By Samantha Joseph
In this first issue piece, we take a look at why the current household debt ratio is something to be worried about, what are the areas of particular concern and a peek at what Bank Negara Malaysia has implemented so far.
Mary (not her real name), has two credit cards with a combined debt of RM26,000, owes RM7,000 to a furniture company from furnishing a new apartment, and pays RM1,750 a month for housing.
“You hardly think about it until you find yourself in so much debt,” she admitted. “I finally went to AKPK for help because I didn’t know what else to do.”
Her cumulative debt payment every month leaves her with no savings from her take-home pay of around RM4,000, as the rest of the money goes to groceries, petrol, food and supporting her two children.
Mary’s story is not uncommon. Under normal circumstances, household debt is not something unnatural. Unfortunately for some, the demands of the increasing cost of living finds them leveraged to the hilt, with little savings and one financial crisis or missed check away from dropping out of the middle classes.
Household issues
But what gets households into such high debts in the first place?
RAM Holdings group chief economist Yeah Kim Leng, attributes the high rate of household indebtedness to easy credit terms, low interest rates and a combination of greed from both banks and consumers. Banks push their promotions, he says, to cater to the demand from households to borrow to fulfil their spending needs.
“Eighty-three percent does not represent some sort of magic number. We do not know what is the tipping point that will send an economy over the edge (to instability), but we are one of the highest in the region so it does merit close scrutiny by Bank Negara Malaysia (BNM),” said Yeah.
A debt-to-GDP ratio represents the size of the total household debt relative to the size of the economy where the higher the ratio, the more vulnerable the economy is to shocks.
The debt-to-household-income ratio means that the amount owed is 1.4 times income. The higher the ratio, the more likely the borrower is living beyond their means as well as representing a higher default risk.
Household debt has risen by 12.7% since 2008, but GDP has only grown at a rate of less than half of that. In fact, GDP growth was 5.1% in 2012, in comparison to an annual growth of 12% for household debt recorded for 2012.
“An indicator of unsustainability is if your debt growth is faster than your GDP growth,” Yeah points out. “A good measure of sustainability is to first bring it down, so that the growth rate of household debt is not higher than that of the nominal GDP.” (Nominal GDP refers to the GDP at current prices, while real GDP refers to growth at constant 2005 prices).
While liquidity in banking institutions increase the number of loans they take on, if consumers spend most of their take-home pay on paying their debts, little money goes into the economy, making it stagnant.
Not only that, when debts are prioritised over savings, the potential fallout is a retired society that is unable to care for themselves.
The leverage positions of borrowers in this group were 4.4 to 9.6 times of their annual income as compared to 2.3 to 3.3 times for those in the upper-middle and high-income groups, said the 2011 report.
A large number of these are civil servants who borrow from NBFIs (non-banking financial institutions) for personal loans.
CIMB Research chief economist Lee Heng Guie pointed out that this sector would be the most likely to be affected by changes in the economy. “I think that if there were any interest rate adjustments or an increase in the cost of living, it would result in substantial financial hardship and social problems for them. Some of them could live on very small balances for them to tide over difficult times.” This is if they even have savings at all outside of the Employees Provident Fund or EPF, a scheme that provides savings for retirees.
EPF’s numbers themselves are less than encouraging for those who have little to spare for savings: in their 2012 annual report, 85.2% of those who contributed to EPF had less than RM 100,000 in their accounts.
Essentially, there is an existing catch-up game between the GDP growth, income growth and debt growth that requires a delicate balance to preserve sustainable debt – and everything except debt growth is losing badly. If income is unable to catch up with growing debt, it does not bode well for either consumer or economy.
Banks, on the other hand, have little to worry about should a high incidence of borrowers be unable to carry out their monthly payments, according to Bank Negara Malaysia’s Financial Stability and Payment Systems Report 2012.
Even assuming that all default incidences, including increased impaired loan ratios and household defaults, the amount of possible losses the banks would have to bear could potentially amount to RM6.1billion. “Even if the incidences of default were to double, the loss amount is well within the available capital buffers of banks of more than RM80 billion as at end-2012,” the report stated.
Of course, if this situation were to become the norm, banks would eventually find themselves in a world of trouble, perhaps one similar to the American sub-prime mortgage situation.
What is being done?
Malaysia is not alone in battling a rising household debt. Canada is facing household debt increases for every year up to 2012, with one in eight Canadians having a debt-to-income ratio of 250%. Malaysians can sympathise, as a large chunk of that was attributed to mortgage loans.
South Korea is also a facing high household debt-to-income ratio: 160% according to Financial Times, 136% according to Global Post. South Korea’s reaction to it is to launch a US$1.3 billion government bailout fund to bail out borrowers.
The concern with a bailout for lower-income borrowers in South Korea is that default rates would go up in expectation that the government will be obliged to continuously help them out, and this also informs the fear of a form of economically-linked moral decay: less financial responsibility.
While a bailout is highly unlikely for us, greater regulatory steps have been taken by BNM to try and curb debt.
In 2011, the minimum income per annum eligibility for new credit card holders was moved to RM24,000 from RM18,000, and a maximum limit for number of cards was tagged to earnings; vehicle loans were limited to nine years and financial institutions were given the power to assess their own ‘prudent’ debt-service ratios according to individual borrowers.
The last step resulted in some banks following the suggested rate of 30% gross income of a borrower, while others, left to their own discretion, allow loan repayment to take up 50% of a borrower’s gross income. 60% is considered the absolute maximum for debt repayment.
But this did not take into account NBFIs whose regulations are far more lax, and were not under the supervision of BNM.
This was rectified by BNM this year, when NBFIs were placed under their jurisdiction through the Financial Services Act 2013. Personal loans also received attention, having their maximum tenure limited to ten years as opposed to the prior 25 years. The flipside to this is that borrowers might instead seek out moneylenders who operate outside the law for a loan.
The other two regulations BNM put into place were prohibiting pre-approved loans and limiting housing loan tenure to 35 years. Here the question is raised in terms of effectiveness – most loan tenures rarely go past 35 years, and banks usually target customers above a certain income level for pre-approved loans, limiting the number of people who are susceptible to them in the first place.
Are the steps being taken for each sector enough to have an impact in reducing household debt? Will the impact be far-reaching enough, and what will the repercussions be for regular Malaysians?
Tomorrow: House and car loans
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