SA’s R458bn unsecured debt mountain and a question of basic human rights – Malcolm Rees

As the economic woes of the country begin to bite and the net income of South Africans decline, consumers are borrowing more to survive. Debtbusters reported in its fourth quarter headline findings in 2019 that people had 15% less real net income compared to 2015 and for higher-income earners who earn over R20,000 a month that figure reached 20%. The rush towards unsecured lending to finance expenses has led to warnings that South Africa is sitting on a debt bubble and international organisations like the United Nations Human Rights Commission has warned that the interest rates, abusive contractual terms and practices of lenders turns “into a trap for many”. Financial journalist Malcolm Rees writes about the explosive growth of the unsecured lending industry in South Africa and says it should be asked at whether the profits that are made by the industry “comes at the financial futures of the poor: and it should be questioned whether it is ethical.” We asked Capitec, the largest unsecured lender in South Africa to respond to the criticism of the industry and they provided us with this one line comment: “Capitec Bank takes note of the views of the writer. Our earnings will be addressed in our audited financial results to be released on 14 April.” – Linda van Tilburg

South Africa’s unsecured lending industry: A threat to basic human rights

As the UN Human Rights Commission zooms in on the threat posed by rapidly growing levels of private debt to basic human rights, we, as South Africans, would have good reason to do the same. 

By Malcolm Rees*

With levels of private debt soaring to record highs in many countries around the world, the United Nations has moved to question the potentially dire impact that excessive lending systems can have on basic human rights.  

Malcolm Rees (centre).

A recently published report on private debt and human rights, due to be presented to the UN Human Rights Council (UNHRC) in March,  cautions that individual and private forms of debt cause “the most direct and egregious violations of human rights … particularly in the case of persons and households living in poverty or marginalized, or those who are forced into a “debt trap”. 

Over-indebtedness; abusive contractual terms and debt collections practices, among others, can “become a burden and a threat for individuals or households, potentially quickly turning into a trap for many, putting the realization of human rights in jeopardy.”

Multiple issues at play in South Africa’s private debt industry, particularly its unsecured lending industry, echo such concerns and compound to undermine a range of basic human rights, not least the rights to dignity and equality. 

These include the over-indebtedness crisis which has swept across the country; extortionate debt collections practices and deepening financial inequality which has, morbidly, grown since apartheid to become the worst in the world. 

It is thus little wonder that South Africa has become one of the most well-known and frequently cited cases among the community of local and international experts who are concerned by the havoc that extractive lending systems can have on the fabric of society.  

The overwhelming sentiment among these experts, and reflected in a range of academic studies, is that the adverse socio-economic impact of the unsecured lending industry has vastly outweighed the benefits gained from bringing a historically disenfranchised population into the fold of the formal financial sector. 

While shareholders of unsecured lenders seem to view the market of low-income borrowers as some kind of magical well whose wealth can be drunk to fuel enormous profits in perpetuity, experts are worried that unsecured borrowers are people whose financial lifeblood is being drained for the benefit of a minority.

And so, as the UN moves to urge global actors, at a policy level, to question the human cost of lending profits we, as South Africans, would have every reason to ask the same. 

Explosive growth

South Africa’s unsecured lending industry exploded into existence following the promulgation of the National Credit Act (NCA) in 2007 and has fundamentally altered the composition of the domestic credit markets. 

Between 2008 and 2011 quarterly values of unsecured and short-term credit extended to consumers grew by 260% to a peak of R28,3bn according to data published by the National Credit Regulator (NCR). 

Quarterly values of unsecured credit granted declined marginally relative to these peaks ahead of the collapse of African Bank in 2014 and owing to new affordability assessment regulations introduced in 2016. 

However, the industry is now, once again, blossoming. 

In the second quarter of 2019, R31bn worth of unsecured loans were granted to consumers, representing 23% of the total value of all loans granted, and surpassing, in nominal terms, the peak levels last seen in 2011. 

