[2702] Tighter lending requirement has its cost

I am unsure what to think about the recent move by Bank Negara Malaysia (BNM) to tighten lending on the non-bank side of the lending system. While the statistics in that sector is scary when compared to the banks, the non-bank sector does provide financial services to the low-income earners. The financial services provided here are not the fancy derivative kinds but rather, it is pretty much bread and butter things: giving out vanilla loans for a lot of stuff.

Without these institutions, these low income groups would probably lack access to financial services that they are enjoying now. That in some way has to mean improved welfare because these loans have to be used for something, either investment or consumption. And investment is simply deferred consumption anyway, which improves welfare eventually.

I have to admit that there are some problems with lending in non-bank financial institutions (NBFI). There is an explosion of personal financing granted by NBFI but in the grand scheme of things, it is small compared to the safer banking sector. Still, in the personal financing sector, more than 50% of loans were granted by NBFI according to BNM in its 2012 Financial Stability and Payment Systems Report. What makes it more worrying is that NBFI has looser requirements compared to the banks. Also, average amount for personal financing given out by NBFIs in 2012 was RM68,000 per person while most of the borrowers are civil servants who do not make much. (Still, impaired loans ratio in 2012 was extraordinarily low in spite of looser requirements. That has to do with a government deduction program. While the program is useful in keeping the ratio low, one wonders what the disposable income level of these borrowers is given that the borrowers are mostly government servants who do not earn too much).

Nevertheless, what would happen if these finance services were restricted? Or tightened?

Some might not go to the banks because they would likely be unqualified to obtain loans. If you cannot qualify for loans from NBFIs, what are the chances of getting loans from a sector with tighter regulation?

Others might not borrow at all, which is probably the ideal outcome for advocates of tighter lending requirements. For those who used the loose requirement to buy unnecessary stuff like buying an iPhone, a widescreen television or an expensive laptop to show-off, then the non-borrowing outcome is good.

But if they borrowed money for education, for food or essentially for smoothing their basic consumption, tightening will make them worse off. In their case, those loans give them a chance to build their life. These loans give them a leg up. Making it costlier for them sounds exceedingly cruel.

The worst outcome is probably if they go to the shadowy part of the economy and that quite possibly means going to the loan sharks. Having borrowers migrating to the least regulated (or even unregulated) sector of the economy cannot be considered a success of regulation. Protection in the underground economy is not as robust in the ”upper ground” economy. There is no bankruptcy law there. Here, not only one increases the systemic risk rather than reducing it through regulation, there will like be human cost — that is costlier than being condemned to bankruptcy — by becoming victims of crime.

That said, the restrictions by BNM are not drastic and those regulations, while it may reduce lending by NBFI, it is unlikely to cause mass exodus from NBFI to elsewhere. So, it is hard to imagine if BNM’s move increases systemic risk at all.

Yet, a small group of individuals will probably do just that and this group may be worse off.

Here is the point I want to stress. There is human cost to the tightening and that has been ignored while the mass media praises the tightening.