Credit Law Review

1. Credit Law Review Technical Committee appointed by Dr Alistair Ruiters September 2003

2. 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

3. 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.”

4. 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 Members of the Technical Committee

5. 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

6. 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

7. 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

8. Primary proposals • Scope of legislation • Disclosure • Fees, charges, marketing practices & intermediary conduct • Protection & Redress • Credit Regulator & enforcement • Over-indebtedness • Price control • Credit Bureaux

9. BenchmarksRegulatory principles • Wallis Report • United Nations’ Guidelines for Consumer Protection

10. 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 BenchmarksConsumer Credit Legislation

11. 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

12. 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)

13. Results from research in SA

14. 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

15. 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”.

16. 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

17. 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. Research FindingsStakeholder views Rudo Research & Training / AfriData Research

18. 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)

19. Research FindingsSize of market - 2

20. Research FindingsHousing finance

21. Current account fees

22. Credit Card Fees

23. Cost of a Credit Card

24. High value instalment sales, Furniture Cost of Instalment sales

25. Instalment Sales & micro-loans Furniture, Instalment sales

26. How are these costs made up ? Cost of most products are significantly increased by Credit Life Insurance & “add-on’s”

27. Lack of transparency, unwillingness to give quotes …

28. Who pays what ?

29. Research FindingsFactors distorting market - 3 Economic reasons for high cost of credit and problems in allocation of credit

30. 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.

31. 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.

32. 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 Factors that aredistorting the market

33. 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. Factors:1. Usury Act Cap:

34. 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. Factors:1. Usury Act Cap 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 life insurance & various fees & charges … with effective 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

35. 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.

36. 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

37. 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.

38. 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

39. 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. Factors:4. Credit risk information

40. 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. Factors:4. Credit risk information 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

41. 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 Factors:5. Court orders

42. 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 5. Court orders & reckless/predatory behaviour 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

43. 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. 6. Competition

44. 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. Factors:6. Competition Many mechanisms that limit competition (on cost/price of credit) Little pressure to reduce rates

45. 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.

46. 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

47. 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.

48. 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

49. 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.

50. 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. A barrier to entry which reduce competition Levels of bank fees/charges adds directly to very high cost of credit unequal access & preferences are incentives for reckless behaviour … & disincentives for competitors unequal access & preferences increases the uncertainty, risk & cost for whole market