By Munozovepi Gwata

In 2008 the world was shocked by what was considered by many, as the worst economic crisis since the Great Depression. The 2008 economic crisis was detrimental to several economies and had a global impact even though the origins for the crisis was established in the United States (US). Several factors contributed towards the financial crisis, and fortunately South Africa (SA) was not affected too badly by the 2008 global financial crisis in comparison to other emerging markets, nor has SA experienced a financial crisis that is comparable to the 2008 crisis. There are several reasons for this, but much of the success can be attributed to the National Credit Act 34 of 2005 (NCA).

A brief overview of the 2008 financial crisis

There were several factors that led to the financial crisis of 2008. The financial crisis was heavily induced by strong deregulation in the US markets. This deregulation gave opportunity to the banks and other financial institutions to invest heavily in financial instruments called derivatives. These derivatives were considered very low risk and extremely profitable endeavours. The keen interest to invest in the derivative market, placed a demand on mortgages, which were the real asset that were correlated to derivatives. With a high demand for derivatives the banks started to venture into the subprime market to find new clients to issue with mortgages. The subprime market was a considerably high-risk market, because it was made of households that had limited credit history and low-income, which made them economically vulnerable. Through entering this market, the banks ended up issuing loans to many US citizens who could not actually afford the mortgages. As a result, many of these debtors ended up defaulting on their loans and this devalued the derivative market and created detrimental losses for financial institutions. It has been reported that the US economy lost an approximate US$ 22 trillion in 2008 (Eleazar David Melendez ‘Financial Crisis Cost Tops $22 Trillion, GAO Says’ (www.huffingtonpost.com, accessed 7-11-2018)). There were several factors that contributed to the financial crisis of 2008, but one of the factors that played a critical role in creating the financial crisis, was the high volume of reckless lending.

The role of the NCA in containing the impact and influence of the financial crisis

The NCA’s primary role is to protect the consumer. In order to achieve this the NCA takes measures to prevent and offer relief for reckless lending and for over indebtedness. Usanda Gqwaru (‘Is the National Credit Act accidentally a step towards curtailing financial system fragility as described by Minsky’s Financial Instability Hypothesis?’ (https://2017.essa.org.za, accessed 5-11-2018)) argues that this preventative role of the NCA, also has the dual effect of creating a cautionary guard against a financial crisis.

Section 81 of the NCA sets out an assessment that needs to be made before credit can be issued. It outlines three different scenarios that constitute reckless credit. Furthermore, reg 23A sets out the methods in which a credit provider can validate gross income. Gqwaru (op cit) states that these provisions in the NCA prevent SA from entering what is called the ‘ponzi phase’. The ponzi phase in the context of Hyman Minsky’s financial instability hypothesis is the critical phase that occurs before a financial crisis.

According to Minsky there are three critical phases that lead to a financial crisis, namely:

• The hedge phase, which is the loaning money phase. At this stage the money is still lent with caution and precautionary measures are put in place.
• The speculative phase. This is the phase, which is categorised with economic prosperity and optimism, which leads the banks to be more lenient and flexible on their lending. This is the phase in which loans are issued to debtors that under the hedging phase may not have qualified for credit.
• The ponzi phase, is the last stage and during this period creditors who are already burdened with debt, are issued with even more debt by the banks, under the pretence that the economy will turn around. This is the catalyst that creates the financial crisis.

What is argued by scholars such as Gqwaru (op cit) is that the NCA, prevents the South African economy from ever entering the ponzi phase, because credit cannot be issued in terms of the NCA to debtors who cannot afford the credit. This argument can be extended to say that the provisions of the NCA also acts as a buffer against the speculative phase, because the NCA sets out fixed assessment criteria, which is not amended to adapt to different economic environments. Therefore, even during periods of economic bliss the assessment criteria for credit remains the same. In SA reckless credit is strictly regulated and prevented by the NCA. On the other hand in the US, legislation such as the Community Reinvestment Act and institutions such as Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) were directing banks to increase their exposure in the subprime market.

The possible threat that can compromise the effect of the NCA

There are several ingredients that resulted in the financial crisis, but great emphasis is placed on the reckless lending carried out by creditors. Other than the profitable pursuit for derivatives, US banks could justify increasing access in the subprime market through legislation, such as the Community Reinvestment Act. The Community Reinvestment Act was created to address the discrimination in the US credit market. A financial institution could justify questionable issuing of loans through the veil of the Community Reinvestment Act. I am concerned that in light of recent case law a new veil has been introduced into the South African credit market.

The recent case of Truworths Ltd and Others v Minister of Trade and Industry and Another 2018 (3) SA 558 (WCC) has further contextualised, or perhaps I should say, limited the role of the NCA. In the judgment the court accepted that reg 23A(4) of the NCA should be reviewed and set aside in light of the facts of the case. The argument that was presented before the court was that the provisions of reg 23A(4) resulted in discrimination against self-employed and informal employees who do not have bank accounts and/or pay slips. They further argued that this prohibits certain groups from access to credit. It was then argued that eliminating certain groups of people from the prospect of getting credit was not the function of reg 23A. Rather the function of reg 23A is to prevent reckless lending, therefore, eliminating credit to a certain group of people lacks rationality, and fails to be in accordance with the principle of legality. The court accepted that reg 23A(4) should be set aside and reviewed.

The possible effect and outcome of this judgment is that new methods of assessing income may be enacted to cater to people who are self-employed or informally employed. These new methods may not be concerned with payslips, or bank statements because, as mentioned in the facts of the case, some people do not have bank accounts. The consequence of this is that unless strict measures are set in place there will be no way to determine who is truly unemployed, employed or self-employed. Therefore, if there is no verification to confirm the status of employment (informal, formal, self-employed) then it will be very hard to detect matters of fraud. For example, an employed person could deceive the credit provider and declare themselves to be self-employed or informally employed to evade a stringent income assessment. Even though the debtor will still be required to prove how they can repay the debt, the burden of proof will remain unequal between different categories of employment. Using an affidavit, for example, to demonstrate the financials of the debtor as opposed to bank statements and pay slips may result in an increase in fraud, which will undermine the credibility of affidavits being used as financial statements.

The other possible risk that can emerge is that there would be the existence of dual assessment systems, which undermine and compromise each other. It can also lead to uncertainty pertaining to how gross income should be assessed. Alternatively, one criterion of the assessment methods may remain, but the methods of assessment made are broader and more flexible to accommodate the different categories of employment. This could give opportunity and lead to reckless lending by credit providers. The intention of the court was to remove barriers to credit, but in doing so they have also indirectly removed the safeguards of the South African credit market.

Conclusion

The NCA plays a dual role. The primary role of the NCA is to protect the consumer from credit providers, the secondary role is to act as a buffer that protects the South African economy from the effects of an internal or external debt crisis. The risk posed by the recent Truworths case is that the intent to create more inclusionary methods of income assessment, may unintentionally compromise the credit market. It may incentivise greedy credit providers to issue riskier loans, which could jeopardise and trap the consumer and furthermore undermine the protective role of the NCA.

Munozovepi Gwata BA (Law) is a third year LLB student at the University of Pretoria.

This article was first published in De Rebus in 2018 (Dec) DR 16.