COSATU Submission on the Report: Examination Of Costs And Interest Rates In The Small Loans Sector, Submitted To The Department Of Trade And Industry, 8 September 2000

COSATU Submission on the Report:

Examination of Costs and Interest Rates in the Small Loans Sector

Submitted to the Department of Trade and Industry, 8 September 2000

Table of Contents

Introduction
Overall approach
Comments on Recommendations of the Report

Recommendation 7.2.1: Who to try to regulate?

Recommendation 7.2.2: Interest rate ceilings

Recommendation 7.2.3: Other restrictions on lenders

Recommendation 7.2.4: Improved borrower education

Recommendation 7.2.5: Improving the flow of information for borrowers as well as lenders

Recommendation 7.2.6: Restrict borrower access to lenders for certain categories of borrowers

Recommendation 7.2.7: Stimulating investment in SMME finance

Recommendation 7.2.8: Increased monitoring and analysis of the sector

Conclusion

Introduction

This constitutes COSATU’s comments on the study commissioned by DTI from Ebony Consulting International, entitled "Examination of Costs and Interest Rates in the Small Loans Sector", as gazetted in Government Gazette No. 21381 ("the Report"). COSATU has in the past commented on the microlending industry, notably in our Submission to the Portfolio Committee on Trade and Industry on 2 March 1999 on Bank Charges, Microlending and the Usury Act ¹. This submission should thus be considered in conjunction with our previous interventions. We will deal firstly with our overall approach to the issue and the general perspective of the Report, and thereafter with the recommendations of the authors.

Overall approach

The microlending industry in South Africa has mushroomed in recent years. This has, however, occurred in a largely unregulated fashion and the abuses and malpractices in this industry - which affect poor South Africans most - are well known. The need for strong government regulation of the microlending sector is clear, as "regulation" either by the market or by industry associations has proved to be wholly inadequate. COSATU supports the steps being taken by government towards improved regulation, and believes that a further strengthening of policy is needed.

The problems in the microlending sector are also to a large extent a symptom of the failure of the banking sector to meet the needs of low-income earners. Seen in this context, a strategy to address the problems in the microlending industry needs three prongs: direct interventions to regulate the microlending industry itself; a broader transformation of the financial sector to ensure that banks meet South Africa’s developmental needs, including the credit needs of low-income earners; and a shift-in government’s monetary policy to make it more expansionary and development-oriented. Given the terms of reference of the Report at hand, our comments in this submission will focus on regulation of the microlending industry itself. We would, however, welcome the opportunity to comment on the transformation of the entire financial sector, possibly in joint hearings of finance and trade and industry.

The overall approach of the Report seems to be a characterisation of the microlending industry as a free market success story which needs minimal intervention. This is problematic on two counts: firstly, as pointed out above, the very growth of this sector is a reflection of the shortcomings of the big banking sector and as such it is not something to be applauded. Secondly, given the serious problems and exploitation prevalent in this sector it can hardly be seen as a success story and as such strong government intervention is required. The Report, however, seeks to minimise such intervention which it characterises as "market distortions".

The authors seem to have faith in increased competition to drive down prices and improve microlending for consumers. Given the rapid growth of the sector and the number of microlenders aggressively plying their trade to potential customers, it is clear that promoting competition cannot be the main plank of a strategy for the sector. The Report itself notes (at page 49) that there are now numerous players and serious competition in the market, but that this competition has not necessarily led to much downward pressure on markets. The explanation proffered by the Report for this is that the market has not yet been penetrated to its full potential. In the light of its explicit expectation that prices will stay constant for the foreseeable future, it is surprising that competition is relied on as the main mechanism for reducing interest rates.

A further, and related, problem with the overall logic of the Report is an apparent concern that if microlending is too well regulated, the sector will just informalise or more customers will go to informal lenders, hence government should not even attempt to regulate too strongly. This logic is equivalent to arguing against comprehensive regulation of tax or the labour market, in the hope that people will comply. It is unacceptable to use an expectation of failure to implement policy as an argument against instituting policy in the first place. The challenge is to regulate all sectors of the microlending industry and to formalise the informal sector. If proper implementation of policy is constrained by inadequate resources, then additional resources should be allocated to such functions.

Comments on Recommendations of the Report

We will address each of the recommendations of the Report in turn.

3.1 Recommendation 7.2.1: Who to try to regulate?

The Report argues that, on the criteria of return on investment and cost effectiveness of regulation, regulatory efforts should focus on the formal sector. This recommendation is surprising and problematic on two counts. Firstly, it is in the informal microlending sector that many of the worst abuses and exploitation occurs. For this reason, COSATU would have expected a focus on this sector, as well as the formal sector, in order to eliminate these problems and to bring informal lenders within the regulatory net. Excluding them creates a perverse incentive for microlenders to informalise in order to avoid regulation. Secondly, according to the Report informal lenders actually account for the bulk of the microlending industry (R15 billion from an estimated total annualised turnover of R25 billion). This makes it even more imperative that regulatory efforts include informal lenders.

