximately R10.4bn, on instalment sale of approximately R54bn, store cards of approximately R5.8bn, credit cards of R13.1bn.
Micro-loans clearly play a role in cases of over-indebtedness, but it is only a small part of the credit picture and the underlying cause of over-indebtedness frequently lies outside of the micro-lending sector. Many over-indebted individuals appear to have short term cash loans, given the tendency of borrowers to turn to these loans as a last resort when they find themselves in an over-indebted position. However, one month cash lending appear to be a symptom of the problem, rather that being a primary cause of over-indebtedness.
Reckless lending by certain micro-lenders, or lending beyond a borrower’s ability to repay, is contributing to over-indebtedness. From the MFRC’s reckless lending inspections, certain lenders are found to advance further loans even where a consumer is already over-indebted. Although both long term and short term lenders contravene in this regard, the negative impact of short term lenders are found to be greater. Our inspections have indicated that certain lenders may even advance a further loan in cases where the borrower’s debt commitments already exceed the total income. Such lending behaviour is frequently the result of the lender not being aware of all the existing debts, and not doing a proper affordability assessment. (The steps that the MFRC have taken to combat reckless lending are presented in section 0.)
There are a number of systemic problems that appear to act as catalysts for over-indebtedness. These are most concerning and have to be addressed. It includes issues such as:-
Payroll deduction facilities: although these have real value for consumers, many employers are reckless in the manner that they administer payroll deduction facilities. Access to payroll deduction facilities creates an incentive for lenders to act recklessly and it is necessary that the employers introduce a larger measure of ‘self regulation’ than what is presently practiced.
Prioritization of bank debt orders: Many banks have developed mechanisms through which they give a preference to certain types of debit orders. This creates an incentive for reckless behaviour by the credit provider.
Access to court orders: It is quite possible for a reckless credit provider to obtain a garnishee or emolument attachment order and thus obtain the assistance of the state for the recovery of a debt that should never have been advanced.
Access to information: Information on significant loan books are currently not shared between credit providers (these include certain mortgage books, vehicle finance books, provident fund secured loans, insurance backed loans and a number of others). Many credit providers (including many banks, provident fund lenders and others) further do not even take the information that is available into consideration, and thus do not do proper affordability assessments.
Without addressing these systemic weaknesses, the dangers of over-indebtedness will remain and may even get worse. While micro-loans and retail credit is currently seen as a major problem, in the future it may well be credit cards or bank overdrafts.
Far too little attention is given to the extent of reckless behaviour by borrowers. If there is no effective penalty on borrowers for knowingly incurring debts that cannot be repaid (or for disclosing false information to the credit providers), this may well create an incentive for the borrower to try to gain from taking on such debts – particularly if there are weaknesses in the enforcement mechanisms.
Regulatory response in respect of registered micro-lenders
In order to prevent increasing over-indebtedness, the MFRC established the National Loans Register (NLR) and introduced Reckless Lending Rules. The NLR is a database of micro-loan information, which enables the lender to assess the level of indebtedness prior to lending, while the Reckless Lending rules establishes criteria for reckless lending, and enables the MFRC to take disciplinary action where necessary.
More than 500 lenders are already using the NLR, more than 5 million loans registered are registered on the NLR and more than 3 million enquiries have been made since the NLR’s inception. Through a Memorandum of Understanding between the MFRC and the Consumer Credit Association, micro-lenders also have access to the approximately 25 million credit records kept on the credit bureaux, while other credit providers have access to the micro-loan information on the NLR.
MFRC’s Reckless Lending Rule reads as follows:
"The lender shall, prior to entering into a money lending transaction with a borrower, consider the ability of the borrower to make the required payments in respect of the money lending transaction and still to meet his or her necessary living expenses, having regard at least to the following-
information on the national loan register;
information provided by the borrower in the application form, which shall include information pertaining, amongst others, to the borrowers current and anticipated obligations in respect of loan repayments, payments for municipal services and maintenance payments;
information otherwise disclosed by the borrower to the lender;
the nature of the loan and the purpose for which it is required; and
the borrower’s borrowing behaviour reasonably available or known to the lender."
The rules in the NLR and on Reckless Lending came into effect in June 2002 and we are already engaged in reckless lending inspections. We believe that this creates appropriate mechanisms for preventing registered micro-lenders from continuing to contribute to over indebtedness.
