Improving access of low-income people to formal financial services : evidence from four microfinance organisations in KwaZulu-Natal.
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Date
2003
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Abstract
The first aim of this research was to examine the current financial technologies, outreach and
fmancial viability over time (from 1997 to 2002) of four MFOs providing agricultural, microbusiness
and consumption credit in KwaZulu-Natal (KZN), South Africa (SA).
Understanding the limitations and advantages of these financial technologies could facilitate
institutional reform to improve access by low-income people to viable formal financial
services in KZN. The second aim of this study was to estimate factors that affect the credit
rationing decision and applicant loan default at the MFO providing consumption credit
(MFOI), and the factors affecting default on medium-term agribusiness loans provided by
MF02 which was one of the agricultural MFOs. These analyses were intended to help to
improve client selection procedures and to reduce loan default rates at these MFOs.
Study results show that institutions that finance specifically agricultural activities could
improve the quality of their services by providing better access to branches and reducing loan
approval times through improved screening and administrative procedures. Making financial
services (consumption and production loans) available to both non-agricultural and
agricultural sectors would also help to reduce portfolio risks resulting from the covariant
incomes of small farmers. Savings mobilisation should also be considered, although
institutions need to develop appropriate capacity to handle savings before mobilising
deposits. The study shows too that the rural poor in SA have the capacity to save (for
example, the average number of active savings accounts held by individuals at MF02 rose to
474 052 in 2002).
Study results also suggest that the provision of both savings and loan services helps an
institution to reduce borrower transaction costs in accessing financial services and means that
savings can serve as a form of collateral and borrower information for lenders. Lenders need
to charge interest rates that reflect the true cost of lending in order to cover costs, given that
small loans to the rural poor in SA are risky and costly to administer. Charging a suitable
interest rate, however, is not a sufficient condition for achieving financial self-sustainability.
Reducing high arrears through stricter loan contract enforcement will also promote the
financial self-sustainability of MFOs in SA.
Moveable assets, such as vehicles and equipment, were not effective sources of collateral due
to the high costs of attaching these assets in rural parts of KZN. Cessions on sugarcane crops
were often constrained by flaws in collection mechanisms, where borrowers could deliver
sugarcane to sugar mills on non-borrower quota numbers. Secure and transferable property
rights were important preconditions if land was to have value as collateral. Collateral
substitutes such as joint liability mechanisms were less effective when lending to large farmer
groups (30 - 60 members) compared with small groups (4 - 6 individuals) of micro-entrepreneurs
operating in urban areas in SA. Costly legal action to recover debts further
undermined borrower accountability for loan repayment and thus did not discourage morally
hazardous activities. Reputational capital was an integral part of the financial technology
successfully used by MFO1, and could be more effectively developed by agricultural lenders
in SA if they strictly enforce the policy of denying borrowers access to future funds if they
default on previous loans.
Based on data over the period 1998 to 1999, less contactable borrowers that were employed in
sectors with a high likelihood of retrenchments, with higher debt-to-income ratios and with
more defaults and payment profile arrears, were more likely to be credit-rationed by MFO1
staff. Applicant contactability was another key part of MF01's monitoring intensive financial
technology, but constrains MFO1 from broadening its financial services to small businesses if
these are not easily contactable. Credit bureau information on previous loan default was
critical in this microfinance market where it is difficult to obtain formal collateral. The policy
implication is that lenders need to share default information and credit bureaus need to
correctly capture this information.
Borrowers with higher debt commitments, previous loan defaults, who were less contactable
and who worked in sectors where employment was less secure, were more likely to default at
MFO1. Low-income borrowers had lower levels of liquidity that reduced their ability to repay
debt. The influence of contactability in loan repayment highlights the trade-off between
monitoring-intensive and collateral-intensive technologies. Although MFO1 used reputational
capital as a collateral substitute, the imperfect nature of this collateral type necessitated
intensive client monitoring. Lender MFO1 also needed a well-diversified portfolio across
employment sectors to reduce the impact of systemic income risks. The impact of previous
credit history on loan repayment suggests again that this information can be an effective
collateral substitute if information is shared between lenders, and the rule of not granting
credit to defaulters is strictly enforced.
Based on data over the period 1993 to 1994, borrowers with smaller loans (lower asset bases
and smaller businesses), lower own equity contributions, engaged in contract ploughing and
cartage or broiler production ventures, with lower liquidity and with no previous borrowing
experience, were more likely to default of MF02's medium-term agricultural loans. Larger
borrowers had well-diversified asset bases that enabled them to better withstand negative
income shocks and reduced the need to divert funds for loan repayment to current
consumption. Improved liquidity generated from other sources of income (such as wage
remittances and other business ventures) also improved loan repayment ability. Lenders thus
need to focus on all sources of income, not just on the income generated by the investment
project for which finance is provided, in assessing client repayment capacity.
Ploughing contractors probably need closer monitoring to ensure that equipment is properly
maintained and that sufficient income can be generated from the business to repay loans.
These contractors could also be encouraged to diversify into contract transport activities that
provide more regular income. Given the increased competition and periodic outbreak of
disease in the chicken industry when the study was conducted, borrowers should be
encouraged to diversify to reduce price risk. Increasing the owner's equity stake in the
investment, while a second-best option, may be a suitable alternative where collateral is
ineffective in enforcing loan contracts. Borrowers that had an established record with the
lender tended to repay their loans, again highlighting the importance of reputation in a
borrower-lender relationship.
Description
Thesis (Ph.D.)-University of Natal, Pietermaritzburg, 2003.
Keywords
Rural development--KwaZulu-Natal--Finance., Financial services industry--South Africa., Agriculture--Economic aspects--South Africa., Community development--KwaZulu-Natal--Finance., Credit--Management., Theses--Agricultural economics.