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Middle EastJune 1 2008

Kuwait’s direct action holds useful lessons

Targeted intervention, such as that imposed on borrowing limits by Kuwait, could work in other problem areas of banking.
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The current credit crunch has many consequences that strike at the core of banking relationships. One is increased personal indebtedness aggravated by housing negative equity, declining economies and soaring inflation. Across many countries, the current blight is forcing many consumers into increased borrowings to keep their households together. And there is a direct correlation between dire economic circumstances, growing indebtedness and the social ­consequences of non-repayments, repossessions and the rest.

The Bank of England noted that the increase in total net lending to individuals in February (£9.8bn) was higher than the increase in January and the previous six-month average. And a recent study by Bristol University showed that credit users in their late 50s and early 60s owe at least four times as much in unsecured credit as their counterparts did a decade ago; and outstanding credit commitments increase the risk of financial difficulties 26 times over.

But while caveat emptor (let the buyer beware) remains a prime guiding rule, is there an alternative to the cycle of increased indebtedness ending in tears? In Kuwait, the central bank has deliberately decided to avoid the adverse consequences of overborrowing by imposing a limit on what banks can lend. Under the rules, instalment repayments of all loans shall not exceed 40% of a borrower’s net disposable income or salary placed in the bank. As 90% of Kuwaitis are civil servants and their salaries go direct to their bank, the ­system works and has limited the availability of credit. The banks may be squeezed to some extent, and the use of credit cards has declined as a result, but the central bank governor is pleased to avoid the possible social problems of over-indebtedness.

Is this type of specific, targeted intervention applicable elsewhere? While some may argue that the 40% of net disposable income is a relatively crude measure that would not only be difficult to implement but would also not take into consideration the complex needs of sophisticated customers, setting a ­specific target is simple and clear and possibly solves a problem before it begins.

If there are lessons to learn from the current crisis, new approaches need to be taken. Setting limits may work for over-indebtedness in Kuwait, but such a direct approach may also work in other areas, such as limiting the level of ­market funding, à la Northern Rock. Radical strategies are needed, strict ­limits may be part of the answer.

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Read more about:  Analysis & opinion , Comment , Middle East , Kuwait