Fee, interest caps on loans a double-edged sword

The Department of Trade and Industry (dti) has waited far too long to overhaul credit regulations. Aside from the fact that millions of South African consumers are already over-indebted, efforts to play catch up may lead to unintended consequences that hurt poor people the most.

Welcoming the caps on interest rates and fees charged on loans that came into effect last week, CEO of DebtBusters, Ian Wason nonetheless cautioned that credit providers may simply refuse loans to high-risk consumers, since they are now earning less money for the same risk.

“This could drive more people toward loan sharks and other unaccredited lenders in order to make ends meet,” he commented earlier this week.

When the draft regulations on proposed caps to rates and fees were first issued in June 2015, the Banking Association of South Africa (BASA) expressed support for some of the caps – such as those applicable to mortgages and developmental credit – but argued that they may drive undesirable behaviour.

“Faced with a contraction of gross yields on unsecured loans, banks may encourage customers to take shorter-dated loans with their relatively higher interest rates and initiation fees,” the South African Reserve Bank (Sarb) said of BASA’s written submissions to the dti in its September 2015 Financial Stability Review (FSR).

Banks may turn to credit life, which remains uncapped, as a mitigating factor, or credit may simply “migrate” to the informal lending sector, “which demands higher interest rates and affords less protection”, BASA said.

If credit is curtailed, “it is unlikely that overall consumer welfare would be improved”, the Sarb said.

“The benefits of the proposed reduction in interest-rate ceilings to the consumer and the economy are therefore unclear… it would be prudent to conduct such a detailed macroeconomic impact assessment of the proposed changes,” the Sarb found.

Judge says regulatory review has merit

It is not clear whether such a detailed economic impact assessment has been conducted by the dti, which did not respond to questions from Moneyweb on this issue.

In a press statement issued by the department on Wednesday, it was noted that, Minister Rob Davies, in his review of the regulations, considered a PwC study of the credit industry and took into account input from major banks, micro-lenders and others.

“The Minister… needs to balance the competing interests of credit providers and those of consumers,” the dti said, noting, “consumers drive economic growth”.

According to the Minister, there is a “pressing need on the State to ensure that its citizens are not subjected to exorbitant credit fees and interest rates”.

And yet, caps on interest rates and fees charged on unsecured loans have remained unchanged (until May 6) for ten years.

MicroFinance South Africa (MFSA) lobbied for rates and fees on short-term loans to be reviewed for six years before the National Credit Regulator (NCR) – after two court orders and an urgent application – finally did so in 2015.

MFSA, which represents 487 micro-lenders or roughly 30% of the sector, argues that the current rates and fees on short-term loans do not reflect the true cost of credit provision, which has significantly risen over the last ten years.

“A proper economic impact assessment needs to be done so we can understand how rates are determined,” maintains Hennie Ferreira, CEO of MFSA.

The association went so far as to launch an application in March to delay the May 6 implementation of the cap on initiation fees on micro loans and have the regulations reviewed in their entirety.

The urgent part of the application, which was heard last week, was dismissed on the grounds that a last-minute delay in the implementation of the regulations would cause more harm than good.

Notably, however, the Judge found that a final determination on the second part of MFSA’s application, to have the regulations reviewed, is in the public interest. He directed MFSA to approach the deputy judge president to have the matter reviewed on an urgent basis, which it intends to do.

Ferreira argues that reducing the cost of loans will neither control reckless lending nor prevent over indebtedness. “Pricing should be based on an assumption of risk, and demand and supply,” he submits.

Too much too late?

While it would be nice for competitive forces to naturally push interest rates and fees lower, this does not appear to be happening.

If banks are lending money from the Sarb at 7% (the current repo rate), a 28% annual charge on an unsecured loan is, arguably, still far too high.

Short-term loans, meanwhile, could still effectively yield an annual interest rate of 38% under the new regulations (down from 60% previously), assuming a new loan is taken out each month.

Clearly, the system is broken.

Clark Gardner, CEO of Summit Financial Partners, which is taking Capitec to court over reckless lending allegations, describes payday loans, which are loans of one month or less in the short-term category, as “destructive”.

“We would really have liked to see the law reduce the initiation fee significantly after the first payday withdrawal in a calendar year to prevent the current encouragement of getting consumers into debt spirals by rolling their payday loans from month to month,” he says.

Initiation fees on short-term loans are the same as those on unsecured loans (R165 per credit agreement, plus 10% of the amount in excess of R1 000, never to exceed R1 050), but consumers tend to take out more of these loans.

“This is highly profitable for the lenders but very destructive to families, society and our economy in the longer term. Increasing rates merely allows credit providers to take more risk, which means marginal cases obtain credit that they perhaps could not afford. If the unsecured lending industry aimed for a default rate of say 10% to 15% these rates would be more than profitable,” he argues.

The latest figures from the NCR’s Credit Bureau Monitor indicate that around 24% of 83.6 million accounts in South Africa are in some way impaired, which includes being three or more payments in arrears. The figures for unsecured lending only would undoubtedly be higher. “The only reason the default rates are so high is that lenders can afford to take such high bad debt rates when rates are so high,” says Gardner.

According to the NCR, commercial banks hold on average 84% of all unsecured loan agreements, and on average 85% of short-term loans entered into between the fourth quarter of 2012 and the fourth quarter of 2015. Microlenders hold only one third of credit extended in terms of such short-term loan agreements.

Regardless, that the cost of credit needs to fall and, perhaps more importantly, more responsible lending is enforced is indisputable.

But doing nothing for years and then doing everything at once is hardly a helpful way to implement policy, either for credit providers or consumers.

Amendments to the National Credit Act, which notably include more stringent affordability assessment rules, were effected only last year, eliciting widespread comments that the damage – in terms of the ballooning of unsecured credit and over-indebtedness of consumers – had largely been done.

Proposed caps to credit life insurance, meanwhile, also issued last year, have not yet been finalised despite the obvious abuse that’s been happening in this industry for years.

I tend to agree with Ferreira when he submits that, until all the players in the consumer credit industry can get around a table to seriously discuss these issues, it will be very difficult to create a positive and sustainable credit landscape in South Africa.