towards formal sector banking resulted in a lack of appropriate credit instruments for poorer people. .... credit in South Africa has changed between 1995 and 2000. Lastly ...... credit agreement will not be able or willing to service the interest or.
Development Southern Africa Vol. 21, No. 5, December 2004
Financial intermediation, regulation and the formal microcredit sector in South Africa Reza C Daniels1 This article evaluates demand- and supply-side aspects of the formal microcredit sector in South Africa and the environment in which the sector is regulated. Although South Africa has a competitive financial sector relative to a sample of upper middle-income countries, the historical bias towards formal sector banking resulted in a lack of appropriate credit instruments for poorer people. In 1992, new regulations facilitated the legalisation of microfinance institutions and, by 2000, the sector had grown to over 2 per cent of total credit extended by the monetary sector, with over 1 300 institutions supplying microcredit to the public. The article presents the first statistics of different types of microcredit institutions as well as some of their disbursement trends, recorded since 1999 by the Micro Finance Regulatory Council. Thereafter, the demand for credit is assessed between 1995 and 2000, before best-practice regulation and South Africa’s degree of compliance are discussed.
1. INTRODUCTION This article evaluates the formal microcredit sector in South Africa, its scope and development, and its role in the financial sector and the economy more generally. It is informed by the premise that households and institutions save and invest independently, and that the role of the financial system is to intermediate between them and to apportion available funds to where they are needed. This process, of course, is regulated; thus, attention will also be given to the governance and institutional dimensions of the sector. The microfinance industry is composed of credit, savings and insurance institutions. In this article, only the providers of microcredit are investigated. Microcredit providers in South Africa are also part of either the formal or the informal economy. In this article, only formal institutions are evaluated. The reason for focusing on the formal microcredit sector is that it provides an excellent example of how demand, supply and regulatory aspects of the industry interacted to facilitate its rapid growth. It is interesting, not least because of the confluence of these factors, but also because of the inherently ambiguous welfare implications of the sector that proffer both positive and negative societal impacts. The microfinance sector was formally (legally) established in 1992 when the state issued an Exemption to the Usury Act that removed interest rate ceilings on small loans under R6 000 with a repayment period of less than 36 months. The rapid growth of the industry provided the impetus for a second Exemption to the Usury Act in 1999, where revisions 1 Research Associate, Southern African Labour and Development Research Unit, School of Economics, University of Cape Town, Cape Town, South Africa. The author would like to thank Trade and Industrial Policy Strategies for their generous support towards the production of this article. Special thanks must also be extended to the team at the Micro Finance Regulatory Council for their time and patience with respect to the provision and explanation of the data and their limitations. Helpful comments from two anonymous referees are also very much appreciated. All views, errors and omissions are the responsibility of the author.
ISSN 0376-835X print=ISSN 1470-3637 online=04=050831-20 # 2004 Development Bank of Southern Africa DOI: 10.1080=0376835042000325732
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to the amount of small loans were increased from R6 000 to R10 000. The Micro Finance Regulatory Council (MFRC) was established to manage the sector, and new regulations for governing the way microloans would be administered and repayments collected were added. However, the growth of the industry has raised as many questions about the financial sector’s operation as it has answered those concerning a conducive regulatory climate. Firstly, why has there been such rapid growth in the industry, given that South Africa has a fairly sophisticated financial sector in the first place? Partly related to this is the question of who the end users are of the loans supplied by microcredit institutions (MCIs). Put differently, we need to understand the demand for credit and the segment of society that demands the services supplied by MCIs. We then need to analyse the rationale for the regulatory framework and assess whether it can protect consumers while facilitating the development of microlenders. This article is, therefore, primarily an exploration and contextualisation of the formal microcredit sector in South Africa, the activities of which the MFRC has only recently begun to record formally. It presents some of the first data ever recorded on the types of MCIs themselves, and attempts to integrate demand-side factors into the analysis by using household indebtedness data from Statistics South Africa’s Income and Expenditure Surveys (IESs) (SSA, 1995, 2000). Analysing the manner in which these institutions are regulated and the potential limitations associated therewith allows for a more complete understanding of the sector. The primary limitation of this article is that it does not include a review of informal sector MCIs. However, because we are concerned with how the sector became formal through regulation, and are estimating its size since it first started in 1992, the exclusion is a necessary consequence. This does not imply that informal providers of microcredit are deemed unimportant or insignificant. The analysis is also restricted to the credit component of microfinance, rather than the savings or insurance components. The latter issues were deemed beyond the scope of this article, as they would require comprehensive treatment equal to that given to microcredit. The rest of the article proceeds as follows. First, South Africa’s financial sector is assessed in comparative perspective (i.e. relative to other upper middle-income countries). This section is provided to contextualise the performance of South Africa’s financial sector and to provide a basis from which the establishment of the microcredit sector can be understood. The size of the microcredit sector within the overall financial sector is then estimated before more detailed supply-side features are considered, such as the type of institutions, the size of average loan disbursements and the share of outstanding loans. We then proceed to analyse whom MCIs lend to and whether the demand for credit in South Africa has changed between 1995 and 2000. Lastly, international best practice concerning the regulation of the sector and South Africa’s compliance with this framework is discussed, noting those issues that remain unresolved and discussing what this means for the sector more broadly.
