Responsible lenders will gain from teaching borrowers

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THE NEAR collapse of African Bank Investments Limited (Abil) provides credence to the maxim that extending credit comes with heavy obligations and responsibilities. It is particularly imperative as South Africa’s financial system, the banking sector to be precise, had previously excluded certain segments of the consumer market – the majority of whom were low and moderate income earners – from accessing credit.

Bringing these consumers into the financial mainstream carried a substantial risk that required sound mitigating measures. Abil shares plummeted last week after debilitating warnings of potential losses and an announcement that it required about R8.5 billion in fresh capital as a result of impairments to the tune of R17bn, classified as the bad book value.

It has to be noted that this may have started many years ago when Capitec announced its entry to the credit market, offering unsecured loans. This set the cat among the pigeons, competitively speaking, in the unsecured lending space, where African Bank was the dominant player.

This meant employing aggressive operational strategies not only to retain the client base but to make the product more attractive to attract volumes to counter the new player.

In June 2012 Capitec announced that it had increased its maximum unsecured loan offering from R150 000 to R230 000, significantly higher than any of the offerings by the big four banks and African Bank’s R180 000 payable over a maximum period of 84 months. The move surprised many of us in the financial services sector. Surely, R230 000 and R180 000 cannot be classified as microcredit amounts? That’s the size of an entry-level mortgage bond to be serviced over 20 years at prime plus 4 percentage points to the riskiest borrower. The move by Capitec was a substantial adjustment as the new amount represented an increase of 53 percent.

Undoubtedly, the majority of the bank’s borrowers are those classified as low and moderate income earners. The latest consumer credit market report shows that the greatest use of unsecured credit facilities are for those earning less than R15 000 a month, taking up over 70 percent of the unsecured credit transactions. The healthy returns on these loans meant that lenders would apply relaxation methods in credit granting and loan origination.

This had many consumers able to access credit from these second-tier banks to finance their consumption expenditure. While this increase in granting credit to low-income earners in previously underserved markets is welcome, offering such credit in the absence of financial literacy is regrettably poor and carries negative implications, as we are witnessing now with Abil.

This could be devastating for borrowers as they are likely to be trapped in a web of indebtedness they will find hard to extricate themselves from. This is precisely because lenders did not take the initiative to properly inform consumers of their responsibilities, budgeting, financial conduct, management of credit contracts and credit linked accounts.

Financial literacy must be viewed by creditors like Abil as a fundamental necessity and even more essential to low- and moderate-income households.

It is an imperative investment to empower consumers on important aspects of credit contracts. Financial comprehension has an impact on all borrowing and lending decisions, even the most complex, as the pricing of loans is largely determined by two factors: the cost of funding and the risk of lending to different market segments.

Risk-based pricing in this market is high as lenders use it as a basis for security but the very consumers are constrained by factors such as affordability and information asymmetry and become susceptible to non-payment behaviour, as observed by Abil’s non-performing loan book.

An article by the author, published in the International Journal of Finance & Banking Studies (Volume 2 No 2, 2013), found that any credit provider extending finance to a consumer risks default, making borrower education or financial literacy an essential model used to estimate default incidence based on an optimisation model of consumer choice as lack of financial literacy imposes serious limits on the ability of individuals to make informed financial decisions.

It was also scientifically established that devising content that is specifically targeted and aligned to their credit requirements will provide consumers with clear understanding of their roles and corresponding obligations.

The poorer the relationship between creditor and debtor, the higher the propensity to default on these exorbitantly priced loans. The more fragile the relationship between lender and borrower, the more likely is a negative attitude, untrustworthiness, and irresponsible behaviour by borrowers.

A customer-centric attitude and a lender that values a borrower improves customer behaviour significantly.

Thus, it is contended that empowerment contributes greatly to a consumer’s ability to make informed judgements and take effective decisions regarding the use and the management of money. It becomes a vital tool which can be employed to enhance a customer’s financial knowledge and credit behaviour, a process from which lenders benefit handsomely too.

On regulatory measures, South Africa is privileged to have regulatory frameworks established to regulate credit bureaus, credit providers and debt counsellors. These measures are introduced to manage credit granting, monitor over-indebtedness of consumers, avoid reckless lending practices and protect borrowers from unprincipled lenders.

While there are efforts to enhance transparency, supervision and disclosure, increase protection and improve standards, it, however, seems that further efforts are required to make these regulations tighter and disclosures more concise and understandable and as such we welcome the ongoing credit market amendments that seek to increase protection and transparency to benefit consumers.

It must be stated that it was a combination of excessive borrowing, reckless lending, risky investments, weak financial regulations and poor supervision standards that caused 2008 financial meltdown in the US that lit the global financial system. This evidence was contained in the 2011 Financial Crisis Inquiry Report.

The underwriting standards were remarkably compromised in favour of palatable profits for lenders, as applying rational appraisal methods would have meant not only losing clients but also losing out on anticipated inflated returns.

The impact as we all know was catastrophic, especially for mortgage account-holders. We need not be reminded that lenders should be held more responsible and accountable by regulators.

 

Dr Vuyisani Moss is a market analyst at the National Housing Finance Corporation.


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