The structural shift in SA’s credit landscape which has occurred alongside the recent unsecured lending boom may have been good for the businesses and investors which profited heavily from it, but has come at a cost to SA’s wider citizenry.
This was the underlying message of Professor Carel van Aardt and Johann van Tonder from Unisa’s Bureau for Market Research (BMR).
The pair spoke at the release this week of the fourth quarter 2012 Consumer Financial Vulnerability Index (CFVI) from the offices of MBD Credit Solutions, a subsidiary of listed unsecured lender Transaction Capital.
Although achieving an objective implicit in the National Credit Act (NCA) of providing access to credit for SA’s lower income earners, the overextension of unsecured credit into the economy alongside the very high costs associated with unsecured credit has had a detrimental effect, they said.
A burden on consumers
The NCA, which was implemented in 2007 just prior to the lending boom, allows for unsecured credit charges calculated at 2.2 times the prime rate + 10%.
The NCA’s interest rate cap allows for interest charges which are effectively much higher than would have been permitted under the Usury and Credit Acts which it replaced, says van Tonder.
This increases the financial burden on borrowers encumbered with unsecured forms of credit.
According to data from the South African Reserve Bank, debt servicing costs of consumers actually declined from 6.9% of disposable income in the second quarter of 2012 to 6.5% in the third quarter.
However, according to van Tonder the high costs of servicing unsecured debt may mean that this figure is somewhat misleading.
The decline in Reserve Bank numbers reflects a 50 basis point drop in the interest rates translated to an effective R5.4bn saving for indebted consumers.
However, “a result of the shift from unsecured credit to secured means that consumers might be more overindebted in terms of their debt servicing costs then we think,” says van Tonder.
He believes that the higher costs of unsecured credit means that consumers may be indebted to the tune of R151bn as opposed to the attributable R124.4bn implicit in the Reserve Bank’s calculations.
This difference of 26.7bn far outweighs the benefits consumers have received from the R5.4bn saving that came alongside the interest rate drop.
“This could mean that the disposable debt to income ratio could be closer to 8% than the 6.5% provided by SARB (Reserve Bank),” he says.
Paradoxically, “with the repo rates down the interest rates started to increase so consumers are becoming more and more indebted even though interest rates have declined … the reason for this is that the amount of debt that consumers took on just kept on growing and growing and growing,” he says.
Of some serious concern is the fact that the BMR’s calculations of debt encumberment owing to the unsecured shift is based only on the elevated costs of credit allowed by the NCA.
However, Moneyweb investigations have shown that the actual cost of unsecured credit may be significantly higher than the increased costs associated with interest.
This is as most unsecured lenders impose a range of charges alongside the extension of credit which make the debt burden notably more unpleasant for the consumer.
Chief amongst these charges is insurance which is not covered effectively by the NCA.
For example, a Moneyweb analysis showed that a Lewis credit customer may expect to pay an effective cost of credit in excess of 70% on a loan with an interest charge in the low 20%.
“We are aware of the problem of insurance but we haven’t done any research on that,” said van Tonder, “that is one of the points when the NCA came into force, we warned of this practice … we wanted to see a continuation of the way the cost of credit was expressed under the Usury Act as a total cost.”
A threat to future indebtedness
It is also important to consider that the unsecured boom has occurred alongside unprecedented low interest rates in SA.
The 2.2x multiplier component of the NCA cap means that when interest rates do rise, as they inevitably must, unsecured borrowers will be placed under significantly more financial duress than secured borrowers, who would only expect a corresponding increase in their debt servicing burden.
Accordingly, the dramatically increased levels of unsecured credit in the economy has significantly increased the risk SA consumers have of showing notable declines in their levels of financial vulnerability in the years ahead, says van Tonder.
From a point of near financial security at 58.9 in the first quarter of 2012, the CFVI has showed marked declines in the second and third quarters of 2012 reaching a level of 47.9 where consumers are considered to be “very exposed” to becoming financially vulnerable.
It has improved slightly for the fourth quarter of 2012 climbing just above the barrier for “mildly exposed” at a score of 50.1 with the debt servicing component of the index also showing improvement.
However, says van Tonder “there is not a big problem right now, but once interest rates start rising again this (consumer debt burden) might start going all the way back if we are not very careful in our policy making,” he says.
“Yes the vulnerability index did increase so consumers are mildly exposed rather than very exposed but there might be a problem developing in the debt servicing sphere in this economy if the lenders continued to switch debt from the secured space to the unsecured space.”
A drag on the economy
The NCA was designed to allow access to credit for SA’s previously economically disenfranchised.
And with the boom it has undoubtedly succeeded in doing that, a fact often highlighted by unsecured credit proponents and the CEOs of major unsecured lenders.
However, with the amount of unsecured credit in the economy and its costliness, van Tonder and van Aardt are of the opinion that the NCA is in effect working counter to the government’s ambitions as contained in the New Growth Path.
In short, it is having the effect of dampening economic growth and worsening unemployment, they say.
“Definitely the high costs of unsecured credit are creating a drag on our economy,” says van Tonder.
This is as expensive credit increases the debt servicing burden of consumers thus reducing their purchasing power.
With more money going to lenders and less to other segments of the economy, this creates a drag.
Van Aardt says there is a significantly improved multiplier on the wider economy when a consumer spends on retail on items such as food and clothing, on primary services or on transport as opposed to when he/she spends on financial services where the multiplier effect is diminished.
Thus, the more indebted a consumer the less of a positive impact he has on stimulating the wider economy.
Lenders “are doing nothing illegal but as with any policy in the world you need to review the policy to make sure that it is in line with the overall objective which is to create jobs,” says van Tonder.
While the current costs of credit are worsening unemployment, creditors may benefit from reducing interest charges “if you create more jobs then more people will qualify for credit.”