Are Pinoys afraid of debt?

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On August 10, 2016
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Are you?

A recent survey showed that the Philippines has high levels of personal debt, and this is just among those who have investment transactions.

About 41% of Filipino investors borrowed money to finance their children’s education, medical expenses, and discretionary expenses. That proportion is second only to that of Malaysia in Southeast Asia, according to the Manulife Investor Sentiment Index survey released in March 2016.

But that is just one portion of a more complex whole. A closer look would yield nuances in how Filipinos view credit. It would lead to questions such as: Who are the biggest borrowers? What are the popular channels for credit? Why do Filipinos borrow? And what are the challenges to obtaining credit in the country?

To answer these questions, we created these charts.

Most Filipino adults actually think borrowing is good.

They believe that borrowing money is “beneficial” to them and their family. That’s the belief held by 77% of the adult population, according to a 2015 baseline study done by the Bangko Sentral ng Pilipinas (BSP).

Chart 1@2x

They see nothing bad with borrowing. In fact, 85 in every 100 Filipino adults want to have access to formal financial products and services, according to the study.

Across the world, borrowing money has helped the poor. Without credit access, an entrepreneur’s capital is limited to his wealthand for many poor, the cost to start up a business can be hard to raise.

World Bank survey of cross-country studies concluded that “improved access to finance reduces inequality and poverty.” These studies found that the country’s “financial deepening” can narrow income inequality and those countries with mature financial system are associated with faster poverty reduction.

The effect is not immediately obvious. There’s a point when income gap initially widens when a pack of the less-wealth entrepreneurs who successfully get credit diverges from the majority of poor.

When low-wealth individuals gain access to credit, they invest the money in building businesses. Eventually, a wider group of poorer individuals benefits, because wage rates increase as these less-poor entrepreneurs use their access to credit to build their companies.

The effect of credit access on declining inequality is thus through higher wages. On the bigger picture, the result is profound: poverty is reduced, employment rises, and economic growth accelerates.

In the Philippines, it’s not so much that the poor is getting any poorer, according to Jose Ramon, senior fellow at the Philippine Institute for Development Studies. “Their incomes are rising,” he said, “albeit only as fast as inflation.”

Over the past 30 years, household incomes have been growing—but the income was highly unequal. In 1988, the richest family earned 18 times more than the poorest family—24 years later, the gap narrowed but remains wide: the richest family earned 10 times more.

In this sense, access to credit can help poor families either augment their meager income or spur their own entrepreneurial activity.

Sadly, only a very few Filipinos transact with lending companies.

For every 100 Filipino adult, only 23 have transacted with a lending company, according to the BSP’s baseline survey. At first glance, this finding seems positive: people are less inclined to borrow and thus there’s less debt.

But it’s actually a cause of concern.

Chart 2@2x

When households get their loan approved, that would mean additional capital if it’s a cash credit or additional asset if it’s a car or home loan.

Because they’re able to access credit, they can now consume more goods and services. Businesses then need to produce more goods and eventually hire more workers. In the end, their consumption helps the economy grow bigger. Right now, household consumption accounts for 69% of the economy.   

But household debt in the Philippines remains low compared to other emerging markets despite its record-high growth rates over the past six years. Experts think domestic consumer lending is not enough to propel economic growth to higher path.

Household debt is equivalent to 6% of the country’s GDP compared to 20% in Indonesia and an average of 25% of GDP in emerging markets, according to McKinsey & Co.

In 2014, credit watcher Moody’s Investor noted: “The low levels of household debt in these two countries (Philippines and Indonesia) indicate that the recent growth has been from a modest base due to low penetration of banking.”

So in the coming years, as the Philippines is predicted to be one of the fastest-growing economies, there’s an opportunity to increase consumer lending given the current low percentage of household debt.

But this growth in consumer lending should be spread across the country.

But the thing is, most of the loans come from only one region.

Data from BSP shows that the whole banking system held loan and receivables amounting to P5.8 trillion as of December 2015. The data includes both industry and household consumption such as credit card, auto loan, and salary loan.

Data provided by BSP to Stack shows that majority of the total loan portfolio came from the country’s wealthiest region alone, indicating the very disproportionate access to credit.

Chart 5a@2x_REVISED

Within the wealthiest region, there’s also disparity. Banks located in NCR’s wealthiest city, Makati City, posted P2.9 trillion in loans and receivables, accounting for 58% of NCR’s total loans.

The two largest regional economies, Central Luzon and Calabarzon, account for 4% of the total loans.

Meanwhile, banks in Autonomous Region in Muslim Mindanao, the poorest region with the least number of financial access points, had P1.7 billion in loans, representing about 0.02% of the total portfolio. 

