Africa Finance Forum Blog
This post was originally published on the Center for Financial Inclusion website.
A few weeks ago, South Africa's Department of Trade and Industry published new proposed regulations pertaining to the National Credit Act limiting fees and interest rates on short-term and unsecured loans along with credit cards. The public may lodge comments to the draft regulations up until 30 days after its publishing date of June 25th. The intelligence used to inform the proposals have not been released so it is not clear what policy, cost, or operational factors were taken into consideration to arrive at the outlined changes. Meanwhile, the microfinance industry in the country, which has been lobbying for the flexibility to charge significantly higher interest rates and fees, seeks to understand the regulators' rationale.
The draft regulations were published after a protracted court battle where one of the industry associations representing micro-lenders requested the court to force the regulator and policymakers to review the fees requirements of the National Credit Act. The fees and interest rates hadn't been reviewed since the Act became effective in 2007 - a concern when taking into account factors like inflation.
Credit providers have responded with dismay and concern about the proposed changes, especially the interest rate caps on unsecured loans. They have expressed the fear that the proposed interest and fee changes will affect the cost of administering credit, reduce profits, and constrict access to credit for borrowers. Other commentators have viewed the reductions favorably considering consumers are already over-indebted to a large extent and the interest rate cycle is predicted to start trending upwards. On this blog a few months ago, I shared that in 2014, the National Credit Regulator (NCR) Credit Bureau Monitor revealed that out of South Africa's roughly 23 million credit active individuals, about 11 million have impaired records.
Now, for some specifics. Bear in mind that the rates listed below are subject to change according to fluctuations in the market's interest rate cycle - namely, fluctuations in the market's "repo rate," which is the rate at which the central bank lends to commercial ones. However, the proposed amendments do dampen the effect of repo rate changes on interest rates so that increases in the cost of capital for banks don't get passed on to borrowers.
- Credit Cards & Overdrafts: Current per annum interest rate: 22.65%; proposed interest rate: 19.775%
- Unsecured Credit Transactions: Current per annum interest rate: 32.65%; proposed interest rate: 24.75%
- Short-Term Loans (Up to R8,000 (US$648) Repayable Over Six Months): Current per month interest rate: 5%; proposed interest rate: 5% on first loan, and 3% on any additional loans within the same year
- Maximum Monthly Service Fee: Currently R50 per month; proposed R60 per month
- Mortgage Agreement: Current (per annum) interest rate of 17.65% would not change with new rules
The draft provision has raised major concerns and uncertainties regarding specifics surrounding the rules and regulations. For example, for monthly service fees, the draft states: "This service fee covers the cost of administering a credit agreement which is the operational cost of the credit provider such as rent, labor, communication, banking, processing of repayments and related costs." It remains unclear what credit providers are allowed to charge for outside the proposed R60 per month and how this will affect sustainability and profitability.
The proposed regulations are part of a broader legal reform strategy in South Africa to address overindebtedness and reckless lending, which the government views as getting out of control. The strategy encompassed recent amendments to the National Credit Act to introduce more stringent loan affordability tests, and moves to stop credit providers from employing unnecessary and hidden fees. The amendments on affordability were promulgated this past March. The amended legislation introduced the new affordability guidelines because any such regulatory mechanisms were lacking. In some cases of reckless lending we are investigating, evidence indicates that consumers consistently under-declare their monthly expenses by as much as 60 percent, that way it appears they have more money for loan repayment.
The affordability amendment requires credit providers verify income as well as conduct the following assessment: calculate the consumer's discretionary income; take into account all monthly debt repayment obligations; and take into account maintenance obligations and other necessary expenses. Additionally, a credit provider must take into account the consumer's debt repayment history under credit agreements.
The new affordability measures incorporate minimal expense norms, which are individuals' necessary expenses that a provider must accept they have and keep free from use for loan repayment. Given the structure of these new expense norms, their introduction will restrict credit to lower income consumers, especially those who currently depend on state grants, unless they have proven additional income. Many view this as a good thing but others fear that they will gravitate towards underground lenders who charge illegal and usurious interest rates and use hard core and illegal collection tactics like retaining bank cards.
Though these affordability amendments to the National Credit Act are already enacted, we'll be eager to witness what transpires during the 30-day comment period for the proposed interest rates and fees amendments. Of course client well-being and protecting against overindebtedness is the central priority of microfinance, but these proposed changes don't seem to match the financial realities required to serve lower income clients.
Farmers in developing countries face severe uninsured production risks and consequently may largely benefit from the introduction of formal financial instruments that would help them to smooth consumption. To shed light on this issue, in a recent World Bank working paper, we consider three separate policy interventions and examine their impact on consumption, investment and welfare. Specifically, we studied stylized contracts for weather index-insurance, savings and credit accounts, based on the formal financial instruments available for the rural households living in Burkina Faso and Senegal. We started our analysis from benchmark scenarios and then progressively moved towards more realistic policy interventions that incorporate the different limitations that each financial product carries.
