24 NOVEMBER 2015 – 07:55

Consumption lending is holding back growth, writes Shawn Hagedorn

SA’s economy will struggle to average even 1% or 2% annual growth on a per capita basis in 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 a soft rand. Plummeting prices combined with regulatory bumbling will constrain income from resource exports, inducing job cuts. Nowhere, however, have SA’s policies been so ill-conceived and provoked more lasting damage than in actualising the notion that poor people deserve access to exorbitantly priced loans.

SA’s economic policies should focus on achieving sustainable growth through rising competitiveness and global integration while advancing transformation imperatives. SA’s economic development challenges are severe and, as with animals giving birth, 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 the potency of compound interest, yet most will have undergone lectures on household economics. In contrast, lending at high rates to workers who cling to a rung that is one up from poverty is the economic equal to fishing with fine mesh nets: juvenile fish are harvested before they can spawn.

The straw man 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 lenders legitimise borrowing in ways loan sharks never could. Parental warnings against borrowing from those lurking in the shadows are lost in translation when lenders sit in impressive offices draped with aspirational marketing images.

Such elder guidance will simply be dismissed as “not keeping up with the times” as borrowing is what “successful” people do.

Another fatal flaw to justifying formal sector lending as an alternative to loan sharks is that 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 worker to be surrounded by many unemployed relatives. Pressures to fund a funeral or wedding are intensified when all that is necessary is to succumb to lenders’ marketing schemes.

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

Until rather recently, children had learned what they needed to know from their parents as they would, in effect, repeat their lives. The industrial era substituted working in fields from a young age with working in factories or begging. Schooling was for the nobles until the idea of a middle class took hold a few generations ago.

Families transforming from poor to lower middle class in SA today often must scrimp on meals towards the end of the month. Such an environment is not conducive to investing in education.

SA’s banks employ very clever people, but they can’t sell home loans at 27%, the consumer loan rate ceiling that 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 a month for 20 years at 10% interest can service a R1m loan. Change the rate to 27% and the loan principal declines 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 at 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% a 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 to appreciate that if the loan losses are covered by the poor, and the profits flow out of the community, then overpriced loans impede development.

The successes of the Grameen Bank of Bangladesh were interpreted a decade ago by 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 important 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 the development doyens. It should not be surprising that the benefits of borrowing from others in the same community compound locally….

SINCE the subprime mortgage crisis in the US and the sovereign debt crisis in Europe, there has been a shift towards deleveraging of household balance sheets.

The recent markdown in the value of SA’s export resources highlights the disadvantages of overindebted consumers, including how this further worsens SA’s competitiveness challenges.

If 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 rivals.

But there should be no misunderstanding about the damage that high-priced lending does to SA’s economy and transformation. Capitec and some other financial service providers have designed 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 marginalised communities, various formal sector lenders will fund consumption, while access to investment capital is scarce and education options are bleak. Such dynamics breed very negative outcomes.

Financial services regulation should maybe borrow a trick from liquor licensing. Just as there can be requirements for establishments to maintain ratios between food 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 compounding effects are too devastating. Perhaps they would then develop sustainable products that advance SA’s transformation and growth objectives.

Published in Business Day