The microfinance sector in South Africa is a large and growing sector of the national economy. It aims to bring access to financial services to the poor and unemployed by assisting them in setting up income generating micro businesses. With the vast inequality in income distribution between the wealthy and the poor, the microfinance sector is playing an increasingly important role in the banking sector as the retail banking sector attempts to provide financial services to millions who have previously never had access to finance. Increasingly government has begun to view the microcredit sector as a significant part of its employment creation and economic growth targets and has increased the capacity of its state microfinance agencies.
The South African government is certainly not the first to use microcredit as an avenue with which to tackle development issues, as many governments have prioritised the development of the sector as a way to further job creation and economic growth. In spite of such policies aimed towards the poorer in society, the poorest of the poor are themselves unable to access finance even from microfinance institutions (MFIs) as those costs would still be prohibitive to the economically marginalised. However, it is important to understand that growth in the small and microenterprise sector will ultimately result in employment creation and therefore also poverty alleviation to a degree.
In order to advance the growth strategy, it is important to assess whether the finance advanced is actually reaching the microenterprise or if it is used in setting these up. This does not seem to be the case. The microfinance industry in South Africa is estimated to be R50 billion. Studies have shown that only 6% is loaned to small businesses while the rest are consumer personal loans which are mainly used to buy food and to pay off old loans. It is clear that many consumers are caught up in a seemingly endless cycle of borrowing often made worse by the desperate financial circumstances that the poor face. As a result consumers often approach “loan sharks” or “mashonisas” who are quick to advance loans and require little or no documentation which the more formal MFI’s require. MFIs therefore need to build strong relationships with communities and build a reputation for efficiency in delivery of their services.
So the question remains, can microfinance become effective in poverty alleviation, even when offered by the mainstream registered MFIs? Regardless of the provider of the credit, microfinance is always going to be expensive. For MFIs to be financially viable, they have to build in the credit risk and lack of security into their pricing. This results in astronomical interest rates borne by those requiring microcredit; rates which are much higher than those available to the much wealthier. And so, for the poor who end up indebted due to their poverty, they find that their poverty deepens as they try to escape the vicious cycle.
In recent months, there has been increased focus on the In Duplum rule and how it can protect/s consumers, poor and wealthy alike, from the effects of crippling interest charges. The In Duplum rule is deeply rooted in South African common law and indeed has a very strong moral basis imposing a limit on the interest that can be charged on a loan. Interest is capped when the amount equals the outstanding capital; a situation which arises very frequently in the high interest environment of microfinance. However, the practical application of the In Duplum rule remains challenging in many environments. While major banks are refining their systems to ensure compliance, it is doubtful that smaller MFIs have their systems configured to suspend interest once this has reached the level of the outstanding capital. It is likely that even the mechanisms in law designed to alleviate the interest burden will fail the poorest that probably need it the most.
The high cost of credit associated with microfinance is likely to trap the poorest consumers in an endless spiral of debt. As long as finance is granted by private entities they will have to price the credit appropriately to remain in business and unsecured credit cannot be inexpensive even with the highest intentions. It will therefore remain a contentious issue whether microfinance will assist even those who are using the funds to start up micro businesses to advance out of poverty. The case for poverty alleviation will probably be strongest when government funds are used and state MFIs grant finance at highly subsidised rates to individuals looking to set up micro businesses at interest rates that they can actually afford. There is always a cost though and where state subsidisation occurs, the taxpayer will ultimately bear the cost.