2. THE FINANCIAL SECTOR IN COMPARATIVE PERSPECTIVE This section evaluates South Africa’s financial sector in comparative perspective before turning to how microcredit is articulated within the financial sector. By structuring the
The formal microcredit sector in South Africa
833
discussion in this manner, a suitable context will be created for evaluating specific supply- and demand-side aspects of microcredit. Generally, South Africa has a fairly well-regulated and sophisticated financial sector, and encompasses the banking, insurance and securities industries. It includes both those financial service providers seen as intermediaries (e.g. banks, insurance companies and pension funds) and those seen as facilitators (e.g. stockbrokers, securities underwriters, investment bankers, etc.) (Hawkins, 2002:3). An independent regulatory authority regulates each of these industries – the Registrar of Banks in the case of banking institutions (comprised of the Bank Supervision Department of the South African Reserve Bank), and the Financial Services Board in the case of the insurance industry and the securities market, although the Johannesburg Stock Exchange is the de facto daily regulator of the latter (Hawkins, 2002:4). Furthermore, Hawkins (2002:4) notes that: Since the opening of the economy associated with the democratic elections in 1994, the sector has experienced the promulgation of regulatory legislation in each of the industries, which has improved the level of compliance with the relevant international standards body. In the case of the banking industry, this is the Bank for International Settlements (BIS) in Basle. In the insurance industry, the International Association of Insurance Supervisors (IAIS) sets the core principles, and for the securities industry, the International Organisation of Securities Commissions (IOSCO) sets the standards. The recent changes in legislation have resulted in a financial sector that largely meets existing requirements of each of these regulatory authorities. Some comparative indicators of the depth, structure and efficiency of the financial sector relative to 11 other upper middle-income countries (including Argentina, Botswana, Brazil, Chile, Czech Republic, Gabon, Malaysia, Mexico, Poland, South Korea and Turkey), as well as three developed countries (Germany, Japan and the United States), are presented below. The objective is to assess exactly how efficient South Africa’s financial sector is when compared with other upper middle-income countries and global benchmarks. First, the study focuses on the share of domestic credit the banking sector provides to the gross domestic product (GDP), the contribution of liquid liabilities to GDP, and the contribution of quasi-liquid liabilities to GDP. These indicators give us an idea of the depth and structure of the financial sector. Second, we focus on the ratio of bank liquid reserves to bank assets, the interest rate spread and the spread over the London interbank offered rate (LIBOR). These indicators give us an idea of the structure and efficiency of the financial sector. The data in this section have been taken from the World Bank Development Indicators (World Bank, 2001:282– 4). Domestic credit provided by the banking sector includes all credit to various sectors on a gross basis, with the exception of credit to the central government, which is net. The banking sector includes monetary authorities, deposit money banks and other banking institutions for which data are available, including those institutions that do not accept transferable deposits but incur such liabilities as time and savings deposits (e.g. building societies). The ratio of domestic credit provided by the banking sector to GDP is used to measure the growth of the banking system, because it reflects the extent to which savings are financial (World Bank, 2001:285). In a few countries, governments may hold international reserves as deposits in the banking system rather than in the central bank. As the
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claims on the central government are a net item (central government claims minus central government deposits), this net figure may be negative, resulting in a negative figure for domestic credit provided by the banking sector. Liquid liabilities (also known as ‘broad money’) measure the percentage of M3 money supply to GDP. It is the sum of currency and deposits in the central bank (M0), plus transferable deposits and electronic currency (M1), plus time and savings deposits, foreign currency transferable deposits, certificates of deposits, and securities repurchase agreements (M2), plus travellers’ checks, foreign currency time deposits, commercial paper, and shares of mutual funds or market funds held by residents. Liquid liabilities include bank deposits of generally less than one year, plus currency. Their ratio to GDP indicates the relative size of these readily available forms of money – money that owners can use to buy goods and services without incurring any cost (World Bank, 2001:285). Quasi-liquid liabilities are the M3 money supply less M1. They are comprised of longterm deposits and assets, such as certificates of deposit, commercial paper, and bonds, which can be converted into currency or demand deposits, but at a cost. Table 1 presents these indicators. The table shows the contribution of the banking sector, liquid liabilities and quasi-liquid liabilities to GDP for a selection of upper middle-income countries and three comparative developed countries. Data are ranked by the percentage contribution of the banking sector to GDP in 1999.
Table 1: Selected indicators of the depth and structure of the financial sector Domestic credit
Countries
Quasi-liquid
provided by banking
Liquid liabilities
liabilities
sector (% of GDP)
(% of GDP)
(% of GDP)
1990
1999
1990
1999
1990
1999
South Africa
97,8
155
44,6
45,1
27,2
12,7
Malaysia
75,7
151,6
64,4
136
43
110,8
South Korea
65,7
96,6
54,6
93,8
45,7
84,6
73
72,5
40,7
52,2
32,8
41,4
Czech Republic Brazil
n/a 89,8
62,7 51,8
n/a 26,4
67,9 31,8
n/a 18,5
43,5 25,3
Turkey
19,4
49,8
24,1
51,8
16,4
46,2
Poland
18,8
39,3
32,8
42,8
16,6
28,5
Argentina
32,4
35,6
11,5
31,6
7,1
23,9
Mexico
36,6
28,8
22,8
28,9
16,4
20,4
Chile
Gabon
20
22,5
17,8
16,6
6,6
6,6
246,4
269,7
22,1
31,2
13,7
23,6
United States Germany
110,9 105,4
164,2 145,2
65,5 67,9
62,4 78,1
49,4 n/a
46,4 n/a
Japan
266,8
144
187,5
125,8
159,6
77,4
Botswana
Source: World Bank (2001:282–4).
The formal microcredit sector in South Africa
835
Immediately evident from the table is South Africa’s prominent position as the upper middle-income country with the greatest percentage of domestic credit provided by the banking sector in 1990 and 1999, with Malaysia following closely. This level of financial depth is, in fact, favourably comparable with the sample of developed countries included in the table. The growth of the financial sector, as measured by the difference between 1990 and 1999 figures, is greater in the case of Malaysia, though both countries had among the fastest growing financial sectors in the entire sample. However, the data tell a very different story when considering both liquid and quasiliquid liabilities. As far as the former is concerned, South Africa has a fairly moderate percentage contribution to GDP relative to other upper middle-income countries, combined with very low growth rates between 1990 and 1999. When evaluated in conjunction with the data on quasi-liquid liabilities, it becomes clear that South Africa’s financial sector has undergone a period of relative austerity as far as medium-term asset holdings are concerned, as it is the only upper middle-income country that has seen a decline in quasi-liquid liabilities to GDP. This could perhaps be partly explained by South Africa’s status as a newcomer to financial sector deregulation, especially as regards exchange controls, as well as the fact that the 1990s was a tumultuous decade with considerable uncertainty. Further insight into these trends can be gleaned from Table 2.
