When COVID-19 curtailed economic activity around the world in March 2020, many borrowers lost their incomes and the effects quickly rippled through credit markets. To head off loan defaults, regulators in many countries permitted, encouraged or even mandated financial institutions to offer moratoria to borrowers. Moratoria periods are only now ending, so it is still too early to draw firm conclusions. However, our research so far suggests that while moratoria have helped financial institutions to stabilize their balance sheets, the benefits for borrowers are more equivocal.
There may never have been a time when moratoria were offered to so many people in so many countries all at once. By the end of April, 88 percent of the microfinance institutions (MFIs) participating in CGAP’s Pulse Survey reported using moratoria and other forms of rescheduling more than usual. Of those reporting the extent of their use, nearly a quarter had restructured more than 30 percent of their portfolios, mainly through moratoria. Moratoria and other forms of rescheduling continued in May and beyond, so these numbers have likely increased over time. While the survey data are only from MFIs, moratoria have been used by most types of regulated lenders.
This unprecedented use of moratoria provides an opportunity to examine them as a tool for credit market management from the perspective of regulators, financial services providers and borrowers. This post draws on two CGAP papers on moratoria during the crisis: one focuses on policy and the other on implementation challenges and consumer protection. These papers include findings from research and interviews conducted in India, Peru and Uganda.
From the perspective of providers, moratoria appear to have been a good thing. A key reason regulators encouraged moratoria was to prevent financial institutions from being deemed insolvent due to the enormous provisions they would need to apply if a growing number of borrowers were unable to continue paying off their loans. While regulators understood that moratoria would hide the true state of a portfolio for a time, there was reason to believe that borrowers would resume repayment in what was initially expected to be a quick, V-shaped recovery. Even though the recovery period has lasted much longer than expected, there have not been many instances of COVID-related nonperforming loans causing financial institutions to fail, thanks in part to the use of moratoria as well as measures to shore up financial institutions’ liquidity.
From the borrower perspective, the impact of moratoria seems to be more mixed. Reducing borrower hardship may not have been the primary aim for regulators in using moratoria, but it was certainly a secondary objective. While temporary relief may be much needed, it comes with a longer term cost. In nearly all the countries we examined, the terms of moratoria allowed for interest to accrue during the moratorium period, raising the total amount of interest paid over the life of the loan. For a borrower, a true payment holiday without interest accrual would provide unequivocal relief; however, in most countries, interest accrual has been deemed acceptable, even though it is costly to low-income borrowers.
Mexico is one of the few countries where the regulator has encouraged lenders to offer some form of permanent interest or principal relief. By contrast, the Indian regulator allowed not only interest accrual but also interest on interest (interest capitalization), though it is now considering rolling back this provision, following a high-level panel’s finding that interest capitalization would harm small borrowers.
Regulators have generally viewed a number of other terms as unacceptable, and we concur. The following four points emerge as key for protecting consumers when offering moratoria:
- Minimize additional and unexpected costs to the borrower by prohibiting fees (especially for moratoria initiated by the lender) and capitalization of interest (interest on interest).
- Avoid requiring borrowers to make large lump-sum payments of interest or principal. Instead, amortize missed payments over the remaining life of the loan. If higher payments unduly burden the borrower, the loan term can be extended.
- Ensure borrower’s credit records are not damaged by participating in a moratorium. Participation should not negatively impact a borrower’s creditworthiness with their current lenders or in credit bureau records that might influence other lenders. However, protecting credit scores has proven to be a challenge.
- Always give borrowers a choice to accept or refuse a moratorium offer. Many institutions in Peru and some in India imposed moratoria without consulting borrowers, many of whom preferred to continue repaying their loans. In Peru, objections to such reprogramming led policy makers to revise their guidance.
Some lessons also are emerging on the implementation of moratoria. Processing enormous numbers of moratoria has turned out to be a nightmare for financial institutions, and these challenges have affected consumers by making it harder to receive moratoria. It has been challenging for many providers to communicate with borrowers when branch offices and call centers are closed. Lower-income, rural and less digitally literate borrowers are less likely to receive key information about moratoria and to understand unfamiliar terms. Facing the administrative burden of case-by-case negotiations, some providers have called in staff from all parts of the institution to help. IT systems often have not been able to cope with so many changes to loan terms, causing backlogs and spikes in consumer complaints.
One attempt by regulators to prepare for crises took place in Peru. Before the pandemic, Peru’s regulators had created a “catastrophe protocol” for natural disasters that allowed for streamlined loan reprogramming. Although the protocol had to be adjusted for the pandemic, it is a sensible concept. Policy makers and providers who have been through this round of moratoria may want to develop their own protocols to be better prepared for future events. Lenders also may wish to incorporate lessons from this experience into their business continuity plans, including lessons related to communicating with customers during emergencies and processing large numbers of reschedulings.
As of this writing, the moratoria story is far from complete. In many countries, such as Uganda, where most moratoria were offered for three to four months, or India, where they were to end by September, borrowers are only now resuming repayments. Our recent interviews in Uganda suggest that borrowers there are asking for a second round of relief, and interviews in India raise questions about high-pressure collections tactics. At this time, policy makers, providers, consumer advocates and industry associations must be especially vigilant to ensure that consumers can handle their revived debt repayments and that they are not subjected to predatory practices or conditions.