As we review the status of the microlending industry in South Africa and weigh the recommendations on interest rates that will have a tremendous impact on the future of microlending, it is worth taking a step back and asking the following questions:

The answers to these questions will help to guide characteristics of the interest rate policy to be developed. The statements below provide a starling point for our recommendations.

VISION FOR THE FUTURE - WHAT WOULD WE LIKE THE MICROLENDING INDUSTRY TO LOOK LIKE?

WHAT ARE THE CHARACTERISTICS OF THE REGULATORY SYSTEM THAT IS NEEDED TO ACHIEVE THIS VISION?

At the root of this study are three main concerns for the DTI:

Each of these is caused by a variety of factors, some of them overlapping, some of them not Associated with each of these causes are a number of categories of solutions, with different options within each one. We will systematically explore each of these different areas, with a recommended set of options for addressing the constraints that will hopefully allow the DTI to establish the right policies to achieve the vision laid out above.

The base cause for this condition is due to two major factors: aggressive lenders and uninformed or naïve clients. The high interest rates being charged to the clients are not the cause of the over indebtedness, but do exacerbate the problem.

Three major types of solutions are possible to address the main cause of the problem:

Exploitation can be seen either as lending a borrower more than She needs or wants to borrow or charging them a higher rate than they thought that they would be paying by adding on extra charges. The base cause for this condition is due to aggressive lenders, uninformed clients, and poor information flow between clients about alternative options. Exploitation can take the form of overselling the borrower on credit (i.e. lending him/her more than s/he needs), not providing accurate information to the borrower about the implications of the cost of lending and the borrower not being aware of other options.

As with the problem of over-indebtedness, there are three major categories of solutions that are appropriate to address the cause:

While consumption credit is spreading like wildfire, based on payroll deductions, small and microenterprise finance, where repayment is based on cashflow not on guaranteed salary deductions, is not growing very rapidly. The commercial banking sector provides very little enterprise finance under R50000 and the microlenders provide very little above R1O,000. The fact that it is cashflow based, means that the perceived risk is higher than payroll based lending.

Unlike the problems noted above, which focus on over indebtedness and consumer exploitation, there are two main causes for the insufficient supply of small enterprise finance: inappropriate lending technologies to cover the risk and costs associated with lending and a lack of incentives to the lenders to enter the market.

Based on the above analysis and the considerations for the vision of the microlending sector in the future we propose the following recommendations to address the issues confronting the microlending sector.

Between the purely informal lenders (the mashonisas and stokvels), short term cash lenders, commercial retail lenders, and the term lenders, we recommend that DTI should concentrate Its regulatory efforts on those groups where it gets the biggest return on investment The formal short term cash lenders, the commercial retail lenders, and the term lenders account for the largest portion of the lending and are easiest to monitor and regulate. in contrast, the informal lenders are very difficult to monitor and, on a lender by lender basis, handle very few clients. Trying to regulate the informal sector hence becomes relatively cost ineffective.

Otherwise, regulations should apply to all participants in the sector. This will promote a smooth transition for participants within the sector to find that segment in the industry where they wish to operate.

7.2.2 Interest Rate Ceilings

The analysis demonstrated that the size of the branch has a big impact on the surplus that the branch earns, as does the age and maturity of the lending institution. Given the wide range of margins that were witnessed, the instinctive reaction is to not recommend setting any interest rate ceiling at all. After all, setting interest rate ceilings will restrict the flow of credit into the system by forcing marginal lenders (primarily in the rural and peri-urban areas) to close or go underground. This will impact those who have the greatest need for short term emergency credit, the poor, forcing them to go to the informal lenders who are even more expensive.

However, if the DTI insists on setting interest rates, they should not be set based on the cost of money, but based on administrative costs of making the loans. In order to promote the greatest amount of transparency in the industry to promote and stimulate investment in new products, while still maintaining the level of service provision, the Oil should set the interest rate ceiling as high as possible and should set it as a fixed rate. Interest rate ceilings may lead to some disinvestment from the sector, restricting the cash available for short term loans, as well as many of the smaller lenders going underground into the informal sector. But having a fixed rate of interest will allow investors to do their calculations and determine where they wish to invest their money.

The effective interest rate ceiling should be based on the price that has been set by the current short term market forces. This will cause the least distortion in the market, today, and will not penalise the rural poor. Therefore our recommendations would be to place the ceiling at 30 percent per month, if one has to place a ceiling at all. This ceiling can be targeted for a gradual reduction over a period of time providing the industry with time to develop new tools and technology to reduce their administrative costs and to reduce their risk. A period of one to two years should be allowed for the interest rate reductions.

if interest rate ceilings are being set based on the administrative costs, the DTI should address the short-term cash lenders separately from the term lenders, as they have extremely different cost structures due to their methods of operation and risk profile of their clients. While the ceiling for the short term cash lenders should be set at 30 percent (effective interest rate), initially, the ceiling for the term lenders should be set at 10 percent (effective interest rate), with targets for gradual reduction over a period of one to two years.

7.2.3 Other Restrictions on Lenders

As noted in the discussion above, there are other kinds of restrictions that should be placed on lenders that will have a more important impact on addressing the concerns confronting the DTI.

