Microfinance Industry in South Africa- a review of the sector

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Microfinance Industry in South Africa- a review of the sector

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Microfinance Industry in South Africa

-A review of the sectorby
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Tatenda S Zingoni (16383990)

Masters in Development Finance

University of Stellenbosch

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TABLE OF CONTENTS

1. Introduction to the Microfinance Landscape 3

2. Background of the Microfinance Industry in South Africa 5

3. Current Structure of the South African MFI landscape 7

3.1 Regulatory Framework for the Microfinance Industry 9

3.2 Accessibility of Microfinance 10

4. Factors hindering Microfinance Industry Development in South Africa 11

5. Recommendations for Developing the Microfinance Industry 14

6. Summary and Conclusions 16

7. Bibliography 17

"The stark reality is that most poor people in the world still lack access to sustainable

financial services, whether it is savings, credit, or insurance. The great challenge before

us is to address the constraints that exclude people from full participation in the financial

sectortogether, we can and must build inclusive financial sectors that help poor people

improve their lives." (Kofi Annan, former United Nations Secretary-General, 2003).

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1. Introduction to the Microfinance Landscape

Microfinance refers to small-scale financial services (primarily credit and savings)

provided to people operating small (micro) enterprises. Savings services allow savers to

store excess liquidity which they can use later and to obtain returns on their investment.

On the other hand, credit services enable usage of anticipated income for current

investment or consumption (Robinson; 2001). A common feature amongst microfinance

institutions operating globally is the main focus on women as clients.

There are two approaches in the microfinance literature; poverty lending approach and

financial systems lending approach (Rhyne; 1998 and Gulli; 1998). The former places its

focus on lending to the poorest of the poor, while the latter places its attention on lending

to the creditworthy among the economically active poor (those with ability to use small

loans and have the willingness to repay them) and on voluntary savings mobilization. The

World Bank defines extreme poverty as living on less than 75 cents per day (World

Bank; 1990).

The reason why dichotomy exists between the two approaches is due to differences in

prior needs of the targeted groups of people. People who are extremely poor have prior

needs such as food, shelter, medicine, training and employment. Such people can

therefore not be expected to think about concentrating on entrepreneurship, when

fundamental physiological needs have not yet been met. The financial systems approach

focuses on institutional self-sufficiency. This is whereby a firm is able to sustain its

operations based on its own performance, rather than reliance on donors and/or grants.

According to Robinson (2001), the poorest of the poor should not be the responsibility of

the financial sector. Instead, the food, employment and other basic requirements needed

to overcome desperate poverty are adequately financed by government and donor

subsidies and grants. Such a view on the industry has led to the preference of the

financial systems approach in the provision of microfinance.

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Poverty lending uses subsidies primarily to fund its loan portfolios, which is an

unsustainable practice. On the other hand, the financial systems approach encompasses

commercial financing of microloan portfolios; additional capital can therefore be

leveraged to assist more people (Robinson; 2004).

On a global level before the 1980's, a number of economists and policymakers

considered the presence of microenterprises as indicators of economic dysfunction i.e. the

inability of the formal economy's structure and low growth rates sufficient in absorbing

the national labour force (Webster and Fidler; 1996). This led to a neglect of microenterprises

by governments of different countries as their focus was more on

improvement of the management of the formal economy, with aim of improving its

absorptive capacity.

Conventional banking practices such as needing collateral for loans and not lending to the

poor because they were not credit-worthy' were challenged by Muhammed Yunus with

his establishment of the Grameen Bank in Bangladesh. This move set the wheels in

motion for a microcredit revolution (Yunus; 1998). The requirement of collateral by

mainstream financial enterprises excludes a number of people from accessing finance.

The Bolivian non-governmental organisation (NGO) PRODEM (Fundacion para la

Promocion y Desarollo de la Microempres) commenced issuance of loans under a

solidarity group lending model which had been developed by ACCION International in

Latin American countries in the 1980s (Rhyne; 2001).

