Theoretical view of formal unsecured lending in South Africa

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Introduction

There are symptoms of borrower exploitation by lenders in the South African unsecured lending market. Karl Marx defines exploitation as the forced appropriation of the unpaid labour of workers (Elster 1978). Placing such a definition in the context of lending would imply that lenders unfairly extract a portion of borrowers’ wealth (Theobald, 2014). This assessment manifests itself in an excessive repayment burden, increasingly high levels of borrower over- indebtedness, and lender portfolio losses.
Affirmative gestures are the 2007 and, more recently, the 2014 credit amnesties, which illustrate the South African government’s intervention in an attempt to solve these problems. However, as research done by the NCR reveals that about 40% (3.2 million) of clients who received an amnesty in the 2007 credit amnesty, had defaulted on new loans within two years. An amnesty does not change borrowers’ behaviour, thus it can be expected to be an unsustainable, short-term reprieve for the demand side of the credit market. Research conducted by the Credit Providers Association (now known as the South African Credit & Risk Reporting Association) on 600 000 people given credit amnesty in 2007 found that 64% of those who benefited from the amnesty then entered into new credit agreements, and 74% of those ended up with bad or adverse accounts (Benjamin 2013).

Background and context to unsecured lending

The South African financial services industry is dominated by large multinational corporates and traditional banking institutions. According to PricewaterhouseCoopers (PwC) (2012) and Deloitte Touche Tohmatsu Limited (2012), traditional banks hold an approximate 86% of all banking assets in the South African market, niche banks make up 10%, and microfinance houses secure the remainder of the market. More than 4 000 credit providers are registered with the NCR in South Africa, but the six major banks control the majority of the market. The major banks are: ABSA, First National Bank (FNB), Standard Bank, Nedbank, Capitec and African Bank. It’s interesting to note that in lower-income countries such as South Africa, traditional banks still dominate lending in all its forms; perhaps this is because of the asymmetry of information
The World Bank defines asymmetry of information as a situation where two economic agents in a market transaction have different amounts of relevant information. Asymmetry may allow the agent with more information to practise opportunistic behaviour. The economics of information show how information asymmetries undermine credit markets in places where potential customers have few assets to offer as collateral (Besley 1995). Traditional banking institutions offer an array of financial services, from transactional accounts to loan products for both individuals and businesses. These services cover most financial needs of consumers and businesses, and have been coupled with products such as asset insurance and health insurance. The 2013 All Media and Products Survey (AMPS) data on the South African banking sector show that ABSA, Standard Bank, FNB, Nedbank and Capitec dominate most segments of the banking market and have faced little competition across all banking products from smaller niche participants.
Access to credit is central to economic life (Mashigo & Schoeman 2010). in South Africa, over the past 10 to 15 years, there has been an emergence of niche financial providers that offer limited and targeted financial offerings to customers (Finmark Trust 2015). Participants such as Capitec, African Bank, FinBond and Atlas Finance have entered the market and concentrated most of their efforts on offering short-term, unsecured personal loans to individuals. There has also been the emergence of non-financial service providers, such as retailers including PEP, Woolworths and Spar, which have begun to offer financial services (Watson 2015). Bank executives acknowledged the threat posed by non-traditional competitors, such as retailers and mobile service providers (PwC 2013).
