Insolvency Recidivism – what causes it?

Tom Locke - Insolvency Trustee in London, Ontario
July 26, 2022

Insolvency recidivism is when people repeat bankruptcies or proposals, but what causes recidivism?  In the early 1990s changes in the Bankruptcy & Insolvency Act made it easier and more cost effective for people to file for bankruptcy and to make proposals to creditors.  As more consumers availed themselves of the relief the government expressed concern about second and third filings.

Rather than taking a broader view of what was going on the government, in essence, blamed the victim – the insolvent individuals.  The reality is that banking deregulation led to the proliferation of credit cards in the late 1970s and early 1980s.  These credit cards carried very high rates of interest and were promoted very aggressively.  In 1980 there were 10.5 million bank issued credit cards in circulation in Canada, by 1990 that number had more than doubled to 23.2 million.

The amount of debt Canadians were carrying was far higher than ever before, in 1980 Canadians charged some $9.44 billion on credit cards, a decade later in 1990 that value had increased to $42.45 billion a 450% increase in debt.  Clearly the problem did not originate with users but rather with lenders.  Banks knew this only too well.  Audits of their internal practices did not come under external scrutiny for decades, but what they revealed was a reckless policy of pushing credit cards on people who were not qualified. 

Banks were concerned, in the early 1990s, by the increased level of defaults and insolvencies.  But in spite of increased losses, profits were extremely high as consumers struggled to maintain payments even if it meant borrowing from one card to pay another.  Bank tellers were receiving bonuses for (suggestively) selling credit cards and lines of credit even though in many cases, known to their bosses, they were fudging numbers to qualify people for more credit than they ought to have had

Obtaining credit has become far too easy, and no amount of consumer education will change that.  The only thing that will impact greed driven loose lending policies is legislation.  In Quebec, the government took an important step to protect consumers from exploitation by increasing the required minimum monthly payments.  And more recently the federal government has proposed an amendment to the Criminal Code (Bill S-239) that will reduce the legal rate of interest from 60% per annum to 20% plus the overnight rate

The most bankruptcy filings we have heard of was five (5), surely the bankrupt individual was culpable, but so were the lenders, including banks.  A first time bankruptcy remains on a (Equifax) credit report for six years following discharge, so a total of 6 years and nine months.  A second and subsequent bankruptcy filing remains on the report for 14 years following discharge.  This is germane because if our five time filer had to wait until his credit report was purged to get more credit (and to file for bankruptcy again) assuming he were 20 years old at the time of the first filing, and assuming he could not get credit until his report was purged, he would have been 83 years old at the time of the last filing

The reality is that lenders are in the business of lending, and they want to lend as much as possible to mitigate any losses.  Consumers are not, and never will be, as sophisticated as bankers when it comes to anything bank related, including lending/borrowing.  High interest rates on credit cards and low minimum payment requirements also mitigate defaults but perpetuate indebtedness.

In an ideal consumer lending world, mortgage rates would be around 6% and credit card rates should be a lot less than 10%.  Sustained low mortgage rates have led to higher priced housing and the consolidation of unsecured debt into mortgages, freeing up credit cards for more spending.  Mortgage debt in Canada has approximately doubled in the last half decade and credit card spending has not shown any signs of abatement.  In the face of this massive increase in lending, insolvency filing rates have been in a freefall.