Table 2: Selected indicators of the structure and efficiency of the financial sector Interest rate spread
Spread over LIBOR
Ratio of bank
(Lending minus
(Lending rate
liquid reserves to
deposit rate %
minus LIBOR %
bank assets (%)
points)
points)
Countries
1990
1999
1990
1999
1990
1999
Turkey
16,3
19,9
n/a
n/a
n/a
n/a
Czech Republic
n/a
18
n/a
4,2
n/a
South Korea
6,3
17,2
0
1,4
1,7
4
20,6
10,7
462,5
5,8
495,9
11,6
n/a
n/a
Poland
3,3
Brazil
6,7
8,4
n/a
n/a
Malaysia
5,9
8,3
1,3
3,2
21,1
1,9
Botswana South Africa
11 3,3
7,5 7
1,8 2,1
5,2 5,8
20,4 12,7
9,2 12,6
Mexico
4,2
6,4
n/a
20,5
2
5,7
11
17
10,2
16,6
Chile
3,8
4
8,6
4,1
40,5
7,2
Argentina
7,4
2,6
n/a
5,6
Gabon
n/a
n/a
16,3
3
United States
2,3
6,6
1,9
2,7
1,7
Germany
3,2
6,6
4,5
6,4
3,3
3,4
Japan
1,5
1,8
3,4
2
21,4
23,3
Source: World Bank (2001:282–4).
2,6
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The ratio of bank liquid reserves to bank assets (note that data ARE cited on an end-ofyear basis) is the ratio of domestic currency holdings and deposits with the monetary authorities to claims on other governments, non-financial public enterprises, the private sector and other banking institutions (World Bank, 2001:285). The ratio captures the banking system’s liquidity levels. In countries whose banking system is liquid, adverse macroconditions should be less likely to lead to banking and financial crises. South Africa’s liquidity is approximately average when compared with the balance of the middle-income sample, although it increased by over 100 per cent between 1990 and 1999. The ratio is similar in both magnitude and direction to that of the United States and Germany over the period under investigation. The ‘interest rate spread’ is the interest rate charged by banks on loans to prime customers minus the interest paid by commercial or similar banks for demand, time or savings deposits. It is an important indicator of the efficiency of the financial sector, as it indicates the margin between the cost of mobilising liabilities and the earnings on assets. A narrowing of the interest rate spread reduces transaction costs, which lowers the overall cost of investment and is therefore crucial to economic growth. Interest rates reflect the responsiveness of financial institutions to competition and price incentives. The interest rate spread, also known as the intermediation margin, is a summary measure of a banking system’s efficiency. To the extent that information about interest rates is inaccurate, banks do not monitor all bank managers or the government sets deposit and lending rates, the interest rate spread may not be a reliable measure of efficiency (World Bank, 2001:285). As far as the interest rate spread in the table is concerned, South Africa saw a broadening of the percentage points in line with all other nations, except Chile, Japan and Poland, where the lending minus deposit rate narrowed between 1990 and 1999. Hence, there seems to have been a general loss of efficiency in money markets across these nations over this period. However, this is not indisputably corroborated in the following column, where the spread over LIBOR (defined as the interest rate charged by banks on short-term loans in local currency to prime customers minus LIBOR) shows more variation in the results when compared with the interest rate spread. LIBOR is the most commonly recognised international interest rate and is quoted in several currencies. The average three-month LIBOR on US dollar deposits is used in these data. The spread over LIBOR reflects the differential between a country’s lending rate and the London interbank offered rate, ignoring expected changes in the exchange rate. It is also a measure of the efficiency of the financial system, and a comparative international indicator. Interest rates are expressed as annual averages (World Bank, 2001:285). For South Africa, the high but relatively constant figures for the spread over LIBOR indicate that there is a significant deviation in interest rates relative to the rest of the sample, implying that efficiency is low. However, the minor differences between the figures reflect very different circumstances and, in fact, hide important aspects of South Africa’s monetary policy regime during this period. In 1990, the spread over LIBOR was perhaps more indicative of instability and uncertainty in the financial sector, whereas by 1999, the monetary policy regime was far more stable, albeit recovering from the shock of the Asian crisis of 1998. 1999 was also the year that monetary authorities shifted the focus of policy explicitly towards inflation targeting, suggesting that, at least initially, interest rates were to be sacrificed to the goal of lowering inflation.
The formal microcredit sector in South Africa
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Thus, it is clear that South Africa certainly has a competitive financial sector, even if certain aspects of its performance are debatable. However, if it were truly competitive and provided credit instruments that were differentiated and priced in line with their social marginal cost, surely there would be no need for microcredit? This raises the question of the diversity of the financial sector. Unlike more developed nations, where the informal sector is generally insignificant in both numbers and contribution to GDP, South Africa and its middle-income country peers have large informal sectors, significant income inequality, and often very large proportions of poor households relative to the total population. These individuals are often deemed too risky to be provided credit by the formal sector, and informal moneylenders have historically thrived in this market. The Exemption to the Usury Act promulgated in 1992 consequently enabled these historically informal moneylenders to become formal, legally registered enterprises for the first time. As seen below, the growth of microfinance providers burgeoned to an impressive degree by the year 2000, testifying to the importance of this sector, not only from the perspective of the supply of microcredit, but also with respect to the demand for microcredit. It has since taken its place as a legitimate and important part of the financial sector, and has attracted much attention from all sectors of society, including organised labour, small, medium and microenterprises (SMMEs) and civil society more generally. It is to these issues that we now turn in an attempt to analyse the microcredit sector accurately.