The increased financial services competition allowed smaller niche lenders and retailers the opportunity to serve the under-served market in South Africa. Traditionally called the microfinance market, microfinance institutions provide financial services to the poor (Odi et al. 2013). Their strategies initially focused on offering products like unsecured loans and insurance products to lower-income groups – typically individuals earning between R3 000 and R12 000 a month – while the larger banking institutions consolidated their market shares in the middle- and upper- income segments. They tended to steer clear of this section of the market in the early 2000s, because they considered it too risky for lending after the termination of access to the Persal (government payroll) system (Theobald 2013). The first significant move by traditional banks into the lower-income segments of the population was the introduction of the Mzansi account. The Mzansi account was designed by the incumbent banks as part of a government initiative to promote inclusive financial products and services for the unbanked sector of the economy (Finmark Trust 2013). According to the Banking Association of South Africa, the Mzansi initiative was launched by banks in 2004 to provide affordable banking services to the unbanked yet bankable population as part of Financial Sector Charter (FSC) commitments. Prior to the introduction of the Mzansi account, it was estimated that about 17.8 million individuals had no access to basic financial services, and most of these individuals fell within the living standard measures (LSM) 1–5 market, the lower income market segments.
Niche credit providers identified a significant gap in the South African lending market at the bottom of the economic pyramid. The country was in the beginning stages of making changes to its banking system that could significantly impact on the people living at the base of the pyramid and their local economies (BoP Learning Lab 2011). Until recently (within the past 10 to 15 years), larger banks did not realise the opportunity at the bottom of the pyramid. These individuals had consistent or permanent employment, but did not necessarily possess all the five Cs of credit: character, capacity, capital, collateral and conditions (Haeberle 2009). This target market may be seen as the working poor. The working poor are defined as individuals who were “mainly” at work (at least six months) during the previous year and are living in a poor household with an income below the “at-risk- of” poverty threshold (Guillén & Dahl 2009). Lower-income earners, or the working poor, specifically did not meet the collateral and capital requirements for traditional loans. The credit needs of this economically active group were therefore not being met through large banking institutions, which opened a lucrative opportunity for niche credit providers. Niche credit providers began to offer targeted and tailored unsecured credit products to lower-income groups. At this stage, it is necessary to define unsecured and secured lending.
Secured lending is any kind of lending secured by collateral. Collateral is an asset pledged by a borrower to a lender until a loan is paid back. If the borrower defaults, the lender has the right to seize the collateral and sell it to pay off the loan (Balkenhol & Schutte 2001). This means that if a loan is not repaid, the asset being financed is taken back or repossessed. Mortgage and vehicle asset finance are typical examples of asset-backed loans. An unsecured credit transaction is credit in respect of which the debt is not supported by any pledge or other right in property or suretyship, or any other form of personal security (National Credit Act 2005). This means that if a borrower defaults on a loan, the financial institution cannot automatically repossess assets of the individual without lengthy and costly legal proceedings. The recourse for an unsecured credit provider is limited to debt collection and legal procedures, and excludes immediate asset repossession. These definitions are critical to the discussion of risks. Typically, unsecured lending carries a much higher risk for lending institutions than secured lending, because there is no defined asset to repossess and sell to recoup some of the capital and interest lost by the defaulting party. The approach to the provision of unsecured lending by niche providers was somewhat different to that of established traditional banks. Focused on higher risk individual clients, niche unsecured lenders increased the speed of application to disbursement (NCR 2012), improved access to credit – both physically and in value – and focused on doing high volumes of business. This new approach