The group lending model is the dominant methodology used by a number of

microfinance institutions globally. Microloans are given to a group of people and they

have joint responsibility for paying back the loan. The advantage of this model lies in the

avoidance of individual's failure to pay, characterized by the individual loans model.

Group support (and pressure) provides members of the group with incentive to ensure

responsible behaviour.

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Although micro-credit was the harbinger of the revolution of financing the poor, the

movement has grown to a point of encompassing other elements of finance. Demand by

the market has spurred innovations in provision of savings and insurance for this segment

of the population, the previously un-banked people. Microfinance has therefore become

the accepted categorisation as it transcends the boundary of just focusing on micro-credit

provision.

2. Background of the Microfinance Industry in South Africa

A high level of unemployment in the 1990's ushered in a period of growth in making

finance available to microenterprises. The signing of an exemption to the Usury Act in

1992 removed price controls on small loans. Commercialisation of micro lending in

South Africa took off greatly, though the intended outcome was not realised. Instead of

funds being channelled into microenterprises, consumer spending became main recipient

(Porteus & Hazelhurst; 2004).

The micro-lending industry in South Africa began in earnestness in the 1980's with the

creation of a number of institutions in the commercial and not-for-profit categories. The

1992 exemption of the Usury Act removed price control on small and short term loans

(under R6000 with a term less than 36 months).

A study in 1997 on the micro lending environment conducted by Professor PG du Plessis

of the University of Stellenbosch showed that in 1997 an estimated 3500 formal microlenders,

2000 semi-formal micro-lenders and 25000 informal micro lenders were in

operation. Transactions which were common were in the cash loan (short-term) end of

the market (Du Plessis; 1998).

Microenterprises receiving funding from different institutions operate in different sectors

of the economy. In South Africa some of the main types of enterprises include; fruit and

vegetable growing and selling, spaza shops, furniture businesses, crches and day care

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centres, dressmaking, hairdressing, transport (taxi) businesses and selling of clothes.

Provision of microfinance in the country is mainly focused on inhabitants in townships

and rural areas. Coverage by MFIs is for the different provinces, with each province

having unique characteristics and thus requirements.

As is the case with a number of countries in which microfinance has thrived, women

constitute the majority of the clientele of the microfinance institutions operational in

South Africa. The most oft cited rational for a bias toward women is their ability to

impact more people in their households via their enterprises.

Amartya Sen (Nobel Prize for Economics winner) highlights that, "development has to be

more concerned with enhancing the lives we lead and the freedoms we enjoy." (Sen;

1999) Many individuals are marginalised from the mainstream economy due to factors

such as lack of education, lack of market exposure and mainly because of lacking access

to finance. On a global level, the microfinance industry is evolving to become a major

stimulus for economic development of marginalised persons.

Despite different institutions having tailor made solutions to suit the different areas in

which they operate, there are common characteristics which are embodied by these

microfinance institutions (MFIs). The aim of MFIs is to foster sustainable income

generation, job creation and social empowerment (Robinson; 2001). Microfinance

institutions have a holistic approach with regard to the way they carry out their activities.

The initial small loan can eventually re-integrate these entrepreneurs into formal

networks of the economy and foster the structural and sustainable development of local

communities

Examination of the development of the microfinance industry on a global scale shows a

common trend amongst the different countries which have embarked on this process.

Similarities between environments in which the microfinance sector has thrived include

less developed financial sector along with less developed manufacturing and distribution

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sectors. This lack of adequate economic development opens up an opportunity for

entrepreneurship aimed at meeting the different needs in the economy.

The microfinance revolution in South Africa took a different trajectory due to certain

peculiarities regarding the economy's historical structure. Emergence of the nation from

apartheid saw a great thrust by financial institutions to formally tap into a segment of the

market they initially had no or minimal access to.

