1 credit law review technical committee appointed by dr alistair ruiters september 2003

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Credit Law Review

Technical Committee appointed by Dr Alistair RuitersSeptember 2003

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Mandate of the Technical Committee

To review the regulatory environment for small loans & consumer credit in South Africa, in order to make recommendations for legislative and regulatory reform.

Note: Consumer Credit in all cases assumed to include money loans

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Terms of Reference “To review the regulatory environment for small loans and consumer

credit in order to make recommendations for changes to the legislation, regulations and enforcement framework. The overall objective of the review are to:- Ensure that consumer rights are appropriately protected. The regulatory

framework has to recognise and accommodate the specific needs of low and middle income consumers and of any particular vulnerable groups.

Ensure that the regulatory environment is consistent with international benchmarks, whilst recognising the specific needs of the South African population and economy.

Ensure that the regulatory environment facilitate increased access to finance, and in particular access to SMME finance, low cost housing finance and finance for asset accumulation by low/middle income consumers.

Ensure that the regulatory environment facilitates increased competition in all sub-sectors of the market for small loans and consumer credit and, in particular, that appropriate mechanisms are created to detect and deal with market practices that undermine effective competition.

Ensure that the regulatory structure is consistent with other legislation and regulations impacting upon the financial services and consumer retail sectors, and that it facilitate effective co-ordination between the regulatory bodies that oversee different institutions or transactions that fall in this area.”

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Members of the Technical Committee

Roshana Kelbrick

David Porteous

Moses Moeletsi

Kgosi Pule

Gabriel Davel

Expertise(Professor in law, Unisa)

PhD, Economics, Housing Finance

Consumer protection, Provincial government

Practicing Lawyer

Chartered Accountant, Micro-finance

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Procedure followed by the Committee

Review of International Dispensations for regulation of consumer credit

South African Research: market practice, perceptions, legal framework

Workshops with DTI, local & international experts

Compiled detailed report with assessment of situation & regulatory proposals

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Primary findings - 1

Consumers feel disempowered, see certain products as dangerous but don’t believe they really have much choice

Would like more disclosure, better treatment, but consistently indicate that the urgency of obtaining credit/excitement of making a purchase ‘overrides reason’ when entering into contract

Industry & experts agree that current laws weak, outdated & inconsistent in treatment of different products; and that lack of consistent enforcement a particular problem

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Primary findings - 2

Compared to leading dispensations, SA at least 20 years behind, but current challenges very similar: over-indebtedness, credit bureaux, marginal/high cost cash lenders, credit life insurance, disclosure/consumer awareness

Empirical research indicates huge cost variations in sub-markets, huge differences between disclosed & effective cost of credit, ineffective competition (price), with Usury Cap distorting market & segregating market into “super-included” and “super excluded” components.

Legislative weaknesses & weak enforcement a major contributor to current problems, aggravated by problems in contract enforcement through courts

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Primary proposals Scope of legislation Disclosure Fees, charges, marketing practices &

intermediary conduct Protection & Redress Credit Regulator & enforcement Over-indebtedness Price control Credit Bureaux

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BenchmarksRegulatory principles

Wallis Report

United Nations’ Guidelines for Consumer Protection

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BenchmarksConsumer Credit Legislation

New Zealand

Australia

European Union (directives)

United Kingdom

US, Canada

Brazil, India, Malaysia

Recent, detailed review of legislation

Modern dispensation, comprehensive assessment by Australian competition regulator

Concise, minimalist, applying to all member states + recent comprehensive Proposal for revised Consumer Credit Directive (2002)

Country application (of directives), Task Force on over-indebtedness & on “loan sharks” (exempt agreements)

Credit bureaux, disclosure rules, “Truth in lending”

Considered, less relevant given sophistication of SA market

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International BenchmarksCommon issues - 1

Improved disclosure of the cost of credit in order to enhance the consumer’s ability to make informed choices; particularly, between cash purchases & credit use & to

compare different providers. BUT: debate between “comprehensive disclosure” vs

“simplified standard disclosure” Improved regulation of credit life insurance, to prevent if

from being used to inflate the cost of credit; mostly included in disclosable interest rate (SA excluded) impact of fees & charges a concern in other countries as

well A number of countries are giving attention to over-

indebtedness, considering rules that would enhance responsible lending practices (& affordability assessment) curb reckless sales and marketing techniques

