Never a moneylender be … Aristotle, 350bc: “Very much disliked is the practice of charging interest; and the dislike is fully justified … money intended to be a means of exchange … of all ways of getting wealth this is the most contrary to nature Cicero, 50 BC: “Gentlemen should not toil themselves with means of livelihood which provokes ill-will, such as collecting customs dues and money-lending” Bacon, 1597: “It is a vanity to conceive that there would be ordinary borrowing without profit; and it is impossible to conceive the number of inconveniencies that will ensue if borrowing be cramped … better to mitigate Usury by declaration, than to suffer it to rage by connivance”. Bentham, 1787: “The business of a moneylender … has no where nor at any time been a popular one. It is an oppression for a man to reclaim his own money: it is none to keep it from him”

& weaknesses in credit market regulation & National Credit Act in SA SOAS Financial Crisis & weaknesses in credit market regulation & National Credit Act in SA Gabriel Davel March 2009

In 2005, South Africa passed a National Credit Act, regulating all credit providers, credit bureaus & debt counselling New legislation passed in response to bank failures in 2002, Inefficient allocation & high cost, particularly for low income & SME finance Extensive research confirmed that credit market was dysfunctional … based on international best practice, but with significant modifications Act covers all consumer credit, bank and non-bank finance, furniture & consumer goods finance & developmental credit National Credit Regulator created to enforce Act Approximately US$140bn of consumer credit, provided to 17 million consumers 3,232 credit providers with 29,811 branches, $100bn of credit National Credit Act also covers regulation of credit bureaus regulation of debt counsellors collection & publication of statistics on credit market

Origination of sub-prime loans Securitisation, CDOs & CDSs So what went wrong … … 3 independent calamities that blew up simultaneously Origination of sub-prime loans Reckless & misleading lending practices, applied on large scale, with ample access to funding, had the inevitable result of mass default Securitisation, CDOs & CDSs Structures for funding & risk transfer through ‘collateralised debt obligations’, ‘credit default swaps’ & derivative instruments = (a) loan obligations packaged & sold, (b) risk attached to such loans were divested & sold to different parties “Deleveraging” The need to reverse the excessive “leverage” that developed between the capital in financial institutions & the volume of assets = need to raise additional capital or reduce assets

Loan origination perspective of the sub-prime crisis NCA Comprehensive, uniform coverage S163 = principal responsible S103 & S104 Reckless lending sections Debt counselling … & incentive to reschedule Problems in sub-prime loan origination:- = misleading disclosure + abusive practices Brokers incentivised to maximise origination and minimise cost … & able to pass risk of default on to others … & given access to unlimited funding through securitisation “Teaser rates” attractive draw-card, with 2 year lag before reality sets in “Reduced documentation loans” means affordability disregarded … and then the housing prices declined consumers not innocent little angels, but a consumer that is pressurized & mislead cannot be expected to make “informed or rational choices”

Securitization & derivatives amplified negative impact of reckless origination “The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Knowledge of how dangerous they are has already permeated the electricity and gas businesses, in which the eruption of major troubles caused the use of derivatives to diminish dramatically. Elsewhere, however, the derivatives business continues to expand unchecked. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts.” - Warren Buffet , February 21, 2003 Derivative are high risk, independent of ‘sub-prime’. The derivative blow-out could as well have occurred in any market, sub-prime mortgages was a handy setting, with teaser rates as fuse Collateralised debt obligations (CDO) & credit default swaps (CDS): securitising the debt obligations, segmenting risk, & selling to investors … moving assets & risk off balance sheet, increasing leveraging, lower regulatory capital requirements … to investors that did not understand underlying risk, through instruments that are complex Securitization gave reckless originators access to unlimited funding + ability to avoid impact of default, passing risk on to ‘parties with least understanding or appetite’,

Then “deleveraging”, the ghost that was always there … and may haunt us for some years still … “significant deleveraging is both necessary and inevitable … the deleveraging in the banking sector will take place along multiple dimensions: requiring asset sales, slower new asset growth, and radical changes to banks’ business models as many previous sources of revenue have nearly disappeared. A similar deleveraging process is under way for many nonbanks …” - IMF Global Stability Report, Oct 2008 IMF & others have for some years identified need for “deleveraging” in the financial sector, irrespective of ‘sub-prime’ Institutions have to raise additional capital and/or bring assets back on balance sheets. Consequential “negative multiplier” implies need for significantly more capital, to support the same quantum of assets, exactly at time when investors are most risk averse Thus, generally reduced availability of funding going forward, and “sub-prime” a swear word

Obviously, also other issues, … Trade imbalances and the liquidity surpluses which it caused ? but trade imbalances as old as trade, and what about Dutch Disease? How do we deal with asset bubbles rethink Greenspan/Bernanke philosophy = allowing bubbles to burst & clean up afterwards Is bursting bubbles feasible? Include in inflation calculation, targeting? Negligence of rating agencies, accounting firms, regulators … why? Why were problems not identified, no action taken? Does “macro-prudential” monitoring / regulation” add any value? The problems with human nature … a la Machiavelli, Darwin, Peter’s Principle, De Sade …

And then there was the National Credit Act, Warnings of unintended consequences, and wildly blamed for disallowing credit grantors to push more credit down over- indebted consumers throats, Regulating reckless credit and much, much more …