Let's first set the stage of the study.Droughts, locust invasions, storms and floods caused by insufficient drainage infrastructure or dam system failures are among the most frequent natural hazards in West Africa. These calamities have significant livelihood consequences as indicated by the staggering number of food insecure people in 2012 (18.4 million, including about 1 million children under the age of 5), because of low and uneven rainfall coupled with attacks on crops by pests and locusts (UNICEF, 2012). These dramatic consequences are linked to the fact that when on-farm work constitutes the main source of income, fluctuations in agricultural income may have sizeable repercussions on consumption. In the absence of improved agricultural practices and formal financial products, farmers need to rely on a host of informal strategies to shield their consumption. Since the seminal work of Townsend 1994, research indicates that these informal risk-coping mechanisms, however, offer at best imperfect protection against risks, and these solutions tend to perform even worse in the case of wide-scale events such as droughts or floods. Besides, uninsured income risk has also indirect negative impact on consumption. Rare but severe weather shocks may induce farmers to under-invest in high-return, but also high-volatility projects, further depressing potential consumption.
Can weather index-insurance, savings or credit accounts mitigate these negative welfare effects? Each of these financial products has the potential to improve farmers' welfare, yet none of them completely abstract from complications that may limit the extent of the gains achievable. For example, index insurance and insured credit may not be immune from basis risk, arising because of the imperfect correlation between the insurance payout and farmers losses; on the other hand, savings may be very expensive means to cope with large shocks, and rather ineffective against calamities that occur in quick succession.
Which of these financial instruments is more welfare-enhancing? To answer this question, we set-up a dynamic stochastic optimization problem of consumption and investment and perform counterfactual analysis. A key feature of the model is that on-farm investment is subject to multiple sources of risk, both idiosyncratic and covariant in nature, and that a large part of this uncertainty is covariant. This allows us to correctly model the basis risk inherent in some of the financial innovations available. We numerically solve the optimization problem using calibrated parameters based on crop model as well as existing evidence in the literature focusing on Burkinabe and Senegalese farmers. We then show the impact on consumption, investment and welfare from the separate provision of three financial instruments: weather insurance, savings and credit. As anticipated, we start our analysis considering the effects from the provision of the "optimal" contracts (from the farmers' point of view) and then relax these assumptions and investigate the impact from providing more "realistic" contracts. The results for Burkina Faso and Senegal are strikingly similar. In both cases, the provision of weather insurance as well as credit leads to an increase in consumption and a decline in precautionary investment in riskless return-free assets. While qualitatively similar, these choices are quantitatively different as captured by the vast differences in the level of welfare gains that can be achieved.
Irrespective of the wealth owned, weather insurance enables farmers to achieve larger welfare gains which are decreasing in wealth. Over time, farmers gain less and less from the provision of these financial instruments due to the fact that the initial increase in consumption is not compensated by a sufficient increase in on-farm production. As we move away from the benchmark scenarios it becomes clear however that the welfare gains from weather insurance are highly sensitive to its pricing and that offering a relatively small discount (fee), substantially increases (cut) the benefits achievable by farmers. The introduction of saving accounts on the other hand induces farmers to save more and eventually allows farmers to consume more. As a result the welfare gains are increasing both in wealth and over time. Richer farmers gain more as they can enjoy higher returns on larger endowments. The initial contraction in consumption combined with the increase in riskless investments leads to higher consumption in the future and consequently larger gains. In sum, the selection of the "optimal" financial instrument depends on the level of wealth of the households as well as the quality of contract offered. This study offers a simple framework to reflect on these issues and assess the quantitative welfare implications of the different instruments across level of wealth and over time.
This blogpost is based on the paper "Handling the weather: insurance, savings and credit in West Africa", prepared by Francesca de Nicola from the World Bank.
A stronger role of the private sector, focus on women economic empowerment and call for more involvement of farmers at the CAADP Partnership Platform 201514.07.2015,
The 11th CAADP Partnership Platform (PP) took place in Johannesburg, South Africa from 25th to 26th of March. This year's theme was "Walking the Talk: Delivering on Malabo Commitments on Agriculture for Women Empowerment and Development", in alignment with the 2015 African Union (AU) theme on women's empowerment and development. Since this partnership meeting immediately followed the Malabo Declaration, the gathering presented an opportunity for participants to re-examine the commitments made by African Head of States in Malabo in regards to the agricultural growth and transformation agenda. In light of AU's theme for 2015 on Women Empowerment and Development, the meeting sought ways to translate the Malabo commitments into concrete actions that would result in equal access to resources and opportunities for women. It is in this context that the NEPAD Agency launched the Programme "Women in Agribusiness" to support the economic growth and empowerment of African women.