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International BenchmarksCommon issues - 2 The importance of credit bureaux are increasingly

recognised for the role that it can play in combating over-indebtedness, to improve efficiency & lower cost of credit; Recognising need for regulation, protection of consumer

rights The importance of effective competition in the credit

market generally recognised With concern on inherent problems, e.g. related to

consumer’s inability / unwillingness to “shop around” Marginal (high cost) lenders vs main stream lenders

Concern with exempting latter, while vulnerable consumers use former

Receiving attention in New Zealand, UK & US (& others)

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Results from research in SA

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Research FindingsConsumer perspectives - 1 Research firm conducted ‘focus group discussions’

with consumers from different income segments to assess perceptions (Researchers: SAtoZ & Reality Research Africa)

General dissatisfaction with disclosure, feeling of not having been informed of the actual cost of finance … ‘felt cheated’ when 1st repayment has to be made

Preference for dealing with banks & main stream credit providers, but also great frustration with the treatment received even from these “reputable credit providers”

Reality Research Africa

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Research FindingsConsumer perspectives - 2 Given that disclosure prescriptions focus on the

contract, alarming that consumers indicate the signing of the contact as a formality, & the majority hardly reads it

Disenchantment, even fear, common in respect of “zero deposit deals” (HPs); deals with residual balances (car finance) or deals which entail an initial period in which there is no repayment or where the repayments are lower (HP, store card and car finance). Consumers reported having been “caught out” through these terms, that they were generally not well explained, were misleading and that “in the end, the payments will be more”.

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Research FindingsStakeholder views

Solicited views from stakeholders, e.g., consumer protection, current market profile, weaknesses Researchers conducted group discussions and

individual interviews with a large number of consumer & lender representatives, legal specialists, provincial consumer directorates & trade union representatives

Researchers: Rudo Research & Training & AfriData Research

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Research FindingsStakeholder views

Existing legislation is old and ineffectual; should be replaced with one, consolidated Credit Act;

Legislative and enforcement weaknesses are contributing to non-compliance and are undermining consumer protection;

Low income credit providers were less compliant and less effectively regulated than high income clients;

Enforcement is weak and has resulted in extensive non-compliance and circumvention of legislation;

One consumer credit regulator should enforce compliance across all types of consumer credit transactions

Fees & charges, and credit life insurance in particular, inflate the cost of credit, are used to circumvent the Usury Act cap, and undermine disclosure;

Greater honesty by consumers in disclosure of existing debts would be of benefit to both the consumers and the credit providers;

Consumers must read their contracts and understand their commitments;

It is important that consumers be better educated in credit issues;

There is a need for a national register of loans and other commitments;

The data on the existing credit bureaux are inaccurate.

Rudo Research & Training / AfriData Research

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Research FindingsProfile of market - 1 Over period of about 6 months, researchers

investigated volumes & cost of different types of consumer credit

By analysing financial statement, brochures, interviews with banks/credit providers/regulators, obtaining ‘firm quotes’

Results were tested in workshop with ‘experts’, including institutions & regulators

Researchers: Feasibility Consulting (Dr Penelope Hawkins)

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Research FindingsSize of market - 2

Estimated outstanding balances, September 2002

R million

Mortgages 198,822 55%

Overdrafts & other loans 71,769 20%

Leases 10,409 3%

Instalment sales 53,999 15%

Credit Cards 19,059 5%

Micro-loans (non-bank) 7,307 2%

Unregistered micro-loans plus pawnshops etc 900 0.2%

362,265

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Research FindingsHousing finance

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Current account fees

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Credit Card Fees

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Cost of a Credit Card

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Cost of Instalment sales

High value instalment sales, Furniture

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Instalment Sales & micro-loans

Name ofSupplier

Inclusive Price APR

Retailer 1 R 2,314 72%









Retailer 8 R 4,972 116%


Retailer 10 R 6,499 38%

Retailer 11 R 7,600 62%

Retailer 12 R 8,999 57%


Cost of Term Micro-loans

Name of Supplier Loan amount APR

Bank 5 R 5,000 83%

Bank 1 R 1,000 98%

Bank 2 R 5,000 112%

Bank 4 R 2,000 147%

Micro-lender 8 R 2,000 155%

Micro-lender 7 R 2,000 209%

Furniture, Instalment sales

A R 1,799.00 49.00%

B R 1,999.00 79.80%

C R 2,000.00 89.20%

D R 2,000.00 109.40%

E R 2,199.00 68.90%

F R 2,299.00 73.30%

AVERAGE 78.3%1

Furniture Quotes, Sunday Tribune

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How are these costs made up ?

Cost of most products are significantly increased by Credit Life Insurance & “add-on’s”

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Lack of transparency, unwillingness to give quotes …

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Who pays what ?