Chart 5b@2x_REVISED

This spatial inequality in access, in part, reflects the physical distance to financial institutions. The poor are less likely to borrow money from banks, partly because they are just far from them. A large portion of poor Filipinos reside in rural areas, but banks and their outlets are concentrated in urban centers.

Until now, 596 cities and municipalities don’t have banks located in their communities. In short, 36 in every 100 cities and municipalities are so-called “unbanked.”

This disparity indicates that the current formal lending system favors those people living in urban centers who have the money or large assets to begin with.

Lending transaction is the costliest.

Geographic distance partly explains why lending transaction is the costliest.

When the BSP conducted its baseline survey on financial inclusion, the respondents were asked how much they spend to reach the nearest access points and how long they could get there.

Among the dozen access points, reaching the nearest lending company is the costliest. BSP estimated that the average roundtrip fare was P63, followed by banks at P52.

Chart 3@2xVERSION2

It’s costly to transact with lending companies because their numbers are few and far between, as evidenced by the length of travel time. On average, it takes about P27 minutes and 2 seconds to get to the nearest lending company.

For those who borrow, the money comes mostly not from banks.

Most Filipino adults have or had debt: 47% currently borrow money.

But six in every 10 of the adults who borrow money said they got their loans from family, relatives, and friends. According to the latest 2012 Family Income and Expenditure Survey, families granted P26.5 billion loans to persons outside the family.

About 10% took loans from “informal lenders or loan sharks.” And only 4% of Filipino adults borrowed from banks.

The finding underscores the difficulties in getting credit from formal institutions.

Chart 4@2x

Lending to poor households or small entrepreneurs, according to the government’s own think tank Philippine Institute for Development Studies, “is a very risky venture, especially if lenders base their lending decisions solely on the strength of the cash flow position and the character of borrowers.” Any instability in the economy can thus make these loans much riskier.

In most cases, small and medium entrepreneurs remain dependent on internal sources of financing from their startup phase through their current operations. These sources usually come from their own pockets, or from their relatives or friends.

When borrowers go to loan sharks, they’ve become more indebted. There’s no available structured data to determine the average interest rates of informal lenders, but according to reports, there are some who charge 20% monthly or 20% daily.

A smaller survey on informal lenders conducted in 2013 initially saw a double-digit hike in the number of traditional clients composed of market and street vendors. “Non-vendor” borrowers, working-class individuals, who wanted to augment cash for daily expenses, had also multiplied since 2011.

One of the authors noted: “High interest rates and high frequency of payment installments make informal loans a debt trap for many borrowers, keeping them financially afloat for short periods of time, but making it difficult to break out of a borrowing cycle.”

Most Filipinos use credit to buy essentials.

What’s new—but hardly surprising—is that most borrowers don’t take credit to expand their businesses or improve their assets. They incur debt to pay for daily expenses, indicating a sign of financial instability on many borrowers.

Chart 6@2x

According to BSP, many borrowers use credit to buy food. Others take out loans to pay for school expenses, medical expenses, or fund emergencies.

This finding shows that borrowers try to augment their income through credit. And this is more acute, especially for the bottom 20% of families whose income sheets for the past three decades have been in the red.

This also suggests that the amount of their borrowing is not that big, which is expected because they take credit mostly from informal lenders. In fact, only 11% of adults noted they would use their credit to buy assets.

Personal and salary loans are the most common types.

It’s not surprising then that most Filipino adult turn to easiest-to-get types of loans in times of emergencies and short-term needs like school expenses.

Chart 7@2x

Half of the adults who have outstanding loans take personal loans, mostly from lending and financial companies—and about 20% of them apply for salary loan, mostly from government entities such as Social Security System.

While most Filipinos take personal and salary loans, these are smaller in amount compared to credit card or auto loans. BSP data as of April 2016 shows that outstanding loan for credit card stood at P175 billion; auto loan at P168 billion; salary loan at P47 billion; and, other household-type loans at P14 billion.

2 in every 10 adults do not borrow at all.

Of these adults, half say they don’t need it.

Chart 8@2x

About 16% said they don’t have collateral. Various studies have said time and again that banks exclude small-time borrowers from obtaining access to financial services.

One study cited three reasons for this exclusion. One, processing small-value loans costs too much. Two, small-time borrowers are perceived to be too risky. And three, they’re perceived risky borrowers because they don’t hold traditional types of collateral demanded by banks.

The problem is that few Filipino households don’t actually own a land. The 2010 census shows that about 4.5 million out of the 20.2 million households were renters. Only 1.7 million households owned car, jeep, or van—while 3.9 million had motorcycle or tricycle.

In another survey, BSP found out that eight in 10 households remain unbanked, making it hard for most households to borrow since some institutions require show money.