Lessons learned during the first decade of the CAADP implementation fed the reflections that led to the CAADP Results Framework. This Results Framework document, along with the Malabo Declaration, will be translated into action through the Implementation Strategy and Roadmap and the Programme of Work, documents which were drafted prior to the Platform meeting. Although the Malabo Declaration reemphasizes the need for public investment (at least 10% of national budget to agriculture), there have been urgent calls throughout the proceedings to find ways to increase funding from the private sector. The private sector funding will not only leverage existing public investments, but it will also fill the important financing gap necessary to meet the needs of investments expected to boost the agriculture sector. Moreover, implementation of the Malabo Declaration has to go beyond planning and investments to emphasize reforms in economic policies and institutional capabilities through the creation of an economic environment that fosters innovation. To support an increasingly strong private sector in Africa, all economic policy actions should put greater emphasis on farmers and entrepreneurs who are at the centre of all these reforms.
The CAADP highlighted some challenges that could affect the implementation of the Malabo Declaration. These challenges revolve around the need for more coordination and harmonization among stakeholders involved in the CAADP process. Stakeholders should particularly take the advantage of favourable economic policies and increased dynamism of the private sectors to re-mobilize various actors and partners towards financing agriculture. In addressing the challenges of the implementation of the Malabo Declarations, specific economic policies should be designed to accelerate the contribution and inclusion of women who are by far the largest providers in the agricultural production segment in Africa.
Key recommendations for CAADP implementation were given along the following five areas.
- Ending hunger and malnutrition in Africa by 2025: participants at the PP called for investments in more nutritious food and the need to increase dedicated financial resources to promote nutrition activities. In order to address nutrition issues, participants reckoned it is important to diversify food intake beyond known staples and cereals, and promote the use of micronutrients balanced fertilizers. Participants also felt strongly about the need to draft a nutrition advocacy document to complement the CAADP Results Framework and Programme of Work.
- Inclusive agricultural growth and transformation: Policies and regulations should favour access to land and credit, as a way to encourage young people and women in agriculture. Policies should also be conducive to the development of innovative financing mechanisms such as warehouse receipt systems and allow "smart subsidies" to increase access to inputs. Participants recommended the need for an inclusive value chain approach with strong farmer organizations. Such complete value chain would lead to sustainable contractual arrangements.
- Boosting intra-African trade: regional trade integration, fast-tracking of the continental free trade agreement, harmonization and enforcement of non-tariff measures are some of the most important actions that need to be taken to boost intra-African trade. Value chain actors should be trained on business and trade in order to be able to comfortably engage in global trade issues.
- Building resilience and reducing vulnerability to risks: Climate change adaptation and risk mitigation strategies should be mainstreamed in investment plans. There is also a call to develop a continental framework on integrated risk management in agriculture. Sound economic policies should create incentives for investments that result in an enabling and more predictable market environment.
- Mutual accountability: the CAADP Results Framework is the mechanism that countries will use to measure results. However, quality data should feed the process of measurement. To facilitate the biennial review process countries have to undergo, it is important to prioritize and focus on a set of core and easily measurable indicators of agricultural growth and development.
The CAADP has once again demonstrated the need for a multi-sectorial approach based on a strong political commitment supported by the allocation of adequate resources for implementation.
Agricultural finance has been deemed a "policy orphan" in Africa. The lack of coordination among stakeholders further deters the process of establishing common guidelines that are necessary to pull the required public and private resources towards the achievement of a common goal: providing adequate and affordable financial services to the agricultural sector.
Access to agriculture financial services remains a challenge throughout Africa, affecting both the capacity of smallholders to generate sustainable income from their farming activities, and the ability of countries to attain food security and self-sufficiency. An overall financial systems approach to agricultural finance, rather than a "funding agriculture" approach, should be adapted to unleash the potential of the agricultural sector. As such, there is need for a strong agricultural finance policy coordination to guide the often-fragmented interventions that are ineffective among government ministries, regulatory and supervisory authorities.
To address the challenges facing access to agriculture financial services, the Making Finance Work for Africa (MFW4A) Partnership has been supporting the implementation of the Kampala Principles, a set of 11 policy principles that suggests the actions most urgently required to unlock agricultural finance in Africa. Since the first Kampala Principle called for the existence of "a single entity as the advocate of agricultural finance", it became apparent to examine the state of agricultural finance policy coordination in Africa, in order to assess not only the different policy frameworks of the various countries, but also the level of coordination for the potential establishment of agricultural finance policy in these countries.