This excludes a further R21bn granted in credit facilities, which include credit cards, store cards and bank overdrafts which, while unsecured in nature, are defined separately in NCR data. Combined, the two categories represent near 40% of all credit issued in the period. 

As a result, the year on year (YoY) growth to the second quarter of 2019 in the value of outstanding unsecured credit in the economy far outstripped all other forms of credit, growing by over 15%. In 2018 the value of outstanding unsecured credit grew by 8%, still well ahead of all other forms of credit. 

Today, there exists as much as R208bn in outstanding unsecured and short-term credit in the domestic economy, accounting for 11% of all outstanding credit. 

To put that in context, the nominal value of outstanding unsecured credit has grown near six-fold since the start of the lending boom in 2008. In that year, it represented just 3% of all outstanding credit. 

Yet even this dramatic growth masks the true impact that this has had on households.

The contractual amount, including fees and interest owed by borrowers on unsecured loans, is estimated at 1.7 times the outstanding value of unsecured loans according to a recent comprehensive analysis of the industry by asset managers, Differential Capital. 

This implies that the outstanding amount owed by unsecured borrowers is in the region of R350bn. 

As near eight million ‘first-time’ credit consumers, largely represented by vulnerable people historically excluded from the financial system, have absorbed hundreds of billions of Rand in unsecured credit, the South African domestic credit market has been fundamentally transformed. 

But at what cost?

Source: NCR Consumer Credit Market Report, Q2 2019

‘Egregiously’ expensive loans, unaffordable bread 

Unsecured credit and short-term credit are not backed by a form of security, such as an asset, and are typified by high levels of consumer default. This, combined with the costs necessary to fuel the enormous profits of many unsecured lenders, means that these forms of credit tend to be far more expensive than other forms of private credit. 

The all-in annualised cost of unsecured and short-term credit ranges anywhere from 37% for a 61 to 90 month loan, to 225% for a one month loan, according to Differential Capital. 

Mortgage finance, by comparison, tends to be charged at around 11% per annum.   

“We argue that the all-in cost of credit is egregious by any measure,” states Differential.

The fundamental issue with a lending industry that pumps billions of Rands of ‘egregiously’ expensive debt into the hands of millions of predominantly lower income consumers is that it is effectively impossible for that debt to be invested, by-and-large, in wealth-building assets or activity. 

Instead, it has become generally accepted that unsecured credit is used primarily to fund consumption of basic items such as food and clothing, often out of desperation. 

Worse still, the values of unsecured loans being used to re-finance pre-existing debt have increased to alarming levels.  

“The question is when is debt good and when is it bad?” asks former banking executive turned investor and shareholder activist, David Woollam. 

“Broadly, “good debt” is used to invest in a business, education or assets such as house and can be very empowering. “Bad debt” is used for consumptive spending and debt recycling and equates to stealing from one’s future income with very little sustainable benefit”. 

“When you do the numbers, there is very little that unsecured credit could be meaningfully invested in”.

Woollam believes that more than two thirds of unsecured credit is spent on consumption and in financing debt repayments. Differential Capital estimates that a whopping 63% of new unsecured loan disbursements are being used to finance pre-existing debt alone as consumers “borrow from Peter to pay Paul”. 

These figures have been disputed, behind closed doors, by a major unsecured lender which claims that most of its lending is spent on “home improvement”. 

Yet, Woollam, among others, is highly doubtful of this claim which he believes to be based on questionable self-report data and one of a “number of myths which need to be dispelled, or proven, with detailed, credible and independent data analysis”. 

Data shows that the numbers of new unsecured borrowers have been declining and the industry is increasingly relying on a practice of refinancing debt by increasing loan terms and amounts to existing clients. 

“This game of musical chairs just lures borrowers into bigger and bigger loans and masks the real financial stress these borrowers face”, says Woollam. 

