/ 20 January 2009

Unsavoury practices

An illegal version of the Banking Inquiry Panel report, which was posted on website wikileaks, revealed that penalty fees generated on average 8% of the banks’ non-interest revenue.

The issue of penalty fees, as well as debit order practices, was a contentious issue during the bank inquiry hearings.

Lower-income earners with low levels of financial literacy are particularly vulnerable to unscrupulous debit order practices.

The Bank Inquiry Panel recommended that banks make it easier to cancel debit orders and that penalty fees be reduced to R5. In fact the report stated that if the banks do not come into line, the issue of maximum penalty fees should be imposed by regulation.

One bank has started to implement the recommendations and to engage the industry in reform discussions.

Last year Absa reduced penalty fees on mass market accounts to R5. Keith McIvor, macro strategist at Absa, says that the debit order issues raised by the inquiry concerned lower-income earners rather than higher earners who were not managing their accounts effectively. Therefore Absa took the view to cut the penalty fees only on the mass markets.

McIvor says that Absa had already taken the view to move away from bad to good fee income. “No one likes penalty fees; it is not a nice revenue,” says McIvor.

According to the confidential report, based on 2006 figures, Absa had the lowest percentage revenue from penalty fees. Since reducing the penalty fee as well as the introduction of the pre-paid debit card, which has no transactional or penalty fees, McIvor says Absa has dramatically reduced its income from penalty fees in the past year.

Figures in the report show that between 2004 and 2006, although penalty fees were marginally reduced by the banks, the revenue generated from penalty fees had increased. A reason for this was the proliferation of micro lending, which resulted in a higher level of unpaid debit orders.

Absa has been particularly vocal about the need to reform the debit order system, especially those service providers who use the system.

McIvor argues that service providers are allowed on to the system too easily, compromising the integrity of the system. “We feel strongly that we have to manage the back end more effectively than before,” says McIvor.

Walter Volker of the Payments Association of South Africa (PASA) agrees and believes that more banks need to use the Authenticated Early Debit Order system (AEDO).

This requires the microlender to swipe the customer’s bank card and have the customer enter his or her PIN before the debit order contract can be put in place. This ensures that the customer has face-to-face contact with the lender. In return the microlender will be among the first debit orders to come off the account when the customer’s salary is paid.

Only Absa and Mercantile Bank offer this system to microlenders and Volker believes that the banks should promote the system more actively.

This raises questions about why the banks do not do more to protect their customers.

One argument is that there is no negative incentive for banks to clean up the debit order system. As the inquiry showed, banks make more money from rejected debit orders than those that are paid. The average cost to the bank of a returned debit order is about R3,50.

Banks argue that higher fees are needed to encourage customers to meet their obligations and that without high penalty fees the debit order system would be undermined. Yet Capitec Bank, which deals primarily with low-end income earners, is able to charge R3,50 for a returned debit order with no systemic risk.

Absa has not experienced an increase in non-payment since reducing penalty fees. So who exactly are the banks trying to protect ­­ their retail client or corporate client?

The panel observed that banks see themselves in the “role of protectors of the collecting customer by penalising their own account-holding customers”.

Somewhere along the line the banks have forgotten who their clients are. In an attempt to protect their corporate base, banks talk about protecting contracts and the rights of the provider. Comments that penalty fees ensure customers do not default on their contracts and that the bank cannot cancel a debit order as it interferes with the provider’s contract point to the fact that it is the corporate client, not the retail client, that matters.

As the report reminds us, it is up to the service provider to ensure that the person who signs the contract is creditworthy, not the customer’s bank.

The increase in revenue from penalty fees would suggest that service providers are not carrying out their job of vetting their customers. And why should they? There is no disincentive for the provider to sign up a non-payer on the system as it is the customer, not the provider, who pays the penalties.

Volker believes that the banks need to work more closely to root out this behaviour. He argues that if a particular service provider results in complaints, the provider should be blacklisted and any bank that continues to provide a platform to the company should be fined.

Absa strongly supports such measures and has previously, as reported in the Mail & Guardian, been quick to censor unscrupulous providers. Will the other banks follow?