Usage of Credit Cards Beyond Limit : A Case Study of Younger Generations in Malaysia

Transcription

1 Usage of Credit Cards Beyond Limit : A Case Study of Younger Generations in Malaysia Kaviyarasu ELANGKOVAN Undergraduate Student University Putra Malaysia kavi.economicsupm@gmail.com ABSTRACT Young generations around 30 s who hold numbers of credit card and personal loans are an example of today s Malaysia. Many people claims that the socio economy status of someone is reflected by the number of credit cards they own. Without realizing the consequences of the usage of credit card beyond their limit, more and more young peoples aged around 30 s were declared bankrupt due to credit card debts. This research intended to explore the factors that contributed to the bankruptcy of younger generation due to credit card debts. The findings of the research provide useful outcomes to younger generation as well as public in order to increase their awareness regarding the bankruptcy issue that could be seen as a new disease. An update on the insolvency trends, performance and recent initiatives undertaken by Malaysia Department of Insolvency (MdI) were also reviewed in this study. Insolvency Trends and the administrations consisting of individual bankruptcies and bankrupts cooperation were also studied thoroughly. KEY WORDS Bankruptcy, credit cards, young peoples JEL CODES F65 1. Introduction Credit cards were first issued in the USA in the early twentieth century. In Malaysia, the first card was introduced in the mid-1970s (Zafar U. Ahmed & et al., 2010) [1]. At the early on period, credit cards were only issued to professionals or successful business persons by card issuing companies. However, with the passage of time, eligibility criteria for obtaining credit cards have been changed because credit cards are now easily obtained by individuals regardless of their income or other measures of financial wellbeing. As a result, the number of cardholders reached to about three million by the turn of the last century (Zafar U.Ahmed & et al., 2010)[1].The increase of credit card has brought many side effects to the users especially for the people aged below 30. This is because credit card influence them in making the excessive spending because it easier and convenient for user to pay with credit card rather than bring cash with them. As a result, in March 2009, outstanding debts from credit card holders amounted to RM billion were reported. Then, by the year2009 outstanding credit card debts accounted for 1.35 percent of the total loans outstanding or percent of the total consumer credit (Bank Negara Malaysia, 2009; as cited in Zafar U. Ahmed & et al., 2010)[1].Thus, its shows that increase in the number of credit 330

2 card holders seeking bankruptcy records over the years were also reported. The people below 30 are the leading aged group that has been declared bankrupt because of credit card debts (Credit Card Debt and You: Under-30s under Siege, Malay Mail Insight, 2009) [2]. In the bankruptcy survey of the Panel Study of Income Dynamics, the most common reason that households gave for filing for bankruptcy was high debt/misuse of credit cards 33 percent gave this as their primary reason for filing. A 2006 survey of debtors who sought credit counseling prior to filing for bankruptcy found that debt was even more important: two-thirds were in financial difficulty because of poor money management/excessive spending (National Foundation for Credit Counseling, 2006). In addition, all of the empirical models of the bankruptcy filing decision have found that consumers are more likely to file if they have higher debt. Domowitz and Sartain (1999) found that households are more likely to file as their credit card and medical debt levels increase. Gross and Souleles (2002a) similarly found that credit card holders are more likely to file as their credit card debt increases. In Fay, Hurst, and White (2002) found that households are more likely to file as their financial gain from filing increases where the financial gain from filing mainly depends on how much debt would be discharged in bankruptcy. International comparisons also suggest a connection between credit card debt and bankruptcy filings. Ellis (1998) uses the comparison between the United States and Canada to argue for the importance of credit card debt in explaining the increase in bankruptcy filings. General credit cards were first issued in 1966 in the United States and in 1968 in Canada. In Canada, both credit card debt and bankruptcy filings increased rapidly starting in But in the United States, usury laws in a number of states limited the maximum interest rates that lenders could charge on loans, which held down their willingness to issue credit cards. U.S. bankruptcy filings remained constant throughout the 1970s. In 1978, however, the U.S. Supreme Court effectively abolished state usury laws in the Marquette decision, and after that, both credit card debt and bankruptcy filings increased rapidly in the United States.3 Mann (2006) documents a similarly close relationship between credit card debt and bankruptcy filings in Australia, Japan, and the United Kingdom. Livshits, MacGee, and Tertilt (2006) use calibration techniques to examine various explanations for the increase in bankruptcy filings since the early 1980s.They find that only the large increase in credit card debt combined with a reduction in the punishment for bankruptcy can explain the increase in bankruptcy filings since the early 1980s.Finally, mortgage debt has also grown rapidly since 1980, although the growth rate of mortgage debt is well below the growth rate of revolving debt; that is, real mortgage debt per household tripled between 1980 and 2006, while real revolving debt per household grew by a factor of 4.6 over the same period. The increase in mortgage debt and the increase in bankruptcy filings are related in several ways: First, homeowners often file for bankruptcy to delay mortgage lenders from foreclosing on their homes. Second, although mortgage debt is not discharged in bankruptcy, homeowners may want to file because having their consumer debt discharged makes it easier for them to meet their mortgage obligations. Finally, debtors may file for bankruptcy if their mortgage lender has already foreclosed and the house has been sold for less than the amount owed. In this situation, debtors in some states are liable for the difference, but the debt can be discharged in bankruptcy. For more discussion of these interactions between mortgage debt and consumer debt, see Berkowitz and Hynes (1999) and Lin and White (2001)

