It is acknowledged that consumer credit plays an important role in society and is a largely beneficial activity, enabling borrowers to purchase goods and services and spread repayments over time.
However, there seems to a universal problem of reckless lending by lenders, which results in financial distress for borrowers. This is a problem in South Africa, where approximately 40% of consumers have impaired records. Similarly, in the UK, the FCA released two papers (CP17/27 and OP28) in 2017 on affordability and financial distress. It would seem as though most lenders are paying lip service to affordability of consumers, which has resulted in high default rates and resultant financial distress.
Two recent articles in the Guardian newspaper would suggest that more stringent affordability rules are required.https://www.theguardian.com/money/2018/jul/26/household-debt-in-uk-worse-than-at-any-time-on-record
A challenge for regulators and firms is how to design affordability rules – restricting access to unaffordable credit - to minimise this financial distress, without such rules excessively restricting affordable credit access or imposing processes which unnecessarily increase the costs of borrowing. There is legislation in place in most countries that requires borrowers to assess the ability of the lender to assess the borrower’s ability to afford the repayments required in terms of a credit agreement. However, it would seem as though these affordability rules are not applied rigorously, for fear of being accused of restricting access to credit. There is little doubt that lenders are taking advantage of this regulatory impasse and are engaging in irresponsible lending.
With open banking in the UK and a bank statement exchange in SA, it is very easy for lenders to perform and accurate, real time assessment of the borrower’s affordability. This is made possible by accessing the borrowers bank statement data in real time, categorising income and expenses into broad categories, and determining the borrowers disposable net income which can be used to determine the borrower’s ability afford loan repayments. The imposition of such a requirement would in no way impose processes on lending which increase the cost of borrowing. Six months bank statement data categorised into broad categories of fixed, variable and discretionary expenses will enable the lender to determine what the borrower can afford. So, if the borrower applies for credit which is unaffordable, the lender will know what the borrower can afford and adjust the amount of credit applied for to ensure that the borrower can afford the repayments on a sustainable basis. A similar principle can be applied to insurance premiums to ensure that the insured can afford to pay the premiums on a sustainable basis. Lack of accurate affordability calculations leads to huge default rates on credit agreements and lapse rates on insurance policies.
As set out in a previous blog, this is one of the main reasons why South Africa scores so low in terms of financial inclusion. Financial inclusion is not just about access to financial services, but ensuring that such financial services are sustainable.
Unfortunately, the world and most financial service providers are driven by exclusive capitalism that seeks to put profit at the heart of decision-making and action by business, rather than society.