The financial infrastructure in the country was already well developed, which is not the

case in a number of countries where microfinance thrives (Porteus and Hazelhurst, pg 89;

2004). Even though there is a high proportion of the populace who have not been reached

by financial services, not many institutions have taken steps to try and tap into the

microfinance space due to varying reasons. The main reason is the high cost associated

with providing small loans to microenterprises and especially to individuals.

3. Current Structure of the South African Microfinance Landscape

The South African microfinance landscape is characterised by a number of institutions

which service different segments of the market. Institutional types of firms currently

operate in the microfinance sector include commercial banks, trusts and nongovernmental

organisations (section 21 companies and cooperatives). Retailers and cash

lenders constitute the bulk of the registered institutions.

South Africa's government, business entities and NGOs have taken active steps to try and

develop small, medium and micro enterprises (SMMEs) via different initiatives. The

South African economy is characterised by the presence of what the former president

Thabo Mbeki termed "the first and second economy." With the first economy being the

formal economy and second the informal (and relatively overlooked) economy.

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Sustainability of MFIs in South Africa has proved to be problematic due to a myriad of

factors. Although a number of microfinance models have been developed and

implemented in different regions of the world, South Africa needs to ensure that such

models are tailor made to suit the economy's framework. There is need for such models

to be replicated on a large scale.

South Africa has different institutions which serve the microfinance needs of small

enterprises. Umsobomvu Youth Fund microenterprise division and Ithala Development

Finance Corporation are some of the Development Finance Institutions serving small

enterprises. The Small Enterprises Foundation, Marang Financial Services and Women's

Development Business are well established Developmental Enterprise Lenders in the

country (FinMark; 2009).

Consumer Lending Organisations (CLOs) in South Africa have a greater knowledge of

the functioning of the lower income and previously disadvantaged markets. Thuthukani

Financial Services, the Real People Group and Capitec Bank fall under the CLO

category. According to a 2006 FinScope Small Business Survey, Blue Financial Services

was identified as the only CLO which was active in the market. Loans provided range

from R15 000 to R3 000 000 (FinScope; 2006).

Due to the nature of micro financing, conventional commercial banks do not find it viable

to operate in providing loans which are not large. Commercial banks such as ABSA and

Nedbank have mainly non-financial support programmes for small businesses. Supply of

financing is prioritized for term loans above R100 000.

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3.1 Regulatory Framework for the Microfinance Industry

This section outlines the major pieces of legislation which have a direct bearing on the

functioning of the South African microfinance industry.

The Minister of Trade and Industry, in a bid to alleviate the unemployment crisis which

was gripping the country in the early 1990's, by signing an exemption in December 1992

to the Usury Act 73 of 1968. Price controls on small loans were effectively removed,

which opened doors for the promulgation of the microfinance sector.

South Africa's microfinance industry grew from a place of relative obscurity in the 1980-

1992 pioneer periods to a rapid entrance of new firms and expansion of the market in

1995-1999. Growth in the market participants contributed to the South African

government's establishment of the Microfinance Regulatory Council (MFRC).

The council was formed following a June 1999 revision of the Usury Act Exemption

Notice 43. The Act requires that micro lenders wanting to benefit from unregulated

interest rates should register with an approved regulatory authority- the MFRC

(Government Gazette; 1999). Registration with the MFRC enables lenders to charge

more interest than the interest limit set in the Usury Act (which is between 24 and 27%

per year).

According to Porteus and Hazelhurst (2004), the effect of the 1999 exemption was to

basically re-regulate the sector which had largely gone awry following the 1992

deregulation. It should be noted that moneylenders not registered with the MFRC fall

under the ambit of the Usury Act. Lending by the MFIs has to comply with the Act's

requirements, with a limitation of 23% per year on amounts less than R10 000 and 20%

per year on amounts above R10 000 (MFRC; 2003).

