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Micro lending: Fixing the South African Economy

In order for any economy to succeed you need to get everybody participating, either by having a job or by running his or her own outfit. You also need to export more than you import and you need to earn more than you spend. Full stop? No, no  full stop here. As with everything in life hardly everything is absolute, and economics and politics are more related to theology than science.

Fixing the South African Economy

What we also need to fix – especially in South Africa – is the difference between poor and rich, measured using the GINI coefficient, in which South Africa owns the unflattering world record having the highest difference between poor and rich.

As mentioned one way of fixing the economy is that everybody is having a job or run their own profitable business. The youth (<24 years old) unemployment in South Africa is 52,9%. In MEDO we run programmes trying to convince youth of generating their own job by building their own business. As a young adult you have a higher risk profile, both from the genes, but also because you haven’t started a family yet.

In Canada SMEs account for 45% of GDP, much of the economy's growth, 60% of all jobs in the economy, and 75% of net employment growth. In the UK SMEs make up 99.9% of the total number of businesses and SMEs provide 59.1% of all private sector jobs. Jobs come naturally from small business. 82% of all jobs in South Africa are provided by the SMEs. All small business owners are looking forward to the day they can hire extra staff. Big business operators are constantly looking at the next round of retrenchment. We need to generate more small businesses to generate an economy where everyone can participate.

Closer look at the problem

Let look at the fact that the difference between poor and rich is not getting smaller and the fact that small business has difficulties in growing and see if we can score some point in the right direction with one stroke.

One of the ingredients in growing a small business is access to capital. And one of the ways of narrowing the width between poor and rich is stopping the rich constantly making more money on the poor instead of going after the rich.

In South Africa risk-willing capital is being used in micro lending to achieve enormous interest takings and profits by granting excessively expensive loans to people without assets, also called unsecured loans. That means that this risk-willing capital is not available as capital injection in small businesses that could grow and generate jobs.

In the US the maximum allowed interest rate is regulated within each state:

In California the maximum interest for private individuals is 10% – no exceptions. That is not the lowest, which in some states is as low as 7%. And it is not the highest, which in some states are unregulated.

But California is of special interest – pardon the punt, because it is the place we look to for venture capital and angel investments. It is where the stories comes from where Netscape back in 1995 did an IPO (Initial Public Offering), and created the notion that you could cash out before you built a sustainable business, and where Google got $25m in investment in 1999 without knowing how to make money on their technology. But because the investors in California can’t make high interest rate loans using their risk-willing capital, they have to do something else to see their money grow. They have to invest in business against equity. And that means they have to have a real interest in the business, not just a superficial interest, like the banks when they give you a personal secured loan in your business. If you invest in the company against equity, you raise and fall with the business’ success. If you extend a personal secured loan, you get your return independently of the business succeeding or not.

Back to the unsecured loans in South Africa: A number of outlets sells cheap TVs, fridges and other furniture to a higher price, which low income individuals are willing to purchase because the outlet offers the assortment paid over 3 years rather than the full amount cash. But if one saves the same monthly payment over 1 year, one can buy the same item much cheaper in a cash based store, where the price point is a competitive parameter, rather than credit becomes the selling parameter. A TV for the poor cost 3 times more than the same TV for the rich! 

Let me illustrate with a older, but real world example: A cash type outlet owned by JSE listed Massmart are selling a “Sony 5.2 Mgongo” HiFi system for R6400,00. The exact same system cost R11999,99 at an outlet owned by renowned JSE listed micro lending bank. They state that the interest rate is 14%, but a quick check with Excel (=RATE(36;499;-11999,99)*12) shows that the actual interest rate is 28%. Now this payment is subject to – quote: “Monthly instalments, credit prices & interest rates may vary from those advertised. Initiation, service fees and insurance applicable”. With other words you are going to pay more per month than R499. When I tried to verify these numbers, I was told that they are subject to my credit profile. So even insurance is more expensive if I have a more stressed credit profile. Oh, and if you imagine that the system was available for R6400, but with same payment terms, then your interest would actually be 84%, but if you saved R499 per months for a year, you would have the cash to buy the unit. The system is 3 times more expensive for the poor than for the rich.