3. THE SIZE OF THE MICROCREDIT SECTOR Defining the size of the microcredit sector, while possible, has certain limitations. The most reliable attempt uses the total value of loans disbursed by the microcredit sector in 1999/2000 (i.e. R12,9 billion) as a percentage of total credit extended by the monetary sector in 2000 (i.e. R621,3 billion). This results in an estimate of 2,08 per cent, which is a very significant number. The monetary sector is defined as ‘a consolidation of the balance sheets of institutions within the monetary sector, i.e. the South African Reserve Bank (SARB), the former National Finance Corporation, Corporation for Public Deposits and the so-called “pooled” funds of the former Public Debt Commissioners, the Land Bank, Postbank, private banking institutions (including the former banks, discount houses and equity building societies) and mutual building societies. Coin in circulation is included in this consolidation’ (SARB, 2000:S-18). However, this is not a very valid comparison, and remains an ongoing research task. The author discussed the issue of the definition of the size of the microcredit industry with the MFRC. They were uncomfortable with the definition used above, because it does not allow us to examine the importance of the sector for the lower end of the income distribution, which is, after all, the primary client base of the microcredit industry. ‘Total credit extended’, as defined by the SARB, includes corporate credit extension, mortgages and financial leases, which are commensurate with luxury consumption and hence inappropriate to some extent. However, it is the contention of the author that neither the end use of credit nor the qualitative importance of the sector to its client base should be taken into consideration when estimating the size of the sector; and, consequently, the definition is retained in this article. Perhaps a more valid concern raised was a potential problem of undercounting using this definition, namely that it is unclear whether credit extension by retail institutions is included.
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Nevertheless, it should be stated that for a previously non-existent industry to rise to over 2 per cent of the financial sector in ten years is remarkable, and bears testimony to significant latent demand and a conducive regulatory climate. These factors have also helped to endow the industry with myriad institutional forms that service different parts of the consumer market. Supply-side dimensions of the microcredit industry are evaluated below.
4. SUPPLY-SIDE DIMENSIONS OF THE MICROCREDIT SECTOR This section evaluates the structure and scope of the formal microcredit sector. The types of institutions in the sector are identified first, before their characteristics are evaluated. The types of institutions in South Africa comprise section 21 companies, public companies, cooperatives, private companies, trusts, banks and closed corporations. The contribution of each of these institutions is broadly captured in Table 3. From the table it can be seen that closed corporations represent the overwhelming majority (78 per cent) of registered enterprises, followed distantly by private companies (14 per cent) and trusts (6 per cent). However, private companies have the greatest number of branches, as can be expected, with closed corporations following closely. Disbursements figures in Table 4 show that banks comprise the largest component of the microcredit sector, followed closely by private companies and more distantly by closed corporations. This, however, does not translate into a commensurate number of loans disbursed. By evaluating the ratio of total disbursements to the number of loans disbursed, we obtain the average size of the loans disbursed, and so gain important insights into the industry. Table 5 shows that at R7 427,05 on average, banks provide loans of greater value compared with any other component of the sector, followed (surprisingly) by section 21 companies and cooperatives. This suggests that there is no unidirectional relationship between the type of institution and the size of loan disbursed. The large average disbursements among section 21 companies also suggest that these institutions may have information advantages concerning lenders relative to banks and other profitable companies. Table 3: Registration statistics (estimates for 1999/2000)
Industry
Number
By %
Number of
By %
registered
of industry
branches
of industry
Aggregate
1 309
1,00
5 051
1,00
Closed corporations
1 015
0,78
1 669
0,33 0,50
Private companies
182
0,14
2 535
Trusts
76
0,06
129
0,03
Section 21 companies
16
0,01
48
0,01
Banks
9
0,01
342
0,07
Public companies
9
0,01
326
0,06
Cooperatives
2
0,00
2
0,00
Source: MFRC (2001a).
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Table 4: Disbursement statistics (estimates for 1999/2000) Total disbursements
% of industry
Number of loans
% of industry
Industry
(rand)
by value
disbursed
by number
Aggregate
12 950 533 089
100
8 997 254
100
Banks Private companies
4 977 518 753 4 129 801 277
38 32
669 287 2 981 248
8 33
Closed corporations
2 387 332 901
18
3 439 960
38
Public companies
983 488 023
8
1 413 492
16
Trusts
240 642 899
2
366 482
4
Cooperatives
198 967 480
2
90 390
1
32 781 756
0,3
6 395
0,1
Section 21 companies Source: MFRC (2001a).
Table 5: Average loan disbursements (estimates for 1999/2000)
Banks R7 437,05
Public
Private
Closed
companies
companies
corporations
Trusts
Cooperatives
companies
Section 21
R695,79
R1 385,26
R694,00
R656,63
R2 201,21
R5 126,15
Source: MFRC (2001a).
Equally probable, however, is that the data could simply reflect the fact that section 21 companies are less risk averse than other financial institutions due to donor funding. Table 6 shows that banks have the greatest amount and percentage of loans outstanding, predictably followed by private and public companies. We also see differing trends to those in the disbursements section with respect to the rank of institutions. It is evident, for example, that closed corporations disburse proportionally higher relative to total outstanding loans, suggesting that they target clients (and thus disburse loans) with shorter time horizons. Table 6: Outstanding loan statistics (estimates for 1999/2000) Gross loans
% of industry
Number of
Average loan
Industry
outstanding (rand)
by value
loan debtors
size (rand)
Aggregate
10 984 317 410
100,0
3 414 511
n/a
Banks
5 280 483 101
48,1
1 597 370
7 118
Public companies
2 540 161 129
23,1
588 151
696
Private companies
2 179 432 404
19,8
704 612
1 385
Closed corporations
508 305 471
4,6
429 779
694
Trusts
301 000 148
2,7
36 077
657
Cooperatives
130 747 315
1,2
46 187
2 201
44 187 843
0,4
12 335
5 126
Section 21 companies Source: MFRC (2001a).