Table of contents :

• Abstract
• Argument structure
• Problem statement
• Dedication
• Table of contents
• List of tables
• List of figures
• List of abbreviations
• Chapter 1: Introduction
  • 1.1. Introduction
  • 1.2. Background and context to unsecured lending
  • 1.3. Government intervention
  • 1.4. Researcher’s experience of unsecured lending
  • 1.5. Borrower narrative
    • 1.5.1. Borrower introduction
    • 1.5.2. Borrower story
    • 1.5.3. Borrower conclusion
  • 1.6. Lender narrative
    • 1.6.1. Lender introduction
    • 1.6.2. Lender story
    • 1.6.3. Lender conclusion
  • 1.7. Regulator narrative
    • 1.7.1. Regulator introduction
    • 1.7.2. Regulator story
    • 1.7.3. Regulator conclusion
  • 1.8. Background to the problem statement
  • 1.9. Problem statement
  • 1.10. Value of research
    • 1.10.1. Scientific value
    • 1.10.2. Economic value
  • 1.11. Previous studies
  • 1.12. Research questions for this study
  • 1.13. Layout
  • 1.14. Conclusion
• Chapter 2: Theoretical view of formal unsecured lending in South Africa
  • 2.1. Introduction
  • 2.2. Borrower narrative
    • 2.2.1. Types of credit used by borrowers
    • 2.2.2. Moral hazard
    • 2.2.3. Affordability
    • 2.2.4. Borrower narrative link to problem statement
  • 2.3. Lender narrative
    • 2.3.1. Lender overview
    • 2.3.2. Lender incentive principles
    • 2.3.3. Income from loans
    • 2.3.4. Lender risk
    • 2.3.5. Adverse selection
    • 2.3.6. Lender narrative link to problem statement
  • 2.4. Regulator narrative
    • 2.4.1. The National Credit Act, 2005 (Act No. 34 of 2005)
    • 2.4.2. Consumer protection
    • 2.4.3. Regulator narrative link to problem statement
  • 2.5. Conclusion
• Chapter 3: Theoretical view of informal unsecured lending in South Africa with a
  • specific focus on stokvels
  • 3.1. Introduction
  • 3.2. Background to stokvels
  • 3.3. Stokvels and informal credit
    • 3.3.1. Financial cost
    • 3.3.2. Opportunity cost
    • 3.3.3. Moral hazard
    • 3.3.4. Adverse selection
    • 3.3.5. Losses incurred
    • 3.3.6. Recourse
    • 3.3.7. Access to further credit
  • 3.4. Stokvel themes
    • 3.4.1. Behavioural underwriting
    • 3.4.2. Peer pressure
    • 3.4.3. Fairer costs
    • 3.4.4. Disintermediation
  • 3.5. Stokvel caveats
    • 3.5.1. Mobilising potential
    • 3.5.2. Scalability
    • 3.5.3. The unregulated nature
  • 3.6. Formal and informal lending comparisons in South Africa
  • 3.7. Link to problem statement
  • 3.8. Conclusion
• Chapter 4: Peer-to-peer lending in South Africa
  • 4.1. Introduction
  • 4.2. Peer-to-peer lending background
    • 4.2.1. General mechanics of peer-to-peer lending
    • 4.2.2. The start of peer-to-peer lending
    • 4.2.3. The case of Lending Club
  • 4.3. Typical peer-to-peer lending process
  • 4.4. Participants in a peer-to-peer transaction
    • 4.4.1. Lenders
    • 4.4.2. Borrowers
    • 4.4.3. Peer-to-peer lending platform and intermediary
  • 4.5. Risk mitigation
    • 4.5.1. Formal credit vetting
    • 4.5.2. Behavioural underwriting
    • 4.5.3. Default insurance
    • 4.5.4. Loan rounds
  • 4.6. Legislation
  • 4.7. Peer-to-peer lending in South Africa
    • 4.7.1. The status of informal peer-to-peer lending in South Africa
    • 4.7.2. The status of formal peer-to-peer lending in South Africa
    • 4.7.3. Main differences between formal and informal peer-to-peer lending in
    • South Africa
  • 4.8. Link to problem statement
  • 4.9. Conclusion
• Chapter 5: Sustainability framework
  • 5.1. Introduction
  • 5.2. The sustainability requirement within the unsecured lending industry
  • 5.3. Defining sustainability
    • 5.3.1. Sustainability within communities
    • 5.3.2. Circles of sustainability model
  • 5.4. Sustainability attributes
    • 5.4.1. Cost
    • 5.4.2. Repayment
  • 5.4.3. Sustainable attribute links
  • 5.5. Sustainability framework: Circles of sustainability
    • 5.5.1. Circles of sustainability explored
    • 5.5.2. Model background and limitations
  • 5.6. Link to problem statement
  • 5.7. Conclusion
• Chapter 6: Research methodology
  • 6.1. Introduction
  • 6.2. Background to the study
