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July – December 2019

What drives over-indebtedness in SADC countries?

What drives over-indebtedness in SADC countries

By Kingstone Mutsonziwa and Dr Ashenafi Fanta

  • DEC 2019
17 minutes to read

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Why credit is important?

Credit plays a key role in modern society. It helps people to smooth consumption and maintain a lifestyle when they earn less than they spend. It also allows people to cope with the consequences of illness, job losses, emergencies and unforeseen expenses. Credit can provide individuals with start-up capital to get their businesses off the ground and to pay for education in order to obtain employable skills. In general, consumer credit can empower people to make better lives for themselves by leveraging their future earning potential. At a macro level, the expansion of credit fuels household consumption, which is important for economic growth.

The rise in indebtedness

As access to credit increases, so does indebtedness among individuals. This is driven by a “culture of consumption” engendered by massive growth in consumer goods and the “democratisation of credit” leading to easier access to credit. Today, over-indebtedness has become a serious concern and an agenda item for policy makers in countries all over the world.

As access to credit increases, so does indebtedness among individuals. This is driven by a “culture of consumption” engendered by massive growth in consumer goods and the “democratisation of credit” leading to easier access to credit.

But what causes over-indebtedness?

Various factors contribute to over-indebtedness. These include:

  • Certain behaviours: Behavioural science attributes over-indebtedness to impulsivity, overconfidence bias and the illusion of control.
  • The occurrence of risk events: This includes job loss, marital breakdown, unforeseen expenses and poor financial management, modifying the initial conditions in which the contract between creditor and debtor was concluded.
  • Supply-side factors: These include lenders advertising and structuring their products in a way that would take advantage of the psychological biases and weaknesses of customers; and wider access to the formal financial services.
  • The lending policies of banks: A bank’s lending policy can determine an individual’s access to credit. In the UK, for instance, reckless lending was is found to be one of the causes of susceptibility to credit card misuse and over-indebtedness among young consumers.
  • Demographic factors: Factors such as age, gender, number of dependents, work status, marital status, illness or disability, financial literacy can help to explain over-indebtedness.
  • Cross-borrowing: Over-indebtedness can also be caused by cross-borrowing, which happens when one lender fails to satisfy the borrower’s needs.
  • Home-ownership: It has been reported that home ownership can increase the likelihood of over-indebtedness due to the availability of collateral.
  • Interest rates, inflation and house price increases: At a macro level, changes in interest rates, general inflation and house price increases are likely to lead to over-indebtedness.
  • Financial innovation: Financial innovation such as mortgage securitisation is considered to contribute to over-indebtedness.

At an individual level, over-indebtedness can lead to an increased chance of emotional distress, deteriorating well-being and/or mental health, poor health, higher perceived stress and depression, high blood pressure, family breakdown, and higher divorce rates. Over-indebtedness is also associated with decreased self-esteem and social relationships. More concerning, over-indebtedness may increase a person’s chance of involvement in crime like theft and robberies.

Excessive accumulation of debt can also cause households’ social and economic well-being to deteriorate, thus leading to poverty. Over-indebtedness can even create poverty, particularly among low-income, old age households and single-parent households with young children.

At a macro level, over-indebtedness can hamper consumption over business cycles and amplify recessions. It can lead to an increase in non-performing loans, which can weaken bank balance sheets and can cause a credit crunch as financial institutions become cautious about lending. According to the EU, household over-indebtedness adversely affects the overall health of the economy by curtailing aggregate demand, employment and growth.

Behavioural science attributes over-indebtedness to impulsivity, overconfidence bias and the illusion of control.

Taking a new look at the link between over-indebtedness and poverty

Although understanding the extent of over-indebtedness and its link with household welfare can provide input for workable policy interventions, research is marred by measurement problems caused by lack of uniformity in capturing the construct. The link between increased indebtedness and macroeconomic stability is relatively well researched. However, there is a lack of research on the link between over-indebtedness and poverty. That is why the researchers of this article introduced new measures of over-indebtedness using demand-side financial inclusion data to help explain the link between over-indebtedness and poverty in Southern African economies.