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Table 7: Average outstanding loans (estimates for 1999/2000)
Banks 3 305,74
Public
Private
Closed
companies
companies
corporations
Trusts
Cooperatives
companies
Section 21
4 318,89
3 093,1
1 182,71
8 343,27
2 830,83
3 582,31
Source: MFRC (2001a).
The average amount of cash outstanding per debtor is shown in Table 7. Interestingly, average outstanding loans are greatest for trusts, followed by public companies and section 21 companies. This reflects important differences in the industry, and we can infer from the data that trusts, public companies and section 21 companies must either have better information about lenders than banks do, thus contributing to the higher average outstanding loans, or that they have poorer repayment rates and hence higher default statistics. The clients of MCIs are consequently very important to analyse, and it is to the demand side of microcredit that the article now turns to.
5. WHOM DO MICROCREDIT INSTITUTIONS LEND TO? In this section, we are concerned with whether MCIs lend to SMMEs, or to consumers, or to both, and the extent of such lending. A recent survey by the MFRC (2001b:1) revealed that MCIs formed specifically to serve the SMME sector have not enjoyed particular success. There are about 20 non-bank MCIs, which are typically donor-funded section 21 companies that serve approximately 66 000 microenterprise clients. Opposed to this segment is the commercial banking sector, which offers a variety of loans and transactional products to established SMMEs. Commercial banks, however, are reported to have neither the desire nor the experience to finance start-up businesses, where high transaction costs for smaller loans, inadequate collateral/owner’s equity and no track record are often cited as prohibiting factors preventing banks from lending below R50 000 (MFRC, 2001b:1). Furthermore, MFRC statistics indicate that 418 microlenders already lend to some 153 000 SMMEs, representing about 4 per cent of gross industry disbursements. The survey conducted by the MFRC (2001b:1) amongst 30 randomly chosen lenders revealed the following: . Although 60 per cent of respondents had less than 20 per cent of their loan portfolio devoted to SMME lending, 76 per cent regarded SMME lending as either important or very important, whilst over 90 per cent regarded it as important or very important within the next three years. . Given a favourable regulatory environment, the actual number of loans and SMME loan rand value disbursements could be increased at least five times more than at present. We can thus conclude that the majority of lending is currently to the consumer sector, and it is to this sector that we now turn to.
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841
6. CONSUMER DEMAND FOR CREDIT In this section the demand for debt among households is evaluated, namely the level and extent of indebtedness between 1995 and 2000. This time frame, while imperfect in the sense of not providing a pre- and post-microcredit comparison, provides a comparative static view that allows one to establish exactly what happened to consumer indebtedness over the latter half of the 1990s. This provides further insight into the reasons why the microcredit industry grew so rapidly to over 2 per cent of total credit extended by the monetary sector in 2000. Data for this section were obtained from Statistics South Africa’s IESs of 1995 and 2000. The analysis below presents a profile of the level of indebtedness by income category between 1995 and 2000, adjusted for inflation. Total debt comprises the total outstanding balance of finance owed on housing, vehicles, furniture (hire purchase), overdraft and credit cards, retail (hire purchase) and family loans (i.e. the sum of all subcategories of total outstanding debt provided in the 1995 and 2000 IESs). Mean indebtedness per income category is evaluated, and the sample is censored to drop the highest outliers. Specifically, the distribution up until the 99th percentile of indebted households is evaluated. Owing to expected measurement error, the top one percentile of the indebtedness distribution was omitted. This decision was sanctioned by the MFRC after the range of indebtedness values in each income category were presented to them, and after they had evaluated their own records. (The author can be contacted for a full explanation of all the assumptions and calculations in this section.) Income is defined as regular disposable income to reflect the permanent income hypothesis assumption that household budget planning is based more on the regular, rather than the transient or windfall, component of income. We can see from Figure 1 that total indebtedness rises predictably over the income distribution. There were also substantial changes between 1995 and 2000. The change in
Figure 1: Total indebtedness by income category
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indebtedness between the two time points can be summarised as follows. There was an increase in indebtedness for the poorest three income groups (R0 to R15 000), whereafter total debt decreased (for the group R15 000 to R25 000) before increasing again (R25 000 to R50 000). The wealthiest income groups (over R50 000) all witnessed a reduction in total indebtedness. The greatest reduction in debt was witnessed in the R20 000 to R25 000 income group, while the greatest increase was witnessed in the poorest income group (R0 to R5 000). Interestingly, in 1995, the R15 000 to R20 000 and R20 000 to R30 000 income groups show a trend-breaking pattern, rising above the expected values, relative to a monotonic progression. The higher-than-expected indebtedness levels for these income groups are most likely because this is where full-time employed workers enter the labour market. Because these workers earn a regular salary, they qualify for credit, but binding expenditure constraints possibly places pressure on them to borrow at a level that is unsustainable. By 2000, this trend had shifted to the R25 000 to R30 000 group only. However, the kinks in the total indebtedness progression for 2000 at the poorest (R0 to R5 000) and second wealthiest (R75 000 to R150 000) income groups show that group behaviour was very different across the income distribution. The change in the indebted population as a proportion of the total population of each income category is shown in Table 8. This is the key variable that helps us understand whether the demand for debt has increased over the period. The table shows the number of households in each income group that is positively indebted, the total number of households per income group, and the percentage of positively indebted households to total households for 1995 and 2000. The last column on the right indicates the percentage difference between the percentage columns in 2000 and 1995. It can be seen from the table that the total indebted population grew from 1,42 million households in 1995 to 3,27 million households in 2000. The fact that that the numbers
Table 8: Change in indebted population by income group 2000 IES (real figures)
1995 IES % Change
Income
Positive
Total
% positive
Positive
Total
Positive
(1995–00):
category
debt
population
debt
debt
population
debt
% positive debt
R0-5K
271 151
2 134 577
12
56 344
789 522
7
62
R5-10K
449 949
2 420 518
18
105 555
1 844 373
6
216
R10-15K
355 520
1 347 218
26
99 289
1 296 548
8
236
R15-20K R20-25K
261 743 226 563
822 321 604 450
31 37
90 706 75 398
873 248 630 255
10 12
198 208
R25-30K
157 106
413 832
37
71 268
459 052
16
134
R30-40K
242 899
578 835
41
122 912
684 458
18
128
R40-50K
189 849
358 260
52
103 478
508 145
21
153
R50-75K
353 471
611 283
57
210 057
813 971
26
119
R75-150K
492 731
738 504
65
311 472
977 488
32
103
.R150K
274 080
372 433
73
155 848
391 406
40
82
3 275 060
10 402 230
31
1 402 329
9 268 466
15
100
Total
Source: IES (SSA, 2000), own calculations.
