Widening the spectrum

Credit risk

A decade after the end of apartheid, South Africa remains a two-tier country economically and in terms of the financial services available to those in the country's 'second economy'. While the better off are served by a group of local and international banks that are as sophisticated as any in the world, half the country's adults are still 'un-banked' - they do not have access to formal savings, loans, payments or other banking services. Now the government wants to change that, with two draft bills that aim to introduce a second tier of formal banking for the poor and low-paid.

At the same time, the government is revamping its credit legislation to rationalise the current rules regarding interest charges and to extend access to credit services to a wider population, while increasing consumer protection. It has also launched a fund to kick-start the process.

The new banking and credit laws will present a number of business opportunities for existing financial institutions, as well as the chance for a number of other organisations to enter the basic banking and credit markets. However, the legislation and the market present a number of risks, which are causing organisations to tread warily as the situation unfolds.

Last year, the South African government published the Dedicated Banks and the Cooperative Banks Bills as part of an effort to open the financial sector to those who until now have had little or no access to it. Jabulani Moleketi, deputy minister of finance, said in an address to the National Assembly in May that the government hoped that by removing regulatory barriers to the entry of new players, products and services, it would improve access to appropriate savings, credit and insurance products for those for whom such products have until now been unaffordable.

The Dedicated Banks Bill defines two kinds of organisations - savings, or 'narrow' banks, which can take deposits and offer payment services; and savings and loans, or 'core' banks, which can take deposits and offer payment services, as well as certain categories of loans. Because banks will be restricted to these activities and forced to meet high liquid assets requirements on deposits (up to 40% in the draft bill), they are seen to present little systemic risk in a country that is still smarting from the collapse of its medium and small bank sector in 1999-2002. They will also fill the gap left by the disappearance of building societies and similar financial organisations due to commercial pressures in the 1990s.

Concentrated system

"We have a very concentrated retail banking system in South Africa, with most banked people serviced by the big four retail banks, unless you are a high-net-worth individual," says Penelope Hawkins, managing director of Johannesburg-based economic research company Feasibility, which published a report titled The Impact of the Dedicated Banks Bill on access to financial services in June. "The point of the bill is to allow for a different tier of banking to develop. Narrow and core banks would provide a safe place for deposits, allow access to payment facilities and, in the case of core banks, provide both secure and unsecured loans."

Feasibility's report suggests there are around 4 million currently un-banked individuals who are potential customers for the new dedicated banks. These individuals have a minimum income of EUR500 a month ($78), which gives them both the need for banking services and the means to afford the charges. The potential of this market has attracted the attention not only of existing financial institutions, but also of supermarkets, mobile phone companies, insurance firms and others. This is precisely the response the government was hoping for.

"The Dedicated Banks Bill seeks to create new institutions that will provide core banking services, without having to conform to the traditional model of full-scale banks," said Moleketi. "Institutions that it is envisaged will apply for these types of banking licences would include telecommunication companies, large retail companies and micro lenders."

These organisations have advantages such as existing customer bases, branch infrastructures and efficient technology and billing systems. Several organisations have already made moves to position themselves for the introduction of the new laws, mainly through joint ventures with South Africa's 'big four' retail banks - Standard, FirstRand, Absa and NedCor. For example, mobile phone company MTN has teamed up with Standard Bank, as has clothing retailer Edcon. Meanwhile, Absa has formed an alliance with leading furniture retailer JD Group.

But the Feasibility report says potential new entrants see a number of barriers and risks to entering the dedicated banks market. Access to the national payment system and the country's ATM network, and lack of banking experience, are high on the list of barriers. This helps to explain why non-financial organisations are choosing joint ventures with existing banks. The high cost of compliance is another factor, particularly the high liquid assets requirement on deposits, says Hawkins. There is also fear of a repeat of the contagion that led to the collapse of the country's middle and small banking tier, and the associated reputational risk for organisations with businesses in other sectors. To allay these fears, long-awaited deposit insurance for the sector may be necessary, says Hawkins.

Furthermore, given the experience with the collapse of the middle and small bank sector, and the government's aim in to address economic inequality through the new banking laws, the country's financial authorities have indicated that they will look closely at the motivations of applicants as well as compliance issues, when granting new dedicated bank licences. In a speech in December last year, Tito Mboweni, governor of the South African Reserve Bank, said: "The regulatory authorities have learnt to treat (with suspicion) institutions that apply for a banking licence, but that have only the interests of the individual shareholder and not the interests of the depositor base in mind when making business decisions."

