The Credit Market We Deserve

The Credit Market As Is

There are around 20 million credit users in South Africa, with over 10 million in arrears. Countless borrowers have 10 or more creditors, with 75% of their take-home pay sucked into debt servicing. Many stand to have their homes repossessed. More still owe their municipalities, insurers and others.

Conversely, there are 4800 or more registered credit providers in South Africa – banks, micro-lenders etc. that have lost billions of rands to credit impaired consumers and will lose plenty more. The consumer credit market is distressed for a number of reasons. Excessive interest rates are one of the main culprits. Other causes include ill-advised loan products, unaffordability, detached credit evaluation methods and average Return on Equity (ROE) models. These factors combined have disastrous implications for debt consumers.

Hunting Season

The National Credit Act (NCA) was introduced to regulate lenders and protect consumers. However, by permitting excessive interest rates, it has inadvertently sanctioned hunting season on borrowers, particularly the unbanked. Basically, banks work off a capital adequacy ratio of about 15%. Which is a ratio of their capital to risk. As such, banks stand to double, treble or quadruple their ROE, by lending to the unbanked at approved rates.

Retailers have long boosted their profits by ensnaring vulnerable consumers in a debt trap with ‘easy credit’. Moreover, there are few ways for private lenders to earn these levels of ROE legally.This is less lending than it is hunting. And certainly cannot be the kind of credit access the National Credit Act (NCA) authors had in mind for the unbanked. Fair or unfair, high interest rates are not the major cause of debt defaults. The barefaced injustices lenders commit almost daily are largely at root.

A Game of Risk

From a rational perspective, successful lending involves understanding the borrower and being reasonably sure the capital will be paid back. If this could be achieved consistently and fairly, then ROE tweaking should take a back seat. In an environment where ethics are sustainable, ROE should surely result. But unbanked lending is a game of risk, informed by nonconcrete financial models and vague borrower profiling.

The Average ROE Myth

Typical unbanked loan products are based on an average ROE model. This means lenders don’t differentiate between ‘good’ and ‘bad’ borrowers. They charge borrowers the same fees and interest rates. And this basically results in the good borrowers bankrolling the bad. Not only is this unfair, but it also distorts rational lending. The old adage of ‘the greater the risk, the greater the reward’ just does not apply to the unbanked market. Bad borrowers don’t pay back loans, regardless of how high or low interest rates are. However, ‘average’ lending has a tendency to shift the whole lending book into the ‘average’ category, where it will likely collapse.

Detached Credit Evaluation

Detached, one size fits all credit evaluation is fast, simple and falls neatly in line with the theory of averages. But, borrowers are not averages – they are people. Getting to know a borrower is the only true way of ascertaining the potential risk. Credit assessment is at its core understanding a borrower’s needs, humanity and background. One size fits all credit is just not working. Though it is individuals who bear the brunt of defaults.

Affordability

Borrowers and lenders alike should take buying on credit more seriously. Are borrowers taking out credit to address some crucial concern in their lives, or do they just want to buy some new stuff?

Lenders pursuing ROE are too nervous to ask cash-strapped borrowers to buy in cash and financially inept borrowers are blind to the debt trap.Passing a one size fits all credit screening does not ensure borrowers actually afford to pay back the loan on the agreed date. Affordability entails having 30% of your take-home pay at hand for emergencies, and not for surplus debt repayments. And if that 30% extra consists of just R500, you cannot afford the loan, regardless of what the affordability calculator tells you. Banked or unbanked, repayment defaults can far too often be attributed to unreasonable affordability criteria.

Debt Consolidation

Debt consolidation loans are crafty and marketable. It’s the old ‘borrow from Peter to pay back Paul’ strategy. A single loan servicing a number of debts can flop disastrously, when the borrower signs over the family home as collateral. Signing over you home to get some quick and dirty loan is much the same as putting up your pension to play roulette for a night. And it’s high time the judicial system recognised this.

Good Borrowers

Though lenders may be businesses they have a social responsibility to be as accountable to their borrowers, as they are to their shareholders. For a lot of lenders, chasing and taking legal action against defaulting debtors is a nonconcrete process. For borrowers, it’s a living hell. Good borrowers respond favourably if treated with respect. They are a lender’s only hope of having their capital repaid. If a borrower has a history of saving before asking for loan, then that person should not be put on the on their books. While good borrowers should be rewarded with good interest rates and quality service.

In a Fair Market

Imagine a fair market, where lenders would treat borrowers like people, evaluate credit risk appropriately, charge reasonable interest rates, and not impose excessive fees. The bad lenders would get what was coming to them and the good borrowers would be rewarded – as they should be.In a credit market like this, there would be no distinguishing between the good unbanked and good banked – because good people are just that. Diligent lenders would be well within their rights to expect their capital back. And so, both parties would enjoy sustainable, profitable outcomes.

Even the best borrowers may find themselves in the odd tight spot, but it’s a pleasure to help them out and see them recover, which they do.  Just as there may be odd times when lenders get it wrong and give good loans to bad borrowers. But when loan terms are tampered with, contracts broken and crucial information purposely twisted, then taking legal action and demanding restitution becomes completely reasonable. This would be fair to good lenders and good borrowers alike. As there would then be a definitive process for ensuring we all get what we deserve.