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and percentages of households in each income group that incurred debt in 2000 were always greater than the corresponding numbers and percentages in 1995, implies that financial sector deepening took place in South Africa between 1995 and 2000. This view is reinforced by the fact that the demand for credit doubled over the period (i.e. it increased for 15 to 31 per cent of the total population). The income groups that witnessed the greatest percentage change in the numbers of indebted households between 1995 and 2000 were the R10 000 to R15 000 and the R5 000 to R10 000 groups, followed by the R20 000 to R25 000 and R15 000 to R20 000 income categories. While this clearly demonstrates that poorer households were able to access credit, it does not provide conclusive evidence that the microcredit sector was responsible for providing them with all of this credit. However, one can reasonably assume that at least part of this increase was due to MCIs. The role of an appropriate regulatory framework and the manner in which MCIs are governed are evaluated in the next section. 7. REGULATING THE MICROCREDIT SECTOR Given the significance of the regulatory framework to the establishment of the industry in South Africa, the role of the state is of prime importance in understanding the sector. This section focuses on a best-practice model developed by the Financial Sector Development department of the World Bank for the regulation of MFIs more generally, rather than the MCIs discussed in this article. However, the framework is equally valid for MCIs and is consequently evaluated. The extent to which the South African regulatory framework conforms to this model is then discussed. The main tenet behind the regulation philosophy of the World Bank is to provide a transparent and inclusive regulatory framework within which MFIs can progressively evolve into larger financial institutions. Interestingly, the focus on the regulatory framework and its evolving nature at the World Bank is, in fact, a departure from its more typically neoclassical prescriptions for the state. However, the regulatory framework does not cover any issues that pertain to the conduct of MFIs, such as the setting of exorbitant interest rates or conducting ‘predatory’ lending practices, and this is where the utility diminishes. The method employed to facilitate the transition of smaller MCIs into larger ones is to use the analysis of MCIs’ liabilities to highlight the distinguishing features of different types of institutions, and to focus on the risk-taking activities that need to be managed and regulated (Van Greuning et al., 1998:i). The structure of liabilities highlights the primary sources of funding for microcredit and MFIs. They include: contributed equity capital, donor funds, concessional and commercial borrowings, members’ savings, wholesale deposits from institutional investors, and retail savings and sight deposits from the public. The important factors that differentiate MFIs from each other are therefore found mainly on the liabilities side rather than on the asset side of the balance sheet (Van Greuning et al., 1998:i). Three broad categories of MFIs are identified: MFIs that depend on other people’s money (Category A), those that depend on members’ money (Category B), and those that leverage the public’s money (Category C). Using this classification system, the article recommends a tiered approach to external regulation. It develops a regulatory framework model for identifying thresholds of financial intermediation activities that trigger a requirement for an MCI to satisfy external or
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mandatory regulatory guidelines. Table 9 summarises the regulatory framework model, indicating the fund-generating activities of different types of MFIs that trigger a need for mandatory external guidelines, and the proposed regulatory measures and agencies to carry them out.
Table 9: Regulatory thresholds of activities by type of MFI Activity that determines
Proposed form of external
regulatory status
regulation, if required
MFI type Category A MFIs Type 1: Basic non-profit NGO
Making microfinance loans not in excess of grants and donated or
None – voluntary registration with self-regulatory organisation
concessional funds (loan capital) Type 2: Non-profit NGO, limited deposit-taking
Type 3: NGO transformed into incorporated MFI
Taking minor deposits, e.g. forced
None – exemption or exclusion
savings or mandatory deposit
provision of banking law;
schemes, from microfinance
compulsory registration with self-
clients in community Issuing instruments to generate funds
regulatory organisation Registration as corporate legal entity;
through wholesale deposit
authorisation from bank
substitutes (commercial paper,
supervisory authority or securities
large-value certificates of deposit,
and exchange agency, with
investment placement notes)
limitations on size, term and tradability of commercial paper instruments
Category B MFIs Type 4: Credit union, savings and credit cooperatives
Operating as closed or open-common
Notification to, and registration with
bond credit union; deposit taking
cooperatives authority or bank
from member clients in the
supervisory authority; or
community, workplace or trade
certification and rating by a private independent credit-rating agency
Category C MFIs Type 5: Special bank, deposit-taking institution or finance company
Taking limited deposits (e.g. savings
Registration and licensing by bank
and fixed deposits from general public beyond minor deposits
supervisory authority, with a limitation provision (e.g. savings
exemption in banking law).
and fixed deposits, smaller
Microfinance activities more
deposits-to-capital multiple,
extensive than NGOs but
higher liquidity reserves, limits on
operations not on scale of licensed
asset activities and uses)
banks. Type 6: Licensed mutual-
Non-restricted deposit-taking
Registration and full licensing by
ownership bank Type 7: Licensed equity
activities, including generating funds through commercial paper
bank supervisory authority as a mutual-ownership or equity bank;
bank
and large-value deposit-
compliance with capitalisation and
substitutes, from the general
capital adequacy requirements,
public
loan loss provisioning and full prudential regulations (continued)
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Table 9: Continued MFI type
Regulatory agency
Category A MFIs Type 1: Basic non-profit NGO
None, or self-regulatory
Type 2: Non-profit NGO, limited
organisation Self-regulatory organisation
deposit-taking Type 3: NGO transformed into
Companies’ registry agency;
incorporated MFI
bank supervisory authority or securities and exchange agency
Category B MFIs Type 4: Credit union, savings and credit cooperatives
Cooperatives authority or bank supervisory agency or creditrating agency
Category C MFIs Type 5: Special bank, deposit-
Bank supervisory authority
taking institution, or finance company Type 6: Licensed mutual-
Bank supervisory authority
ownership bank Type 7: Licensed equity bank Source: Van Greuning et al. (1998:ii).