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National Small Business Act (Act 102 of 1996)

In this Act "small business" means a separate and distinct business entity, including cooperative

enterprises and non-governmental organisations, managed by one owner or

more which, including its branches or subsidiaries, if any, is predominantly carried on in

any sector or sub-sector of the economy. This Act defines four categories for business

enterprises; medium, small, very small and micro.

3.2 Accessibility of Microfinance

Communities serviced by the MFIs are generally not well developed and at times are

therefore lacking in a lot of basic infrastructure. Organisations which operate in these

communities establish offices in the areas in which they serve, to prevent the need for the

people in the communities to travel far to seek their services.

A number of MFIs have a regional focus in the South African economy. Mandates of the

MFIs differ and consequently some individuals are sidelined from having access to the

micro financing. According to a study conducted by the FinMark Trust in 2009, three

Group Lending Microfinance Institutions extending loans below R10 000 have managed

to reach scale and a high level of operational self-sufficiency.

The firms which were identified are; the Small Enterprise Foundation, Marang Financial

Services, and Women's Development Business. The research established that not a single

individual lending organization extending loans from R10 000 to R100 000 has thus

managed to reach a level of operational self-sufficiency. Inability to recover costs

involved in the lending to individuals is a major reason for not reaching the selfsufficiency. It is more expensive to provide personalized services for individuals relative to groups.

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The group based/solidarity lending methodology is the main system used in the provision

of microfinance by a number of institutions. Individual lending organisations in South

Africa such as New Business Finance and Business Finance Promotion Agency offer

personalized services to clients. However, these firms have not been able to reach self

sufficient levels due to the high operating costs associated with personalized services.

4. Factors hindering Microfinance Industry Development in South Africa

According to CARE (2008), "successful microfinance institutions must achieve the

double-bottom-line'- economic growth without compromising their core mission of

serving poor clients." A great balancing act has to be therefore achieved by microfinance

institutions in order for them to achieve this double bottom-line. A number of factors

outlined below pose as challenges for achievement of the double bottom-line within the

South African microfinance landscape.

South Africa represents a paradox of sorts due to the high cost of offering microfinance

in a relatively rich, high income country (CARE; 2008). In order for microfinance

institutions to be effective, they need to establish their operations where the need is i.e.

the poor, impoverished regions of the country. Such places are characterised by lack of

certain infrastructure and amenities.

MFIs are faced with a problem of high staff turnover due to people deciding to move to

greener pastures. Institutions tend to give high salaries to their personnel in a bid to

ensure their retention. Such high wage bills contribute to high costs for the microfinance

institutions which erode their balance sheets.

When MFIs commence operations in a particular area, the usual approach is to build on

the existing skills of the poor in that area. An unintended result of this is an oversupply of

the same type of enterprise in the same region (CARE; 2008).

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Apart from provision of finance, MFIs need to be capacitated in helping people diversify

their economic activities. It should be noted that if such measures are not taken into

account, cannibalisation of the efforts of the institutions are bound to occur, as people

might not be able to extricate themselves from the cords of poverty.

Skills training for the recipients of microfinance assistance and staff tend to increase the

cost of doing business for the microfinance institutions. With most MFIs primarily

focused on provision of finance, partnerships can be forged with organisations which are

already involved in skills training.

Microfinance institutions in other countries function both as loan grantors and deposit

taking institutions. In South Africa, lack of sufficient capacity prevents deposit taking by

some institutions, and the populace has to use alternative means for saving. The preferred

route which ends up being taken is usage of Post Office Banks, due to their relatively

better accessibility.

Most of the financial institutions rely on information provided by customers but

sometimes the required information is not available leading to constraints and the

customers being eventually denied credit. Lack of reliable address systems acts as a

hindrance to the work of MFIs. In order to process loan requests, identification

documents are required by microfinance institutions. Some of the highly marginalised

communities do not have access to services for obtaining this important documentation.

Loan sharks (usurious lenders) have been in operation for a long time in South Africa and

there are therefore a number of misconceptions with regard to the nature of the

microfinance industry. Given microfinance institutions have to incorporate their costs

into the cost of finance, the rates they charge are far much higher than commercial banks.

