Does Proof of Income (POI) enable creditors to lend more responsibly? Or does it reduce the access to credit for many South Africans? Last week a controversial court ruling was passed effectively eliminating the requirement for proof of income documentation on credit applications in South Africa.
In this blog, I take a look at how the initial POI regulation impacted consumers and the credit world, why and how the changes came about and what these new changes will mean to South-Africans.
Why did the NCA introduce proof of income regulations?
The original National Credit Act, 35 of 2005, came into effect on 1 June 2007. The primary objectives of the Act were to promote responsible credit lending while increasing consumer access to credit and protecting consumers from over-indebtedness. However, some aspects of the Act were not completely clear and open to interpretation, particularly concerning affordability assessment.
The Act simply stated that credit providers were required to take reasonable steps to assess a consumer’s affordability, before entering into a credit agreement. There were no further guidelines on how the affordability assessment should be conducted, and this was too vague to ensure adequate compliance by all credit providers.
The National Credit Amendment Act 19 of 2014 came into effect in March 2015 and contained Regulation 23A, the Criteria to Conduct an Affordability Assessment, setting out clear guidelines for credit providers, to be applied when assessing a particular customer’s affordability. These guidelines included the validation of declared income, or proof of income (POI), utilising payslips or bank statements and came into effect in September 2015.
What was the impact of the proof of income regulations?
The introduction of the new affordability assessment criteria and the very specific proof of income regulations had a significant impact on retail credit growth and retail credit sales. However, not all credit providers complied at the same time – some providers implemented the POI requirements before September 2015, while others complied in the months following September 2015. Therefore a few months elapsed before the full impact of the new regulations could be seen. Also, not all sectors of credit lenders were affected equally either, as some, for example, most of the banks, already incorporated POI documentation as a standard component to their affordability assessment processes.
The most significant impact of the POI regulations could be seen in Q1, and Q2 2016, where total credit granted had decreased by around R16bn or 13%, from before the POI regulations were introduced. The hardest hit industry was the Retailers, suffering ~32.3% year-on-year decreases in credit granted, during the first three-quarters after September 2015, as reported by the NCR’s Consumer Credit Market Report.
Why did the fashion retailers challenge the affordability regulations?
The fashion retail segment places significant reliance on in-store credit, to facilitate merchandise sales. In the months following September 2015, the fashion retail industry suffered a decrease of over R650m, or just over 26% in credit sales.
A few of the big fashion retailers, specifically The Foschini Group, Truworths and Mr Price, challenged the Credit Regulator and the Department of Trade and Industry in court, on the basis that most of their customers are employed in the informal sector and are therefore unable to provide the prescribed POI documentation required.
They believe that their internal affordability assessment processes are sufficient to assess the repayment-ability of consumers and that the prescribed POI documentation is an unnecessary burden for new customers. Self-employed customers, or customers in the informal sector, who do not have the required bank statements or payslips, are effectively being discriminated against by the new regulations, as they do not allow for alternative means of income verification. This goes against the spirit of the National Credit Act, which aims to make credit accessible to all consumers across all economic sectors.
Recently the court ruled in favour of the fashion retailers, stating that credit providers are no longer required to collect onerous prescribed POI documentation from customers applying for credit. However, the ruling does not take away the requirement for credit providers to confirm gross income, as part of the affordability calculation, to determine a consumer’s discretionary income and ability to repay the credit granted.
What impact will this have?
Credit providers have shown various reactions to the court ruling, ranging from eradicating the proof of income requirements to reducing it to a single payslip, while others are keeping the full requirements in place.
As mentioned, the fashion retail industry was particularly impacted by the POI regulations. This sector of the industry tends to lend to a higher proportion of credit unaware consumers, often those consumers in the informal sector, and thus stand to benefit the most from the court ruling. However, given that income will still have to be confirmed, it is doubtful whether credit will be granted without any form of income verification. It is most likely that they will simply go back to the credit assessment practices that were in place before the POI regulations came into effect, which may still involve documentation of some description.
The banking sector, on the other hand, is the one sector that should be able to do away with income verification requirements altogether, for credit applications from existing customers holding a current or savings account, where the monthly salary or income is deposited. Regular salary or income deposits could provide a measure of income verification. However, banks tend to be quite conservative and therefore will most likely continue with the current POI requirements for the verification of income.
The National Credit Regulator intends to appeal the court decision, as they believe that the POI regulations ensure that credit providers are lending against validated declared income, an essential requirement to avoid reckless lending. As a result of the court decision, even consumers who can produce payslips and bank statements are now no longer required to do so.
What does this mean for the future of affordability assessments?
The court ruling will by no means open the gates for easy credit and reckless lending. While the specifically prescribed POI documents are no longer compulsory, credit providers are still by law required to assess consumer affordability, to avoid granting reckless credit. However, now they can make use of their internal methods, models and mechanisms, as well as request their choice of documentation, or perhaps documentation that is easily obtainable by the consumer, when doing so.
In addition, the overall assessment of consumer affordability includes many different components, over and above POI documentation and credit providers will continue to evaluate these components when making credit decisions. This includes the verification of gross income, the inclusion of minimum expense ratios as prescribed by the Act, as well as checking credit bureau information, within seven days of making a credit decision, to assess a consumer’s debt repayment history.
By applying a combination of credit risk and affordability assessment components, credit providers can make sound credit decisions when granting credit, to the benefit of consumers as well as the overall credit industry.