3 Overall, the increase in credit card and possibly mortgage debt levels since1980 provides the most convincing explanation for the increase in bankruptcy filings in the United States. But adverse events and debt levels interact with each other in explaining the increase in bankruptcy filings because, as debt level increase, any particular adverse event is more likely to trigger financial distress and bankruptcy. 2. Findings of Study Given the apparent connection between the expansion in credit card debt and the rise in bankruptcy filings, it s useful to review how markets for credit cards have evolved in recent decades. My discussion here draws on Ausubel (1997), Evans and Schmalensee (1999), Moss and Johnson (1999), Peterson (2004), and Mann (2006). Until the 1960s, consumer credit generally took the form of mortgages or installment loans from banks or credit unions. Obtaining a loan required going through a face-to-face application procedure with a bank or credit union employee, explaining the purpose of the loan, and demonstrating ability to repay. Because of the costly application procedure and the potential embarrassment of being turned down, these loans were generally small and went only to the most creditworthy customers. This pattern began to change with the introduction of credit cards in1966, since credit cards provided unsecured lines of credit that consumers could use at any time for any purpose. The earliest credit cards were issued by banks where consumers had their checking or savings accounts. Because most states had usury laws that limited maximum interest rates, banks offered credit cards only to the most creditworthy consumers and card use therefore grew only slowly. But after the Marquette decision in 1978, credit card issuers could charge higher interstates, and they expanded in states where low interest rate limits had previously made lending unprofitable. Over time, the development of credit bureaus and computerized credit scoring models changed credit card markets, because lenders could obtain information from credit bureaus about individual consumers credit records and could therefore offer credit cards to consumers who had no prior relationship with the lender. Lenders first offered credit cards to consumers who applied by mail, and then began sending out pre-approved card offers to lists of consumers whose credit records were screened in advance. These innovations reduced the cost of credit both by eliminating the face-to-face application process and by allowing lenders to expand nationally, which increased competition in local credit card markets. From1977 to 2001, the proportion of U.S. households having at least one credit card rose from 38 to 76 percent (Durkin, 2000). Over the same period, revolving credit increased from 16 to 37 percent of no mortgage consumer credit, which means that credit card loans gradually replaced other forms of consumer credit. This shift from installment to revolving loans meant dramatic changes in the terms of consumer debt. Secured and installment loans typically carried fixed interest rates and fixed repayment schedules. Credit card loans, in contrast, allow lenders to change the interest rate at any time and allow debtors to choose how much they repay each month, subject to a low minimum repayment requirement. Consumers who repay in full each month use credit cards only for transacting; they receive an interest-free loan from the date of the purchase to the due date of the bill. In contrast, consumers who repay less than the full amount due each month use credit cards for both transacting and borrowing; they pay interest from the date of purchase. If borrowers pay late or exceed their credit limits, then lenders raise the interest rate to a penalty range and impose additional fees

