Mr. Chairman, distinguished guests and friends,
I am thankful to Mr. Balachandran for providing this opportunity
to be with this eminent gathering assembled for a noble cause. Bank of India
has been among the banks known to be a pioneer in several areas of commercial
banking. In this context, the initiative by the bank to establish credit counselling
centers on a pilot basis highlights the pro-active role being played by our
banks. In fact, a major reason for my agreeing to participate in this ceremony
is to demonstrate the Reserve Bank of India's commitment to the cause of credit
counselling - a recent initiative in our country.
In my remarks on this occasion, some introduction on the importance
of this topic would be in order. An overview of the global practice in this
area could then be followed by a discussion of the Indian context with regard
to credit counselling. Any mechanism of credit counselling has to reckon with
the processes, costs and benefits. The concluding thoughts are in the nature
of illustrative issues towards initiating and popularising credit counselling
in India.
Introduction
With the changing growth dynamics of the economy, it is not
difficult to envisage situations where certain segments of the population become
susceptible to excessive borrower optimism or even to vicissitudes in the economic
environment. Such susceptibility could also arise from unforeseen shocks or
emergencies that make repayment difficult. By providing sound advice to arrest
the deterioration of incomes and restructure their debt, credit counselling
offers a meaningful solution for borrowers to gradually overcome their debt
burden and improve their money management skills. In this regard, the question
is whether there is a role for public policy in matters relating to credit counselling?
We must recognise that financial intermediaries, the corporates
and high net worth individuals generally possess in-house knowledge of matters
relating to financial management and can afford to employ outside expertise
as appropriate in regard to their investment decision and management of distressed
loans. Public Policy has enabled an operational mechanism in the form of Corporate
Debt Restructuring (CDR) in regard to loans by banks and development financial
institutions to large corporates. Somewhat similar framework has also been provided
to small and medium enterprise. In regard to agricultural loans and most of
the small borrowers, however, only broad guidelines are issued to banks from
time to time on parameters for restructuring. The extent of active interaction
between individual borrowers and banks is, therefore, not clear.
It is increasingly felt that individuals are not in a position
to take full advantage of the guidelines issued to the banks for variety of
reasons. These may include inadequacies in managing their finances especially
delinquent accounts. Further, individuals may not be able to articulate their
financial situation adequately to the banks. It will be in the interest of the
banks themselves to help individual borrowers through appropriate credit counselling.
Public policy could, therefore, have an advisory role in encouraging mechanisms
in the form of credit counselling in regard to individuals. There are a variety
of ways in which this has been accomplished in different countries, but in India
we are just beginning to address the situation. Some urgency has been lent to
this issue in India in view of rapid growth in consumer loans, housing loans
and the more recent emphasis on financial inclusion. It is interesting to note
that the terms of reference of the Financial Inclusion Task Force initiated
by the Treasury of the United Kingdom to consider solutions to the problem of
financial exclusion identifies three key areas. This includes face-to-face money
advice in addition to access to banking and access to affordable credit.
Global practice
The first well-known credit counselling agencies were created
in 1951 in the United States when credit grantors created the National Foundation
for Credit Counseling (NFCC). Their stated objective was to promote financial
literacy and help consumers to avoid bankruptcy. Credit counselling, however,
came into its own as a result of the passing of the Housing and Urban Development
Act in 1968. Under this Act, the US Department of Housing and Urban Development
was allowed to authorize public and private organizations to provide counselling
to mortgagors. The resulting services and infrastructure to provide them led
to the development of the credit counselling industry.
In 1993, the Association of Independent Consumer Credit Counseling
Agencies (AICCCA) was founded in the United States, citing a need for industry-wide
standards of excellence and ethical conduct. This formally organized the NFCC’s
competition. The AICCCA was formed from the group of counselors who favored
telephone delivery of debt management programs. The NFCC was, in the beginning,
strongly opposed to this telephone business model, primarily favoring face-to-face
counselling as a more effective solution. Eventually, all organizations practiced
both phone and face-to-face processes with some agencies using large inbound
call centers driven by mass media advertising.
The Bankruptcy Abuse Prevention and Consumer Protection Act
of 2005 made credit counselling a requirement for consumer debtors filing for
bankruptcy in the United States. In order to meet this requirement, during the
180-day period preceding the filing of bankruptcy, the debtor must complete
a program with an approved non-profit budget and credit counselling agency.
Such a program may include, but is not limited to, one counselling session conducted
by phone or over the internet.