Overview of National Credit Act Interest & fees Reckless lending rules Marketing & sales practices National Credit Act Enforcement & debt collection Agreements & quotes Unlawful agreements, provisions Debt counselling Regulate Credit Bureaus Create National Credit Register

Questions How does the law change the manner in which credit market function? In which aspects do it differ from credit market regulation in main stream dispensations? How does this address market practices which are destabilising … noting the extent to which in modern finance, financiers endeavour to transfer risk to consumers, in many cases risk which the clients do not have the capacity to manage

Reckless lending, affordability & debt counselling National Credit Act Reckless loan defined, may be suspended Repayment capacity at time of origination Debt counselling legal debt restructuring process “In duplum rule” limit on arrears interest & fees Policy objective Create disincentives for credit providers to cause over-indebtedness Curb “debt farming” (extracting maximum fees from defaulters over long term)

Regulation of interest & fees National Credit Act Disaggregate interest from initiation and monthly fee, limits on each Prohibit penalty fees or interest Prohibit early settlement fees Prohibit ad-hoc interest rate variations (e.g. teaser rates) Objective Remove reputational risk of high APR rates from preventing main stream suppliers providing small loans Curb roll-overs, curb large high interest loans (non-recurring initiation fee; effective rate decline with larger loan size) Curb ‘debt farming’ on small loan defaults

Disclosure - compulsory, standardised, early National Credit Act Prescribed info in adverts Prescribed, binding pre-agreement quote Curb solicitation at home or work Prohibit certain contractual practices Objective Force provision of comparable information on cost of credit at early stage of purchase cycle, … so that purchase decision & credit selection can take place simultaneously … intervene to create appropriate conditions for the competitive market to function

Unfair contractual practices & competition National Credit Act Prohibit certain contractual practices – not “unconscionable conduct” approach Any form of preferential collection prohibited, whether through payroll deductions or preferential debt order processing Objective Prevent credit provider from developing a business model based upon preferences, which would artificially lower the risk of default, and lower incentive for caution

Credit bureaus National Credit Act Objective Credit bureaus registered, audited Special rules to create statutory obligation for data quality Objective Efficient effective access to credit information, particularly, for low cost provision of small loans Regulated as part of credit industry, not under privacy laws Privacy laws inappropriate, credit market requires accurate & efficient credit information

Conclusion I do not believe that there is any cause to argue that “the market has failed” Our regulators and legislators caused the failure, by not maintaining the minimum conditions for the market to function efficiently Partly, due to exceeding lax regulation (sub-prime, derivatives, level of leverage), and negligent professional conduct (rating agencies & accountants) … and not dealing seriously, with the reality of consumer behaviour (per behavioural economics) Also, our legislation has not kept up with changes that took place in financial markets (bank resolution strategies has similarly become out-dated) Made worse by the extent of arrogance & incompetence in the leadership of financial institutions (and regulators)

Thank You ! www.ncr.org.za

Left Out

Implications of sub-prime fall-out for financial systems & SA? Problem not “the capitalist system”, or “low income clients”, but reckless origination & crazy incentive structures, misleading disclosure, broker-based origination, power of business lobby on legislation … sleepy regulators Can be addressed through better legislation, e.g. NCA Lowering of standards for “access to finance” never the answer Yet, SA position better than most others, but significant challenges over coming months & years  Funding constraints for businesses & consumers? Impact of international developments on securitization & development finance more broadly? Implications for housing finance, NHFC?

SA consumer credit market Blaming all problems on debt stressed consumers = BS Aggregate debt stress increased 3% over 12 months, however around 50,000 consumers/m falling in arrears & big spenders most affected Debt counselling: Impact on housing market = increase repossessions + reduce finance for buyers Going forward: consumer confidence (Escom effect), resolution of debt stress lending patterns of banking sector impact upon economy over coming months “good standing” 60.4% =

Credit Bureau Statistics Broad indicator of consumer repayment capacity Reflect credit performance of 17 million consumers, as reported by credit providers to bureaus Ongoing increase in consumers with impaired records, from 36% to 39% over year to Sept’08 Nearly 1 million people with worse records Recent strong increase in retailer enquiries (44%Q/Q), consistent decline in bank enquiries Consumers avoiding new credit (consistent decline in consumer enquiries) Trends consistent with cyclical downturn, not “credit crunch”

Impact of NCA & debt counselling in credit market downturn? Requirement for affordability assessment. Many providers did not do any assessment, used rules like “30% of income” Changed credit provider approach to consumers who default. Stop rush to courts.. Much greater attempt to resolve issues, rather than legal action. Better approach, reduced repayment mostly better than repossession or legal action Debt counselling: 42,000 cases which could become 100,000 soon – contemplate position of these families without debt counsellors to assist? Informal advice often all that is required. 770 counsellors, specialist payment distribution, on-site support, training, investigations = specialised industry ! Blind spots, challenges? Backlogs at courts; Credit provider resistance – including banks; Increasing stress caused by economic downturn & unemployment

Other issues Development credit Compliance NCR approval vs ministerial approval application process Compliance pre-agreement disclosure (quotes), interest & fees, enforcement affordability assessment & credit bureau submission statistical returns