Given all this, there is an understandable caution among potential entrants, which are awaiting the details of the final bill. Meanwhile, banks and organisations primarily engaged in micro-lending are awaiting the outcome of the reform of the country's credit act.

South Africa has a highly developed micro-lending environment, with around 1,900 formal micro-lending organisations. Dominating the top end is Johannesburg-based African Bank, a highly profitable organisation that specialises in unsecured loans of under EUR10,000 to the formally employed. The EUR10,000 cap is to allow the bank to work within the exemption limits of the country's usury laws, which govern the interest rates that can be charged on loans. But while African Bank group risk officer Pieter Marais views regulatory changes as the organisation's number one risk at the moment, the bank is optimistic that the new regulations will work in its favour.

Under current legislation, African Bank cannot charge a sufficiently high interest rate for the risks and costs it would incur with loans over EUR10,000, says Marais. The new legislation aims to do away with the under EUR10,000 usury law exemption, and it is envisaged that a new credit regulator will set a number of new interest rate ceilings for loan types, sizes and repayment terms. Depending on the levels at which these are set - and the indications are that the government will fix these at rates that will allow financial institutions such as African Bank to adequately price for risk and costs - "this could open up an opportunity for us", he says.

As well as creating opportunities for African Bank, the new legislation could also reduce competition. "The new legislation favours larger, more efficient players and puts up significant new barriers for new entrants," says Johan de Ridder, executive director of African Bank. The barriers include more onerous compliance requirements and the establishment of a newly defined crime of reckless lending.

Under current legislation, African Bank cannot issue credit cards and other credit products. "New legislation could open that opportunity for us too," says Marais. But some competition is possible here. De Ridder says: "At the lower-risk end of our customer base there could be some encroachment from banks - the present credit card players. But very few of our customers have credit cards or any formal kind of banking credit. The credit bill errs on the side of more rather than less regulation, and has the deliberate intent of shifting some of the powers away from credit providers to consumers. In that context, the likely response of most formal players will be more risk aversion. We are different - we price for and aggressively take risk on the basis that it gives us higher rewards. We believe that space would become less attractive to competitors because of the structure of the bill."

African Bank is making preparations to issue credit cards should the bill turn out favourably for its business. It has completed integration with the country's payment system, and is running a credit card pilot under current pricing regulations. "The moment more relaxed pricing regulations kick into play then our prospects look very different," says de Ridder.

But the new regulations are unlikely to encourage the bank to go beyond its present market of the formally employed. This is an area that the government is trying to address through its Cooperative Banks Act and the recently created Microfinance Apex Fund, which aims to provide low-cost loans, savings and advice for the poor, particularly in peri-urban and rural areas.


The Cooperative Bank Act is an attempt to encourage and support currently informal savings and loans groups. These groups take many forms, such as burial societies and 'stokvels' - informal savings clubs where there is a rotation of the contribution of income and taking of loans. But unlike dedicated banks, which will be independent commercial organisations, co-operative banks will be formed around a common bond - a village, school, alma mater and so on.

The Apex Fund aims to address the issue of access to credit for the poor, said trade and industry minister Mandisi Mpahlwa in a recent statement: "Through this fund, the Department of Trade and Industry will make available loans to the poor at a rate commensurate with the cost of capital plus cost of delivery. The poor can afford credit when it is made available at market rates," he said.

But micro-finance experts are sceptical. "The Apex Fund may have some impact, but probably only marginal and probably only for a short while," says Ted Baumann, executive director of the Cape Town-based Community Microfinance Network. He sees a lack of political will to make it work, plus weaknesses in its business model. "The need in South Africa is to build institutional capacity at the retail end to deliver micro-credit. This implies the need for incentives and/or direct grants to help improve micro-credit practice and encourage new start-up (micro-finance initiatives). By contrast, the Apex Fund is driven essentially by a welfarist desire to be seen to be doing something and it will probably want to push finance out too quickly, before the institutional retail capacity is there, with predictable results for performance, leading to disillusionment with the whole concept."

Meanwhile, the major retail banks and others are working intensely to increase retail capacity in the country. And not just because the government has told them they have to - the banks now see the glimmer of profit in that sector of the population that until now seemed beyond the scope of any rational business model. "There are definitely opportunities for profit at the lower end of the financial service market in South Africa," says Tobie Willemse, business and strategic intelligence manager for Flexi Banking Services (FBS), the division of Absa aimed at low-income customers. "There are certain legal requirements you have to comply with, but the banks here are past the stage where they feel they are entering this market because they have to."