How the study was conducted

The authors analysed the determinants of over-indebtedness and their links with poverty using data from the FinScope Consumer Surveys conducted by FinMark Trust in different years on 51,359 individuals from 11 Southern African Development Community (SADC) countries (Botswana, Democratic Republic of Congo, Madagascar, Malawi, Mauritius, Mozambique, South Africa, Swaziland, Tanzania, Zambia and Zimbabwe). The FinScope survey typically covers demographic details of respondents, access to utilities, how they access financial services such as savings, credit and insurance products, and whether they used formal or informal financial institutions.

With the growing importance of mobile money as a channel to provide financial services to the hitherto financially excluded segment of society in Africa, a new module was added to solicit information on the extent of access to mobile phones and mobile money.

Measuring over-indebtedness and poverty

There are various definitions of over-indebtedness, making it difficult to measure the construct. According to the EU, households are considered over-indebted if they find it difficult to meet their commitments, whether these relate to servicing secured or unsecured borrowing or to payment of rent, utility or other household bills. Other researchers classify individuals as over-indebted if they are spending more than 25% of their gross monthly income on unsecured repayments; or more than 50% of their gross monthly income on total borrowing repayments (secured and unsecured); or have four or more credit commitments; or are in arrears on a credit commitment for more than three months; and declare their household’s borrowing repayments to be a “heavy burden”. It has also been said that a household can become over-indebted when its total borrowing repayments reduce its income to below the poverty line.

More concerning, over-indebtedness may increase a person’s chance of involvement in crime like theft and robberies.

In this paper, the researchers considered a person as over-indebted if that person:

  • Is borrowing to repay another debt
  • Does not want to borrow because of too much outstanding debt
  • Had a loan application turned down because of too much debt
  • Had debt restructured
  • Defaulted on a debt obligation
  • Had a garnishee or emolument order or have been garnisheed.

As a result of data unavailability, the researchers were compelled to use food poverty as the only variable available across the countries in the study. To generate the poverty variable, they used the statement “Gone without food due to lack of money”. Responses to the statement were recorded as “Always, Sometime, Rarely and Never”. They collapsed “Always and Sometimes” into 1 and “Rarely and Never” into 0. Those who always or sometimes had to go without food are considered economically poor.

The analyses provided interesting insights into over-indebtedness at a regional level. For example:

  • 32% of adults in the region are indebted and access credit from banks, or other formal or informal sources.
  • 36% of adults are credit literate, which exceeds the percentage of those who are indebted.
  • A quarter of adults in the region are over-indebted. Although this does not seem too much when viewed in isolation, it is worrisome given that only one-third of adults are indebted. It suggests that, on average, 78% of adults that access credit are over-indebted.
  • Informal credit is more popular than either bank credit or other formal credit.
  • Penetration of bank credit is small with only 6% of adults having access to it while 10% have access to credit from other formal institutions and 17% have access to informal credit.

There is the potential to access secured formal credit because 63% of adults own residential property. The analysis of home ownership by rural/urban shows that home ownership is higher in rural areas. However, formal financial institutions are scant in rural areas. This means people in rural areas may not be able to use their properties as collateral to access credit. Also, homes in rural areas usually have no title deeds and thus cannot be used as collateral to borrow money.

… household over-indebtedness adversely affects the overall health of the economy by curtailing aggregate demand, employment and growth.

Drivers of over-indebtedness

Over-indebtedness can be triggered by a combination of supply-side factors, personal characteristics and risk factors. This analysis focused on the personal characteristics of adults – such as credit literacy, number of institutions from which credit was obtained, source of credit, home ownership and socio-demographic characteristics. This is what the analysis found:

  • Credit literacy: Credit literacy is negatively related to over-indebtedness in Mauritius, Mozambique, Swaziland and Zambia, suggesting that credit literacy helps to keep individuals from accumulating debt to the extent that they are unable to pay it back. In Botswana, Madagascar, Malawi South Africa and Tanzania, credit literacy is positively related to over-indebtedness, implying that credit literate individuals are more likely to be over-indebted. This may be attributed to a measurement problem.
  • Number of institutions from which credit was obtained: The number of institutions from which credit was obtained is generally related to over-indebtedness, except in Mozambique and Zambia. Individuals who access credit from multiple sources (like banks, non-bank formal institutions and informal institutions), are more likely to experience over- This implies that cross-borrowing may be viewed as a signal to potential over-indebtedness.

Informal credit is more popular than either bank credit or other formal credit.

