Going Abroad: Bad Debt

  The introduction of credit cards in many countries is leaving consumers drowning in oceans of bad debt. What to do?
  Few things are more American than credit cards-including overdue credit card debt. So it should surprise no one that as credit cards expand into markets outside the U.S., bad debt often follows close behind.
  The most recent, and possibly the most unnerving, example is in South Korea, where eight of the nine major credit card firms posted 10.5 trillion WON in losses in 2003. South Korea's largest issuer, the LG Card, alone reported losses of $4.8 billion, and had to be bailed out by the government.
  Taiwan, Hong Kong and Singapore have seen similar run-ups in bad credit card debt, indicating that even countries whose consumers are known for being credit averse are seeing worrisome spikes in chargeoffs.
  In England and Wales, individual insolvencies totaled 10,924 in the first quarter, a 26.8% increase from 8,117 in 2003's first quarter. And some fear that number will soar under what many consider debtor-friendly bankruptcy legislation that took effect April 1.
  In Australia, credit-related bankruptcies have doubled since 1999.
  Concerned by these uncharacteristically sharp increases in bad debt, financial regulators are seeking the causes. And some are laying the blame squarely at the feet of the credit card industry.
  In the United Kingdom, a University of Leeds study late last year found that the average household owed 118% of its income. And it fingered credit cards and other consumer loans as the culprits.
  In addition, the Financial Services Authority warns that U.K. consumers' are carrying record-high debt loads, both in absolute terms and relative to income. In its Financial Risk Outlook 2004 report, the authority notes that at the end of October, households had 916 billion (in UK Pound) of debt, of which 748 billion (in UK Pound) was for mortgages and 52 billion (in UK Pound) was on credit cards.
  And there are signs that "some households have already borrowed more than they can comfortably afford, despite historically low interest rates and benign economic conditions," according to the report.
  What's more, 44% of families with a balance-carrying credit card found it "at least a struggle to keep payments up," the report states.
  In such cases, an increase in interest rates could push consumers into financial insolvency.
  But not all observers see credit card debt as the root of consumers' financial woes. In response to the Leeds study, a spokesperson for the Association for Payment Clearing Services cited a contradictory report absolving the card industry of blame for the growing debt burden of consumers. APACS is a trade association of payments firms.
  "It's all too easy to point the finger of blame for U.K. consumer debt at the credit card industry-but this is a sensationalist approach," the spokesperson says.
  Those conclusions are borne out by analysts tracking card-backed securities in the U.K. and continental Europe. And not everyone is concerned that the U.K.'s new bankruptcy law will lead to a spike in filings.
  The law "basically makes it easier for people to go into bankruptcy so there will be an uptick in bankruptcies," says Chris Such, director at Standard & Poor's London office. "There will be an uptick in bankruptcies but bankruptcies as a percentage of overall defaults is relatively small."
  In continental Europe, defaults "tend to be extremely low," Such says, because Europeans tend to use credit cards "as borrowing tools and pay them down very slowly."
  To be sure, there are many reasons underlying the growth of bad debt in countries outside the U.S. For example, in Canada, where personal bankruptcy filings increased by 97% between 1990 and 2003, a weak economy and high unemployment played a major role. But Canadians are still good risks overall, says one card executive.
  "Close to two-thirds of Canadians pay off their balances every month," says Kevin Stanton, president of MasterCard Canada. "Delinquency rates have been flat but our dollar volume continues to grow."
  Often, spiraling losses seem tied to the number of credit cards per capita.
  In several cases, including Korea, banks rushed headlong into the card business without setting up requisite practices for avoiding poor credit risks.
  Between 2000 and 2002, "a lot of (South Korean) banks issued a lot of credit cards," says Evren Bayri, director of the credit advisory service for Mercator Advisory Group, a Boston-based consultancy. "They grew so rapidly that now most of the outstanding debts are delinquent."
  The aggressive marketing practices of South Korean issuers seemed destined to produce heavy credit losses. Bayri notes that many issuers set up tables at busy intersections, "handing out cards to passersby, taking only a home address for application information."
  The Korean government, too, played a role in the debacle. In its desire to jump-start consumer spending in a traditionally strong savings economy, it offered an income-tax deduction of up to 20% for credit card holders (1999) and introduced a credit card receipt lottery (2000).