3.2 Recommendation 7.2.2: Interest rate ceilings

The Report argues against the setting of interest rate ceilings on the dubious grounds that this would force marginal lenders to close or go underground and thus force the poor to go to informal lenders instead. Here the Report becomes a victim of its own circular logic: having argued against regulation of the informal sector, and accepting that this would result in exorbitant rates being charged there, it then uses this to motivate against strong regulation of the formal sector as this would encourage further informalisation! COSATU rejects this approach and insists on the centrality of an interest rate ceiling to protect consumers. We believe that a cap should apply to all loans, including those under R6 000.

In terms of the level of an interest rate cap, we reject the Report’s recommendation to base this on administrative costs rather than on the cost of money. Such an approach would tend to have regressive effects, with highest rates for the poor. We also reject the Report’s proposals of setting the ceiling as high as possible, and basing it on the price set by current short term market forces, in order to cause the least distortion in the market and not penalise the rural poor. Setting of a ceiling should not be informed by causing minimal "distortions": what the report sees as a market distortion is in fact a legitimate government intervention to meet valid policy objectives. What is the point of setting a cap if the level makes no/little difference to current practices? We believe that the actual figures proposed in the Report (30% monthly rate for short terms cash lenders and 10% monthly rate for term lenders) are still exorbitantly high and will not meet the desired objective of affordable access to credit for the needy. We propose that DTI consults with relevant constituencies and affected communities as to what more appropriate levels would be.

3.3 Recommendation 7.2.3: Other restrictions on lenders

While the microlending sector should be encouraged to set and implement more stringent industry standards, it is clear that a self-regulatory approach cannot be relied upon and cannot be a substitute for strong public regulation.

3.4 Recommendation 7.2.4: Improved borrower education

COSATU supports proposals around the development and delivery of improved educational materials in relation to microlending. Whilst such information should be provided by microlenders, this alone cannot be relied upon given the objective interests of the microlenders. We support the proposal for DTI and the MFRC, in conjunction with consumer groups, to conduct education/sensitisation programmes for consumers.

3.5 Recommendation 7.2.5: Improving the flow of information for borrowers as well as lenders

COSATU agrees with the proposals to set up a national loans register and to require full disclosure, in accessible language, by lenders of all charges as well as the monthly flow of payments and the annual percentage rate.

3.6 Recommendation 7.2.6: Restrict borrower access to lenders for certain categories of borrowers

COSATU supports these recommendation intended at protecting borrowers from getting into debt traps, namely limiting the level of debt coverage that the user can afford and limiting the number of loans a borrower may access at a time.

3.7 Recommendation 7.2.7: Stimulating investment in SMME finance

A number of studies have pointed to access to affordable finance as being one of the major difficulties facing SMMEs, if not the main obstacle to their development². This issue clearly relates to the broader concerns around transformation of the financial sector raised in section 2 of this submission, as well as to government’s monetary policy. The problem of access to finance for SMMEs needs to be addressed not by "making it more interesting" to invest in this market, but by a stronger approach to the regulation of the financial sector in a way that compels the channeling of credit to small, job-creating enterprises with differential interest rates to ensure that finance is affordable. Other obstacles facing SMMEs in accessing finance from banks, such as bureaucratic procedures and geographic inaccessibility, also need to be eliminated. Furthermore, the role of public sector entities – such as the PostBank – in providing accessible and affordable financial services to the poor needs to be expanded.

It is not clear to us whether this section of the Report is intended to refer to SMMEs as recipients of finance or as lenders, which makes it difficult for us to comment conclusively. Either way, however, the recommendation raises issues of concern. The argument that allowing outrageous interest rates at the low end of the market in order to increase access to credit is flawed, as it ignores the fact that the cost of finance is a integral aspect of access to finance. As with consumers, it would be wrong to protect larger businesses from exploitative interest rates while not protecting small businesses who are most in need of such protection. COSATU thus rejects the proposal to increase the interest rate exemption on SMME loans from R10 000 to R25 000 as we believe this would mitigate against growth of the sector, and would be more likely to lead to the failure of emerging enterprises.

3.8 Recommendation 7.2.8: Increased monitoring and analysis of the sector

We support proposals around better capture, analysis and publication of data and trends in the microlending sector.

Conclusion

While the Report contains some useful information and analysis and certain helpful recommendations, it has a flawed logic which leads to some problematic proposals. Given the experience of the microlending sector, it is clear that stronger regulation is needed rather than leaving it to market forces, competition, or self-regulation. COSATU calls on DTI to build on the positive steps which have already been taken in regulating microlending in order to protect low income earners and emerging enterprises. In particular, interest rates need to be capped at levels which ensure affordable micro-finance. More attention is needed on the side of monitoring and enforcement to ensure that policy is effectively implemented in the entire microlending industry.

Footnotes:

This submission can be found on the COSATU website at the following address:
http://www.cosatu.org.za/docs/1999/bankrate.htm
See for example the study commissioned by the former Deputy-President’s office entitled "Poverty and Inequality in South Africa", the DTI report "Financial Access for SMMEs", and a NALEDI report entitled "The importance of labour regulations for small business growth and job creation".

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