Quickly, the concept caught the attention of other countries
and over the last several years, a whole host of countries have undertaken significant
initiatives towards credit counselling. The Consumer Credit Counseling Service
(CCCS) in the UK, established in 1993, helps consumers with budgeting and better
money management as also their debt repayment plans. Funding for CCCS comes
from the businesses in the community which benefit from repayment they would
not receive if the debtor defaulted. In addition, there is also a National Debt
Line through which a bank customer can get free financial advice. In fact, the
Banking Code in the U.K. provides that member banks shall discuss financial
problems with customers and together evolve a plan for resolving these problems.
Canada established a non-profit counselling organization in
2000. Termed Credit Counseling Canada (CCC), the organization seeks to enhance
the quality and availability of not-for-profit credit counselling for all its
citizens. The Bank Negara Malaysia has established a Credit Counseling and Debt
Management (CCDM) agency to provide credit counselling and loan restructuring
advice to individuals. The arrangement is expected to be a prompt and cost-effective
means of debt settlement based on the repayment plan between creditors and the
debtor without intervention of courts. With rising personal bankruptcies, primarily
on unsecured debt, Credit Counseling of Singapore (CCS), established in 2003,
is meant to assist financially distressed consumers.
Indian context
In India, there has been a sharp growth in credit to household
in recent years. According to the all-India Debt and Investment Survey 2003,
nearly a fourth of the households were indebted in 2002. The per cent of indebtedness
households in rural areas increased sharply from 23 in 1991 to 27 in 2003; the
corresponding figures for urban areas during the same period were 19 and 18,
respectively. At end-March 2004, the total number of loan accounts under direct
finance to farmers was nearly 20 million, comprising over 95 per cent of total
number of loan accounts under the priority sector; the amount involved was well
over 70 per cent of total priority sector loans.
Even taking into account the changes in classification and coverage,
bank credit to housing and consumer durables witnessed an exponential growth
rate of over 50 per cent during 2001-2006, nearly double the growth recorded
in overall non-food credit over the same period. As a consequence, the share
of housing and consumer durables in overall non-food credit by scheduled commercial
banks increased from around 5 per cent in 2001 to nearly 14 per cent in 2006.
Rapid economic growth coupled with demographic dynamics has
led to a significant change in consumers’ perceptions in our country. With a
burgeoning middle-class and changing lifestyle aspirations, more and more people
are resorting to debt to finance their consumption and asset creation. At some
stage in some cases, this could potentially lead to excesses, precipitating
defaults. Such defaults could also be the fallout of circumstances beyond one’s
control. Costly medical emergencies, retrenchment from job, hardening of interest
rates could inadvertently raise debt burdens in some cases not easily manageable
within a given income stream. This is partly reflected in the growing number
of customer complaints against banks in the recent past. Over the period January
2003 to June 2005, the number of complaints relating to loans, credit cards
and harassment in recovery aggregated nearly 34 per cent of total number of
complaints, which reinforces the need for credit counselling in a dynamic economic
environment.
The proportion of people dependent on agriculture still remains
high in our country. With a predominantly rain-fed agriculture, monsoonal vagaries
coupled with lack of adequate risk mitigation policies could sometimes lead
to hardship for the rain-dependent segment of the population. This needs to
be considered in conjunction with the fact that the levels of literacy in our
country are still relatively modest at 65.4 per cent in 2001, with wide differentials
between urban and rural areas. For instance, in 2001, the proportion of rural
literate was about 59 per cent as compared with 80.3 per cent in the urban areas.
Additionally, the organised sector employment presently comprises less than
10 per cent of the workforce, leaving the vast majority of the working population
with irregular income streams and paucity of defined safety net, making them
susceptible to unforeseen contingencies. This assumes even greater relevance
in situations where the penetration of formal finance is less than adequate,
presumably compelling people to take recourse to costly informal finance, often
in conjunction with loans from banks.
While the ‘arithmetics’ of extending credit are often diligently
followed by lenders, in the absence of consistent credit histories, banks are
often at a loss in case of non-repayment by borrowers. Given the growing indebtedness,
there is an increasing need to develop follow-up services to enable distressed
borrowers overcome credit delinquencies. Credit counsellor thus offers a viable
task-specific, advisory ad hoc intermediary between the borrower and the bank
concerned.
Counselling on the above lines generally serve three purposes.
First, it examines ways to solve current financial problems. Second, by creating
awareness about the costs of misusing a credit, it improves financial management
and develops realistic spending plans. Third, it advises the distressed people
to gain access to the structured financial system, including banking. However,
such counselling will be appropriate only if it addresses unique situations
of households in different parts of India.
Processes, costs and benefits
It is technically possible for credit counselling to be ex ante
or ex post. Ex ante counselling helps borrowers to decide upon the quantum of
loans they can avail, based on their income profile and stream of cash flows.
