Credit Cards: Boon or Bane
Lowering interest rates on Credit Card borrowing is not the answer to the problem of over-indebtedness. On the contrary, it is more like making the proverbial cut-throat razor cheaper to buy, but still leaving it in the hand of the monkey to continue with his self-harming!
— TD Fuego
When I was writing about the insidious nature of Credit Card (CC) borrowing last year (MT 07-Aug-09), I had no idea about the extent of market penetration of the plastic lending industry in Mauritius. However, latest figures from the BoM suggest that, as at the end of November 2009, 190k individuals possess one.
In themselves, these figures do not seem so extraordinary and should not normally be cause for any undue alarm. Some affluent households may have more than one CC. We all know of some businessman friend who has several company cards. Of course, borrowers in this category do not have much difficulty repaying their debts, either from their own resources or the corporate treasury.
Besides, CC borrowing has to be viewed in the context of the individual’s global borrowing. Crucially, these will include his house loan (HL) and hire purchase (HP) commitments. Defaulting on either of these will result in serious consequences for him and his family, with repossession being the ultimate, mortal sanction. If there is foreclosure on the HL, an entire family becomes homeless, with all the moral and social repercussions that follow in the wake of such an eventuality. There is ample empirical evidence that money problems can lead to serious family strains ending in divorce and psychological disturbance, sometimes ending in self-harm and suicide.
According to DCDM, a staggering 60k+ Mauritian households (20 percent) are over-borrowed, that is having difficulty with or not being able to meet all their repayments. On the other hand, a recent Ministry of Consumer Protection (MCP) study has found a more conservative figure of 40k+ households involving 27 percent of the active population, whose monthly income fall in the range of Rs.7k and Rs.20k. Increasingly, the middle classes are being sucked into the infernal debt spiral. With the economic slow-down, the rise in the price of goods and services and in the absence of any real collective safety net, many are having greater difficulty in meeting their obligations. With the economic downturn still prevalent throughout much of the world, the threat of lay-off and the consequent inability to repay can only worsen.
Against this background, it is heartening to see that the authorities have decided to act. However, rather than look at the problem in its globality, Minister Tang at MCP is proposing to pass new laws that will compel banks to charge less interest on CC and incorporate new rules (unspecified so far) to regulate HP. The presumption is that the largest household borrowing, HL, is fair and fine.
Be that as it may, we can say so far so good. HL and HP are normally fixed in time and instalments spread over that time. Not only do they have to be sanctioned by the lender but, right from the start, the borrower also knows the exact amount and the day of the month on which he must pay the bank/credit company. HL are secured by a mortgage on the property and HP on the goods purchased. Often, there is an insurance policy that takes over in difficult times, like death, disease or temporary loss of job.
CC, however, are an entirely different product. Because of their inbuilt flexibility which allows the holder to draw down any time without having to seek prior sanction, they pose two major problems to the lender. Not only does the lender have to find the matching liquidity to fund the borrowing at any cost, he also ends up with an asset that is unsecured and, therefore, carries a heavier risk.
The interest rates that banks charge on their lending are closely related to the amount of risk involved. CC are probably the highest form of risk lending they undertake. It is, therefore, not surprising that the rates charged on them are sometimes many times those applying to a secured loan like HL. Whilst lowering interest on them may be good news to the customer, it will do very little to encourage prudent use. In fact, the customer may be tempted to borrow yet more, ensuring that the Minister’s good intentions remain just that — good intentions.
CC can be a Godsend in an emergency but, if not used prudently, they can lead to unbearable nightmares. When times are good, the customer does not need CC credit and, even if he does need some in an emergency, he is likely to repay the entirety of the loan on the repayment date. On the other hand, he is more likely to go to his limit (and beyond!) when he is in difficulty–like his/spouse losing job/overtime—and less likely to be able to meet his repayment. After the economic meltdown, this is one area where the major international banks are having great difficulty in realizing their assets from individual borrowers.
Lowering interest rates on CC, therefore, is not the answer to the problem of over-indebtedness. On the contrary, it is more like making the proverbial cut-throat razor cheaper to buy, but still leaving it in the hand of the monkey to continue with his self-harming!