How Rogue Microfinance Lenders Overburden Poor South Africans
Microfinance, or lending small sums to low-income borrowers or entrepreneurs, was supposed to be a source of development and income growth for the poor in Africa. Has it worked?
South African consumers, for example, tend to be highly indebted, and their debt levels are still rising. Fully 31 perent of the value of new credit lines in the country go to those with under $900 in income per month — and 60 percent of credit-active consumers are at least 1-2 months in arrears.
In other words, it’s increasingly looking like those who can least afford it are the most overextended. How did this happen?
“Microlending is very well-regulated… but there are very aggressive salespeople, they’ve got commission-driven sales agents out there selling loans to people who don’t need loans,” Andrew Canter, chief investment officer of Futuregrowth Asset Management, told AFKInsider.
“It got to the point where if you walked into a bank branch, say two years ago, and lets say you were looking for a home loan at — make up a number — 12 percent, [the bank] would actually steer you to a microloan at 40 or 50 percent.”
In other words, instead of borrowing money for productive purposes, like a house, car, or education, people ended up borrowing money to fund consumption.
“The real travesty of it all… you were impoverishing people by using all of their debt capacity, so that they could never get into a position of buying assets, houses, or starting businesses,” Canter said.
As a result of their qualms with the consumption-driven nature of microlending, Futuregrowth decided to wind down positions in African Bank and Capitec in its development funds. One of the key reasons, Canter said, was an overwhelming sense at the firm that people were being taken advantage of by the lending industry.
There is also an issue of whether microfinance — even that which is ostensibly for business purposes — can truly be the agent of empowerment it is often promised to be.
A 2012 paper by researchers Hsain Ilahiane and John Sherry provides evidence to suggest that microfinance can end up perpetuating inequality rather than alleviating it.
For example, the authors cite research which details the failures of microfinance to improve the status of women, who are often its beneficiaries. While microlending provides access to finance, it does not change societal norms around ownership and mobility, meaning that women’s status remains largely unchanged, only now with a debt burden.
Ilahiane and Sherry also criticize the overemphasis of lending for consumption.
Lending For Consumption
In an interview with AFKInsider, they said, “There is quite a bit of literature on various types of microcredit/finance that have penetrated the financial landscape of the poor and some of it, mostly anthropological, is also critical of the non-productivity of this type of development.”
There’s also the question of whether lending — at least for entrepreneurs — is required as often as it seems. Perhaps, for some businesses anyway, skills are of more value than finance?
Loren Crary, director of external relations at Educate!, a non-profit focused on teaching business and entrepreneurship skills to secondary school students in Uganda, says that while the organization does partner with microlenders and teaches students about accessing capital, the students’ age puts a necessary boundary around borrowing.
Instead, Crary explained to AFKInsider that Educate! “teaches skills around savings and ways to build up capital… we teach stuff like how to make liquid soap. It’s not a high margin business but there’s almost always a market, so it’s a way for people just starting out to build capital so they can invest in their next project.”
It’s a slower way of financing a business idea than a loan, but the benefit is that it helps the program’s entrepreneurs to build savings skills and avoid debt. Indeed, savings is a focal point for Educate! — of the key outcomes the organization focuses on is whether students adopt formal savings strategies and plans.
This balance between access to financial services and the risks those services present to borrowers is an interesting issue considering the lack of financial services penetration across most of the continent. While there are myriad forms of informal financial services, only 24 percent of Africans have an account with a formal financial institution — and the industry is actively trying to change that.
Private equity activity across the continent is driven, in part, by huge investments in financial services. But when it comes to taking loans, most are by definition unsecured. Even farmers often don’t have title to the land they farm owing to the preponderance of communal property rights.
If lending grows without the buffers of sustainable lending practices, the result could be detrimental rather than uplifting as borrowers utilize their debt capacity without any commensurate increase in assets, to borrow Canter’s description of the South African situation.
What would sustainable lending look like?
According to Canter, three lending areas that Futuregrowth favors are housing; finance for small, medium, and micro-enterprises; and education loans. For example, several years ago the firm invested in a company called S.A. Taxi Finance, which provides loans to minibus taxi businesses, which are generally shunned by large banks.
Another example is the firm’s investment in Eduloan, which is able to charge student borrowers an interest rate around prime while still making a profit by pre-paying university fees. “It’s good, cheap finance for people to get a university degree — nothing like [the standard microfinance rate of] 50 percent per annum — and it’s a sustainable business.”
Encouraging the industry as a whole to steer in this direction is, howeverm, a more complex task. Speaking about overleveraged South Africa, Canter argues that it’s going to take time, and it will probably be a painful process.
To change the microfinance industry, he argues that institutional investors and other stakeholders need to “stop throwing money at microlenders and increase their cost of capital and reduce their availability of capital. That means their businesses can’t go, go, go, [and] they have to pull back their lending.”
Painful indeed, but perhaps just what’s needed to weed out the unproductive lenders and give rise to those that can help move the continent forward.