Bankable Frontier Weblog

I recently attended a two day symposium organized by Harvard’s Joint Centre for Housing Studies on “Understanding Consumer Credit”. The focus of the papers and discussion was squarely on the US, especially in the light of the problems spilling out of the sub-prime mortgage market into other sectors of consumer credit.  However, I came away with a strong message for financial policy in emerging markets as well.

In many emerging markets, consumer credit is burgeoning. An S&P report estimated that in the BRIC countries alone, the value of outstanding consumer credit has increased at an annual rate of 40% p.a. in the period 2001-2005; and is expected to continue at a rate of 30% p.a. in the years ahead: this means that debt is doubling every 2.5 years. Many factors have led to this, including more competitive financial markets in these countries servicing clients with relatively low debt levels resulting from the limited availability of consumer credit before. But underlying all this, the policy paradigm that promoting greater access to financial services, especially credit, is “A GOOD THING” has gained momentum. Nobel prize winner Mohammed Yunus, pictured below, represents the apogee of this view, when he expresses the view that access to credit is tantamount to a human right.

To be sure, Yunus is thinking especially of the poor who generally have lacked this access. Also, many in the sector have dissented, arguing rather that it is savings, or basic bank accounts, which are the human right. 

However, the US experience with consumer credit represents in many ways the high water mark in the access to credit debate: over the past three decades, there has been substantial liberalization of credit pricing and regulation in the US, leading to substantial innovations in risk based pricing and product design as well as strong distribution by lenders of all types (especially via brokers). According to numbers presented at the conference by JCHS, the rate of increase of households carrying all forms of consumer debt has been highest among the lower middle and lowest income quartiles of the population. In many ways, the general problem of access to credit among lower income people has been solved in the US. But the conference indicated that the result of solving the access problem can be to create another problem: over-indebted consumers with inappropriate products, such as variable rate mortgages in an environment of rate increases and falling property values. This is not only a problem for these consumers, but increasingly for lenders of all types, and as the dimensions grow to become system-wide, even systemic, the government itself which is reportedly having to plan a bailout as large as the one following the S&L crisis in the 1980’s.

The JCHS conference reflected on new evidence that borrowers are seldom if ever economically rational in the sense often presumed by theory and by policy makers (although lenders never presumed this, and rather concentrated on exploiting biases in patterns of behavior). In addition, disclosure of increasingly complex product features has little value it seems if people ignore or don’t understand them. One participant went so far as to suggest that allowing access to some forms of credit is akin to allowing children to play with fire. Some form of effective regulation is necessary to prevent getting burned. Much debate will take place here as to what form that might take.

In developing countries where credit is now burgeoning, effective regulation does not mean turning back the clock from today’s concern for access to the bad old days where outdated, paternalist attitudes protected the lucky few who could get formal credit. But it does mean moving beyond the view that access to credit is everything, far less a human right, to asking about what forms and sorts of access are appropriate and when. After all, the US today shows us what can happen when you get what you wish for!