So you buy some items, that you have to pay the next 3 years, which means any mishaps in your employment life and you are in panic, no school fees, no prober food, because this installment has to be paid first. And you cannot really change your job situation; because you have to make sure you can afford paying off these items. It is not a far cry from debt bonding, where workers cannot leave their employment before they have paid off their debt, i.e. slavery. 

To the point

So if we set a legal limit for interest rate to something like 15% pa for consumer/personal loans AND for business loans with personal surety, we will free up risk-willing capital from micro lenders to equity based investments. The rich would have to stop making money on the poor and try to make it on the rich. It will stimulate business investment and it will assure that investors assist business in making a success, since there is no longer money in it for them unless the invested business is succeeding – and creating jobs!

We do already have a limit on interest rate. According to the National Credit Regulator (NCR), the maximum interest rate for loans longer than 6 months is 31% per annum. The current prime rate is 9,25% and rich people will get a car and a house loan for 1,5-2% less than that. If we take the above example with initiation fee, service fees, and insurance you will find the interest rate for poor people is still about 5 times higher than for rich people.

There are plenty of for and against articles covering micro lending. But considering our, South Africa’s, way of doing micro lending, it is clear that we should rather do a cold turkey and implement a cross the board maximum interest rate, and then see a short term fall of spending followed by a much stronger structure to build our economy on.

Recommendations

  1. Set a legal limit for all consumer/personal loans as well for all loans to businesses that have personal surety. If a business loan has been co-signed with personal surety of any kind, the loan has to be viewed as a personal/consumer loan. My suggestion is 2 x times the prime rate, which currently would be 18,5% pa. The calculation of interest should also be regulated to avoid loopholes and confusion.
  2. The max interest rate is including any and all fees (service fees, initiation fees, etc), legal fees, late payment fees, insurance and other non-voluntary cost, etc. If the limit is 15% pa, and a banker lends out to 10%, he can still add penalties until the interest and fee amount do not exceed 15%. If the loan starts out on 15%, then no extra fees of any kind from any entity for said loan could be charged. In order not to add fees to the price of the product or service, and then gain it back with interest, the product and service should be obtainable for the cost presented without any extra non-voluntary cost.
  3. Any loan taker, who believes he has been overcharged, can bring it to the small claims court, which can request from the lender a full statement of all payments done between the parties. Such statement has to available with 24 hours. And such statement should also be regulated similar to SARS dictating the layout of the IRP5.
  4. If the lender indeed has been overcharging, the loan will be immediately prescribed. And the lender will loose a point similar to the proposed point system for traffic violations. Once all points have been lost, the lender will loose his license to operate  as a lender. The 2 different penalties are to pursue two different traits. The prescription of the loan is to induce loan takers to report any violations, and the point system is to circumvent the lenders in calculating an positive ROI expecting only so many of their violations will be caught.
  5. Any loan takers should be able to pay in any larger amount at any time, without it affecting the agreed interest rate, calculated from the day the extra deposit is made. This includes full settlement of the loan, which can only be charged to the agreed interest to the day of the settlement. No warning of settlement needs to be given. Any request to settle has to be responded to by the lender within 24 hours, who in return has to respond with a calculation of the amount to be paid within 24 hours in order to settle. A NCR hotline email or fax can be CC’ed, to maintain records of evidence.
  6. Any lender who fails to respond according to said deadlines, do not have adequate controls and system in place to operate as a lender, and will therefore have their license revoked.

 

References:

 en.wikipedia.org/wiki/List_of_countries_by_income_equality

 http://www.statssa.gov.za/news_archive/Docs/QLFS_Press_statement_Q1_2013.pdf

 http://www.startupdonut.co.uk/blog/2011/08/why-smes-are-key-uks-economic-recovery

 http://www.loanback.com/category/usury-laws-by-state/

 http://bits.blogs.nytimes.com/2012/05/17/back-to-the-future-the-netscape-and-google-i-p-o-s/

 http://en.wikipedia.org/wiki/Google

 http://www.antislavery.org/includes/documents/cm_docs/2012/s/1_slavery_on_the_high_street_june_2012_final.pdf

 http://asiasociety.org/business/development/how-micro-finance-helps-poor

 http://www.businessweek.com/stories/2007-12-12/the-ugly-side-of-microlending

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