Similar concerns are echoed by Erin Torkelson, whose research has focused on how social grants, extended to the most impoverished of South Africans, had been “transformed into collateral for credit and encumbered by debts” by the controversial payments service provider, Net1. 

Social grant recipients were previously a group of borrowers excluded from the formal lending sector, but the regularity and reliability of state payments made them a very secure market for lenders who nevertheless charged effective credit costs similar to those prescribed for unsecured credit in the NCA. 

Extending credit to the poor might, in the eyes of some economists, be seen as beneficial as it enables a “smoothing over of household crises, with the problem being not just that the poor don’t have money, it is that the poor don’t have money at particular times when they need it”, Torkelson says. 

However, in reality, borrowers “are delaying consumption crises into the future and making them more acute. The next time borrowers can’t cover their basic needs, they have less money because of the high allowable costs on unsecured credit, like interest, monthly fees and initiation fees. So, they borrow more money from other lenders to cover those costs”.

Torkelson also cautions against the oft-cited counter argument for enabling an extractive lending system. That, at the end of the day, borrowers are free to choose whether to take on new loans or not. 

“Some economists love to talk about choice: ‘we are all rational economic actors’. Whenever you hear them talking about choice it is a red herring”. 

“People borrow money because they experience failures in other state services. They borrow because their local clinic is overwhelmed or because they don’t have access to clean water or because their son’s tuition hasn’t been paid by NSFAS”, she says. 

“People are living on so little that they don’t have a choice, nobody is going to let their child die because they don’t have enough money to take them to the private doctor when the clinic is closed”. 

This, she says, is one of the findings of a study completed alongside colleagues Deborah James and David Neves for the human rights activist organisation, Black Sash, due to be published in February.

By definition, an exorbitantly priced lending industry fuelled by consumption, desperation and the refinancing of existing debt cannot work to stimulate sustainable wider economic growth, as envisioned in classical economic models describing the ‘.circular flow of goods and services’.. 

Neither can it work to stimulate net positive returns via entrepreneurial activity for the market of borrowers, as envisaged in the hotly contested models of developmental micro-credit. 

Instead, when consumers are borrowing from their future to pay, at twice the price, for today’s bread, the unsecured lending industry must work at a macro level to extract wealth from the lower-income majority to fuel the profits enjoyed by an elite minority. 

In this way, the industry, works to “gain ownership of the borrower’s futures by exploiting the desperation of the present”, says Woollam.

It is “mostly an expropriation of workers income for the benefit of the rich. The vast majority of consumers in this space are technically insolvent, with few assets and lots of debt, and are having to work harder and harder just to stand still. The headwinds and lack of growth faced by our economy are bound to crack open this uneasy situation at some point in the near future”.

Rampant over-indebtedness

As the unsecured lending industry laps up the disposable income of lower income consumers, it inevitably prods them into the inescapable debt-spirals which entrap millions of ‘people in a cycle of debt and poverty,’ that the UNHRC is concerned about. 

Consequently, SA’s unsecured lending boom is closely associated with the chronic household over-indebtedness that has swept through the country over the last decade.

Today, a whopping 41% of borrowers are described in NCR data as having an impaired record, an indicator of over-indebtedness. While this is down from peak levels seen in 2014, it is still significantly higher than prior to the unsecured boom in 2007.

The levels of loan impairment are a critical statistic as impaired borrowers are more likely to be turned away from the formal financial sector, back into the hands of the villainised ‘mashonisha’. 

Moreover, the relevant improvement in the figure is less likely due to a reduction in consumer over-indebtedness and has more to do with a push-back against abusive debt collection practices, which has had the effect of reducing the prevalence of ‘judgment and administration orders’, included in the ‘impaired records’ line.

By a more reliable indicator of serious over-indebtedness, the prevalence of consumers with an account at least three months in arrears, the situation is not improving. 

As many as 23% of borrowers have an account in default today, nearly double the 13,5% seen in 2007, according to NCR data. 

As such, the recent growth in unsecured lending has regulators nervous, with the South African Reserve Bank ringing early warning bells. 

