• The informal lending trap

    Ben D. Kritz

    Ben D. Kritz

    One facet of economic growth under his administration that President Benigno Aquino 3rd would probably rather no one mention is the expansion of the informal lending sector—the underground financial system personified by the “Bombay,” or “5-6” lender, to whom a significant number of Filipinos turn for credit assistance. To what degree the informal lending business has grown in the past couple years is extremely difficult to determine, but preliminary results of a local study I have been involved in seem to indicate the growth is significant; lenders have described their “portfolios” as having expanded in the past two years by a rough average of 20 percent, and among the traditional clients for informal lending (market and street vendors), the number who have sought informal loans compared to two years ago has increased by a similar amount. Another interesting revelation is that, according to lenders, the number of “nonvendor” borrowers—that is, ordinary working people who do not have their own small business such as a market stall or sari-sari store—has noticeably increased in the past two years as well.

    Granted, there are a number of caveats about these results that need to be acknowledged. For one thing, the study is limited in scope for practical reasons, and might not be realistically representative of the entire country; the actual research, which has proceeded intermittently due to other obligations of the people involved, has been focused in the areas of three large public markets in Cavite province, two small wet markets in Metro Manila and the Baclaran area. The informal nature of the business also makes the gathering of reliable information difficult, as the need for a certain amount of discretion and the short-term nature of most transactions do not encourage participants to keep detailed records.

    Even so, if the indications of the data gathered so far are at all accurate, they support a trend identified in an Asian Development Bank (ADB) finance survey published in November 2011, and a 2009 study by the Asian Institute of Management released at about the same time. Following formal credit tightening by banks in the wake of the financial crisis of 2008, the proportion of formal sector lending accounted for by micro, small and medium enterprises (MSMEs) dropped from about 20 percent to about 1 percent, where it has remained despite the generally healthy growth in the Philippines’ banking industry both in financial and physical terms.

    The general takeaway from all this is that financial circumstances are gradually degrading for an increasing number of people, and the lack of access to formal, regulated credit sources is probably aggravating their financial problems. High interest rates and high frequency of payment installments make informal loans a debt trap for many borrowers, keeping them financially afloat for short periods of time, but making it difficult to break out of a borrowing cycle.

    The informal “5-6” loan is handled in a variety of ways, but two seem to be the most common. For smaller loan amounts, a fixed amount representing the total owed (the principal plus 20-percent interest) is divided into equal payments to be repaid on a daily or weekly schedule; for example, a loan of P2,000 might be divided into 100 daily payments of P24 each. For larger amounts requiring much longer time periods to repay, the lender might require a monthly payment of the interest amount, with the principal amount paid separately in a single or number of smaller payments, with the monthly interest payment obligation continuing until the full principal amount is paid.

    Any sort of informal lending arrangement is, of course, contrary to Philippine law. The Lending Company Regulation Act of 2007 (Republic Act 9474) stipulates that a lending company not otherwise regulated by law (such as a bank, savings and loan association, or pawnshop) may only be a corporation, and must be granted authority to operate by the Securities and Exchange Commission. The Truth in Lending Act (RA 3765) covers any creditor, and requires that information regarding the total amount to be financed, and the interest to be paid both in terms of a simple annual percentage and in pesos be furnished to the borrower in “a clear statement in writing.” Technically, then, every informal lender violates both these laws, which carry stiff criminal penalties; a fine of up to P50,000 and a prison sentence of up to 10 years for a violation of RA 9474, and a fine of up to P5,000 and a prison sentence of up to one year for a violation of RA 3765.

    One protection that is weak, however, is the protection against excessive rates of interest. At one time the Philippines did have a Usury Law, but in 1982 the then-Central Bank suspended enforcement of the law, effectively removing interest rate ceilings and leaving it to the courts to decide whether excessive interest was being charged on a case-by-case basis. In a number of decisions by the Supreme Court or the Court of Appeals, a pattern has been established that, in the absence of an interest rate specified in writing, 12 percent per annum is considered a standard; this does not mean a higher interest rate would not be allowed by the courts in case of a dispute, but it would have to be justified by the lender.

    Most informal borrowers, however, are not keen to stand on their legal rights because that would obviously shut them out of the one available remedy they have for making up financial deficits. Having their daily or weekly incomes continuously attenuated by loan and interest payments prevents them from breaking out of a borrowing cycle, but foregoing the loans would be even more disastrous. For some entrepreneurial borrowers, the microfinance sector does offer an option, but often imposes conditions and high interest rates that are discouraging to potential customers, and offers virtually nothing for working-class borrowers who are simply trying to make ends meet and not finance a small business. The fact that both classes of informal borrowers are expanding is actually indicative of the real problem: The fallacy of the government’s claims of “inclusive growth.” Access, or the lack of it, to formal credit is one thing; the reality that a growing number of people, no matter what their income-generating activities may be, are finding it more and more difficult to live within their means is quite another.