4 Credit card issuers compete heavily for new customers by mailing out unsolicited, preapproved credit card offers: in 2001, the average U.S. household received45 of these offers (Bar- Gill, 2004). Over time, competition among issuers has led them to offer increasingly favorable introductory terms and increasingly onerous post-introductory terms. The favorable introductory terms include zero annual fees, low or zero introductory interest rates on purchases and balance transfers, and rewards such as cash back or frequent flier miles for each dollar spent. The favorable introductory terms encourage consumers to accept new cards, while the rewards programs encourage them to charge more on the cards and the low minimum repayment requirements encourage them to borrow. The format of the monthly bills also encourages borrowing, since minimum payments are often shown in large type while the full amount due is shown in small type. Minimum monthly payments are low typically the previous month s interest and fees plus1 percent of the principle which means that debtors who pay only the minimum each month still owe nearly half of any amount borrowed after five years. After the introductory period, terms become much more onerous: the average credit card interest rate is 16 percent, interest rates rise to 24 to 30 percent if debtors pay late, and penalty fees for paying late or exceeding the credit limit are around $35. This pattern of credit card pricing implies that issuers make losses on new accounts and offset their losses with profits on older accounts (Ausubel, 1991, 1997; Bar-Gill, 2004). Credit card issuers have also expanded their high-risk operations by lending to consumers who have lower incomes, lower credit scores, and past bankruptcy filings. The percentage of households in the lowest quintile of the income distribution who have credit cards rose from 11 percent in 1977 to 43 percent in 2001(Durkin, 2000; Johnson, 2005). Three-quarters of bankrupts also had at least one credit card within a year after filing (Staten, 1993).The shift of consumer debt from installment debt to credit card debt, combined with the pattern of credit card pricing, has made consumers debt burdens much more sensitive to changes in income. When consumers incomes are high, they are likely to pay their credit card bills in full, and therefore their debt burden is low and they pay little or no interest. But when incomes decline, consumers are likely to pay late or to pay the minimum on their credit cards, so that their debt burdens increase and they pay much more in interest and fees. Although credit cards allow consumers to smooth consumption when their incomes fall, the cost of doing so is extremely high and may cause some debtors to enter a state of ongoing financial distress. 3. Insolvency Trends and the Administration (Report by Department of Insolvency Malaysia) As reflected in the Figure 1, the total number of individual bankruptcies registered from 2005 to March 2011 is 90, In the first quarter of 2011, 20,555 creditors petitions were filed in court to initiate bankruptcy proceedings and this marks an increase of 0.78% from the first quarter in the previous year where 20,395 creditors petitions were filed in court

5 Figure 1. Yearly Petitions and Orders made from 2005 to 2011 Generally, Figure 1 further indicates a sharp increase of 40.11% in the number of creditors petitions filed in 2010 in contrast to the number of creditors petitions filed in ,490 petitions were filed by creditors in 2009 whereas as many as 87, 645 petitions were filed by creditors in In consequence to the increased number of creditors petitions filed in 2010, the ending of 2010 shows an increase of 11.65% in respect of individual bankruptcies registered as compared to the number of individual bankruptcies registered in A slight increase is shown in the number of Receiving Orders (RO) and Adjudication Orders (AO) made in the beginning of The first quarter of 2011 denotes an increase of 7.27% number of registered bankruptcy cases as 4,841 RO and AO were made in comparison to 4,513 RO and AO made in the first 3 months of Figure 2. Cases Resolved Based on Categories from 2005 to March

6 Parallel with the Tenth Malaysia Plan and the New Economic Policy introduced by the government, Malaysian Department of Insolvency (MdI) strives to provide an effective administration of bankruptcy cases in ensuring the enhancement of public service delivery system and efficiency. Out of the total number of bankruptcy cases administered, a total of 23,147 cases had been resolved via 3 modes that is, discharge by way of court order, discharge via certificate of Director General of Insolvency and annulment of the Adjudication Orders, in the period between 2005 to March As indicated in Figure 2, majority of cases had been resolved by way of discharge via certificate of Director General of Insolvency made in pursuant to section 33A, Bankruptcy Act 1967 in which 11, 342 (49%) bankruptcy cases were resolved. 8, 101 (35%) bankruptcy cases were resolved by way of annulment of adjudication orders and 16% of cases were resolved when 3,704 bankrupts had obtained their discharge by way of court order. 4. Bankrupts Applications in pursuance to Section 38 of Malaysian Bankruptcy Act 1967 To recap, Section 38 of the Malaysian Bankruptcy Act 1967 restricts undischarged bankrupts from inter alia, leaving Malaysia, carrying on any business and maintaining any action in court, without the previous permission of the DGI. Bankrupts can obtain the permission of the DGI against any of those abovementioned restrictions by submitting their applications to the administering branch and it will be processed within 7 days from the date of application, as promised in MdI s client charter. Figure 3. Number and types of application made by bankrupts from 2010 to

