Loan sharks could never have inflicted so much damage

SA’s economy will struggle to average even one or two percent annual growth, on a per capita basis, over the next several years because its three primary sources of growth have been overwhelmed. Growing value-added exports will be more elusive than ever, notwithstanding prospective advantages of a soft rand. Plummeting prices combined with regulation bumbling will constrain income from resource exports, thus inducing job cuts.

Nowhere however have SA’s policies been so ill-conceived provoking lasting damage than around the notion that poor people deserve access to exorbitantly priced loans. SA’s economic policies should be focused on achieving sustainable growth through rising competitiveness and global integration while rapidly advancing transformation imperatives. SA’s economic development challenges are severe and, as with animals giving birth in the wild, the most vulnerable point is when people emerge from poverty to join the would-be galloping herd of lower middle class workers.

Few well-educated people grasp compounding’s potency, yet most will have withstood lectures on the ABCs of household economics. In contrast, lending at high rates to SA’s workers who cling to a rung, one up from poverty, is the economic equal to fishing with fine mesh nets - juvenile fish are harvested before they can spawn.

The strawman argument for such destructive behaviour is that if the formal sector did not prey on these people, then even more ruthless “loan sharks” would. Such twisted logic sacrifices financial prudence to favour unhelpful guilt-indulging. It is comparable to advocating that crack cocaine dealers should be driven out of business by having pharmaceutical companies flood the market with cheaper, cleverly packaged normal cocaine.

Formal sector lenders legitimise borrowing in ways that loan sharks never could. Parent and grandparent warnings against borrowing from those that lurk in the shadows are lost in translation when lenders sit in impressive offices draped amid aspirational marketing images. Such elder guidance will simply be dismissed as ‘not keeping up with the times’ as borrowing is now seen as something ‘successful’ people do.

Another fatal flaw to justifying formal sector lending as an alternative to loan sharks is: the loan sharks haven’t disappeared. Rather, they benefit from borrowing having become so accepted. Becoming overly indebted is now often tragically conflated with family loyalty. It is not unusual for a young formally-employed worker to be surrounded by many unemployed relatives. Pressures to fund a funeral or pay for a wedding are intensified when all that is necessary is to succumb to formal sector lenders’ marketing schemes.

SA has many financial services executives with impressive credentials but there is little reason to think that any of them has ever studied economic development. This is troubling. Among the neglected course material is how today’s perceptions of a normal childhood are such an aberration from long-standing norms.

Until rather recently, children had always learned everything they needed to know from their parents as they would, in effect, repeat their lives. The industrial era then substituted working in fields from a young age for working in factories or begging. Schooling had always been for the nobles until the concept of “middle class” was invented only a few generations ago.

Families transforming from poor to lower middle class in SA today often must scrimp on meals toward the end of the month. Such an environment is not conducive to investing in education. Those who lend aggressively to the poor and have little understanding of sociology or economic development can too easily dismiss the connections between high indebtedness and poor education outcomes.

SA’s banks employ very clever people but they can’t sell home loans at 27%, the consumer loan rate ceiling lenders desire from regulators. The profound effects of such compounding are just too obvious when house shopping. Also, the banks have bond calculators on their websites.

A family that can pay R10,000 per month for twenty years at 10% can service a R1 million loan. Change the rate to 27% and the loan proceeds decline by more than half. What the money is used for doesn’t matter. Nor does it matter whether someone who is perennially indebted is servicing short or long-term loans. Expensive loans devastate living standards and prospects.

A middle class worker who is highly indebted with loans charging 27% is not really middle class. Viewed from the opposite extreme, the investment returns of Warren Buffett, the world’s most successful investor, have averaged well less than 27% per year.

The loan shark comparison is a particularly dubious argument for reasons well appreciated by people who study economic development – and for grandparents. It makes a huge difference if the lending profits stay in the community. Unless a loan portfolio is losing money, all of the loan write-offs are funded by the customers who repay their loans. The higher the rate, the greater the write-offs are likely to be. This effect is devastating to the development of poor communities – while profits flow to distant investors.

Many informal lenders are nasty people. Others are employers, uncles and neighbours. It does not require a degree in economics or mathematics to appreciate that if the loan losses are covered by the poor, and the profits flow out of the community, then excessively priced lending impedes economic development.

Ten years ago, the successes of the Grameen Bank of India were interpreted by the world’s top development experts to mean that lending to the poor was a profoundly positive development tool. As this view was scrutinised, opinions were adapted to consider key variables such as: the interest rate charged; whether the money was used for investments or consumption; and whether the profits stayed in the community.

SA’s Indian community appears to have been well ahead of many high profile global development doyens. It should not be surprising that the benefits of borrowing from others in the same community compound locally.

Since the sub-prime crisis in the US and the sovereign debt crisis in Europe, there has been a general shift toward deleveraging of household balance sheets while western economies focus on becoming more globally competitive. The recent mark down in the value of SA’s export resources highlights the disadvantages of over indebted consumers – including how this further exacerbates SA’s competitiveness challenges.

If SA’s policy makers wanted to aid formal sector lenders, they should have allowed an orderly liquidation of African Bank at the expense of its creditors. This would have led to more creditworthy customers for the competition. But there should be no misunderstanding about the damage that high priced lending does to SA’s economy generally and transformation in particular.

Capitec and some other innovative financial services providers have demonstrated a commitment to designing microfinance products that aid households and advance growth. The higher the rates that can be charged, the less motivation for the industry to advance such paths.

In SA’s marginalised communities there are typically various formal sector lenders who will fund consumption while access to investment capital is scarce and education options are bleak. Such dynamics breed very negative outcomes.

Financial services regulation is thought to be very sophisticated; yet maybe they should borrow a trick from liquor licencing. Just as there can be requirements to maintain ratios between food sales and liquor sales, lenders could be required to balance consumption lending with investment lending.

The lenders will soon come to appreciate that very few legal businesses can afford to borrow at 27%. The lesson being that the compounding effects are just too devastating. Perhaps they would then develop sustainable products which advance SA’s transformation and growth objectives.

Shawn Hagedorn advises on economic development.

He can be contacted on Twitter @shawnhagedorn and on gmail at hagedorn.shawn. 

The article originally appeared in Business Day.