More importantly, ex ante counselling attempts to influence the stability of
the borrowers’ flow of income and expenses, thereby lowering the probability
of default. Ex post counselling typically occurs after a crisis event, when
the borrower has already missed one or several payments. The purpose of such
counselling is to prevent default and foreclosure. It is, therefore, curative
in nature.
Credit counselling in practice generally tends to be ex post
in nature. Such counselling involves one-on-one meetings, allowing the counsellor
to observe the level of maintenance of the debt and other issues relevant to
the stability of the borrower's situation. It includes advice on not only crisis
management, and budgeting but also exploring avenues and networks that can provide
succour in the interim. Owing to these reasons, such counselling can be expensive,
owing to the not-so-insignificant administrative costs involved.
A credit counselling agency often receives most of its compensation
from the creditors to whom the debt payments are distributed. This funding relationship
could lead to the impression that credit counselling agencies are merely collections
wings of the creditors. It is therefore essential to guard against these undesirable
possibilities.
In many instances, nurturing a borrower back to health after
a default can be a time-consuming process, besides causing severe inconvenience
for the distressed families. Traditional banking technologies rely mainly on
a set of pre-assigned standards to determine whether a potential borrower will
be able to service a loan. This lack of knowledge on low-income household circumstances
restricts the banks ability to objectively assess whether the expected loan
can be sustainable.
Sometimes, a two-track approach towards mitigation of borrower
risks is advocated. In the near-term, credit counselling can constitute an integral
part of banks’ loan application, which can facilitate better assessment of credit
risk and repayment capacity. In the urban areas, where people are more techno-savvy,
such counselling can take place over the internet or the phone. In the rural
areas, such interface could be made more personalised through direct face-to-face
interaction with the affected clientele. Such preventative counselling would
enable the borrower to determine the optimal level of sustainable debt and pre-empt
deterioration of accounts at a future date. This is also likely to lower the
incidence of customer complaints against banks.
An important consequence of the counselling process may be that,
as potential borrowers learn more about the way financial markets function,
they may learn to behave more strategically and to prepay more often when interest
rates are benign. If such behavior becomes prevalent, together with a positive
effect of counselling on default, it may be an additional argument that counselling
helps low-income borrowers.
Issues
It is necessary to recognise that there are several issues which
require to be addressed in identifying possible approaches to initiate and popularise
credit counselling for individual borrowers. Let me flag some of these issues
for your consideration.
First, how well can we combine credit counselling with some
elements of financial literacy?
Second, should credit counselling concentrate on ex ante or
only on ex post elements or some combination of both?
Third, should credit counselling agencies devise differential
mechanisms to take into account different credit segments such as housing loans,
consumer loans, farm loans as well as different categories of individual borrowers
such as salaried, self-employed, seasonally employed etc? Is it better to have
more general credit counsellors?
Fourth, given the differential nature of cash flows and consumption
patterns in rural and urban areas, is there a need for a segmented approach
towards credit counselling?
Fifth, should there be accreditation of credit counsellors?
If so, who should do it - industry association or individual banks? Should counselling
be a full-time or part-time work for the credit counsellors?
Sixth, what should be the elements of confidentiality that are
assured in this process to gain the confidence of distressed borrowers in need
of counselling?
Seventh, how do we select the credit counsellors, equip them
to do the work and make them accountable? What type of training - both in terms
of knowledge and attitude - could be imparted to make credit counsellors effective?
Can the training colleges of banks be of help in this respect?
Eighth, should there be a role for non-governmental organisations
(NGOs) and consumer organisations in order to expand the outreach of counselling
practices?
Finally, should the findings emanating from the discussion of
credit counsellors constitute part of the agenda for the District-Level Bankers'
Committees?
I have only touched upon some of the issue germane to the initiation
of the process at the present juncture. What is, however, important is to recognise
that instead of a 'one-size-fits-all', banks should be free to experiment and
evolve their own mechanisms and adopt approaches best suited to their business
philosophy. Since financial counselling pertains primarily to individual borrowers
at the local level, a decentralised approach could prove useful. Being a relatively
new area whose potential is still to be proved, it is imperative to proceed
in measured steps and reassess the situation based on the experience gained.
In progressing towards this laudable objective, we, however, should not create
another cadre of employees or potentially avoidable intermediaries between banks
and their borrowers.
We, in Reserve Bank are happy to note the initiative taken by
Bank of India in starting credit counselling centres on a pilot basis. The involvement
of trust 'Abhay' lends value and credibility to this pilot project. It is also
noteworthy that one each in urban and rural areas is being initiated. We are
looking forward to learn from the experience of this laudable initiative. I
commend other banks to attempt some pilot projects, as considered appropriate
by them, to explore the potential for beneficial use of credit counselling.
Thanking you.