Meanwhile, according to BSP’s study, about 10% of the respondents said that interest is too high or there are too many documentary requirements.

Direct credit is a failure.

Over the last four decades, the government experimented with a host of direct financing, particularly for poor farmers. But the programs unfortunately didn’t make life any better for many of the beneficiaries.

In the 1970s, the government provided cheap credit directly to beneficiaries. The idea was that with credit at subsidized interest rates, farmers might be able to acquire modern farming inputs, use these, raise their production, raise their incomes, and eventually improve their lives.

But the cheap credit policy was a failure due to high default rates, declining funds for lending, and unchanged status of beneficiaries.

Microfinance was also extended to rural households. The government at one time helped organizations that employed Grameen Bank Approach in providing credit to the poor. One impact study, however, concluded majority of their clients were not poor.

Loan guarantees were explored as a way to bring credit to small-time borrowers like farmers. Two state enterprises, Quedan Rural Credit and Guarantee Corporation and Livelihood Corporation, provided loan guarantees to small farmers. These programs failed too. According to PIDS, these heavily subsidized programs failed to stimulate bank lending to excluded groups

Chart 9@2x

The Philippines’ failed experiment with direct credit programs is not an isolated case.

The World Bank noted that existing evidence suggests “direct provision of credit to the poor may not be the most important channel.” The bank noted that competitive and open market is still the core policy for efficiently allocating capital among people. 

Which now leads us to the final question: can digital technology foster an open and competitive market?

Digital lending is the game changer.

The truth is, it actually can. It’s its business model.

Digital lending uses mobile and online platforms to connect clients who seek credit with a host of banks willing to lend them credit. The pull of platform lending is in its simplicity in solving big problems in providing access to the “unbanked” segments of society.

In other words, platform lending gives back to customers the right to choose. In traditional lending, clients don’t have enough information on various banks’ products, preventing them from getting good deals.

Platform lending operates differently. It acts as one-stop loan shop where information on interest rates, application requirements, and processing time can be accessed easily from a mobile device. Such a solution can cut the time prospective borrowers spend in browsing various websites and comparing the products of banks.

Mobile Loan Saver, Pera Agad, and Lendr, loans platforms from Voyager Innovations’ FINTQ, are examples of digital lending offering this convenience to users.

Banks are not open 24/7—in the Philippines, there are still towns, sadly, without banks or ATMs.

Technology solves these problems. Through the digital lending platforms, loan applicants can save on the cost of traveling to and from bank branches and on waiting time.

Digital lending also brings stiffer competition in an industry dominated by the big banks. The ideal scenario is that banks can view its rivals’ interest rates and adjust its bid accordingly.

But the reality is that big banks dominate the market, leaving small players out.

Digital technology’s introducing this kind of competion in the lending industry by allowing small banks compete with the big banks.

It will be more exciting to find out what can happen when technology finally enables access to other financial institutions such as credit cooperatives, microfinance NGOs, and government entities providing salary and housing loans (GSIS, SSS, and PAG-IBIG).

The Philippines can also take cues from other countries. In Australia, online credit providers are on the rise. The prevailing sentiment is that SMEs are willing to leave their current bank for a specialist non-bank offering a better proposition.

Most importantly, digital lending overcomes the big information asymmetry problem inherent in the lending industry. Digital transactions leave behind a financial footprint that the industry can use to assess credit risk.

As it is right now, the country’s credit information registry maintained by the Credit Information Corporation (CIC) includes 9 to 10 million records comprising positive and negative information of individuals with formal borrowing history. The information are culled from formal financial institutions.

CIC was created after Republic Act 9510 was passed in 2008, establishing a nationwide Credit Information System. CIC’s mandate includes identifying data sources that the law does not mention such as data sources from fintech companies, which are currently outside CIC’s directive.

In an exclusive with Stack, President and CEO Jaime Garchitorena noted that fintech companies can become a gateway for the formerly unserved or underserved to gain a financial track record. One example is the group of fresh college graduates without a job history or any credit transactions to their name.

For such types of borrowers, “what if we find two separate sources of data that when put together can comprise the transaction history?” said Garchitorena.

It’s a start for fintech companies to make lending, and banking in the larger scheme of things, accessible across segments, especially the grassroots. Smartphone penetration is bound to explode from 40% last year to 70% in 2018. The arrival of cheaper models and usage boom in rural areas will only cement the role of mobile in Filipinos’ daily lives.

But the most practical benefit of this marriage between technology and financial services is the introduction of a new method of managing assets to the poor. It’s eliminating inefficient ways of borrowing. And because financial transactions are happening, more so digitally, it is also a way to establish a financial footprint.

contributes and covers tech innovations and financial inclusion for Stack.

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