Consumer Lending and Overindebtedness in Latin America
Latin America, September, 24 2012 -
In Latin America household debt levels have been rising in recent years. This has been driven in part by the growth in consumer lending that has coincided with rising incomes of many low-income households in countries such as Chile, Peru, Brazil, Mexico and Colombia.
This growing consumer base has attracted new providers from international and national-level retail chains to local consumer lenders, eager to capture market share in a population often underserved by traditional financial institutions in the past.
Increased consumer debt level can in part be expected with growing economies. However, in several markets these debt levels may be leading large groups of consumers towards overindebtedness, and could pose a risk to economic growth, household well-being, and financial institutions with significant levels of consumer debt in their portfolios. In Brazil, for example, household debt-to-income levels nearly doubled in five years from 2006 to 2011, from 22% to 40%. We have already seen a consumer lending scandal at major retail chain La Polar Chile that impacted more than 400,000 of their customers, and dropped their stock price by 42% in a single day. While in Mexico information on consumer lending for many microfinance and credit-only institutions shows portfolios with arrears levels of 20-30%.
We view consumer lending to low-to middle-class consumers as one of the biggest consumer protection challenges facing the region. Fortunately there are many promising interventions underway by both policymakers and the private sector to better understand the phenomenon of consumer lending and its implications for households and retail finance, and hopefully be better prepared to address bubbles before they burst. To share some of these experiences, we would like to highlight here three particularly promising approaches.
Institutional-level risk assessment. This approach includes incorporating specific measurement of consumer lending portfolios into review of financial statements, risk and affordability assessment requirements for lending operations, and consideration of staff incentive structures that encourage reckless lending. One of the best examples of this approach to rising consumer debt levels is Peru. The Superintendent of Banks and Insurance in Peru recognized several years ago the growing presence of consumer credit amongst low to low-middle income consumers, with consumer loan growth increasing at approximately four times the rate of GDP growth from 2006-2011, with more than half of all new credits during this period at amounts less than $5,000. To address the potential for overindebtedness in the consumer credit sector, the SBS has enacted a series of supply-side measures, including
- Best practices and risk mitigation strategies that financial institutions dealing with consumer and small business loans should follow or at least take into account.
- Evaluation of financial institutions’ portfolios that focuses on the portion of their portfolio that includes small-value loans, including portfolio in arrears and rate of growth of this portion of their overall lending operations.
- Sanctions in the case that the SBS determines the financial institution does not monitor small-scale borrowers’ overindebtedness risk properly, including the requirement of additional loan loss provision requirements for the financial institution if their portfolio is deemed to be too risky or growing at an unsustainable rate.
Household debt surveys. Demand-side data can help providers and policymakers to understand gaps in our knowledge of consumer lending and debt levels across markets:
- Measurement of actual debt levels across different population segments and product types;
- Why household debt levels are increasing, and the primary uses of this debt in households; and
- The consequences of rising debt levels to a household (i.e. sacrifices in education, health, nutrition and other basic necessities as a result of rising debt levels.)
Another interesting use of this survey data is linking it with demographic and behavioral information, so that these surveys not only measure current household debt levels, but also explore the characteristics and behaviors that lead to high consumer debt.
For example, a household debt survey by the Banco de la República in Colombia examined household debt and financial literacy in a single survey. This led to an important observation that financial literacy performance actually does not correlate very strongly with high or low debt levels amongst the lower-income participants in the survey. This observation raises questions about the effectiveness of traditional curriculum-based financial education as a tool to drive consumers towards better financial management, and may speak to the need for interventions that seek more to influence behavior than increase financial knowledge.
Credit reporting systems.
Credit bureau coverage has expanded considerably in Latin America in the past decade, and there are several new pilots in the region that seek to build on these advances in credit reporting by focusing on the issues of consumer lending and overindebtedness. In Mexico, an ongoing study is examining credit bureau data on borrowers from microfinance institutions and consumer lenders, both to measure debt levels amongst low-income populations, as well as better understand the patterns that lead to overindebtedness. This study builds on the credit bureau data by conducting follow-up surveys with a sampling of the households in the bureau with high debt levels, to try and identify personal and financial traits or habits amongst these consumers that may indicate a propensity towards excessive debt. Another credit bureau pilot project in development in Panama is using psycho-metric information to measure traits such as honesty and responsibility to help identify credit-worthy individuals without any existing credit history, so that they are not excluded from access to financial products solely because they lack a credit history. MIF is also testing the use psycho-metric tools for credit assessments by individual institutions in Mexico , Peru and Costa Rica.
Latin America is a region with significant opportunity and urgency to take a global lead on financial consumer protection. The high supervisory capacity coupled with mature and innovative financial service providers make the region a perfect laboratory to further develop the above efforts to better understand the risks of base-of-the-pyramid consumer lending, and pilot other approaches as opportunities arise. In addition, the rapid growth in access to financial services amongst the lower and middle-class in Latin America create an urgent need for better understanding of both the benefits and the current and future risks that this expansion in consumer lending carries for high-growth countries across the region.