The African Bank fallacy

2014-08-19 21:50

Microfinance, or what has become more recently known as unsecured lending has been hitherto a source of finance that mainly served the disadvantaged and the unbanked. Since the abysmal financial collapse of 2008 the apparent shift from mortgage and secured credit towards more expensive, unsecured credit has undoubtedly unmasked an opportunity among low income borrowers in terms of home improvements, but has also signaled a new market opportunity among high income borrowers through the creation of 80/20 finance (or 80% financed, 20% cash). But, in an environment that is inconsistent with the current economic climate, the growth spurt in unsecured credit, the bulk consisting of credit cards and store cards, may just be a reflection of consumers' financial fragility.

Without a question, the rapid growth in unsecured lending has been largely supply side driven, citing the relatively attractive profit margins, the decreasing returns on mortgages and the Basel III regulations that restrict a mismatch between long-dated loans and shorter-term deposits, as reasons, among others.

If one recalls the microfinance crisis in 2002, in a period of uncapped interest rates devoid of the National Credit Act, one can rule out the possibility that the perceived attractiveness and the profit margin on unsecured loans is a reason for the post-2008 growth in unsecured lending. In the years that led up to the 2002 crisis, the 1999 Exemption of the Usury Act, which permitted lenders to grant loans of R10 000 or less at interest rates that exceeded 30% per annum but repayable over 36 months or less had effectively allowed for the mistreatment of financially ignorant and illiterate low income households. The industry exploded.

Saambou, one of the banks that had benefited from the explosion, rapidly expanded its microloan book from 2000 through the microloan repayment mechanism of the Government’s payroll administrative system, PERSAL, the greater proportion of its borrowers being civil servants. As a result, the bank’s loanbook grew by almost 90%.

But it was short lived.

Once the over-indebtedness of civil servants became apparent, the Government halted further repayments from PERSAL, loan growth fell which was also accompanied by a sharp increase in the provision for bad loans.

Like Saambou, UniFer had sought out new customers by hiring brokers who were paid commissions on the number of loans they sold. Its credit policy was decentralized, which gave brokers the discretion to decide on the creditworthiness of borrowers. As a result, and like Saambou, its microloan book grew at a rapid pace and the relevance of borrowers’ creditworthiness diminished when bigger profits were realized. But as always, the rapid expansion was soon followed by the increased provisioning for bad loans.

Today, however, the industry has exploded but it seems that things have reversed. The introduction of the NCA in 2007 has protected borrowers against exorbitant interest rates, but the fact that there is no enforced maximum loan term increases the borrower's event and default risk, especially for those liquidity constrained, low income households who stretch their affordability to meet their short term needs.

A fundamental flaw of unsecured loans, well, according to me, is that its sustainability cannot be rationed solely in terms of affordability because affordability assessments are subjective and dishonest responses are unrestricted, especially for those borrowers who really need the money. It’s just too easy.

Like the rapid expansion in the microloan books of Unifer and Saambou and the subsequent rise in lenders’ provision for bad loans that led to the 2002 crisis, it’s easy to be blinded by the level of bad debts when there’s a rapid expansion in loan advances and the perceived creditworthiness of low income borrowers are overlooked by the strong interest income.

But now the bubble has popped; the growth in unsecured lending that was so apparent in 2010 can no longer shield lenders’ growth in bad loans.

Although the South African consumer is better protected, to an extent (besides the 30% + interest rates and unrestricted loan terms) than they were in the past and lenders have taken better precaution in terms of their stringent lending criteria and some have reduced their exposure to unsecured loans, I’m unassuming to remind you that history repeats itself.

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