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Bankruptcy and Easy Credits?

Mr. Desmond Wu is Head in Credit Risk Management Department - Industrial and Commercial Bank of China Asia Ltd.

Statistics (Q42001) revealed, inter alia, i) default ratio of 6% for credit cards; ii) 17% of new bankrupts were below 30 years of age; iii) one of the bankrupts owned upto 50 credit cards. 50 are about all credit cards, affinity cards and associated cards in issue in Hong Kong.

Behind these numbers, there is an interesting saying. Once again, lax credit policies, with credit cards issuers cited in particular was quipped to be one culprit causing bankruptcy. And behind this saying, there is an interesting logic. The writer attempts to introduce another aspect and present another viewpoint in looking at this saying and this logic.

Untested Assumptions

The saying that relaxed credit policies cause (or otherwise step up or help fuel) bankruptcy embodies an interesting logic. In a way, the logic could follow, arguably, that the more relaxed the credit policy, the more would be the bankruptcy cases. In another way, the logic is interesting in that it assumes something – something which have in fact to be tested, argued and ascertained. It assumes that credit policies are lax and that, if so, it has been causing bankruptcies.

Towards Credit Policy

Perhaps one of the better ways to determine if credit card issuers in general are adopting relaxed credit policy is to assess their bottom line profit. The writer does not attempt to provide an industrial analysis by comparing the announced results of major credit card issuers in Hong Kong. One general observation is however that credit card business is known to be a sector with a higher return compared to loans and advances to individuals on unsecured basis.

A major function of credit is to help make profit (or minimize expected loss) by identifying and entrenching the risks associated with business. If credit per se is a process in the business activity, then like other business functions, its effectiveness can be assessed (not solely though) by its contribution to profit. And if credit card companies are making the profits they reasonably expect, it is arguable if the credit policy is relaxed – as least it is arguable in profit point of view.

Credit or No Credit: Which Boosts Bankruptcy?

Hong Kong still lacks a thorough and authenticated research on the reasons leading to the upsurge in bankruptcy. One anomaly exists however. In company winding-ups, banks are often blamed for pushing companies into liquidation by tightening up credit; in individual bankruptcy, banks are blamed for giving out too much credit too easily. Some experienced bankers witness a decline in “face” being a hurdle for choosing bankruptcy; some socialists suggest a possibility of legal practitioners too actively introducing bankruptcy as a “solution” to unresolved financial problems. Generally, few would reject that the general economic downturn and the subsequent unemployment are playing important roles. Easy credit is a result of competition. Competition is obviously intensifying vis-a-vis an increased supply of credit card credits and in the number of suppliers. Competition in credit card business is however not restricted to scrambling for cardholders, but increasingly in encouraging more card utilization. It is not hard to realize that cardholders are now more at ease to use credit cards than perhaps a few years ago. That includes making purchase of smaller amounts. The development in fact follows quite closely to that appeared in areas with earlier development of credit card concept, US and Europe in particular.

Bankruptcy by definition is an inability to pay debts as they fall due. It explains that bankruptcy should be cashflow-driven. “Negative equity” per se will not cause bankruptcy (although it takes away the relieve one could rely on by liquidating asset when there is a cashflow problem). Unemployment will! Then, it prompts a big question mark as to how easy credit could have caused unemployment or economic downturn.

Means vs End

As a final remark, one question ought to be asked: will the bankrupts be bankrupted at all if they were not given credit cards?

Perhaps the answer to this question might help us to contemplate an answer: will we blame knife sharpeners for the increase in armed robberies? I, for one, will not.

Created on 13-Mar, 2011 by HKCCMA.

Last Edited on 09-Apr, 2011 by HKCCMA.