Insights from the African retail credit market 0
Posted on 14, January 2014
On a recent engagement for a global retail bank, I was lucky enough to have the opportunity to travel to 10 of the African countries in which they operate. The project entailed examining the source of poor debt quality in the region and focused on collections and recoveries operations. After the first 3 months, we noted a number of common issues facing banks across the 10 countries. It is felt that overcoming these issues will offer significant benefits in terms of portfolio profitability, debt quality and customer service to name a few, but is it as simple as that?
Lack of centralised consumer credit information
Although there are institutions in a few of these countries that are taking steps to consolidate the consumer credit information, centralised credit bureaux similar to the credit reference agencies in the UK or credit bureaux in SA do not exist. The impact of this is that underwriters are unable to accurately assess the indebtedness of potential borrowers at the time of booking the loans.
Interestingly, collections agencies, that is, companies to whom collections and recoveries are outsourced, often have a richer view of the obligations facing customers as they store this information from their clients in the banking sector as well as mobile phone providers and retailers. Unfortunately this information is only used in the collections activities rather than at the point of underwriting by which time the proverbial horse has long since bolted.
Poor understanding of how loan financing works
Our observation of customer behaviours suggests that they have a poor understanding of the mechanics of loan financing. This leads to an unhealthy appetite for debt which is fuelled by inappropriately incentivised loan underwriters who try to make it as easy as possible for people to take on debt so they can meet their targets. Combine this with the absence of centralised consumer credit ratings and it’s easy to see how many customers’ debt service ratios often exceed the recommended levels of 30%, ultimately leading to an inability to service debt and subsequent delinquency.
Lack of national identification schemes
Although many of the countries visited had effective national identity schemes, where these were absent, there were significant challenges. The Ugandan government has ceased issuing national identity cards and Tanzania has only recently introduced a national identity scheme. This makes it very difficult to uniquely identify customers and consolidate their credit information. This not only leads to asymmetric information at the point of underwriting, but also at the point of collections where customer contact information may have changed and it is not possible to link one John Smith to another.
Poor job stability
In many of the countries visited (most notably Zambia and Tanzania), there is poor job stability, particularly in the mining sector where the demand for labour fluctuates. Given the fact that miners are relatively well paid, underwriters are generally willing to grant them loans which would be unserviceable in many roles to which their skills might be transferrable (e.g. construction). This means that when miners find themselves out of employment in the mining industry they face immediate delinquency even if they can find alternative employment in another sector.
Poor quality contact information
KYC (Know Your Customer) regulation requires institutions to consolidate and maintain accuracy and currency of their customer contact information. Unfortunately, this is far from the reality in Africa. In Ghana for example, the growth of housing developments has outstripped the ability of local governments to create an address system (see here for details). In other countries, some customers provide addresses of empty plots and given an inadequate proof of address requirement, there is no way of validating this information. The end result is that bankers are often unable to locate their customers once their obligations are past due and the loans ultimately get written off.
When it comes to phone numbers, the increasing prevalence of mobile phones and the disposability of pay -as-you-go numbers mean that as soon as customers become delinquent, they discard their lines and obtain new ones to thwart the debt collectors’ efforts.
Prevalence of predatory short-term lending
If you take all of the above and add to the mix the rise and rise of microfinance institutions in the African market, you get a worsening situation. Unscrupulous short term lenders often prey on individuals who are unable to pay back debts to other institutions like banks or retailers. These individuals will use the short term loans to finance their longer term obligations and get stung with astronomical interest rates for their troubles, only to re-enter delinquency the following month.
Limited focus on customer lifetime value
Many accounts, particularly those in later delinquency cycles, are outsourced to collections agencies. These agencies often pursue collections targets at the expense of treating customers fairly. Customers who have been poorly treated by collections agencies associate that experience with the lending institution and invariably will move to another bank once they become rehabilitated. As a result, the potential future earnings from these customers are lost. There is an increasing focus by global market-leading lenders on viewing their collections efforts as more of a customer debt rehabilitation exercise, rather than an effort to reduce distressed debt. This distinction is important because the difference is in the treatment of the customer, the ultimate source of profitability.
So what’s the answer?
From what I observed, the operations with the healthiest portfolios were those with the most conservative credit risk strategies, loaning only to those with the utmost likelihood of repaying their debts. But as we all know, risk and reward are inextricably linked and for those wishing to profit in this new world, addressing these issues is going to be the battlefield on which the fight for supremacy in the African retail credit space is won.
Are these challenges in line with your experience? We'd love to get your take in the comments below.
Michael is a Lead Analyst who, at the time of writing (December 2013), had recently returned from an engagement with the collections and recoveries division of a global retail bank in Africa. The exercise was aimed at establishing a more effective target operating model to cater for the challenges being faced in the market.