When America’s housing bubble burst and the subprime loan market tanked in 2007, banks around the world found themselves exposed to subprime debt through an array of complex and opaque financial arrangements. But here in South Africa, financial institutions and government regulators puffed out their chests in pride.
The regulations they’d put in place left the banking system largely unaffected and insulated local investors from much of the subprime fallout. But South Africa’s government failed to take heed of a similar credit bubble, precipitated by the business practices of micro-lenders, growing right under their noses. This was because the government was blinded by good intentions and an unquestioned belief in a market-based path to socioeconomic development.
Seven years later, this failure has come back to haunt the country amid the collapse of African Bank, a small, listed commercial micro-lender with big ambitions. Its implosion — and subsequent bailout — earlier this month has exposed how little South Africa’s banks and regulators actually learned from the subprime crisis.
In 2006, as the first signs of trouble appeared in the American mortgage market, African Bank began to target low-income earners more aggressively with offers of unsecured credit — mostly small loans not backed by an underlying asset. The interest rates and fees were exorbitant, and borderline usurious, due to the assumed risk of lending to poorer people. But the business model proved so profitable that new competitors and even larger commercial banks got in on the act, causing the total value of unsecured credit in the system to skyrocket from 2007 onwards.
It all came undone earlier this month as African Bank announced massive losses and an urgent need for an injection of new capital. The announcement caught investors unaware and caused the company’s stock to shed over 90 percent of its value in two days, forcing South Africa’s central bank to intervene.
It placed the bank under external supervision as part of a $1.6 billion bailout to avert contagion throughout the financial system. The collapse nonetheless prompted the ratings agency Moody’s to slash credit ratings of African Bank’s largest competitor and the country’s top four commercial banks — a move that will ultimately increase the cost of borrowing for these banks and their customers, pushing the country’s slow-growing economy closer to stagnation.
Amid the collapse, investors and the public alike have been asking why the government, the Reserve Bank and other institutions had not stepped in earlier. It’s not as if there were no warning signs.
The first answer can be found in the country’s history: For decades, all but a small white minority were allowed the unfettered freedom to pursue opportunities for economic development. This history shaped the distribution of household income with a huge number of low-income earners at the bottom, 99 percent of whom are black.
Under the guise of righting this imbalance, the country’s post-apartheid government followed a development path that, along with providing a social security program to protect those at the bottom from the ravages of absolute poverty, would bring low-income earners into a financial system that had previously overlooked them. Ensuring this group had access to credit was an important part of this plan.
The government strengthened consumer protections and regulation of financial institutions. But, to make providing credit to low-income earners an attractive business proposition, it left a gap — allowing lenders to provide unsecured credit at higher interest rates, currently capped at 32 percent, and over longer repayment periods — both factors that increase the chances of default and incurring punitive charges and fees.
The government saw this as an acceptable risk of financial inclusion because it had been seduced by the idea that easy access to microcredit would amplify the economic potential of low-income earners. The loans were, in theory, supposed to help poorer people invest in education, small businesses and other activities that would ultimately improve their income-generating capacity.
In reality, borrowers’ incomes hadn’t grown fast enough to keep pace with the extremely high interest payments and fees after they had paid for basic needs like rent, food, transport and telephone bills. This trapped borrowers in a vicious cycle, whereby they had to take on more debt just to survive, and African Bank gladly obliged, until the inevitable default happened.
The Reserve Bank’s rescue of African Bank may have halted the crisis for the moment. But the pressure will only mount from now on. Once the Moody’s downgrade has sent its ripples through the economy, it will strain already tight household budgets and temper the demand for goods and services. This will leave the government with few options as the South African economy, which is forecast to grow at a lowly 1.7 percent this year, loses its luster for domestic and foreign investors.
And the rescue does not deal with the bigger question of whether the country’s socioeconomic development path, which relies on the belief that including people in markets has been a success, is sensible in a country with inequalities like South Africa’s.
The big lesson from African Bank’s collapse and the government’s inability to adequately regulate the microcredit market is that inclusion alone isn’t the answer. Given that commercial banks are seemingly incapable of providing credit and other financial services to poorer people without punishing them for being poor, the government must step in with a bank of its own — one that complements the country’s existing social security program by lending to low-income earners at fair rates.
T.O. Molefe is an essayist, at work on a book on post-apartheid race relations.