Lack of knowledge of the rate structures leads some people to assume that the high

percentages levied by MFIs are usurious. Hence, these institutions end up being lumped

into the same category as loan sharks i.e. they are seen as exploitative of the poor.

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In South Africa, MFIs are currently not able to access client savings in the form of

deposits. Financing of loan books for institutions serving the small and micro enterprises

is mainly via loans obtained at commercial rates. Such a restriction on the ability of the

MFIs to increase their financial base acts as a hindrance to sector growth (Marang; 2009).

The South African government has taken active steps to promote the development of

small, micro and medium enterprises (SMMEs) via initiatives such as the Umsobomvu

Youth Fund. Although such initiatives are meant to be beneficial to the general populace

at grassroots level, at times their sustainability is curtailed due to political expediency at

the expense of financial viability.

Microfinance institutions offer an essential service in the economy. Government and

various stakeholders involved in the microfinance industry need to ensure information is

disseminated to all marginalised communities. At times there tends to be an over

concentration of operations in areas which are deemed more conducive for operations.

For firms to move out of the informal economy into the formal economy there must be

minimization of bureaucratic red tape regarding the business registration process. Small

firms might never grow to becoming large' firms if the environment is not conducive in

facilitating the transition from informal to formal sector.

Interest rate limits imposed by the Usury Act serve as a major disincentive to the

provision of SME loans in the range between R10 000 and approximately R300 000.

"The level of the interest-rate cap prevents financial service providers from charging

interest rates that are high enough to cover the risk and cost, and to provide for an

acceptable return on the loans [of MFIs]" (The Task Group; 2001).

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5. Recommendations for Developing the Microfinance Industry

The lack of experienced, hands-on small business experts to assist in developing the

entrepreneurs running the businesses leads to a lot of failure in the industry. Equipping of

business experts so they can be able to impart their skills to others is a very crucial aspect

needed for MFIs.

In South Africa, different institutions focus on serving the financial needs of different

segments of the small business market. It has been noted that there are certain segments

of the industry which are currently under funded. A Task Group of the Policy Board for

Financial Services and Regulation identified that, "a financing gap exists for loans

ranging from R10 000 to R100 000, and particularly among previously disadvantaged

enterprise owners" (FinMark; 2009).

Steps should be put in place to create institutions which are able to cater for this segment

of the market. Currently, a number of enterprises are constrained from growing due to the

lack of finance.

Although it has been noted that a number of institutions are focused on providing finance

for small businesses, this is mainly centered on capital loans. Providers of microfinance

are advised to not only focus on capital provision, but also on short term bridging finance

(FinMark; 2009). These bridging funds are meant to assist enterprises to meet their

working capital needs. Enterprises fail for a number of reasons, but one of the most

important reasons is the lack of timely availability of working capital.

According to some research conducted by Rutherford, "having lots of cash in hand makes

it more difficult to save" (Rutherford; 2000). Due to the large cash handling by a number

of small businesses, savings mechanisms have to be developed which capture these high

frequency cash flows.

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Legislation governing microfinance institutions in South Africa has to be re-examined

with regard to deposit taking. Instead of clients of MFIs having to find their own means

of saving, if MFIs are allowed to collect deposits, clients will be served better. Also,

MFIs are able to benefit from the increase in funds available for financing their loan

books.

Development Enterprise Lenders which have managed to reach scale in the South African

microfinance space have done so on the back of funders and donors. The industry is still

mainly operating based more on the poverty lending approach. Globally, the trend is

toward the financial systems approach. South African firms which are financed by donors

and government need to adopt the financial systems approach in order to reach financial

sustainability.

At the start-up phase for a number of enterprises, cash flows are tight. Microfinance

institutions have to ensure they are located in close proximity to their clients to minimize

costs of the clients. Apart from close proximity to clients, microfinance providers can

operate as virtual enterprises without having the need for too many brick and mortar

facilities.

