Earlier this year, Differential Capital released a comprehensive analysis of the South African unsecured lending market in which it argued that despite the well-meaning legislation that had created this industry, it was essentially dysfunctional. Instead of empowering disadvantaged South Africans, as was the intention, it had become largely exploitative.
"We accept the need for financial inclusion," the report noted. "However, we contest that high-cost loans (specifically short-term loans) are detrimental to this endeavour. Our research shows that predatory lending is almost systemic to the industry, except for the 'big four' banks."
Consumers on the edge
The default rate for consumers who only have unsecured credit is 48%. For those with both unsecured credit and other credit, this rises to 56%.
Around 81% of those with an unsecured loan earn less than R15 000 per month, and 36% earn less than R5 000 per month. In total, borrowers in this segment owe R137 billion, and, on average, are paying 33% of their net income to service this debt.
Perhaps most alarmingly, the total value of unsecured loans outstanding has grown since 2015, while the number of consumers who have a loan has dropped. The result is that the average consumer owes nearly 50% more than they did four years ago.
One of the main reasons for this is that lenders are not competing on value, but on loan size. Consumers are simply shopping around for the biggest loan that they can get at the lowest monthly repayment, even if that means extending the loan over many years.
The cost is hardly a consideration. This is reflected in the all-in cost of credit over different terms.
For Naeem Badat, co-founder of Differential Capital, this shows an industry that isn't working as it was intended. The ideal of financial inclusion is not being met.
"All that's happening is that consumers are becoming more and more indebted," he says. "If they were becoming emancipated, you would expect the opposite."
For Adrian Saville, professor in economics, finance and strategy at the University of Pretoria's Gordon Institute of Business Science (Gibs), this is the key failing of the way the industry has developed.
"If this was lending going into education and small business building, South Africa would be awash with well-educated people starting small businesses," he says. "But we're not. Instead we're awash with over-indebted low-income earners buying consumer goods."
The potential for unsecured lending to facilitate economic development is well appreciated. In many parts of the world, it has allowed those who are excluded from the economy to gain a foothold by giving them some way to access capital.
However, this is not what has happened in South Africa. By encouraging a profit-driven industry, the legislation has led to something entirely different.
"There was a noble desire for financial inclusion, but although the regulations are intentioned in a certain way, they enable something else," says Badat. "Even if you are trying to enable sustainable lending in South Africa, the framework of this market means that you simply can't compete."
The question is how you address this. One school of thought is to seek firmer regulation, but that has two obvious drawbacks.
The first is that more regulation would make unsecured loans more difficult to access, forcing more people to turn to the unregulated mashonisas (loan sharks). The problem is the demand for credit as much as the way that it is met.
The second is that regulation is sometimes impossible to enforce. As Deborah James, a professor of anthropology at the London School of Economics, points out, many borrowers are in rural areas where they have few choices.
"Some of these areas are just so far off the beaten track, you just can't imagine any regulation easily being put in place, or enforced," she says.
The myth of self-regulation
There is also no prospect of the industry moderating its own behaviour. According to Differential Capital's analysis, since 1990 one bank in South Africa has failed every two years on average. This is unquestionably a high-risk industry, yet lenders are still eager to operate in this space because of the outsized returns they can earn.
"If I am making a loan of R100 to three people and one of them fails, but in 12 months I can get R150 back from two of them, I've got my money back in year one and then we're into profit," says Saville.
"If you can put the cost of credit up against non-performing loans and get the former to outweigh the latter, you actually have a viable model for as long as you can keep the bottle spinning."
It is not enough of a disincentive that the bottle keeps running into obstacles. This is what happened with Saambou, with African Bank, and with The Business Bank, which became Capitec. Yet practices are not improving.
The average term length and average loan size have been growing, but the average credit score of new borrowers has been going down.
"The numbers are scary," says Zwelakhe Mnguni, chief investment officer at Benguela Global Fund Managers. "There is going to be somebody who hits the wall."
The bigger picture
When this happens, it could not only entail systemic risks to the financial sector, but also represent a direct cost to the fiscus if government has to step in again to issue a bailout. Unsecured lending in South Africa is therefore more than a moral hazard. It presents meaningful socio-economic risks to the country as a whole.
"The industry has been mired in controversy, and in the press for the wrong reasons," says Badat. "We've seen bank failure after bank failure, which comes at a cost to society. Our estimates are that 85% of government employees have unsecured loans. That is police officers, state-owned enterprise employees, municipal workers – and ultimately it's the South African taxpayer who is paying for that."
It is also the reality that over-indebtedness leads to levels of desperation that can spill over into unrest. The most pertinent example was the Marikana tragedy: numerous studies have found that the miners demanding higher wages were under severe financial strain due to unsecured loans being paid back through automatic deductions from their bank accounts.
South Africa is therefore in an extremely difficult position. Having allowed the unsecured market to develop the way it has, there is now no obvious way out.
What is clear, however,is that the situation cannot be allowed to perpetuate.
"Even if you are in favour of capitalism overall, you should want an environment that is not completely extractive," says James.
The solutions, however, have to be creative, because South Africa's environment means that the demand for credit is not simply going to disappear. The levels of unemployment and income inequality make that impossible.
"If you are a parent looking your child in the eyes knowing that you don't have money to pay for their studies, your only salvation is probably to take a loan to let that child go and pursue their dreams at university," says Mnguni.
Any attempt to change the industry must therefore be part of a much broader push to changing the economic reality of the people who seek out these lenders. But it must also involve serious efforts to improve education and influence behaviour.
"There are numerous examples of ways in which you can change behaviour quite spectacularly through informal interventions," says Saville.
"One is Latin American telenovelas [TV soap operas], where women were shown in influential and aspirational positions, and the behaviour of people watching shifted to the shape of these influencers. Other examples include prize-linked savings schemes or the creation of savings groups that make saving aspirational."
Critically, any practical solution to the unsecured lending problem in South Africa must also provide alternatives.
That means making some sort of modest finance available to people to allow them to escape from the debt traps they are in. How this is offered and administered would have to be carefully thought out, but it is somewhere that the private sector could work successfully with government to produce results that benefit everybody.
"I don't think you can hit this with a magic stick and cause it to happen overnight," says Saville. "This is about behaviours and financial literacy and shifting the system. But something has to be done."