The civil service debt swap arrangement has raised so much debate over the past two weeks with so many theories being bandied around.
I will not dwell on the merits and demerits of the initiative, but want to look at the genesis of what has led to this.
I came across a rural-based primary school teacher who lamented her financial situation.
She had borrowed money from a micro-finance lending arm of a named financial conglomerate for a period of three years at a monthly repayment rate of K2,000 effected through the payroll system for the public service (PMEC) on a gross salary of about K5,000.
Later on, a representative from the same financial conglomerate went to their school to market ‘some product’ which she was induced to sign up for presumably to cover for her parents’ funeral expenses at a monthly deduction rate of K600.
This took several months to be effected through DDACC direct debit from the bank where she has a salary account which has unexplainably turned out to be a monthly deduction of about K1,500!
With other statutory deductions such as PAYE, NAPSA, health insurance, she has for the past several months been netting a salary of about K900 to provide for a family of three and two divorced parents.
When I asked her what product she signed up for, she said she does not know exactly but that she signed the DDACC form at the DEBS office.
She followed up the matter with the financial institutions regional office in Kabwe and they only apologised for the ‘double deductions’.
They assured her that they would send her a refund payment by the end of June together with other fellow teachers affected.
This is the end of July now, and she has not received the refund cheque!
This is a whole too familiar story for many civil servants around the country.
But how do situations like this happen when we have financial sector regulators, and when people (especially learned ones) should know that they should only append their signatures to documents that they understand?
One of the manifestations of lack of financial literacy (financial illiteracy) is over-indebtedness as highlighted by Anna-Maria Lusardi and Peter Turfano in their 2009 paper on Debt Literacy, Financial Experiences and Over indebtedness.
This study considered debt literacy as the ability to make simple decisions relating to debt contracts, and the application of basic knowledge on interest compounding to every day financial choices.
It is important to note that debt literacy is considered as a component of financial literacy.
Literature reveals that globally, personal over-indebtedness has become a major concern for governments and regulators.
This has been linked to the proliferation of financial services, especially easy credit, mainly arising from the liberalisation of financial markets and the increase in competition, and financial illiteracy on the part of financial service consumers.
The significant increases in consumer indebtedness is causing concern about its economic and social impact.
In particular, over-indebtedness is attracting attention from national and international authorities because of its potential effect on both the sustainability of households’ indebtedness and the stability of financial systems.
From a social point of view, the excessive accumulation of debts, accompanied by households’ liquidity constraints, causes deterioration in households’ social and economic well-being, leading in the long term to social exclusion and poverty.
At one level, the answer to the question of whether to be concerned about over-indebtedness is obvious.
Over-indebtedness hurts poor clients whose welfare is the declared objective of most lenders, funders, and governments.
And over-indebtedness sooner or later tends to produce delinquency and default, which threaten the lending institutions’ own viability.
So over-indebtedness should always be a concern, in principle.
In line with happenings around the world, over-indebtedness is also becoming eminent in Zambia due to the proliferation of financial service providers especially the micro-finance institutions following the liberalisation of the economy.
Indeed, concerns have been raised about some public workers getting negative salaries as a result of excessive borrowing.
A first driver of over-indebtedness is financial imprudence i.e. poor financial decisions caused by an inadequate understanding of the real cost of repaying the loan.
According to the UK’s Department of Trade and Industry, 2001, this factor may be linked both to the issue of the transparency of lenders’ terms and conditions and to borrowers’ financial literacy and ability to manage their finances correctly through failure to plan for expenses and income.
Imprudence may also derive from psychological biases and mental shortcuts that affect consumers’ decisions and predictions about borrowing, such as the over-confidence, bias, i.e. the tendency to underestimate the probability of suffering an adverse event.
People are considered “over indebted” if they have serious problems in paying off their loans or debts.
Technically, over indebtedness occurs when the repayment outcome of a loan contract does not correspond to the original expectations of either the borrower or the lender or both.
Such a definition creates a problem when it comes to measuring over-indebtedness.
So proxies or indicators are, instead, used.
For example, one could measure borrowers’ debt payments as a percentage of their income on the assumption that people whose debt service ratio is high are more likely to encounter serious difficulty in repaying.
In 2010, The European Commission (EC) developed a common definition of over-indebtedness which is used across the European Union (EU).
In a recent study by the author, to determine levels of indebtedness, sources of indebtedness and reasons for indebtedness at a large public institution in Kitwe, the author identified high levels of indebtedness amongst these public service workers.
The EU framework for measurement of household over-indebtedness was used in the survey. The approach is widely used because it is more comprehensive and thus more reliable than single indicator measures.
This framework uses five composite indicators namely: negative impact, default and arrears, debt and debt service ratios, multiple borrowing, and borrower struggles and sacrifices.
For negative impact, the test, then, would be whether the debt makes the borrowers worse off than they would have been without the debt.
Loans that make borrowers better off should thus be preferred even if repaying them ties up a big portion of the borrowers’ income, or the borrowers have to struggle to repay.
Default is the most common indicator for over-indebtedness; this arises when borrowers have loans they can no longer repay.
Arrears or delinquency are indicators of over-indebtedness in that they start flagging the problem a little earlier, when a payment is late, but before it’s clear, the loan won’t be repaid.
Arrears and default rates often measure a consequence of over-indebtedness but not over-indebtedness itself.
They are the most widely used indicators only because they are the easiest to measure.
Arrears identify individuals who are behind with an unsecured credit commitment on a credit card, hire purchase agreement or personal loan.
Debt and debt service ratios define as over-indebted borrowers who have borrowed “over” a certain limit.
The limit is often framed as the ratio of individual or household debt service to income (or take-home pay).
One is over-indebted if loan payments eat up more than X per cent of one’s income.
A very good example of such a ratio, is the PMEC (civil service payroll system in Zambia) imposed initiative of regulating payroll lending by limiting total payroll loan and non-loan deductions (taxes, allowances, etc.) to 60 per cent of gross pay (e.g., employees must take home at least 40 per cent of their gross pay) in line with the civil servant payroll deduction threshold. Unfortunately, this does not capture debt assumed outside the PMEC system.
Public service workers enter into loan agreements directly with lenders where loan deductions are made through DDACC direct debits from their salary bank accounts, making it difficult to maintain the PMEC threshold and impossible for employers to have an idea of employees’ debt levels which, if excessive, may reduce employee productivity due to anxiety, stress and worry.
This can make employees susceptible to corruption and fraud as means to get out of the debt trap.
This is the major cause of over-indebtedness on the part of civil servants that the Zambian Government is trying to address through the debt swap arrangement.
Added to these is debt acquired from informal sources, such as by obtaining goods and services on credit, from friends, family members, kaloba, ifilimba and village banks.
(To be continued).
(The author, a holder of a B.Acc (CBU), CBA (Bangor), M.Acc and MBA-Finance (BGSU), and Doctor of Philosophy in Finance from the University of Kwazulu-Natal in South Africa, is a lecturer in the School of Business at the Copperbelt University) .