It has been noted that women constitute the bulk of recipients of financial assistance by

microfinance institutions. This is something global MFIs have basically adopted as their

modus operandi along with South African MFIs. Although focus has largely been on

women based on the rationale they are better clients and more disadvantaged than men,

there has been somewhat a marginalization of men. MFIs are recommended to not just

concentrate their energies on women, but to also diversify and include men in their

operations.

In a bid to ensure repayment of loans, South African micro lenders used to retain the card

and pin of the borrower. The government in 1999 banned the use of the card and pin as a

recovery method. Currently the industry does not have a cost effective loan recovery

system which aligns with industry requirements (MFSA; 2010). MFIs are basically at the

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mercy of the clients until a system is established which aids recovery. Due to the concern

about the recoverability of loans, some institutions end up restricting their lending.

The grants given to South Africans who are unemployed along with many other grants

are important for sustaining the livelihoods of these individuals. It should however be

noted that a consequence of these grants is the creation of dependency on the state by the

individuals. Instead of focusing on providing grants, which are for consumption purposes,

government can partner with MFIs in assisting communities engender entrepreneurism.

6. Summary and Conclusions

The provision of microfinance to small enterprises is expected to present enormous

potential for the improvement of people's standards of living. South Africa is

characterised by a high proportion of people involved in informal activities. Facilitation

of these firms to nurture and grow their enterprises is expected to enable transitions from

the informal into the formal economy.

Regulations currently in place for the industry need to be streamlined to ensure that

finance providers and potential entrants into the market, find it viable to provide the

financing. Certain restrictions brought about by regulations have left some segments of

the small enterprises market not serviced i.e. loans between R10 000 to R100 000.

The microfinance revolution which started in the 1980s has reached epic proportions and

there is no limit regarding the growth potential of the industry. Globally the usage of

information systems in microfinance is a growing phenomenon. South African MFIs are

beginning to utilize such systems in order to ensure they serve their clients better.

Microfinance providers and various stakeholders in the industry need to establish ways of

ensuring ease in loan recovery. Apart from provision of finance, firms need to also assist

their clients with skills training.17

Bibliography

CARE. 2008; Microfinance in Africa: State of the Sector report- Bringing Financial

Services to Africa's Poor

Du Plessis. 1998; The Micro-lending Industry in South Africa

FinMark. 2009; Investigation into collateral options for lending to micro and small

enterprises

FinScope. 2006; FinScope Small Business Survey, Gauteng. 2006.

Gulli, H. 1998; Microfinance and Poverty: Questioning the Conventional Wisdom.

Washington, DC.: Inter-American Development Bank

Marang. 2009; Marang Financial Services 2009 Annual Report

MFRC. 2003; http://www.mfrc.co.za/faq.php [Accessed: 1 May 2010]

Porteus, D and Hazelhurst, E. 2004; Banking on Change- Democratising Finance in

South Africa, 1994-2004 and beyond. Cape Town, FinMark Trust

Rhyne, E. 1998; "The Yin and Yang of Microfinance: Reaching the poor and

Sustainability." MicroBanking Bulletin 2:6-8

Robinson, MS. 2001; The microfinance revolution. Washington, DC.:World Bank,

International Bank for Reconstruction and Development

Rutherford, S. 2000; The Poor and Their Money. Delhi: Oxford University Press

Sen, A. 1999; Development as freedom. Oxford University Press

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The Task Group- Falkena et al. 2001; SME's Access to Finance in South Africa: A

Supply-Side Regulatory Review

Webster, L and Fidler P. 1996; The informal sector and Microfinance Institutions in West

Africa. Washington, DC.:World Bank, Africa Industry and Energy Department and
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Private Sector Development Department

World Bank. 1990; World Development Report 1990: Poverty

Yunus, M. 1998; Banker to the poor. Aurum Press

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