  By giving tax incentives for credit card use, the South Korean government increased chances that consumers would misuse credit, says Nora Freedman, associate analyst with Framingham, Mass.-based Financial Insights. Compounding the problem was the requirement that cardholders pay their bills in full within 30 days, causing delinquencies to soar, she adds. Inexperienced South Korean consumers ran up balances totaling $54.47 billion between 1999 and 2003.
  "This should be the classic example of how not to use cards," she says.
  In Taiwan, many banks use sales agents to acquire cardholders, says Henry Tsuei, president, China and North Asia, First Data International. "These sales agents are compensated on volume and not necessarily quality of applicants," he says. "This factor, combined with intense competition for new customers, have led to issuers taking on higher-risk customers."
  Consumers in emerging markets, such as Korea, also have little or no experience in handling credit, making it more likely that they will use it improperly, Freedman says. "Consumers need to understand what credit is and what the consequences of using credit are," she says.
  Many countries with nascent credit card markets lack the sophisticated credit bureaus that have helped most U.S. issuers avoid massive losses. And those countries with credit bureaus often share only negative information.
  "It's just as important to know the positive credit information as it is negative," she says. "It's often important to know how much debt is out there that they're paying off in increments."
  Perhaps the greatest protection against bad debt is "the classic knowing your customer, knowing their credit histories and incomes before you hand them a card," Freedman says.
  That's the case in the Middle East, where banks are keeping bad debt under control by marketing only to their existing customers, says Sriram Natarajan, head of risk management for American Express Middle East. "These parts have seen a lot of growth, but there has been also a lot of control by the banks," he says. "The lending has been extremely conservative."
  Almost Subprime
  That conservatism is reflected in data compiled by Euromonitor International. In Saudi Arabia, consumer credit grew by 368% between 1998 and 2002. But the portion of consumer credit outstanding on credit cards decreased from 19% in 1998 to 4.3% in 2002.
  Issuers in the Middle East have good reason for limiting to their customer base the pool of potential cardholders-the large expatriate population, Natarajan says. Expatriates make up 75% of the population in the United Arab Emirates, 50% in Kuwait and 30% in Saudi Arabia.
  These foreign workers-who typically stay in the country between two to four years-pose a unique challenge for issuers. They often skip the country without paying their debts, leaving no forwarding addresses or other personal information, Natarajan says. This can be a major obstacle in a region where there are no formal credit databases.
  "Data definitely is a challenge," he says. "Most banks here are almost lending subprime, except for the ones who (already) have accounts with them."
  What alarms many is that the same conditions that lead to credit losses-poor or nonexistent credit data on individuals, poor risk management and the lack of regulatory or legal controls-also make bad card debt difficult to collect.
  But issuers, shell-shocked by skyrocketing bad debt, are beginning to adopt measures to aid in recoveries. In Korea, issuers are shifting focus from marketing and acquisition to collections, Tsuei says.
  And the lack of a sophisticated collections infrastructure doesn't necessarily preclude successful recoveries. In markets where bankruptcy still carries a stigma, old-fashioned, low-tech peer pressure may be quite effective, Tsuei says.
  Nevertheless, as populations become more mobile, being able to track down debtors (is) "becoming increasingly difficult," Tsuei adds.
  Such is the case in the Middle East, Natarajan says. But issuers there are devising new ways of curbing bad debt, including requiring new applicants to provide signed, undated checks for the value of the credit limit.
  In Australia, too, some regulators are fretting about the amount of debt, including credit card debt, taken on by consumers over the past few years. Because Australia's economy "has been so strong for so many years," consumers have been able to handle their debt loads, says a source at the Reserve Bank of Australia, the country's central bank.
  "The concern here is there are quite high levels of household debt and if things turn down," credit quality could deteriorate, says the source, who wished to remain anonymous.
  But most Australian cardholders don't carry a balance from month to month, the source says. And many use cards simply to get rewards points, and pay them off at the end of the month. "It wouldn't be unusual for people to spend $5,000 or $6,000 a month," he says. "It looks like an increase in debt ... but it's not long-term debt."