Van Greuning et al. (1998) argue for a risk-based approach to financial regulation that focuses on the same issues with which managers and boards of directors would be concerned. Aside from highlighting the central role of institutional capital, the approach helps to identify the risks that prudential regulation should address. The approach is deemed useful in designing regulatory standards that recognise the differences in the structure of capital, funding and risks faced by MFIs. In this regard, it is noted that most MFIs are simple financial institutions that are not likely to be involved in sophisticated instruments and risks. Nonetheless, they are exposed to a number of financial and operational risks faced by financial intermediaries. Some risks that can result in a defined loss are regarded as ‘pure’ risks, namely operational risk, credit risk and liquidity risk. On the other hand, ‘speculative’ risks that can result in either a profit or a loss include interest rate risk, market (price/investment) risk and currency risk. Operational risks arising from fraud, error, and systems problems are especially important in microfinance operations because of their internal governance structure. The major categories of risk faced by financial intermediaries are summarised in Table 10. The nature of the business and the institutional structure of MFIs determine the priority ranking of risks that need to be managed. The processes of internal regulation through governance and mandatory external regulation are closely linked to each other. Van Greuning et al. (1998:ii) contend that several key players from the MCI sector, the
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Table 10: Major categories of risk faced by MFIs 1. Balance-sheet structure
Past and future risks resulting from intended or unintended changes in the
2. Profitability structure
Risks resulting from changes in the composition of various sources of
3. Capital adequacy/solvency
The risk that the institution will have insufficient capital to continue
size, structure and composition of the balance sheet income and expense categories that affect the efficiency of the institution operating at its average risk-weighted asset profile, as well as the risk of non-compliance with internally set or externally prescribed minimum capital standards 4. Credit risk
The risk that a counter-party (including a sovereign counter-party) to a credit agreement will not be able or willing to service the interest or repay the principal
5. Treasury risk † Liquidity risk
The risk that the institution has insufficient funds on hand to meet its obligations. This risk includes concentration of large depositors or funders, reliance on volatile deposits and funds, and the currency structure of deposits and funds
† Interest rate risk
The risk of an adverse flow of income and expenses and the ultimate diminution in the institution’s net equity as the result of adverse changes in interest rates
† Market risk
The risk of capital gain or loss resulting from investments in commodity,
† Currency risk
The risk of changes in exchange rate having a negative impact on foreign
fixed interest, equity or currency markets receivables and foreign payables, when the institution has foreign currency-denominated balance sheet items 6. Operational risk
The risk from non-financial areas such as accounting, electronic data processing, loss of market share, employee relations, or physical events causing a financial loss or stoppage in operations
Source: Van Greuning et al. (1998:20).
regulatory agencies and the general public have a critical partnership and shared responsibility in the risk management process. In South Africa, the regulatory framework conforms in many ways to the ideal-type model proposed by the World Bank. For example, the reporting guidelines for lenders are very similar in principle to those identified by the World Bank (cf. ‘Rules of the MFRC’ and specifically ‘Reporting in Terms of Rule 7 of the Rules of the Micro Finance Regulatory Council’ at www.mfrc.co.za). There is also no explicit prevention of smaller operations from becoming established financial institutions, other than the usual Prudential and Usury requirements affecting the industry. However, these requirements constitute significant entry qualifications that are not easily achieved. Therefore, while there are no theoretical barriers, there are substantial operational and practical concerns. Two further issues not covered by the World Bank framework, but nevertheless fairly fundamental to the sector, are predatory lending practices and the setting of interest rates. The former entails a complex regulatory task, as it is difficult to identify, much less monitor. However, the increasing role of credit unions and related prudential
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legislation have allowed for a conducive regulatory climate that aims to curb predatory lending practices. The extent to which this will be successful is uncertain. As far as the setting of interest rates is concerned, it is important to note that there are currently no ceilings on interest rates. Although the 1999 Exemption to the Usury Act did propose a ceiling of ten times that of prime, a subsequent ruling by the courts disallowed this and the ceiling was lifted. The major concern with having no ceiling is that lenders could take unfair advantage of ill-informed clients. The rationale behind having no ceiling is that it is perceived to play a negative role in the industry by driving lenders underground. Aside from the obvious consumer benefits that would be derived from the imposition of a ceiling, it is important to note that the state sends a resonant market signal by doing so. Given the rapid growth of the industry, however, it is entirely feasible that the perceived negative impacts of the lack of a ceiling may, in fact, be overstated due to abundant competition. A separate issue to that of the regulator is the policy environment governing the industry. Here, the degree to which the regulatory climate assists all MCIs, including rural nongovernmental organisations, and sophisticated banks, is unclear due to complementary (though sometimes contradictory) legislation that supersedes the operational level of a regulatory authority. It should be noted that the differences between MCIs reflect important differences in the target populations or end users of finance. More importantly, the institutions also implicitly cross the jurisdiction of several government departments, which raises political complications that could have a material and detrimental effect on certain components of the sector. In legislative terms, this is most clearly present by the separate functions of the Department of Finance (the Usury Act) and the Department of Trade and Industry (the active establishment of finance programmes and the encouragement of SMME development). The degree to which institutional bottlenecks are encouraged by this separation of authority and function is unclear, however, and is not clearly identified by the World Bank’s guidelines. In addition, the Department of Social Development, in conjunction with the United Nations Development Programme, has for some time now presided over a programme supporting microcredit provision for the urban and rural poor. This obviously crosses into the jurisdiction of the Department of Trade and Industry and there are, in fact, accounts of animosity between these departments (Baumann, 2001). At the very least, this could not possibly have helped to engender an efficient regulatory framework for the industry. Consequently, when discussing the regulatory framework of the microcredit industry, it is important to distinguish between the role of the regulator and the policy framework itself. As far as the regulator is concerned, every indication is that the MFRC conforms to international best practice or, where this is not the case, could soon do so with minimal effort. However, the general policy framework and the conflation of functions (which need not be a problem) between government departments are more serious, and can only be addressed at an operational level. 