FBS has a raft of products and services currently on offer or under development. It is a leading provider of Mzansi accounts - a government-inspired simple low-cost account limited to deposits, withdrawals and debit card payments. Launched in October last year, half a million accounts had been opened by February at the big four retail banks plus Postbank. And the banks have also co-operated on the launch of a Mzansi instant money transfer service. Through this, any individual with a national identity book and a personal identification number can transfer an amount between EUR100 and EUR5,000 instantly anywhere in the country without needing to have a bank account. The cost ranges between EUR17 and R80.

Willemse claims this is the first service of its kind in the world, and an indication of the creativity and effort that banks such as Absa are now putting into the lower end of the market. And they are seeing the rewards. FBS has seen "significant growth" in the past few years, says Willemse, and, although he would not give figures for recent profits, he says the division has become "one of the money spinners for the bank".

Absa, African Bank and other financial institutions in South Africa are starting to tap into what CK Prahalad, professor of corporate strategy and international business at the University of Michigan Business School, calls "the fortune at the bottom of the pyramid". In a recent book of the same name (Wharton School Publishing, 2005), Prahalad argues that "the real source of market promise is not the wealthy few in the developing world, or even the emerging middle-income customers. It is the billions of aspiring poor who are joining the market economy for the first time." One of the examples he cites of a successful bottom-of-the-pyramid business is ICICI Bank's micro-lending programme in India.

Absa has looked at ICICI's micro-lending business model and believes it has some relevance for South Africa. Equally, it also thinks it has lessons to teach ICICI, and the two banks are discussing how they can share best practice, says Willemse.

But Absa is not looking just within South Africa's borders. It is currently talking to Barclays Bank, which bought a majority stake in it in July, and which is active across Africa, about how the two might roll out their new bottom-of-the-pyramid business models in the continent's emerging markets.

"This is where the growth will be for the next decade, not in the mature markets of (the higher income earners of) South Africa, the UK or elsewhere," says Willemse. "And traditional banking doesn't work in this (bottom-of-the-pyramid) market, so you have to come up with something that is unique but totally relevant." l

[BH] Investment products for the low paid

[BX] While there have been a number of initiatives to bring banking to the poor and low-paid in South Africa, there have been almost no attempts to provide investment opportunities to these individuals. Johannesburg-based Umbono Fund Managers aims to change that, with the introduction of a new low-cost structured product that aims to give the financially excluded an opportunity to participate in the country's economic growth through investment in its equities market.

Umbono is offering a product that combines two unit trusts wrapped in a life product. Called As'Investe, the product's target market is those individuals who fall within categories two to seven of South Africa's Living Standard Measurement (LSM) - a categorisation of people according income level per household. Other products on the market are designed typically for LSMs four to five upwards, says Nhlanhla Shezi, retail sales and marketing director of Umbono.

Minimum monthly contribution for As'Investe is EUR50 - most similar products in the country start with minimum investments of EUR250. Of the EUR50, EUR40 is directed to the unit trust investments and EUR10 set towards life/funeral cover. Funeral cover is seen as essential for many South Africans, and while As'Investe offers only EUR2,000 cover when typical funeral cover products are EUR10,000, it will be welcome additional cover for many households, says Shezi.

Umbono has run a pilot project over the past nine months, based at a single post office branch, which notched up sales of around 4,000 policies - "a resounding success", says Shezi. The nationwide launch takes place in November, and Umbono is projecting sales of around 90,000 by the end of the first year.

The firm has managed to keep the costs of its product down through a series of partnerships with service providers and distributors, such as Absa bank for custody and the South African Post Office for sales. It has also obtained a EUR12 million investment from an external source that the firm would not name to fund the venture until it is self-sustaining.

Shezi says the major risks As'Investe faces are possible poor take-up - which the pilot suggests will not be the case - and a potential high lapse rate. The latter risk is being addressed by focusing on customers who are employed and who have salaries paid into the account from which the As'Investe premiums will be deducted.

Although Umbono is pioneering the market in low-premium investments, it believes it won't be long before others follow suit. "With current increasing political pressure on banks and other institutions to develop products that are suitable for the poor, banks will offer competitive products," says Shezi. "We believe we have first-mover advantage."

Clive Davidson

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