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Farayi Dyirakumunda Correspondent
There has long been a perception that personal loans advanced to individuals are used to drive consumption and are not beneficial to the overall economy as they do not assist or drive investment.

Therefore, the proposition is that in consumer finance, the default funding preference should always be savings, unless there is clear justification for why credit would be better suited. In other words, personal loans are viewed as “bad”, whereas other forms of credit towards productive purposes or secured loans/mortgages are “good”.

This debate has come to the fore with the increasing accessibility of personal loans through micro-finance institutions and other forms of retail credit. The attraction to credit is simply that it allows the benefit of immediate spending, however, credit has another constant companion: the risk of over? indebtedness, which increases with growing levels of debt.

Over the past few years, individuals have turned to credit to fund a lot of their purchases. Household indebtedness among salaried employees such as civil servants in particular, has therefore increased steadily over the post-dollarisation period, with the debt-to-income ratio in certain instances rising beyond 100 percent.

Access to consumer credit has steadily increased while credit use has become more intensive, with the average household having multiple commitments, compared to the levels recorded in 2009.

An important question then arises. What then are the actual reasons consumers mostly take out these short- term loans? And can there be a guideline of what constitutes good credit? We have observed that most low- to middle- income customers are taking loans to cover unexpected expenses and the balance goes towards items such as school fees, a shopping deal, fashion items or gadgets.

Urban customers appear to have an appetite driven primarily by a higher sense of entitlement to aspirational material things and a greater expectations of consumption towards a perceived higher standard of living. These borrowers are often determined to provide their families with aspirational material goods consisting of nice home items, consumer electronics, trendy clothing, and are prepared to go to very considerable lengths to do so.

Those with lower incomes often have to borrow to secure basic needs, however, in many instances their incomes are too low to sustain the monthly repayments. In such cases, the debt is closely associated with poverty, and the growth in debt is closely connected with the growth in poverty, particularly in single income households with children.

It seems then that, greater saving and more responsible borrowing will both help households smooth their expenditures and ensure a sustainable and balanced economic recovery. As a credit reference bureau, we have a commitment towards the promotion of responsible credit behaviour and in designing our credit assessment tools we included the need to assess consumer affordability. We want consumers and lenders to make better borrowing and lending decisions respectively.

In addition, we propose that owning and responsibly using a credit line through paying loans on time within the agreed-upon payment, helps consumers develop a favourable credit history and a favourable credit score. Financial institutions or other lenders will utilise this credit history when a consumer needs credit for things such as a mortgage, funding a business activity or purchasing an asset. The more responsible you are with credit, the more creditworthy you become.

The guidelines for the relative appropriateness of credit over savings are not hard and fast and provision is made for differing attitudes towards debt. That said, respecting client decisions doesn’t prevent us from recommending suitable client behaviour and according to a study by the Financial Access Initiative, there are two main types of expenditure for which credit should be the preferred vehicle over savings as illustrated below:

Consumer Funding Preference

Credit

Productivity enhancing activities

Unpredictable expenses

Savings

Non-productive activities

Predictable expenses

Impulse purchases

According to the FAI study, there are two main types of expenditure for which credit should be the preferred vehicle over savings. The primary one is when the object being funded can significantly increase household productivity.

As with business investment, the metric here is straightforward: if the opportunity cost engendered by the delay required to save up the needed sum exceeds the cost of credit (both in terms of interest and risk to the borrower), then credit should be the preferred vehicle.

The second type of expenditure where credit is preferable to savings is unpredictable expenses. Saving for unpredictable expenses, such as medical care, seems to be more difficult than for predictable ones, such as school fees. That makes credit a critical tool for dealing with emergency spending needs. But emergency is a relative term, and the immediate availability of credit makes it also a perfect tool for funding impulse consumer goods purchases.

This problem is best addressed by taking the impulse out of the process, using savings schemes designated for such aspirational but otherwise non- productive goods.

In conclusion, we believe that appropriate levels of credit can certainly alleviate hardships in households by expanding options when managing consumption over time.

If an otherwise credit-constrained household can borrow, even for a short period, it can potentially smooth expenditures around periods of income or consumption shocks, which in the absence of borrowing can lead to adverse events. Our role within the credit market is to assist both consumers and providers of credit to make informed decisions that are mutually beneficial and promote responsible credit behaviour.

• Farayi Dyirakumunda is a Director at XDS Zimbabwe, a credit reference bureau and risk management company. He can be contacted on [email protected] <mailto:[email protected]> / www.xds.co.zw <http://www.xds.co.zw>