8. CONCLUSION This article has reviewed supply, demand and regulatory aspects of the formal microcredit sector in South Africa. It has shown that South Africa had, and continues to have, a
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sophisticated financial sector that is among the most advanced sectors in the world in terms of its depth, structure and liquidity. The efficiency of the sector decreased somewhat between 1990 and 1999, but recent changes to macropolicy imply that this has been a necessary and transient adjustment. Despite the competitive characteristics of the financial sector, the total absence of suitable financial services for poorer people, combined with the Exemption to the Usury Act in 1992, led to the creation of the formal microcredit sector that burgeoned to an impressive 2 per cent of total credit extended by the monetary sector in 2000. The first statistics recorded by the MFRC on the types of institutions in the sector showed that over 1 300 institutions, with a combined total of over 5 000 branches, existed in the industry by 1999/2000. The types of institutions were differentiated by their average disbursement level, outstanding loan statistics and average outstanding loans. Banks and section 21 companies had the largest average disbursements. Banks, public and private companies showed the greatest value of loans outstanding, while trusts had the highest average outstanding loans of all enterprises. The lack of a consistent performer in these categories exemplified that there are myriad factors at play. These include: whether the institution targets a niche market of some sort; the depth of information lenders are able to obtain about borrowers; the kind of risk profile each institution establishes; the average time horizon of disbursements; differential default rates and the reasons behind them, to name but a few. This is the key rationale for the existence of not-for profit MCIs, which often take a more actively pro-poor (higher risk) lending policy and initiate innovative social norms to encourage repayment, such as the famed social collateral initiatives of the Grameen Bank in Bangladesh. On the demand side, it was evident that the overwhelming majority of South African MCIs lent to the consumer sector rather than the SMME sector, though it was generally the consensus that the SMME sector would become more important in the medium term. However, consumers of microcredit could very well be using the monies towards the operation of some small-scale or otherwise informal activity, implying that a degree of overlap between these client groups is likely at present. In the consumer sector, the demand for credit, as proxied by the number of individuals who became positively indebted between 1995 and 2000, increased by more than double. More importantly for this analysis though, was the fact that the poorest income groups disproportionately benefited during this time. The growth of the microcredit sector therefore contributed to greater access to credit for the lower categories of the income distribution, which has both positive and negative implications. On the positive side, lower income groups now have access to finance that was previously not available (or available in more limited ways), and so have greater scope to smooth consumption. On the negative side, a lack of awareness among consumers of debt, combined with the rapid growth of the industry, could cause people to become over-indebted. Even more troubling is the fact that the vulnerability of the poor to aggressive lending practices by the microcredit industry is one of the few issues not covered by the sector’s regulatory framework, or by any other guidelines from external agencies. Legislation for consumer protection is consequently one of the more pressing issues that confront the state in the short term. In a more specific sense, the regulatory framework for South African MCIs was found to compare favourably with international best practice, as advocated by the World Bank. However, when we separated the discussion between the regulatory institution and the
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policy framework guiding the state’s broader involvement with the industry, certain inconsistencies came to the fore. On the public policies surrounding the microfinance sector, the lack of a coordinated approach to implementation between the Department of Finance and the Department of Trade and Industry (DTI) on the one hand, and the Department of Social Development and the DTI on the other, is worrisome. This is especially so, given that the majority of lending in the microcredit sector is directed towards consumers and not SMMEs. On the positive side, however, this form of bottleneck can easily be overcome with appropriate diplomacy and political will. It is imperative that it is overcome, as components of the microcredit sector are potentially highly leveraging with respect to facilitating individual and community poverty alleviation efforts and microenterprise development. REFERENCES BAUMANN, T, 2001. Microfinance and poverty alleviation in South Africa. Cape Town: Bay Research and Consultancy Services. Available online at: http://talk.to/brcs HAWKINS, P, 2002. Liberalisation, regulation and provision: the implications of compliance with international norms for the South African financial sector. Working Paper No. 1. Johannesburg: Trade and Industrial Policy Secretariat. MICRO FINANCE REGULATORY COUNCIL (MFRC), 2001a. Selected industry statistics. Johannesburg: MFRC. MICRO FINANCE REGULATORY COUNCIL (MFRC), 2001b. SMMEs and the microlending industry: a snapshot assessment. Johannesburg: MFRC. SOUTH AFRICAN RESERVE BANK (SARB), 2000. Quarterly Bulletin, December 2000. Pretoria: SARB. STATISTICS SOUTH AFRICA (SSA), 1995. Income and expenditure survey. Pretoria: SSA. STATISTICS SOUTH AFRICA (SSA), 2000. Income and expenditure survey. Pretoria: SSA. VAN GREUNING, H, GALLARDO, J & RANDHAWA, B, 1998. A framework for regulating microfinance institutions. Financial Sector Development Department. International Bank for Reconstruction and Development/World Bank. Washington, DC: World Bank. WORLD BANK, 2001. World Development Indicators, 2001. International Bank for Reconstruction and Development/World Bank. Washington, DC: World Bank.
