By NEIL HARTNELL
Tribune Business Editor
Commercial banks have revealed that debt consolidation loans frequently fail to reduce a troubled borrower’s debt service ratio to the 45 percent of income previously targeted by industry regulators.
Central Bank licensees, responding to the consultation on credit risk guidelines, warned that insistence on a fixed ‘one size fits all’ debt service ratio could drive borrowers towards “unregulated” consumer lenders and away from commercial banks and the formal economy. They speculated that the $300m drop in outstanding consumer credit over the four years to end-December 2021 could have been at least partially driven by borrowers switching to such lenders.
The Central Bank, though, in its response pointed to the relaxation of lending rules announced on August 12 this year, in which it permitted Bahamian commercial banks on a “case by case basis” to approve personal credit that would take a borrower’s total debt service ratio to a new maximum of 50 percent. The new ratio was also contained in the “management of credit risk guidelines” released yesterday.
Yet one unnamed bank, in its feedback, warned: “From a consumer credit and lending perspective, we note that many Bahamians are highly leveraged borrowers, and largely risk classified as medium-high to high risk. In addition, borrowers are able to obtain financing from unregulated lenders without restriction.
“Consolidation loans are sought from the commercial banks, which serve to reduce the customer’s debt service ratio and total debt service ratio, but often time the 45 percent debt service ratio is not achievable.” Observers will likely view that as a potential red flag, given that debt consolidation loans are often viewed as the last resort to stabilised troubled borrowers, but the suggestion here is that even this strategy fails to get them back on track.
“Whilst consumer loans in the commercial banks reduced by $300m between December 2017 and December 2021, the actual size of the country’s consumer loans is unknown as there is no reporting by the unregulated lenders and therefore the ‘decrease’ could actually be a transfer to unregulated lenders,” the same bank warned.
“ Against this backdrop, the implementation of an across-the-board debt service ratio of 45 percent could have the unintended consequence of pushing more financing to unregulated lenders. Improving the financial health of the average consumer borrower requires a holistic approach as opposed to one that will accelerate the movement of loans from supervised financial institutions to unregulated lenders..........
“Given the economic challenges of the last three years, implementation of a maximum total debt service ratio of 45 percent would retard economic recovery at this time. Consideration should be given to high income, stably employed borrowers whose disposable income is still significant at total debt service levels above 45 percent, highlighting the importance of considering disposable income.”
The Central Bank said it has done just that with the relaxation unveiled on August 12, 2022. “During the pandemic, the Central Bank had relaxed the total debt service ratio requirements of supervised financial institutions to encourage the sector to provide much needed support to the economy. The total debt service ratio is a macro-prudential tool of the Central Bank, thus this prudential ratio is subject to change,” the Central Bank replied.
“The impact that unregulated lenders would have is tied to the transparency in lending efforts that is a part of the credit reporting framework. Additionally, supervised financial institutions are expected to verify borrower income sources. Thus any additional borrowing would have to be supported with the borrowers disposable income.”
The credit risk management guidelines, released yesterday, reveal that the total debt service ratio has been increased from the previous 40-45 percent to 50 percent. Serving as a benchmark to determine a borrower’s ability to qualify for and repay a loan, the Central Bank confirmed: “The total debt service ratio applies only to personal loans for the purchase of all types of real property, loans secured by real property and the re-financing of all such loans.
“The total debt service ratio limit must not exceed 50 percent unless stipulated regulatory requirements have been imposed by the Central Bank on specific supervised financial institutions.” However, this 50 percent ceiling does not apply to commercial lending.
The Central Bank said all its licensees, including the commercial banks, must demand that borrowers provide a minimum 15 percent equity on all mortgage and personal loans. The only exceptions are those facilities secured by mortgage indemnity insurance, which will see this ratio fall to 5 percent. And, in calculating debt service ratios, haircuts of between 40-50 percent are to be applied to rental income, gratuities and investment income.
“When calculating the total debt service ratio, ordinary monthly income is defined as the sum of wages and gratuities, guaranteed rental and investment income. A 40 percent, 50 percent and 50 percent haircut should be applied to rental income, gratuities and investment income respectively,” the Central Bank said,
“Supervised financial institutions are to require a minimum equity contribution of 15 percent on all personal loans, with the exception of those secured with mortgage indemnity insurance which has an equity of 5 percent. The 15 percent equity contribution does not apply to cash secured credit facilities.” While there will be some exceptions to this, the Central Bank warned they are not to become the norm.