Tightening the Screws on Microfinance
By Faith Kiarie
South Africa is currently embroiled in a debate regarding interest rates in the microfinance sector. In my previous article, I briefly referred to a “dearth of microfinance” in South Africa. This is a term that’s often associated with micro lending, microcredit and consumer credit. Here, it is used broadly for all providers of microfinance services – around nine categories. In South Africa, this term has been known to evoke strong emotions. While some revere microfinance institutions for their support for the less privileged, others see them as profit-seeking and detest them for what they see as taking advantage of the poorest amongst us.
Whatever your position on the matter is, the role that such institutions have played in assisting people haul themselves out of poverty traps, globally, is undeniable. It is thus unsurprising that a proposal by the Department of Trade and Industry (DTI) to cap interest rates – particularly but not exclusively - on unsecured loans has aroused a hot debate in the South African financial world.
The loudest argument against this action is that lending to the poor is a risky business. The sizes of the loans are usually too small to cover operating, processing and monitoring costs. Indeed, one is moved to sympathize with this view as few microfinance intuitions in the country are self-sufficient, most with too little capital to allow for expansion. Of course, those with an opposing view assert that these firms are morally bankrupt, in it to rake up profits while passing on the costs of their inefficiency to the most economically vulnerable in society.
Another factor said to make lending to this income segment complex is the regulatory environment within which these firms operate. Many clients do not have access to traditional types of collateral and legislative support to facilitate lending to this market is lacking. An example of how the problem is exacerbated can be found in rural South Africa. Traditional leaders usually have control over communal lands and even though the dwellers on the properties own the land by all means and purposes, the system doesn’t legally secure individual ownership.
This insecurity has denied heaps of people from managing assets that are surely theirs. So if firms want to extend credit to this group, it’s an administrative nightmare to value their assets. There is insufficient access to and knowledge of what can be put up as collateral. So in the event of a default, the question of how much can be claimed and how long the payback period will be is difficult to answer satisfactorily.
Additionally, unemployment levels in South Africa have remained stubbornly high over the years – especially so amongst the youth – an Achilles heel for the industry. Currently, quite a few microfinance players engage in group lending and target women in particular. This strategy has worked quite well thus far. However, capping lending rates is unlikely to help them reach more people.
Neither is it likely to attract more competitors into the field, which doesn’t do consumers any favors. As it is, some forms of grants are sorely needed by the majority of microfinance institutions to grow and achieve economies of scale.
Whichever way one looks at it, the DTI faces a difficult decision. Stakeholders naturally have differing, if somewhat conflicting interests, and legislators are going to be hard-pressed to figure a just outcome for both lenders and customers. Lenders in this business have been lamenting that they can expect an income haircut of between 18 and 24 percent– numbers they say will risk putting a great deal of them out of business. How futile it’d be to protect consumers against exploitation from non-existing businesses.
Capitec bank, on the other hand, is in a position to soak up market share that may be available if this law is passed. The bank has been a breath of fresh air for the lower and middle income tiers as they already lend below the proposed rate and their fast-growing client base is evidence that consumers punish uncompetitive businesses without the help of government.
Nonetheless, the bank has been quite conservative about the growth of their loanbook – even more so after the collapse of its main competitor - African Bank. An unintended consequence of setting interest rates may therefore be that regulated institutions will have more reason to be more stringent about lending requirements – leaving markets wide open for illegal lenders. The fact is that loansharks, called Mashonisas in South Africa, will lend to just about anybody, at whatever rate they wish, and can threaten those unable to pay back.
The recent fall of unsecured lending giant, African Bank, reminds us all of the importance of curbing reckless lending and the level of indebtedness of South African consumers is worrying. But correcting these wrongs needs to be done without removing all responsibility from borrowers, without punishing lenders who’ve been observing the law, and without putting unnecessary strain on economic growth.
Moreover, the issue of financial inclusion, and the role of microfinance within it, has become an area for political parties to score points. It’s crucial that whatever decision is reached isn’t politically motivated or short-sighted. Politicians are usually quick to batter on – and perhaps rightly so — about the monopolization of formal banking by a few. But this area is stable, which is more than can be said about developmental finance, which has yet to reach its full potential under the government’s watch. Stuart Theobald of Business Day recommends that instead of capping rates, regulation should be geared towards “forcing all lenders to provide comparable standardised information” to clients. Whatever decision is made, it’s going to be an interesting space to watch for the coming months.
Faith Kiarie recently completed an honours degree in finance at the University of the Western Cape. She is interested in economic development in Africa, especially that of women.
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