7 Figure 3 depicts the number and most common types of applications made by bankrupts. In the first 3 months of 2011, 1,735 applications to obtain the permission of DGI for various reasons were made and 100% of it was approved. Applications made to leave Malaysia in the first quarter of 2011 shows a slight decrease of 3.7% when only 1,585 applications were made, as compared to the 1,644 applications made in the first quarter of applications made by bankrupts to obtain the permission of DGI to carry on any business were approved in the first quarter of 2010 in contrast to 153 similar applications made in the first quarter of 2010, which marks a decrease of 33.33%. Nevertheless, applications made by bankrupts to obtain the permission of DGI to maintain court action indicates an increase of 30.6% whereby 48 bankrupts made the application within the first 3 months of 2011 in comparison to only 37 applications made in the first 3 months of Figure 4. Statement of Affairs filed by bankrupts from 2009 to 2011 The level of bankrupts cooperation can mainly be indicated in the number of Statement of Affairs filed, as against the number of individual bankruptcies registered in a year. A bankrupt s cooperation in filing the Statement of Affairs is imperative in ensuring an efficient administration of each bankruptcy case. It is also essential in considering any of the applications made by the bankrupt during his/her period in bankruptcy. As shown in Figure 4, between first quarters of 2009, 2010 and 2011, a noticeable steady increase in filing of Statement of Affairs by bankrupts is recorded in each quarter. 48.8% increase in filing of Statement of Affairs is shown from the first quarter of 2010 in which 2, 615 bankrupts had filed their Statement of Affairs in the first as compared to only 1,757 who did so in the same period of The cooperation given by bankrupts continues to increase by 6.3% when 2, 780 bankrupts had filed their Statement of Affairs in the first quarter of Conclusions As the bankruptcy due to credit card debts has increase especially among people aged below 30, serious effort should be taken to curb this issue. Thus, researcher has come out with several recommendation or suggestion regarding this issue. Firstly, it is recommended to encourage 336

8 people aged below 30 s to use the debit card rather than credit card in order to reduce the debt and bankruptcy among them. Debit card will debit money directly from the owner account which prevents one s to spend more than his or her ability. Whereas, credit card allow the card holder to borrow money from the issuing bank and there will be interest charges from the credit card company on the purchases that had been made. Thus, the higher debts can increase the chances to be declared as bankruptcy among credit card holder. Therefore, using debit card is the wise action when making the purchases since it will only allow the card holder to spend within their limit. Other steps that can be considered is to increase the knowledge about credit card and bankruptcy among people aged below 30 s. Providing the credit education to the people aged below 30 as well as public can help them in managing their money wisely and use the credit correctly to avoid debts. It can be done through financial seminar, talk from professional person or forum. The credit education can help one s to manage their financial, debt and set up a better planning for the future and it should begin as early as possible. Then, it is recommended for the government or any non government organization (NGO) to aggressively come out and implements the campaign in order to create the awareness regarding the credit card debts. For example, in the campaign should encourage public as well as people below 30 s to bring their cash or use debit card rather than use the credit cards when buying things. By doing so, the public and people aged below 30 s can think twice before purchase any product or service. Through this kind of campaign, it can increase the awareness regarding the credit card debts implication and the advantages and disadvantages of having the credit card. References 1. Ausubel, Lawrence M. (1997). Credit Card Defaults,Credit Card Profits, and Bankruptcy. American Bankruptcy Law Journal, 71(spring): Bar-Gill, Oren (2004). Seduction by Plastic. Northwestern Law Review, 98 (summer): Barron, John M., Michael E. Staten, andstephanie M. Wilshusen (2002). The Impact of Casino Gambling on Personal Bankruptcy FilingRates. Contemporary Economic Policy, 20(4): Domowitz, Ian, and Robert L. Sartain (1999). Determinants of the Consumer Bankruptcy Decision. Journal of Finance, 54(1): Efrat, Rafael (2002). Global Trends in Personal Bankruptcy. American Bankruptcy Law Journal, 76 (winter): Gropp, Reint, J. Karl Scholz, and Michelle J.White (1997). Personal Bankruptcy and CreditSupply and Demand, Quarterly Journal of Economics, 112(1): Lin, Emily Y., and Michelle J. White (2001). Bankruptcy and the Market for Mortgage and Home Improvement Loans. Journal of Urban Economics, 50(1): Livshits, Igor, James MacGee, and Michele Tertilt (2006). Accounting for the Rise in Consumer Bankruptcies Moss, David A., and Gibbs A. Johnson (1999). The Rise of Consumer Bankruptcy: Evolution, Revolution, or Both? American Bankruptcy Law Journal, 73 (spring): Shuzen, Ng. (2009). Credit Card Debt and You: Under-30s Under Siege, available at: Wang, Hung-Jen, and Michelle J. White (2000). An Optimal Personal Bankruptcy System and Proposed Reforms. Journal of Legal Studies, 29(1):

9 12. Zafar U. Ahmed, Ishak Ismail, M. Sadiq Sohail, Ibrahim Tabsh, Hasbalaila Alias (2010). Malaysian consumers credit card usage behavior, Asia Pacific Journal of Marketing and Logistics, Vol. 22 No. 4, pp