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CFA Society The Bahamas Financial Literacy Good Debt vs. Bad Debt

www.cfasociety.org/bahamas


What is Debt?

What is ‘Debt’

Dictionary.com defines debt as: Noun 1.  something that is owed or that one is bound to

pay to or perform for another 2.  a liability or obligation to pay or render

something 3.  the condition of being under such an

obligation www.cfasociety.org/bahamas


Debt Picture in The Bahamas

www.cfasociety.org/bahamas Source: Central Bank of The Bahamas

Bahamas has $2.3Bn in Consumer Debt Outstanding as at Sep 2017

$156M is Past Due

Good Debt vs. Bad Debt


What is ‘Good Debt’

•  Good debt is an investment that will grow in value or generate long-term income.

•  Good debt “pays for itself” – The funds that are borrowed are placed in an

investment that generates sufficient return to both a)  repay the original amount borrowed, plus the

cost of said debt; and b)  provide additional value for the owner


What is ‘Bad Debt’

•  Bad debt is debt incurred to purchase things that quickly lose their value and do not generate long-term income.

•  Bad debt may also be considered debt that carries a high interest rate.


Good Debt vs. Bad Debt Good Debt Bad Debt

•  Small Business Loan

•  Loan to purchase shares

•  Land Acquisition Loan

• Credit Card Debt •  Vacation Loan •  Payday Loan • Cash Advance

Loan • Car Loans


Good Debt vs. Bad Debt


•  Grey Areas: – Home Loan – Debt Consolidation Loan – Education Loan

•  School Fees •  University/Special Skills Education

– Credit Card Cash Back/Rewards Programs

Appropriate Levels of Debt


Debt Level (Advanced vs. EM Countries)

•  In an October 2017 report, on the subject of Household Debt and Financial Stability, the IMF opined that:

“although finance is generally believed to contribute to long-term economic growth, recent studies have shown that the growth benefits start declining when aggregate leverage is high”

•  The report mentions that household debt-to-GDP is higher in advanced economies (approx. 60+%), whereas household debt-to-GDP in emerging market economies is lower (approx. 20+%)


Debt Levels (Advanced vs. EM Countries)

•  The same report states that during 2016: “... In the highest quartile, the household debt-to-GDP ratio fell only slightly from 88 percent to 86 percent in advanced economies and continued to rise from 28 percent to 32 percent in emerging market economies.”

•  Using The Bahamas 2016 consumer debt of $2.37Bn vs. a GDP of approx. $10Bn, household debt-to-GDP is approx. 24 percent –  Slightly higher than avg. EM household debt-to-GDP

level


Debt Levels (Advanced vs. EM Countries)

•  Is this a bad thing? Not necessarily

•  The IMF Report goes on to say: –  “On average, an increase in household debt boosts

growth in the short term but may give rise to macroeconomic and financial stability risks in the medium term...the negative medium-term consequences of increases in household debt are more pronounced for advanced than for emerging market economies.”


Household debt Total, % of net disposable income, 2015


Source: OECD (2018), Household debt (indicator). doi: 10.1787/f03b6469-en (Accessed on 08 February 2018)

Household debt Total, % of net disposable income, 2015


Source: OECD (2018), Household debt (indicator). doi: 10.1787/f03b6469-en (Accessed on 08 February 2018)

Bahamas – approx. 230%

What is an “appropriate” level of Debt?


•  Central Bank of The Bahamas guidelines recommend a 45% TDSR for individuals

•  What is “TDSR”? – Total Debt Service Ratio (TDSR) is the

percentage of household income dedicated to meeting debt repayment obligations

•  Many households with TDSR’s above the recommended level struggle to meet their monthly repayments due to other commitments (e.g. utility bills, rent, groceries, etc)

Debt Management Strategies


Strategies to manage debt

•  Minimize the use of debt to purchase consumables

•  Avoid high-interest rate debt and excessive fees – Reduce and eliminate high-interest debt

•  Prepay debt where at all possible •  Plan and save for “big-ticket” purchases •  Create a budget to track spending as well as

debt service


Conclusion •  Debt is a tool

– Used wisely, it can help to create wealth and improve standard of living

– Used unwisely, it can lead to financial challenges and ruin



Thank You