Biting back

25 March 2004 - Your Bond magazine

Some banks have been rapped over the knuckles by the banking services ombudsman for pocketing profits on the sale of repossessed properties. We find out what's going on and how it affects home owners.

Banks have their own proverbs about customers and defaulters and there are always two sides to any story.

Banks project themselves as client-friendly and service-orientated though they no longer do so as emphatically as building societies did in the good old days with slogans such as 'People you can talk to' and 'Your helping hand in the land'. At times, however, the issues between banks and their clients come to the fore, especially when vulnerable borrowers are on the receiving end.

Ombudsman rules in favour of home owners:
The ombudsman for banking services, Neville Melville, recently issued a directive to banks against an uncommon but established practice amoung some banks. Home-loan defaulters are usually at their bank's mercy once a summons has been issued and a sale in execution has been arranged. very often no one appears at the Sheriff's auction to purchase the property, so the bank buys the property at a nominal purchase price of R10 or R100. this is no the bank's best-case scenario by any means for it now has to take transfer of the property and resell it, usually through an estate agency. This costs the bank around 8% of the selling price in agent's commission and, with the owner often staying on in the property rent-free while all legal stuff gets sorted out, the banks consistently end up losing thousands when the dust finally settles.

With rising property values, however, banks occasionally end up making a profit on resale. Some banks have been pocketing the difference, a practice which appears to be perfectly sound legally. The aggrieved home owners, however, have complained of exploitation by the bank, claiming that the excess should be paid to them. The argument is that the banks should seek to achieve no more than to balance their home loan books as the supply of home loans to the public should be regarded as a customer service industry only.

Melville, in response to such a case handled by his office, has warned banks that pocketing the profit on property resales goes right against the grain of common law. 

This opinion has yet to be tested in the courts. What concerned the ombudsman, however, was the bank's simultaneous practice of only crediting the homeowner's account with the R100 it paid for the property, leaving the rest of the loan debt still owing to the bank. Melville has recommended that banks always credit their clients' account with the full proceeds acquired on resale and, if any profit accrues, it must be paid to the home owner.

Borrowers are reacting to arbitrary practices:
The Banking Council of South Africa has agreed with Melville's directives. Banks will inevitably comply with the ruling, especially as they very rarely have a credit balance left after a repossessed home is bought in and resold privately. Bank customers are reacting to other practices, however, especially those which are perceived to be arbitrary. It's the man in the street against a corporate giant every time and there's a growing resentment whenever banks are perceived to be a law unto themselves. it certainly cannot be suggested that contracts between the two are based on an equal bargaining basis. the banks hold the aces and are sometimes inclined to use them ruthlessly.

Earlier this year, one aggrieved customer, angry because he believed his bank had not treated him fairly, duly let loose five puff adders all over the banking hall and threatened to do it to other branches of the same bank. If the bank touched any of his snakes, he warned he would sue it for R10 million. Extreme case, surely, but there are many customers who share the frustration.

One local banks is well known for granting home loans subject to the condition that the borrower first transfers another property and cancels the bond on it. The bank's rationale is that it does not want the borrower paying off two bonds at once. The seller of the property, however, often complains that he sold to the buyer on the express condition that the sale should not be subject to the sale of another property. 

The bank effectively has introduced a suspensive condition that wa snot included in the original contract. One recent case is known where the same bank effectively obliged an owner to sell her own home as a condition of granting a loan on another property she was only purchasing as an investment. No one from the bank ever discussed this with her and she only discovered the condition some time later.

Should banks be regulated as a service industry?
Banks can reply that they are normal businesses and cannot operate purely on client-sensitiveness or subjective considerations. They have to make a profit to make a living and can fairly argue that they should be able to impose their own conditions of ant home-loan grant which the borrower is free to accept or reject. The customer in return, however, will again complain that the odds are loaded against him and that he has no other options. Often, as shown already, it is a non-customer of the bank such as the property seller who is victimised and prejudiced.

Legislation is being introduced to restrain the freedom of banks to offer home loans as and where they choose and on whatever conditions suit them. The Mortgage Disclosure Act  came in a few years ago, obliging banks to spread their home loans fairly across all sectors of the market. On the drawing board is the Community Reinvestment Bill which, when promulgated, will prevent banks redlining certain areas. How far should banking practices be regulated?

Nothing should be done to restrict their rights to protect their interests but, if banks are going to exceed reasonableness at any point and prejudice their borrowers who cannot negotiate on equal terms with them, some form of protection should be given. Government in South Africa increasingly sees banking as a public service industry and further legislation to balance the relationship between banks and their hungry customers may follow.

In defence of the banks - playing the devil's advocate?

Banks can very legitimately make a case of their own against their home-loan customers. When advancing huge sums for property purchases, banks take them on good faith and trust them to maintain their monthly instalments. There's  nothing to stop the borrower defaulting, however, and the consequences  are often serious for the banks. They already show considerable patience and goodwill in not acting immediately against these defaulters. Usually, the customer must fall at least three months in arrears before the bank takes action, and it can take another six months before the property is sold in execution. In the meantime, the borrower invariably enjoys the sunshine and stays rent-free on the property. In most cases the bank takes a loss and, if it is not allowed to pocket its profits in other sales, it has no means of setting off or recovering its losses.

Home loans are at the bottom of the ladder, anyway, when it comes to earning dividends. Banks can lend money more profitably on motorcar purchases and other credit agreements where the interest is often way above prime. the same goes for overdrafts and credit card allowances. Most banks grant concessions to home owners of between 1% and 2% below prime, which cuts their margins to the bone. They're pressed to do this in competition with each other and securitisation companies and rely heavily on other loans to create adequate margins. Home loans are not their favourite source of revenue and it's not too hard to understand why they prefer to err on the side of caution when stipulating conditions of grant.