Microlending has a history that can be traced back to 3 000 BC. Throughout this period people have shown a tendency to become over-indebted, and when this happens on a large scale it is often ruinous for lenders. In South Africa, microloans are growing at a rate of 44% per year, and many listed companies are expanding their activities in the sector. Jacques Plaut researches a few of the most well known microlending crises, and concludes that the current high rate of growth in South Africa is a sign for investors to be cautious.
'You are one of the most contemptible usurers in your unspeakable business. Men of your type are a curse to the community, and the money they gain is blood money.' With these words Daniel Tolman was sentenced to prison in 1913, on a charge of lending US$10 at an annual interest rate of 200%. One wonders what the judge would have thought of the UN's Year of Microcredit 2005 ('microcredit has been changing people's lives and revitalising communities since the beginning of trade'), or of the 2006 Nobel Committee’s decision to award its Peace Prize to Grameen Bank, a Bangladeshi microlender.
According to the National Credit Regulator, South Africans owe a collective R88 billion in the form of unsecured loans. To put this number into context, our annual gold exports are about R81 billion, the listed retail sector made R19 billion in profit last year, and GDP is R2.4 trillion. What is more striking than the absolute number is the rate at which it is growing: 44%, which means the amount of unsecured debt doubles every two years.
A very old profession
The history of microlending is colourful and sometimes tragic. There are records of loans made at 48% per month in classical Athens, of pawnbrokers in the middle ages charging 80% to 170% per year, and of payroll lenders in the US charging 20% per week. Mesopotamia, Greece, and Rome each had at least one debt crisis due to microloans: 'Farmers were sometimes able to keep only the sixth part of their produce. Personal slavery of whole families for debt was permitted and became common. There are plenty of examples closer to our own time, certainly not confined to poor nations:
- Japan had nearly three million over-indebted consumers in 2006, and 14 000 registered money lenders. Today only 1 000 of the lenders are left, and the listed ones have lost two-thirds of their value. The high debt burden prompted regulators to impose an interest rate cap.
- The Indian state of Andhra Pradesh at first embraced microlending as a means to end poverty. However, the debt burden soon became unsustainably large and since October 2010 regulators have prevented microlenders from collecting their loans.
- Many readers will remember UniFer and South Africa’s own microlending crisis in 2002. The government became concerned about the rising indebtedness of its own employees, and stopped the practice of allowing lenders to deduct interest payments directly from workers’ salaries. UniFer was unable to collect its debt, and after trying to hide the problem by making even more loans, went bankrupt in a spectacular fashion.
In most of these cases the story is similar: people borrow more than they should, the debt burden becomes overwhelming, newspapers start reporting on aggressive collection practices and debt-related suicides, regulators change the rules, and finally most microlenders go out of business. Incidentally, for the purposes of this article I use the term microloan to mean any unsecured, high-interest loan. Placing non-profit development banks in the same category as medieval pawn shops is perhaps unfair, but at least in the South African context microlenders tend to be comparable businesses.
The regulators’ dilemma
It is difficult to make a call on how microloans should be regulated. One camp argues for letting borrowers make their own financial decisions and for allowing lenders to charge what they want: high returns will attract competition, drive down prices, and give more people access to credit. Some even argue forcibly that microloans are the key to ending global poverty, by allowing entrepreneurs to access capital. But the whole weight of history speaks to people’s tendency to borrow too much and the ensuing problems.
In reality, people use microloans to pay back previous debt and to finance consumption more often than they use them to start small businesses or for emergency car repairs. Most of the research that purports to show that microloans help the poor, only really shows that it is better to borrow at 50% from a microlender than at 250% from a loan shark.
The situation in South Africa
The law regulating microloans in South Africa is the National Credit Act. It has many sensible provisions: fees and interest rates have to be disclosed in a way that helps borrowers to do comparison shopping, and lenders may not extend 'reckless credit'. This means, for example, that if a customer does not take home enough money to feed himself after paying off all his loans (something that happened in South Africa’s 2002 microlending crisis), the lender is at fault and a court may cancel the debt.
These provisions might not be enough to prevent South Africans from becoming over-indebted. Customers can lie about their current level of indebtedness when applying for a new loan, and so far borrowers do not seem to be shopping around for the best deal. The average new loan has grown to R17 000, which is hardly 'micro' and has a duration of more than three years. Certain lenders are even offering seven-year microloans. The pure microlenders are not the only ones benefiting from this. Earnings from personal loans contribute handsomely to profits at some of the clothing and furniture retailers, and of course all this money is eventually spent somewhere: another benefit for retailers.
Fortunately, we do not have to make the call on regulating microloans; our job is to protect your investment. Some microlenders are very well run companies with astute managers, and may prove to be sound investments. Others have displayed questionable reporting and lending practices. As a whole, though, when unsecured debt is growing at 44% per year it is a sign to be cautious. Even seemingly unrelated sectors of the economy that are experiencing a temporary windfall could be more risky than they appear.