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Research FindingsFactors distorting market - 3

Economic reasons for high cost of credit and problems in allocation of credit

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Consumer Credit Markethighly inefficient … It seems valid to conclude that the consumer credit

market is very inefficient, whether in terms of: High cost to consumers not translating into high

returns for suppliers; Competition are not leading to lowering of prices; Inability of banks and other large credit providers to

successfully enter the low income market Inability of suppliers to evaluate or accurately price

for risk, or; The inability of the market to evolve in a manner that

would give low income consumers access to low cost distribution channels or other benefits of economies of scale.

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A dysfunctionalmarket ?

Thus, while sophisticated risk management and information technology is available, together with a relatively developed capital market that could provide loan capital, the cost of credit is exceedingly high in certain market segments. At the same time, the supply of credit in certain segments appears to fall substantially below the demand. These factors appear to point to dysfunctionality in the consumer credit market.

In the course of the Credit Law review, and the specific research into the economic factors that have an impact upon the credit market, a number of factors were identified, each of which distorts the efficiency of the credit market and leads to inefficiency in the allocation of credit or causes the cost of credit to be higher than it may otherwise be.

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Factors that aredistorting the market Usury Act Cap Legislative deficiencies

& uneven enforcement Disclosure Credit risk information Court orders &

predatory behaviour in certain segments

Banks Act National Payments System

(NPS) Mortgages Competition Legislative / Regulatory

uncertainly

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Factors:1. Usury Act Cap:

The Usury Act interest rate cap has been in place for nearly a century. This appears to have divided the market into two sub-markets, which function very differently. Below the cap, the interest rate is a good indicator of the cost of credit and many large and reputable credit providers are competing for market share. The second sub-market consists of virtually any type of credit where the client is not a ‘prime client’ or does not have very good security to offer. The cap does not allow the provider to cover its operational cost, the perceived risk and a sufficient margin. The credit provider thus adds to the income by charging credit life insurance and various other fees. The actual cost could thus be substantially more than the interest rate and is not transparent. In the Usury Act Exemption category the cap does not apply and government attempted to improve disclosure by defining “the annual rate for the total cost of credit”. However, it is perceived as a high- risk market (including high reputational risk) and lenders are reluctant to enter this market or to make substantial operational investments. There is thus a clear segmentation between the market in which ‘prime clients’ obtain credit, and the credit market(s) for other clients, with the former being actively contested, competitive and fairly well disclosed. The latter is typified by weak disclosure and limited competition on the price of credit.

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Factors:1. Usury Act Cap

The Usury Act interest rate cap has been in place for nearly a century. This appears to have divided the market into two sub-markets, which function very differently. Below the cap, the interest rate is a good indicator of the cost of credit and many large and reputable credit providers are competing for market share. The second sub-market consists of virtually any type of credit where the client is not a ‘prime client’ or does not have very good security to offer. The cap does not allow the provider to cover its operational cost, the perceived risk and a sufficient margin. The credit provider thus adds to the income by charging credit life insurance and various other fees. The actual cost could thus be substantially more than the interest rate and is not transparent. In the Usury Act Exemption category the cap does not apply and government attempted to improve disclosure by defining “the annual rate for the total cost of credit”. However, it is perceived as a high- risk market (including high reputational risk) and lenders are reluctant to enter this market or to make substantial operational investments. There is thus a clear segmentation between the market in which ‘prime clients’ obtain credit, and the credit market(s) for other clients, with the former being actively contested, competitive and fairly well disclosed. The latter is typified by weak disclosure and limited competition on the price of credit.

cap, divided the market into two sub-markets

one, profitable (larger loan sizes, serving ‘prime clients), another in which provider supplement income by adding credit lifeinsurance & various fees & charges … witheffective cost much higher than cap

“exempt market”, perceived as a high-risk market (incl. high reputational risk), lenders are reluctant to enter this market, to make substantial operational investments, …orientation towards short term profit maximazition

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Factors:2. Disclosure:

Weaknesses in the disclosure rules imply that the actual cost of credit is frequently much higher than the disclosed interest rate. This undermines the consumer’s ability to make informed choices and relieves the pressure on suppliers to reduce interest rates.