“Of particular concern is the strong increase in unsecured lending to the household sector”, reflects the SARB’s November 2109 Financial Stability Review. 

This growth and the high cost of unsecured loans is “likely to weigh on households’ finances and impact the ability to repay debt”. The non-performing loan ratio for the unsecured sector has been ticking upward since 2018, “indicating that the sector may already be facing some difficulty meeting its unsecured debt obligations”.

Over-Indebtedness, Debt Collections and Human Rights

As levels of unsecured credit have, once again, reached the peak-boom levels seen in 2012 we should, perhaps, reflect on the tragedy that took place in that year when 34 miners, compelled by an acute sense of economic hardship, went on strike and lost their lives at Marikana. 

“Many of these miners were left with scarcely enough money to cover their basic living expenses, after their monthly instalments have been deducted from their accounts. In fact, miner indebtedness has been quoted as one of the key causal factors of the notoriously violent Marikana strikes”, states a Stellenbosch University Law Clinic submission for consideration of the UNHCR thematic report. 

The Clinic has been at the forefront of a battle to combat egregious debt collections practices, exposed in the wake of the Marikana massacre, via the Emolument Attachment Order (EAO) or ‘garnishee’ system.

EAO’s, are legal orders which can be used by lenders to compel employers to deduct money directly from debtors’ salaries for the repayment of debts in default. 

Debt collections abuse features prominently in the UNHRC report with specific attention afforded to the South African case. 

EAO abuse has also become central to several landmark court judgements which have, in turn, worked to highlight the human rights concerns associated with unscrupulous lending. 

In 2015, the Stellenbosch Clinic succeeded in bringing an application to bring EAO legislation in line with the South African Bill of Rights, to the Western Cape High Court. The ruling put an end to debt-collections attorneys securing default judgments against borrowers in courts far outside of their local jurisdictions while also ensuring that such orders had to be approved by magistrates, not ill-equipped court clerks. 

In the judgment, Judge Siraj Desai found excessive charges via EAO’s to have a “direct impact” on a range of constitutionally enshrined legal rights stating that “the ability of people to earn and support themselves and their families is central to the right to human dignity”.

Last year, a ruling by Judge Murray Lowe placed further onus on creditors to use courts accessible to borrowers by compelling them to refrain from using the high courts, as opposed to magistrates court, in matters relating to the NCA. 

High courts tend to be less geographically accessible and are often unaffordable to borrowers which, Lowe noted, are often from historically disadvantaged backgrounds.  

“Inaccessibility to the Courts goes against inter alia the principle of equality,” said Lowe in his judgment, adding further that “the balancing of fairness … must recognise that Defendants/Respondents, in litigation, must have practical reasonable and effective access to the Court chosen and that it is virtually inevitable that in the context of the NCA this cannot generally be the case in the High Court”. 

Prior to these landmark judgments, debt collections attorneys had routinely opted to secure EAO’s against borrowers in courts from their homes or places of work, and where court Clerks where uncritical when authorising the EAOs – a disingenuous practice, known as ‘forum shopping’. 

The Stellenbosch Clinic, along with Summit Financial Partners, then succeeded in a second ground-breaking court victory in December last year when the Cape High Court delivered a damning judgment against credit providers which had overcharged consumers in legal and interest fees.

The order should put an end to a wide-spread practice whereby collections attorneys, acting on behalf unsecured lenders, interpreted sections of the NCA designed to limit the amount borrowers can be charged in the collection of debt, to exclude legal fees. 

The self-serving (mis)interpretation of the ACT, in particular its ‘in-duplum’ provisions, saw notoriously exploitative debt collections attorneys further abuse the garnishee system by charging unwitting borrowers all manner of legal fees for the collection of their debt. 

