South Africa has witnessed extraordinary growth in unsecured micro-lending over the last few years. Is this due to South African banks taking uncalculated risks in favour of higher premiums, or merely due to a correction of previous discrepancies in the South African credit industry?
If this situation is not monitored closely, South African banks could be heading down a slippery slope.
Micro-loans are easily accessible to the greater public. Demand is such that banks can charge as much 32% interest, while the product still remains attractive.
Traditionally, South African banks did not offer unsecured credit to local lower income earners. These individuals were forced to use other less regulated alternatives, such as loan sharks, to cater to their credit needs.
Prior to the passing of the National Credit Act, banks were content with pursuing larger premiums from large secured loans such as property bonds. This later proved to be not as profitable as anticipated due to overstated property prices and difficulties in collecting debt from customers that defaulted.
The National Credit Act set new rules that made these large secured loans even less profitable. The Act also changed the rules for micro-lending, limiting the amount that could be charged for interest and administration. This eliminated traditional unregulated credit providers and left a gap in the market, making it feasible for banks to enter the micro-lending sector.
In South Africa’s current low interest rate environment and its minimal volatility, it is difficult for banks to make large margins on their traditional lending products. The banks all offer the same services and the only differentiation is price.
To make matters more difficult, the requirements stipulated under Basel III have also driven up the cost of lending, especially longer-term home loans, making them less profitable for banks. As a result, banks are being forced to seek revenues elsewhere to keep profits up and shareholders happy. Hence the large marketing to, and high growth in, micro-lending.
Coface South Africa believes the current growth rate is not sustainable. The risk in the micro-loans business is high, even though the lending base is vastly diversified due to the large number of individuals making up the base.
If the economy were to suddenly go into a downward spiral or interest rates were to rise, micro-lending banks would probably suffer great losses due to a major domino-effect default.
A substantial portion of the growth in the micro-lending can be explained by previous inconsistencies in the regulated credit industry. However the situation needs to be monitored closely to ensure that banks are following the correct procedures, those defined by Basel II, and are not recklessly lending funds simply to keep profits up.
*Saijil Singh is the lead analyst at Coface South Africa