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Factors:2. Disclosure

Weaknesses in the disclosure rules imply that the actual cost of credit is frequently much higher than the disclosed interest rate. This undermines the consumer’s ability to make informed choices and relieves the pressure on suppliers to reduce interest rates.

actual cost of credit is frequently much higher than the disclosed interest rate

undermines the consumer’s ability to make informed choices (cash vs credit; & between different credit providers)

relieves the pressure on suppliers to reduce interest rates

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Factors:3. Legislative deficiencies & uneven enforcement

Ineffectual disclosure rules allow for substantial circumvention of the Usury cap. The enforcement of the Usury Act and Credit Agreements Act has been both ineffectual and unequal between different providers and products. Through lack of enforcement, the practices of less scrupulous providers have become the norm. As a result, the non-prime market operates in an oblique manner with little effectual or transparent competition.

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Factors:3. Legislative deficiencies & uneven enforcement

Ineffectual disclosure rules allow for substantial circumvention of the Usury cap. The enforcement of the Usury Act and Credit Agreements Act has been both ineffectual and unequal between different providers and products. Through lack of enforcement, the practices of less scrupulous providers have become the norm. As a result, the non-prime market operates in an oblique manner with little effectual or transparent competition.

Ineffectual disclosure rules allow for substantial circumvention of the Usury cap

enforcement has been ineffectual and unequal between different providers and products

practices of less scrupulous providers have become the norm … the non-prime market operates in an oblique manner with little effectual or transparent competition

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Factors:4. Credit risk information

Current credit information exchange is fragmented and incomplete. Credit bureaux exclude information on substantial and important parts of the consumer credit market, while the information on the bureaux is frequently inaccurate. This undermines the credit provider’s ability to identify non-creditworthy consumers; leads to high levels of bad debt and thus to increased cost of credit across the board.

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Factors:4. Credit risk information

Current credit information exchange is fragmented and incomplete. Credit bureaux exclude information on substantial and important parts of the consumer credit market, while the information on the bureaux is frequently inaccurate. This undermines the credit provider’s ability to identify non-creditworthy consumers; leads to high levels of bad debt and thus to increased cost of credit across the board.

credit information exchange is fragmented and incomplete

exclude important information & information on bureaux frequently inaccurate

undermines the credit provider’s ability to identify non-creditworthy consumers

leads to high levels of bad debt … thus increasing the cost of credit across the board

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Factors:5. Court orders

The current requirements for the granting of court orders (e.g. garnishee orders or emolument attachment orders) are such that the court does not consider whether the credit provider ‘acted responsibly’ prior to issuing a court order court order. This creates an incentive for creditors to act recklessly, or to extend more credit than what a consumer can reasonably repay, given that the credit provider assumes that it will be able to obtain a court order if the consumer defaults. Court orders do not differentiate between reckless and responsible credit providers, and the actions of the ‘reckless credit provider’ creates an added risk for the more cautious credit provider, or a provider of long term or large amounts of credit, implying that the latter are inclined to withdraw from the non-prime markets

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5. Court orders & reckless/predatory behaviour

The current requirements for the granting of court orders (e.g. garnishee orders or emolument attachment orders) are such that the court does not consider whether the credit provider ‘acted responsibly’ prior to issuing a court order court order. This creates an incentive for creditors to act recklessly, or to extend more credit than what a consumer can reasonably repay, given that the credit provider assumes that it will be able to obtain a court order if the consumer defaults. Court orders do not differentiate between reckless and responsible credit providers, and the actions of the ‘reckless credit provider’ creates an added risk for the more cautious credit provider, or a provider of long term or large amounts of credit, implying that the latter are inclined to withdraw from the non-prime markets

court does not consider whether the credit provider ‘acted responsibly’

incentive for creditors to act recklessly, on assumption of being able to obtain a court order if the consumer defaults

actions of the ‘reckless credit provider’ adds particularly to risk for providers of larger, longer term loans & latter thus inclined to withdraw from the non-prime markets

actions of the ‘reckless credit provider’ increase risk, cost & interest rates of whole market

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6. Competition The research identified a number of mechanisms

through which credit providers can avoid or can limit competition on the price of credit. These include payroll deductions, collection through ‘preferred debit orders’ and collusion between different parties that are involved in the broader consumer credit industry. The many weaknesses in the competitive environment imply that different suppliers do not compete on the price of credit, and thus that there is little pressure from consumers to reduce interest rate and related charges.

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Factors:6. Competition The research identified a number of mechanisms

through which credit providers can avoid or can limit competition on the price of credit. These include payroll deductions, collection through ‘preferred debit orders’ and collusion between different parties that are involved in the broader consumer credit industry. The many weaknesses in the competitive environment imply that different suppliers do not compete on the price of credit, and thus that there is little pressure from consumers to reduce interest rate and related charges.

