Are Moratoriums Good for Clients?
Moratoriums are a popular policy remedy during the COVID-19 era, but different client circumstances call for different types of moratoriums
By Isabelle Barrès, Center for Financial Inclusion
This article also appears on the CFI blog here
Policymakers have been busy putting in place measures to protect financial services clients and the population at large from the consequences of the COVID-19 pandemic. Of all the measures that have been put in place, moratoriums have been particularly popular. Defined as a temporary suspension of business as usual during financial hardship, a moratorium seems like an appropriate response when nothing is “business as usual”. Countries around the globe have put in place moratoriums on debt repayments for a wide range of lenders.
Moratoriums can bring many benefits for clients, such as providing much needed relief in a time of cash constraints, formally anticipating a breach of contract between the lender and the creditor, and avoiding negative reporting to the credit bureau.
But is this the full story? While moratoriums are meant to benefit clients, there are a number of variables in design and implementation of moratoriums that need be considered before concluding that they are indeed beneficial.
Moratoriums Are Not Created Equal
Moratoriums come in different shapes and sizes. Many moratorium schemes defer repayments – typically for 3 months – but accumulate interest on the outstanding debt, therefore increasing the total cost of the loan. When institutions or clients start paying back, they are faced with not only their original debt payment obligation (accumulated for the months not paid), but also the additional interest they would not have had to pay had they paid per the original schedule. This type of scheme raises concerns about clients’ ability to repay their loans once the moratorium is over, as recent evidence suggests may be the case emerging in Pakistan.
Other types of moratoriums only defer payments, but do not accrue additional interest, and others yet are coupled with a broader set of debt relief measures, such as rescheduling and lowering fees. Moratoriums that do not accrue interest present a better value proposition to customers as they provide relief from loan payments during the time of crisis, but do not overly burden customers as they emerge from the period of crisis.
One Size Does Not Fit All
Whether they are beneficial or not for clients depends on the inherent features of the offer and the particular needs of clients. Not all clients face the same constraints, and different constraints and challenges call for different solutions. Client circumstances will determine whether a moratorium is useful, as exemplified in the scenarios below:
Clients may have the funds available to pay their loan but may not be able to physically make the payment due to logistical constraints associated with the pandemic (lockdowns preventing them from accessing their branches, no access to alternative repayment channels, etc.). For them, a break on payments may allow them to retain a good credit standing while they cannot repay and safeguard the funds for when they are mobile again.
Clients may not have the ability to pay their debt anymore, due to the impact of the crisis on their income flows. For these clients, a simple delay in repayments will not be adequate.
Assuming that they are able to go back to their pre-crisis income levels, they may not have the ability to meet the demands of their existing obligations plus the delayed payments and accrued interest. A more appropriate solution in this case would be rescheduling the debt, taking into account the lack of or reduced level of economic activity and resetting the loan at a time when activity picks up again.
Clients may benefit from increased economic opportunities during the crisis (e.g. delivery workers). What they may need is increased access to credit to answer growing demand for their services, rather than relief on existing debt.
Because moratoriums on capital and interest payments are experienced differently by clients based on their circumstances, they should not be seen as a blanket solution for everyone. Relying only on moratoriums during times of crisis – or implementing a moratorium for all clients – is too simplistic. Moratoriums should be one of many tools used to alleviate debt burdens for clients who need it, depending on their situations. The same argument has been made to recognize the fact that not all lenders require the same level of relief, and holds equally true for borrowers. Policymakers should mandate that providers offer moratoriums as an option to their clients, but should not mandate automatically deferring repayments.
Default Opt In With Caution: Clients’ Right to Know and Choose
While many countries have put moratoriums in place, policymakers have not been consistent with guidance on their implementation. As a result, we have seen a number of approaches on how financial service providers are handling moratoriums: some have offered moratoriums across the board, others have reached out to customers and offered the option on a selected basis. Others yet have put control in the hands of the customers and are waiting for them to request it.
Financial service providers should consider that due to default bias, clients tend to go with whatever option was chosen for them, so FSPs should carefully consider how they set their opt-in or opt-out structures.
Moratoriums have the potential to help clients who have suffered income losses due to COVID-19 by deferring debt obligations. But to determine whether moratoriums will actually have the intended impact, several questions need to be addressed:
How is interest handled in the moratorium? Does the deferment increase the total costs for clients?
Does the moratorium also include loan restructuring or is a lump sum required at the end of the loan’s duration?
How are clients informed of their obligations under a moratorium and do they understand their options? Can they choose to opt in or out?
CFI has several recommendations for the design and implementation of moratoriums to ensure that clients do, in fact, benefit from the moratorium.
Opt-In as Default
If the moratorium will benefit all clients (deferred payments with extension of the terms, no penalties), clients should be opted in by default.
Opt-Out as Default
If the conditions of the moratorium do not benefit everyone (such as increased overall fees, lump sum payments, etc.), then providers should use opt-out as the default setting.
Clients should be informed, whether through opt-ins or opt-outs, of the default decision that has been made on their behalf and the specific terms of the moratoriums. If clients are refused a moratorium, they have a right to understand the reason for refusal. Clients should also be informed about the consequences – such as increased overall loan costs – of moratoriums.
Client Choice and Recourse
Clients who have automatically been opted in to a moratorium should have the option to opt-out. Inversely, clients who have not been offered a moratorium should have a right to ask for it, and know how and where to complain if needed.
When implemented with the clients’ interests in mind, a moratorium is an effective instrument, but a number of different circumstances of the client must be considered. In order to ensure that clients benefit, the recommendations above should be considered.
Isabelle Barrès is Vice President and Campaign Director of the Smart Campaign at the Center for Financial Inclusion