A recent study commissioned by MFW4A, in collaboration with GIZ, drew on the agricultural finance policy case study experiences in five African countries across different sub-regions. It suggests recommendations to enable country-level stakeholders to strengthen agricultural finance policy coordination, and provides the relevant background and orientation for the Partnership and its Agricultural Finance Stakeholder Working Group (AFSWG) for future advocacy and implementation activities in agricultural finance. The result of the study confirms the lack of agricultural finance policy coordination across case-study countries, despite the existence of well-articulated agricultural sector policy documents. The study also reveals the strength of agricultural development policy documents drafted as a result of the Comprehensive African Agricultural Development Program (CAADP) process. However, key players such as central banks and other financial sector regulatory and supervisory authorities, private sector financial institutions, agribusinesses and civil organisations along value chains have often not been involved in the drafting process of the CAADP investment plans. Moreover, agricultural development policy documents do not address the key issues of access to finance in a holistic way, failing to take into considerations constraints to access agricultural finance faced by smallholder producers and institutions.
Lack of collateral, high transaction costs, weak legal and regulatory frameworks, limited appropriate financial instruments, high perceived risks of agricultural loans, weak financial infrastructure, limited financial literacy of clients are some of the shortcomings to agricultural finance. While these constraints are common to most African States, each country uses different mechanisms to address them, and are often fragmented.
A dedicated policy response is necessary to address the challenges posed by agricultural finance. This will result in building a sound financial system able to increase financial intermediation in favour of the agricultural sector. A policy response will also serve as the basis on which financial institutions and the private sector would develop adequate products, tools and mechanisms to meet financial needs of various actors along the agricultural value chains.
In the process of developing an agricultural finance policy, the role of a coordinating body becomes even more important. Such an entity will not only bring all the relevant stakeholders from the public and private sector around the same table, but it will also ensure that elements of agriculture and elements of finance are both considered when establishing an agricultural finance policy framework. The juxtaposition of agricultural development and financial systems policies in one policy document will result in responding to specific needs expressed by the agricultural sector.
The National Agricultural Investment Plans (NAIPs) developed as part of the CAADP process highlight issues of agriculture finance in some countries. While the CAADP process could offer a coordination avenue to address agriculture finance in a holistic way, NAIPs have tended to focus primarily on public sector investments. The active participation of the private sector in the CAADP process could lead to successful agriculture finance mainstreaming in the NAIPs, provided key aspects of sound-practice agricultural finance policy are integrated in the process.
Erick Sile joined GIZ/MFW4A in November 2014 as the Agricultural Finance Senior Advisor to support NEPAD/CAADP. Previously, he worked for the United Nations Capital Development Fund (UNCDF) as Regional Technical Advisor, helping to promote financial inclusion. As Program Manager and Project Director at the World Council of Credit Unions (WOCCU), he worked in several countries in Africa developing policies and procedures, implementing various methodologies of reaching out to the unbanked. Erick holds an MBA in Finance and Information Systems from the University of Wisconsin, Madison, USA.
This post was originally published on the FSD Africa website.
Last quarter saw the launch of one of the most in-depth pieces of research FSD Kenya has ever undertaken. We tracked the financial lives of 300 low income Kenyan households for over a year. The resultant 'financial diaries' gives us some exceptionally rich insights into what it means on a day-to-day basis to be poor. There is more detail on the study in FSD Kenya's latest newsletter. The findings resonate with much other research in which FSD Kenya and others have been involved in the last few years. These converge on a sobering conclusion: we remain far from a point at which we can say that financial markets are working for the poor.
This isn't to say that the innovations we've seen don't represent important and laudable achievements. The problem is the disconnect which exists between how poor people see and manage their finances and what is offered by financial institutions. In part, of course, this simply reflects familiar challenges. You can't afford to pay much to manage an income of KShs 2,000 per month. Average transaction costs have to come down dramatically if greater usage is to become an option. But suppose we were miraculously able to exploit the full potential of technology and reduce costs to near zero. How much real value would the participants in the diaries study see in mainstream products currently on offer?
There is much talk of late about the need for client-centricity in financial inclusion. But how do we go beyond an attractive sounding catchphrase to action? One modest suggestion, echoing work by independent researcher Ignacio Mas, is to stop all this talk about financial products. It seems doubtful that the people whose lives are so vividly depicted in the financial diaries think they want any financial products. Rather they need solutions to real world problems - juggling competing demands, challenges and opportunities in conditions of scarcity, risk and downright uncertainty. Perhaps we need to start by thinking hard about how some of the stories in the diaries could have had better outcomes. Only then should we start trying to create the tools which could help make this happen. FSD Kenya will be devoting considerable effort in the coming months to applying this approach. As ever, we are looking for partners in this endeavour.