Many mechanisms that limitcompetition (on cost/price of credit)

Little pressure to reduce rates

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Factors:7. Mortgages Clients with high value mortgages in prime locations

have access to various products and can shop around. Outside prime areas (and in township areas in particular), the housing market is ineffectual and mortgage finance is generally unavailable. Problems in housing registration and housing transfer contribute substantially to this state of affairs. A large majority of the population can thus not benefit from what should be their best security - their mortgage - and faces generally high cost of finance. This population’s investment in housing stock does not translate into the creation of “securable assets”and asset accumulation is undermined.

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Factors:7. Mortgages Clients with high value mortgages in prime locations

have access to various products and can shop around. Outside prime areas (and in township areas in particular), the housing market is ineffectual and mortgage finance is generally unavailable. Problems in housing registration and housing transfer contribute substantially to this state of affairs. A large majority of the population can thus not benefit from what should be their best security - their mortgage - and faces generally high cost of finance. This population’s investment in housing stock does not translate into the creation of “securable assets” and asset accumulation is undermined.

Mortgage unlock many products,& much lower rates

Majority of population cannot benefit from what should be their best security - a mortgage over their home - and faces generally high cost of finance

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Factors:8. Banks Act

The Banks Act conditions for a banking licenses limits entry into banking and thus limits competition and innovation, both of which contribute to higher interest rates. The Banks Act constraints on non-bank credit providers on raising loan capital also limits non-bank credit providers’ ability to expand and make the market more competitive.

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Factors:8. Banks Act

The Banks Act conditions for a banking licenses limits entry into banking and thus limits competition and innovation, both of which contribute to higher interest rates. The Banks Act constraints on non-bank credit providers on raising loan capital also limits non-bank credit providers’ ability to expand and make the market more competitive.

High entry requirements limit entry,competition amongst banks … higher rates

Also major constraint on non-bank lenders’ ability to raise loan capital, expand, compete … higher rates

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9. National Payments System (NPS) The research indicated that there are various

arrangements or fee structures related to the NPS and banks’ transaction processing that are excessive and biased against small or short term transactions; that directly add to the cost of credit and that contribute to limiting competition in the provision of credit. In addition, unequal access to the payments system for different credit providers, e.g. preferences enjoyed by certain participants, increases the uncertainty and risk of many credit providers (and non-bank credit providers in particular) and contributes to increasing the cost of credit to the consumer.

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9. National Payments System (NPS) The research indicated that there are various

arrangements or fee structures related to the NPS and banks’ transaction processing that are excessive and biased against small or short term transactions; that directly add to the cost of credit and that contribute to limiting competition in the provision of credit. In addition, unequal access to the payments system for different credit providers, e.g. preferences enjoyed by certain participants, increases the uncertainty and risk of many credit providers (and non-bank credit providers in particular) and contributes to increasing the cost of credit to the consumer.

Levels of bank fees/charges adds directly to very high cost of credit

unequal access & preferences are incentives forreckless behaviour … & disincentives for competitors

unequal access & preferences increases the uncertainty, risk & cost for whole market

A barrier to entry which reduce competition

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Illustration of arrangements,National Payments System

Attempting to replicate payroll deduction functionality, thus to reduce credit risk for particular creditors … & increase risk for everyone else

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Finally:Regulatory uncertainly

In a number of areas there is a very high level of regulatory uncertainty. This includes the future of the Exemption Notice, the future approach to interest rate regulation and the treatment of credit life insurance. Given such uncertainty, credit providers tend to take a short term view. This inevitably leads to an increase in the cost of credit.

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SummaryPrimary problems to be dealt with

Fragmented, inconsistent & inefficient legislation … & the Usury Cap … & inconsistent / weak enforcement

Weak disclosure, too late Predatory behaviour Very many factors that undermine

competition Other Acts: Banks, NPS, Court orders Regulatory uncertainty Priority: Price control or protection against

over-indebtedness ?

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SummaryOverall approach Integrate fragmented market, integrate “exempted” &

“Usury Act” markets … equivalent regulation & oversight by one body … effective, consistent enforcement

Remove inefficiencies and incentives for reckless behaviour introduced by legislation & enforcement, both in Usury/Credit Agreements Acts & Exemption Notice; & Magistrates Courts Act

Improve disclosure: standardised & comparable at earlier stage in purchase cycle

Move away from ‘price control’ as primary focus of regulation, towards protection against over-indebtedness, & assistance to vulnerable or exploited individuals

Improve level of competition at every level; … & attack all forms of anti-competitive behaviour

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Discussion of this section of the presentation

1 credit law review technical committee appointed by dr alistair ruiters september 2003

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