Informal and formal credit
/If I were to ask you, who charges a higher interest rate on loans in Vietnam, who would you guess? A) An informal money lender from the neighborhood who may hire big guys to collect, B) one of these new startups providing credit to the unbanked?
Most people would probably think the startup would be much cheaper. Especially because they are trying hard to grow market share, so like Uber at its start, they offer products and services at cost or even below.
Source: StoxPlus 2018 via VIR
You would be wrong. Actually, you might be right, but not all of the time. This researcher dove deep into informal credit in the Vietnamese economy and found that many of our first impressions aren’t actually based on facts.
Formal loans have interest rates as high as 50%. In his research, a woman ends up paying $1,550 for a $560 loan from FE Credit.
Many informal loans are have high rates but loan fees are less and the loans themselves are easier to get. The case study mentioned here talks about a 4%/month interest rate, compared to a formal cost (all-in) of 5.4%. Of course, this is because the loan size is pretty low (VND500,000). If it were bigger, VND2.2m in this case, it would be about the same cost, but potentially more onerous paperwork. This example uses one of the traditional banks, but is indicative of formal credit prices for small loans.
It will be very hard to get people banked, because so many of them don’t have proper registration, which is necessary for loans. We talked about this before, but just to remind, Vietnam requires everyone to be registered. Currently 5-6 million people lack household registration, “including 36% and 18% of Ho Chi Minh City and Hanoi’s population, respectively.” These people find it difficult to access formal credit,
Many people think informal credit is horrible, because the stories can be scary. Debt collection by the informal guys is not always a pretty picture (think big thugs with tattoos and baseball bats - or that’s what I picture). And so the government is trying to crack down on “black credit.” But it is hard:
So lots of people are involved, but only 8 cases were taken to court. The police say it is hard to get all the documentation to get these cases to court. I am sure it is. But even the 864 telephone numbers is probably a meaningless number in comparison to how big informal credit is. That brings us to the following question:
How large an issue is it? It is really difficult to get a sense of how large informal credit is in the economy. Fitch reports that consumer loans add up to 58% of GDP at the end of 2018, but that counts just bank loans. And a good portion of those are mortgages (38%) or household business loans, which are secured.
The vast majority of Vietnamese did not have bank accounts in 2017. Source: World Bank
But we need to add to that the level of informal loans in the system. If it is another 10pp of GDP, it would already be quite high. And that 10pp is just a guess. As much as 20% of urban dwellers have no access to credit (because they lack household registration), and these are very likely borrowing to build business or homes or to buy vehicles to work in the city.
Let’s try to work it out: One source said that in the 2000s, informal credit had dropped to just a third of all credit, down from 77.5% in 1992. A third is still crazy high! A third would mean that the actual underlying consumer credit in the market is 50% more than the statistics say. To give an indication of how this could happen, according to the World Bank, only 30% have bank accounts, although some of these people have been serviced.
I can’t know for sure, but I am pretty sure that the number has fallen from 33% since the 200s, so let’s say we need to mark up credit by 15% (about half of what it was in the 2000s). That would still mean that there is $21bn more in consumer credit than officially reported. That would imply the consumer credit is more like 67% of GDP rather than 58%.
I could be way off, but all the anecdotal evidence points to informal credit being massive.
Why should we care? There are a bunch of reasons:
Higher debt-to-GDP is riskier. We have talked about this a lot, but the main reason is that in the case of a recession, these debts may be hard to service. If you have to choose between paying a loan shark and a bank, I would pay the loan shark! Baseball bats scare me! And so banks may face much higher NPLs than expected. We saw this in 2011 and 2012, when the government cut down on banks because of high NPLs. GDP growth suffered.
One caveat to this is that informal credit was massive before, and now it is much less. So the big run up in credit in the economy may stem from this move from informal to formal. Basically, it was a problem before, we just didn’t know about it.
The move to formal credit is important not just for statistics but to get a real sense of what is driving economic growth. Plus, we assume (and it may not be true) that the formal sector will better price risk. (Just typing this makes me feel foolish - loan sharks are probably pretty good at pricing risk).
The formal sector is much safer for borrowers. Once again, I would rather a bank come after me than a loan shark. And the government can regulate it.
It points to an underlying issue: the household registry really hurts migrants. Fixing that would help poor migrants a lot!
Informal lending is never going away. But if it can continue to be diminished by the formal sector through products that are more transparent, cheaper and better regulated, that would be ideal.