It is worth noting that the establishment of the NLR and MFRC’s reckless lending rules have been informed by and is consistent with the approach that was successfully implemented by Japan in the early eighties, and the approaches that are being discussed and considered in countries as wide ranging as the USA and Bolivia, and that is being proposed as part of a revised consumer credit directive for the European Union.
Apart from these rules and disciplinary actions, the MFRC has been engaged in educational initiatives to change borrower behaviour. Since the MFRC’s establishment, we have on an ongoing basis been conducting workshops with borrowers, consumer representatives and NGO-orientated NGOs. We also try to raise awareness through adverts, brochures and regular features in the national print media, and an ongoing communication through the network of community radio stations. During the past 6 months the MFRC already conducted 61 consumer awareness workshops which was attended by more than 9,000 participants (shop stewards, employer representatives, provincial government staff and CBO staff that interfaces with consumers), placed 43 consumer awareness adverts and were involved in 62 community radio broadcasts. An effective consumer awareness programme is in place, but this is not a quick fix solution and could probably be increased even further.
We also developed and published guidelines for employers regarding payroll deductions and consumer education, and different brochures on various aspects of consumer protection. These are distributed free of charge.
Furthermore, the MFRC raised in excess of a million rand for the implementation of a debt counselling programme which is currently being developed.
We believe that the threat of over-indebtedness requires a response at a much broader level than only by MFRC. We believe that the following are some of the key challenges:-
Broad based action: Responsible lending criteria should be applied by all credit providers, while some kind of affordability tests should also be applied by insurers. Each of these categories are playing a role in over-extending the client. The primary focus should be on the bigger institutions rather than the small micro-lenders. The formed has a much more detrimental impact on the general consumer base that small, local entities.
Payment preferences: Reckless lending and over-indebtedness go hand in hand with mechanisms that make it possible for lenders to recover their loan repayments, even when a borrower is already over-committed. Primary amongst these are payment preferences which are being created on payrolls and through the National Payments System, and through which both banks and insurers are endeavouring to ensure that their repayments are prioritized.
The extension of loans that are secured against pension and provident fund benefits and against insurance settlement values appears to be growing significantly. Many of the lenders that are involved, including banks and insurance companies, are doing very little in terms of assessing clients’ level of affordability or in terms of sharing the information on the extent of indebtedness with other credit providers. Any over-indebtedness with such loans will undermine the households retirement funding and insurance cover and should be great cause for concern.
Current legislation governing court orders should be tightened in order to ensure that reckless credit providers do not get access to court orders, and thus obtains a garnishee order or emolument attachment order for the recovery of credit that should never have been extended. Weaknesses in this legislation (and in the application thereof by the courts) appear to aggravate the current problems by creating an incentive for credit providers to act recklessly.
The sections of the Magistrates Court Act dealing with Debt Administration are creating similar problems, and appear to be extensively abused by administrators, to the detriment of consumers. (Note that the SA Law Commission is engaged in a review of this legislation).
All these problems are aggravated by the fact that there is currently no effective mechanism in South African legislation to enable a consumer that is over-indebted, to reduce the debt burden or to be rehabilitated. There is an urgent need for the introduction of effective ‘personal insolvency legislation’.
Last but not least, is a critical need for more reliable national statistics on indebtedness and debt profile of consumers. It is extremely important to have an accurate and representative picture of the debt profile of South African households as there is a very real danger of taking inappropriate action due to misperceptions that are based upon very narrow and unrepresentative data sets (such as looking only at data on judgments and summonses).
Micro-lending and HIV/Aids: The MFRC mandated research on the interface between HIV/Aids and micro-lending in order to assess whether it was possible to introduce regulatory measures that could protect Aids affected/infected borrowers from over-indebtedness or exploitation. The conclusion from the project was that the highest priorities are (a) to implement effective action against reckless lending, and (b) to implement specific borrower and lender education related to the implications of Aids for micro-lending. We are developing a programme to address these needs.
The researchers drew attention to the potential for increased borrowing through the Aids cycle, and the danger that this may result in over-indebtedness and limit the Aids affected households from recovering from the economic/financial impact of Aids. However, they also pointed out that such households would frequently have a desperate need for finance.
These observations highlighted the danger that reckless lending poses, and was taken into account in the MFRC’s approach to reckless lending.
We do believe that over-indebtedness require serious attention. However, it is a complex issue that require a response by a number of different parties. We would do anything in our power to assist and support the development and implementation of such a comprehensive response.