DTI should institute a system to make the term lenders responsible for limiting the level of debt exposure that they place on borrowers through the PERSAL system. This should be based on a repayment ceiling of 25 percent of gross salary (for interest and principal repayments). This is considered to be the safe lending limit in most developed countries for term loans, where salaries are higher, so should be considered as the maximum allowable in South Africa. This will protect the long-term integrity of the market Short term loans, which respond to emergencies and which can be paid off after a month should not be subject to this ceiling. In any event, it could never be enforced.

DTI should institute measures that will increase the risk to lenders who practice irresponsible lending practices, such as depriving them of recourse to compensation in case of default. As with the recommendation above; this will force the lenders to take responsibility for their actions.

DTI should motivate the large term lenders, as well as the short term cash lenders, to institute their own more stringent industry standards on lenders for acceptable levels of debt exposure. These should be based on levels that the lenders determine, in conjunction with the MFRC and DTI, to be safe levels that will protect the integrity of the market and promote responsible lending.

Improve the system for handling complaints by the MFRC. While most systems should be incentive based to motivate lenders to do the right thing, monitoring of complaints must be immediate precise if the MFRC is to have an impact on controlling the lenders who deviate from the established rules.

7.2.4 Improved borrower education

Simultaneously to addressing concerns to problems caused at the lending level, attention must be paid to the borrowers, to inform them of the dangers of taking on too much debt and to make them responsible for their own actions. One very effective way to help address these issues is to include the employers in the solution, as with PERSAL. These recommendations include:

DTI should promote the development and delivery of improved education materials for prospective borrowers and their employers by the microlenders. Since the employer is the best point of control for lenders desiring to provide the service through the company, they must be included in this campaign and must insist that the microlenders provide the educational material as a condition for entry into the company.

DTI and the MFRC, in conjunction with consumer groups, should launch a national education /sensitisation programme on the risks of becoming over-indebted.

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

Clearly, there is limited flow of information about borrowers at present even though there are three credit bureaux that are concentrating on the clients of the short term cash lenders.

Therefore, the DTI should promote the creation of a national loans register that will allow lenders to identify the level of debt exposure already facing an individual, either through creating a national loans register managed by the MFRC (government financed) or by the private credit bureaux (privately financed).

DTI should continue to require the full disclosure by lenders of all charges to the consumer and the monthly flow of payments over the course of the month in easily understandable language, including the annual percentage rate as calculated by the MFRC.

7.2.6 Restrict borrower access to lenders for certain categories of borrowers.

This is the flip side to restricting lender access to clients, and can only be done under certain circumstances. It would require a centralised system, and at the extreme would only make it more difficult for the borrower to access credit. But if s/he really needs it, s/he will find it.

Both of these can be easily bypassed by the borrower, but at least making them aware of it and promoting industry standards as safe limits may make it more difficult for them to access them.

7.2.7 Stimulating investment in SMME finance

Stimulating investment in SMME finance remains a serious challenge. It was clear from the field work that the formal banking sector has little incentive or initiative to invest in making loans into this sector. There has been some investment specifically in microenterprise finance by Quatro Trading, which has achieved a very sizeable book for Span shop lending, but this is VERY short-term working capital finance. Traditional microenterprise term finance is in short supply, as well as loan funds below the commercial bank’s "glass floor" of R50,000.

The constraints revolve around incentives to lend and appropriate technologies to reduce the cost and risk of lending. Since the commercial banks have demonstrated limited interest in the sector, the recommendations must therefore focus on stimulating new lending technologies and investment in the sector from the microlending side. The recommendations are:

Increase the ceiling on the exemption from SMME loans beyond RI 0,000 to R25,000. Increasing the ceiling will make it more interesting for commercial microlenders to invest in this market Loans at this size should be comparatively easier to track and monitor than the microloans, to avoid abuse, and could be restricted to firms that have specifically registered with the MFRC for this range of products. Keeping the ceiling wail below the "glass floor" will limit abuse of the Exemption by commercial banks wishing to divert funds into this much more lucrative market, but only on the margin. This will also lead to the promotion of technological innovation in this segment of the market by those lenders who have demonstrated the best aptitude for innovation: the microlenders.

Continue to facilitate capacity building through government sponsored programmes such as Khula and promote standardised reporting to the MFRC for enterprise lenders. These latter two items will work in tandem with the increased interest rate ceiling to stimulate innovation in the sector.

7.2.8 Increased Monitoring and Analysis of the Sector

The work carried out under this study has been the most in-depth analysis of the MFRC data on microlending institutions and of the data from the PERSAL system to date. Both systems could capture data more efficiently for improved monitoring by the responsible parties (MFRC and Oil). An unprecedented opportunity now exists to carry out proper analysis of the evolution of the sector. Therefore the recommendations are:

The MFRC should continue its strong efforts to capture data on the Industry, to carry out regular analysis on the trends In the Industry, and publish those reports for the industry as a whole. This will promote the flow of information, as well as allow for better tracking of the Industry. The better flow of information should stimulate competition.

The DTI should carry out regular monitoring of the trends on the PERSAL system to monitor the Impact of Its policy initiatives on addressing the key problems of over-indebtedness. This is not a complicated process, the information just needs to be identified in advance, and the key searches must be effected on a regular basis.

Implementing these two monitoring activities will provide sound information on the transformation of and trends in the microlending industry following the implementation of regulatory policy. This will inform the DTI on kinds of interventions that have been most successful in addressing the key problems, assisting it with future decisions.