  • Cross-borrowing: This study’s cross-borrowing measure has a limitation in that it captured borrowing across lenders in the banking, non-bank and informal financial sectors. As a result, cross-borrowing within each sector has not been considered due to data unavailability. Future studies using cross-borrowing within each sector can provide a more accurate picture of its effect on over-indebtedness.
  • Home ownership: This is positively related to over-indebtedness in six out of the ten countries included in the analysis. Ideally, home owners are expected to exhibit better household welfare levels and be less likely to experience over-indebtedness. In an economy with a developed mortgage market, a positive link might suggest high level of indebtedness driven by home loans and the subsequent inability of home owners to repay their outstanding mortgages. However, given that the mortgage markets in many SADC countries are underdeveloped (the mortgage loan to GDP ratio is less than 10% except in South Africa, Mauritius and Namibia), the alternative explanation for the above relationship might be that home owners have a relatively better chance of accessing credit using their property as a collateral compared to non-home owners, and hence they have a higher chance of over-indebtedness.
  • Income: Contrary to expectation, increased income is likely to increase over-indebtedness, suggesting that perhaps behavioural rather than economic factors better explain over-indebtedness.

The link between over-indebtedness and poverty in the SADC countries

This analysis focused on the effect of over-indebtedness on poverty, which is one of the welfare indicators. Based on the data, over-indebtedness increases the chance of poverty except in Botswana, Mauritius and Madagascar. It has also been said that over-indebtedness can erode income to the extent that people are unable to afford the basic needs of life. The negative relationship between over-indebtedness and poverty in Botswana, Mauritius and Madagascar might be due to individuals using excessive debt as a means of subsistence. However, a caveat to this conclusion is the potential role of social capital to increase individuals’ coping ability.

… homes in rural areas usually have no title deeds and thus cannot be used as collateral to borrow money.

Home ownership is related to a lower chance of experiencing poverty in five out of nine countries. Home owners in Botswana, Malawi, Swaziland and Zimbabwe are more likely to experience poverty while those in South Africa, Mauritius, the Democratic Republic of Congo, Tanzania and Madagascar are less likely to experience poverty. In this study, the home ownership variable was based on whether respondents lived in the property they own. This could bias the results as this approach disregarded the quality of the property. Respondents that owned property in urban areas were more likely to exhibit better welfare outcomes compared to their counterparts in rural areas.

Number of dependants is related to an increased chance of poverty in countries except in

Swaziland, Tanzania and Zimbabwe. The negative relation between dependants and poverty in Swaziland, Tanzania and Zimbabwe might be due to the contribution of dependants to household income in rural areas through agricultural labour, thus increasing these households’ coping capacity.

Obviously, income and employment decreased the chance of poverty across all the countries. Similarly, the incidence of poverty was lower in urban areas than in rural areas, implying that the brunt of poverty rests on the shoulders of rural people.

In general, over-indebtedness is related to an increased chance of experiencing poverty in South Africa, Malawi, Swaziland, Tanzania and Zimbabwe. In Botswana, Madagascar and Mauritius, the over-indebted are less likely to experience poverty, which might be due to the poor in those countries financing their cost of living by obtaining credit from multiple sources.

Conclusions

The results suggest that over-indebtedness is driven by, among others, lack of credit literacy, cross-borrowing and a lack of income. The results also suggest that over-indebtedness is likely to impoverish the indebted.

Contrary to expectation, increased income is likely to increase over-indebtedness, suggesting that perhaps behavioural rather than economic factors better explain over-indebtedness.

These findings have important policy implications. Policies that encourage access to financial services such as credit should therefore be designed in such a way that increased financial inclusion does not aggravate poverty and inequality. Also, government agencies such as central banks and treasuries should educate individuals on the benefits and costs of credit.

  • Find the original article here: Mutsonziwa, K., & Fanta, A. (2019). Over-indebtedness and its welfare effect on households: Evidence from the Southern African countries. African Journal of Economic and Management Studies, 10(2), 185-197. https://doi.org/10.1108/AJEMS-04-2018-0105
  • Kingstone Mutsonziwa is from Department of Information and Research, Finmark Trust, Johannesburg.
  • Dr Ashenafi Fanta is a senior lecturer in Development Finance and programme head of USB’s PhD in Development Finance.

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