Loose lending caused the default deluge

A large number of personal loan and credit card defaults in the UAE could have been reduced, had banks enforced proper regulatory mechanisms and prudent risk management practices, according to officials of a consultancy and analytics firm.

They said banks needed to come up with stricter regulations and tighter lending criteria based on real facts, as a vast majority of defaulters had no intention of paying back the loans.

"When we began the survey of borrowers we noticed that many of the borrowers didn't pay their first bill. Obviously, with many of them not having made the first payment we got to know that their intention was to skip the payment," Ashruf Hassaballa, General Manager, Orion Analytics, told Emirates Business.

"When we looked at their payment behaviour we could determine who was intentionally paying and who didn't. Although there were standard cases of job losses and the borrowers couldn't pay the loan, but the trend clearly shows that their intention was not to pay."

Shahab Jafry, Content Manager, Orion Analytics, said: "An overwhelming number of personal loan and credit card borrowers just didn't make first repayment. This must have been intentionally done.

"There were mainly two or three categories of borrowers. The one was composed of a very low earning group, which would see an unprecedented opportunity to borrow and they borrowed heavily and disappeared.

"Another group of borrowers invested the borrowed money into the market, especially in the real estate market and when the market turned bearish they just disappeared," said Jafry.

Credit crisis and default

He said the economic slowdown definitely exasperated the problem, but we found that the original problem lay in the loose lending policies by banks and to the much looser risk management practices. Banks were just lending across the board during times of a very high growth but a lot of leakages went unnoticed. It is when the credit crunch came in and when they had not enough money to lend that they started looking at the money that had gone waste.

During high growth period, many banks in the UAE were giving bonuses to credit card departments on the basis of the number of cards they were handing out without taking into account the exercise that went behind the risk management. So they went a little out of the way to lend to people that didn't deserve at that point of time. A slightly more prudent risk management would have lowered the number of defaults, he said.

Jafry said banks had no idea who they were lending to as everything was going smooth, and their risk management department too had no profiling of the potential defaulters. At the same time a lot of speculation was going on, especially in the real estate sector. As a result, borrowers took advantage of the loose lending policies and invested a lot of that borrowed money into flipping or speculation and banks were not in a position to check that.

However, just raising the salary bar for lending to individuals could be one of the solutions to prevent defaults, but this is not the only solution because then banks would have very few people to lend to, said both analysts.

"There has to be strategic rethinking on how to evolve proper risk management tools by banks," said Hassaballa. Orion Analytics yesterday released its first Skip Report gauging the incidence of skipping (borrowers leaving the country without settling bills) across the UAE between the time period 2000 and Q3-2009.

According to the study, skipping emerged as one of the principal concerns of the economic division as the international financial crisis swept across the region and affected financial activity in the UAE.

The skip phenomenon

Yet a closer look at commercial banks' personal lending and credit cards statistics reveals that the skip phenomenon had started adversely affecting bank lending well before the international recession forced increased defaults, and was prevalent even in the boom years marked by high economic growth and personal borrowings as the emirates positioned itself as the key financial hub in the region.

"Our findings reveal that the problem is associated more with ad hoc lending policy pursued by individual banks as opposed to an unavoidable skip environment, and can be dealt effectively by an appropriate policy response that ties commercial bank lending activity with central bank directives governing the lending regime. So far, there is neither a cohesive database profiling skippers between lending institutions, nor is there an effective oversight instituted by the central bank," the authors said in the report.

As the international recession set in and unemployment unexpectedly rose in an unprecedented manner, a large bulk of the working population was caught wrong-footed, unable to meet credit obligations in the face of bleak earning prospects. It was a little surprise, therefore, that the majority of them chose to simply skip. Furthermore, the system has no mechanism of identifying previous defaulters. If one individual is to be black-listed from one bank and approach another for a loan or credit card, there is no central database to facilitate identification of previous defaulters, it added.

Still, the effects of the liquidity crunch and unemployment increase are not the sole factors behind the rising skip phenomenon. Easy credit in the boom years encouraged unwarranted borrowing long before the credit markets were strained.

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