Loose monetary policy eases credit access for the rich, but squeezes the poor. Also, volumes among unsecured lenders are falling.
This column was first published in Business Day.
The record low interest rates, which were confirmed by the Reserve Bank’s monetary policy committee (MPC) last week, are highlighting odd features of the financial system. One is that loose monetary conditions mean access to credit becomes cheaper and easier if you are rich, but harder if you are poor.
To see that, consider how unsecured lenders are reacting to low rates. Rather than boosting volumes as consumers are attracted by lower pricing, volumes are falling.
Interest rates are a lever through which the MPC controls the economy. Lowering the cost of debt should spur economic activity by making it cheaper to borrow to invest or consume. Overall, this appears to be working. In 2020’s fourth quarter, 6.2% more credit was granted than in the same period the year before, after a sharp recovery from previous quarters, according to National Credit Regulator statistics.
Because of an odd quirk of SA’s regulatory approach, unsecured lenders’ maximum interest rate is capped at repo plus 21%. The current cap is thus 24.5%. Before the pandemic, when the repo was 7%, the total cap was 28%. Lenders are also allowed to charge between R165 and R1,050 in origination fees per loan.
When the repo falls, banks dutifully reduce the interest they charge clients. This doesn’t directly affect their profitability because there is a partial reduction in their costs — they pay depositors less — and because bad debts reduce, all else being equal. In the mix of costs they face, the fixed costs of loans are also proportionately low.
For unsecured lenders the economics are quite different. Most do not benefit on the funding side from lower rates. Non-bank lenders rely much more on shareholder funds than repo-linked deposits. They also have a high proportion of fixed costs compared with funding costs in their businesses. Unsecured loans have a high marginal cost to originate.
Because costs don’t fall proportionately, the reduction in repo directly affects lenders’ margins. For such lenders, the only way to respond is to reduce lending volumes to only those clients who remain profitable enough to service. When repo rates are cut, the result may well be a reduction in unsecured lending overall, particularly of smaller amounts to riskier customers, which could have the opposite effect to that intended by more liberal monetary policy.
SA would be better off if unsecured lending were subject to a single fixed cap that did not depend on the repo. A reduction in the repo would improve lenders’ profitability to the extent that there is some small benefit to them from that portion of the funding mix that is a variable cost. That would enable greater lending into the market when the repo declines.
Eating into profit
Lending into the market has decreased as rates have dropped. In the fourth quarter of last year 24.5% less unsecured credit was granted than a year before. More telling, just 15% of all lending was unsecured lending. Throughout 2018 and 2019, the proportion was more than 20%.
There could be various drivers of this decline from the demand side. Borrowers will be cautious given economic uncertainty, which could be more acute in unsecured lending target markets than other credit categories. Supply could also be constrained not because margins are lower, but because the credit outlook is darker. But the data also shows that lending declined disproportionately to low-income consumers relative to high-income consumers, suggesting lenders are shifting volumes where the cap is not eating into profitability.
Both the proportionate decline in unsecured lending in total credit granted and the shift towards higher-income consumers support the interpretation that the supply side has been constrained. A number of anecdotes from such lenders confirm that this is what is occurring.
This is a perverse outcome of lower regulated interest rates. It is not one the MPC would be too concerned about, as more than 80% of consumer credit is still undertaken by banks, so the monetary transmission mechanism largely works. But it does mean that the section of the economy that rely more on unsecured loans will have less access to credit in looser monetary conditions. This has public policy implications as it worsens inequality, given that the less well-off rely more on unsecured lending.
Credit regulations are the purview of the department of trade, industry & competition, rather than National Treasury, which regulates banks and other aspects of the financial system. This has long been an odd quirk — it would surely be more logical for the NCR to be rolled into the Twin Peaks architecture that governs the rest of the financial system, which could allow for better co-ordination with wider financial and monetary policymaking.
For now we must live with the fact that monetary efforts to lean against the economic consequences of the pandemic can work only in the better-off parts of the economy.
• Theobald is chair of consulting firm Intellidex.