  • 6.3. Description of the overall research design
    • 6.3.1 Techniques and procedures
    • 6.3.2. Time horizons
    • 6.3.3. Choice
    • 6.3.4. Strategy
    • 6.3.5. Approaches
    • 6.3.6. Philosophy
  • 6.4. Research design components
  • 6.5. Methodology
    • 6.5.1. Antecedent variables
    • 6.5.2. Autoethnographic study (narrative study)
    • 6.5.3. Survey
    • 6.5.4 Focus group
    • 6.5.5. Sustainability review
  • 6.6. Data analysis procedures
  • 6.7. Data analysis
    • 6.7.1. Antecedent variable 1: Savings activities
    • 6.7.2. Antecedent variable 2: Debt activities
  • 6.8. Limitations
  • 6.9. Ethical considerations
  • 6.10. Conclusion
• Chapter 7: Research findings: Survey
  • 7.1. Introduction
  • 7.2. Survey: Lender-orientated responses
    • 7.2.1. Saving status of respondents
    • 7.2.2. Level of saving by respondents
    • 7.2.3. Saving destinations of respondents
    • 7.2.4. Percentage return obtained by respondents
    • 7.2.5. Online banking activity
    • 7.2.6. Online activity
    • 7.2.7. Lending to family or friends
    • 7.2.8. Loan repayment by family and friends
    • 7.2.9. Lending to strangers
    • 7.2.10. Lender preferences on the uses of lent funds
    • 7.2.11. Lending-risk-versus-reward relationship
    • 7.2.12. Peer-to-peer default risk sharing
    • 7.2.13. Lender preferences towards a borrower’s location
    • 7.2.14. Lender preferences towards a borrower’s race and gender
    • 7.2.15. Interest rates charged on peer-to-peer loans
  • 7.3. Survey findings: Borrower-orientated responses
    • 7.3.1. Debt types of borrowers
  • 7.3.2. Loan usage
  • 7.3.3. Sources of loans
  • 7.3.4. Credit provider selection
  • 7.3.5. Loan applications online
  • 7.3.6. Borrowing from individuals instead of a bank or credit provider
  • 7.3.7. Borrower concerns when entering into a loan
  • 7.3.8. Most expensive debt
  • 7.3.9. Refinancing debt
  • 7.3.10. Trade-off between cost and loans from family and friends
  • 7.3.11. Peer pressure experienced when loans are taken from family and
  • friends
  • 7.3.12. Online loan applications
  • 7.3.13. Debt levels among borrowers
  • 7.3.14. Perceptions of traditional credit providers
  • 7.3.15. Revisiting the use of the internet as a medium to borrow
  • 7.4. Conclusion
• Chapter 8: Research findings: Focus groups
  • 8.1. Introduction
  • 8.2. Research findings: Focus groups
  • 8.2.1. Lending and degrees of separation
  • 8.2.2. Interest and degrees of separation
  • 8.2.3. Variables in lending
  • 8.2.4. Interest charges and variables in lending
  • 8.2.5. Borrower preferences
  • 8.2.6. Peer pressure experienced
  • 8.2.7. Trust
  • 8.3. Conclusion
• Chapter 9: Research findings: Adapted circles of sustainability framework
  • 9.1. Introduction
  • 9.2. Adapted circles of sustainability framework
  • 9.3. Application: Formal unsecured lending
  • 9.3.1. Discussion: Formal unsecured lending framework perspectives
  • 9.3.2. Outcome: Formal unsecured lending aggregate score
  • 9.4. Application: Informal unsecured lending framework perspective
  • 9.4.1. Discussion: Informal unsecured lending framework perspective
  • 9.4.2. Outcome: Informal unsecured lending aggregate score
  • 9.5. Conclusion
• Chapter 10: Discussion, conclusions and future research
  • 10.1. Introduction
  • 10.2. Value of research
  • 10.3. The sustainability of formal and informal unsecured lending in South Africa
  • 10.4. Peer-to-peer lending and its use as an alternative to traditional unsecured
  • lending in South Africa
  • 10.5. Research results for peer-to-peer lending in South Africa
  • 10.5.1. Research results: Narrative study
  • 10.5.2. Research results: Survey
  • 10.5.3. Research results: Focus group
  • 10.5.4. Research results: Adapted circles of sustainability framework
  • 10.6. The problem statement
  • 10.7. Research questions answered
  • 10.7.1. Research Question
  • 10.7.2. Research Question
  • 10.7.3. Research Question
  • 10.7.4. Research Question
  • 10.8. Financial education gap
  • 10.9. Peer-to-peer regulations
  • 10.10. Study limitations
  • 10.11. Future work
  • 10.12. Conclusion

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