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Microfinance Industry in South Africa

-A review of the sectorby

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

sector…together, 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, crèches 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.