Making Microfinance Work in South Africa

Despite its success implementation in many countries, the traditional Grameen Bank model of microfinance has not yet penetrated South Africa’s dual economy of extreme inequality. In South Africa, the financial services sector has focused on populations in top Living Standards Measures (LSM), leaving the poor with little access. This paper is a synopsis of research conducted as part of Kellogg’s Global Initiatives in Management program into strategies for improving access to financial services in South Africa. This paper analyzes the evolution of present situation, exploring South Africa’s barriers to traditional microfinance institutions (MFI), and provides recommendations for improving the availability of credit through MFIs as well as other sources.


Grameen Bank’s Global Success

Muhammed Yunus created the Grameen Bank in 1976 to provide poor Bangladeshis access to credit based on future potential rather than acquired assets. Villagers used the credit in a wide variety of ventures, from agriculture to manufacturing and trading. The Grameen bank model operates by establishing branch banks for multiple villages. As branch employees get to know the local population, they identify prospective borrowers and educate them about the bank, its purpose, and functions. At this point, villagers form groups of five borrowers. Initially only two of the five are eligible for a loan. Future loans are made to the remaining members only after the first two are repaid. The idea is that the responsibility of the group serves as collateral. The model has resulted in a repayment rate of 95%, with 50% higher incomes for the households involved. As of March 2008, 7.5 million borrowers have participated, helping to earn its founder the 2006 Nobel Peace Prize and to stimulate adoption of the model on a global scale.

So why hasn’t the model worked in South Africa?


South Africa’s Two-Economy Divide

South Africa’s apartheid era left a significant gap between the country’s rich and poor, with the poor increasingly falling behind. According to the World Bank, South Africa has one of the world’s highest rates of income inequality. Only 13% of the country lives in “first world” conditions, while nearly 50% lives in conditions defined by the bank as “third world.” Three quarters of this group lack access to electricity and running water. The basis of this dual economy is both historical and structural. As a legacy of apartheid, the rural poor live in villages that are crowded between commercial farmland and game reserves aimed at attracting tourists. On the other hand, the manufacturing and retail sectors of the economy are well developed, providing little opportunity for self-employment in the urban areas. This combination results in South Africa’s poor being almost completely dependent on the formal economy for survival.

Access to financial services is a key component of economic empowerment, but the country’s economic divide has hampered the development of microfinance. For example, a directory search of South African microfinance institutions yields just 13, including nine NGOs and non-profits. As a result, microfinance in South Africa is often redefined as lending to mid-poor individuals, rather than to the most indigent segments. Here, the “unbanked” are defined as those whose needs are unmet by both the formal and informal banking sectors. And South Africa has no shortage of individuals in this category.


Serving South Africa’s Unbanked

Though South Africa’s financial services sector is sophisticated by several measures, even rivaling that of the US, years of apartheid resulted in inefficiency and high cost structures within major banks, with four banks holding nearly 90% of the country’s assets—and neglecting the nation’s poor. And the banks, having grown accustomed to large margins and little competition in working with the upper classes, had little reason to search out new markets, such as those associated with microfinance.

Nonetheless, motivated in part by social concerns, major player Standard Bank created E Bank (now E-Plan) in 1993 to provide services to low-income South Africans. Nedbank soon entered the low-income market in a joint venture with Capital One, but pulled the plug in 2004, unable to operate the venture profitably. ABSA and Saambou subsequently gained a major share of the unbanked segment by providing micro-enterprise loans. However, both succumbed to shattering losses after 2000; Saambou’s fall amid several fraud charges is often compared to that of Enron. Not surprisingly, big banks lost their appetites for the unbanked market, and less scrupulous lenders soon filled the void.

In October 2000, the South Africa Communist Party (SACP) led demonstrations protesting financial service inequity, calling for transformation. Two years later, the National Economic Development and Labour Council (NEDLAC) agreed on strategies to transform the financial services sector. Among these: the provision of affordable banking; the development of sustainable financial institutions; and appropriate regulation for micro-lenders. A subsequent Financial Sector Charter developed by the banking industry resulted in greater formal commitment to serving South African unbanked segments, notably in the area of infrastructure.

Several initiatives emerged from this charter. For example, Mzansi accounts, launched in October 2004, are bank accounts providing free entry-level services, including one monthly deposit. Within a year, more than 1.5 million Mzansi accounts were opened, mostly by women. The accounts’ success has been attributed to their relative liquidity and security, as well as the account-holders’ ability to visit a physical banking structure. Low-cost Mzansi money-transfer facilities were opened in late 2005, helping account-holders move money easily, especially from urban to rural areas.

On the opposite end of the spectrum, Capitec Bank is an example of how smaller sustainable institutions are arising to serve low income clients. Capitec is a small commercial lender that was started by a group of South African businessmen to serve low-income segments. The bank targets low-income salaried individuals, rather than the poorest groups, but has performed well in this niche. Like Capitec, African Bank focuses on formally employed customers, providing unsecured credit and other services.


South Africa’s Micro-lending Sector

Despite these advances, which have tended to target the formally employed, South Africa’s poorest segments are still reliant on controversial micro-lenders. Historically, the only points of access to financial services for the poorest South Africans, these lenders have charged comparatively high interest rates and generated significant profits. However, the passage of 2007’s National Credit Act, which included rate and fee caps, has reduced these profits and may lead to more underground micro-lending. Similarly, because South Africa’s micro-lending sector was not the result of a social responsibility mission, it has not typically sponsored financial literacy training for consumers, making traditional MFIs preferable.


Barriers to Traditional MFIs

A major challenge for MFIs in South Africa is that goods and services that could be provided to urban consumers by micro-enterprises are already produced on a large scale by established, mainstream companies. Thus, rural areas of the country likely represent better microfinance opportunities, and a sample of South African rural women interviewed as part of this report agreed. Nonetheless, the dispersed nature of likely microfinance clients in rural South Africa poses operational challenges not faced in more population-dense nations such as India. In addition, experts point to a “salary burden” associated with paying MFI-employed South Africans, who would expect wages consistent with those earned by counterparts in mainstream institutions. Some within the goverment —including Vusi Gumede, Chief Policy Analyst for South Africa’s government— also argue that there is a reduced need for microfinance in the country because the government has already provided major grants raising the poor’s standard of living.

The Small Enterprise Foundation (SEF), founded in 1992, provides hope for MFIs in South Africa. Using the Grameen model, SEF has loaned a total of R532 million since its establishment. Among the factors driving its success are its location in the country’s northernmost province, which houses many of the poorest segments in the nation, and its operational focus, targeting productivity improvements and mandating that loan officers pay their own expenses through interest on loans handled.


Recommendations
A three-pronged approach is recommended to develop South Africa’s microfinance industry: 

• LSM 3-5 Population: This segment could be served by niche players such as Capitec, partnerships between banks and micro-lenders, and greater consolidation within micro-lending to create economies of scale. The government has already established two organizations to stimulate entrepreneurship among these groups: Khula Enterprises and the Umsobomvu Fund. These organizations represent the power of public-private partnership, providing education and guaranteeing up to 80% of loan collateral.
   
• LSM 1-3: Partnerships among the government, micro-lenders, and NGOs will also be of great value in supporting these poorest segments. The government could also subsidize MFIs that have adopted the Grameen model and help provide micro-entrepreneurs training on business practices and financial literacy.

Reforms in line with these recommendations will lead the South Africa closer to meeting the unique financial needs of the country’s poorest population segments in a sustainable way.