In a range of cases examined by this journalist practices such as these saw poor workers being levelled with default judgments authorised by clerks operating from distant or inaccessible courts which forced them to repay amounts equivalent to many multiples of their original borrowing. Often, interest charged on these vastly inflated debts was so high that borrowers would, in effect, remain indebted in near perpetuity. 

Perhaps most egregiously, it is evidenced that abuse of the EAO system lead to major credit providers intentionally over-indebting consumers, even denying them the opportunity to repay debts, for the express purpose of obtaining highly secure and highly lucrative default judgments against these borrowers. 

In effect, says Senior Attorney at the Stellenbosch Clinic, Stephan van der Merwe, some unscrupulous debt collectors have built business models based on “engineering over-indebtedness.”

In his ruling, Judge Hack noted that all parties concerned recognise that there is a problem of spiralling indebtedness in South Africa despite which, consumers are constantly being coerced and cajoled into taking on more debt. 

“The question is whether … credit providers have shown the responsibility called for to balance the respective rights and responsibilities of credit providers and consumers. The facts of this case suggest no. The escalation of indebtedness as a result of costs set out (by the applicants) suggest the credit providers are not even paying lip service to the need for fairness and equity”, said a clearly incensed Judge Bryan Hack in his judgment. 

Thus, while the ‘in-duplum’ judgment is likely to be appealed, should it come into effect, it would prove a deathblow to many such credit providers and their associated debt collections outfits. 

“There is a ray of sunshine” in terms of SA’s private debt industry says Van Der Merwe who argues that in a range of legislation tied to the constitution and bill of rights there has been a clear intention to protect borrowers from abusive practices. The recent judgments serve to tighten this legislative framework. 

The question now on everyone ones lips is when will SA see a class action lawsuit geared to bring the benefits of this legislation to affected borrowers. 

Similar rights concerns have been raised in a  2017 report by the South African Human Rights Commission found that that over-indebtedness in South Africa “significantly affects an individual’s ability to cover their basic household needs, thereby affecting their access to socio-economic rights”, which has a corollary effect on the right to dignity, as described by Judge Desai. 

Further, while “lending schemes may be predominantly targeted at middle-income groups, it is the lower income groups and those in poverty who are rendered the most vulnerable to human rights violations resultant from unethical lending and debt collection practices”, found the Commission.

Financial Inclusion, Economic Exclusion

The close relationship between lending systems and worsening financial inequality is one of the key concerns being raised in the UN’s interrogation of private lending and human rights.  

“As stated by the Human Rights …the issue of foreign debt, both public and private, is closely linked with increasing inequality worldwide and with the obstacles to sustainable human development resulting from the debt burden, including in achieving the 2030 Agenda for Sustainable Development through adequate financing.”

By eroding consumer’s disposable income and swapping it for profits enjoyed by a minority, extractive lending systems characterised by expensive debt exacerbate financial inequality. 

A recent World Bank report on poverty and inequality in South Africa, cited high over-indebtedness among lower income consumers as one of the reasons that financial inequality has increased since inequality was enshrined in the abhorrent laws of Apartheid. 

Levels of financial inequality in South Africa are today among the worst in the world, by any measure, according to the World Bank. 

In terms of net wealth inequality, a shocking 70.9% of the wealth in the country is held by a single 1% of the population. Meanwhile, the bottom 60% of the population enjoy a mere 7% of the country’s wealth, according to the World Bank.

Let those numbers sink in for a moment. 

This paradoxical, and morbid, worsening of financial inequality since apartheid is likely the single biggest human rights crisis faced by the county. 

“If the pursuit of profit results in the exploitation of the poor and the ever-widening disparity of wealth, this gives meaning to the other rubric that the rich are getting richer and the poor are getting poorer”, as noted by Judge Hack. 

The phenomenon has led some of the world’s most fierce critics of extractive lending systems to conclude that structural segregation in South Africa is being re-established through financial bondage. 

We have moved “away from a race-based form of inequality seen during apartheid to a market validated form of inequality”, says Dr. Milford Bateman, a leading international critic of theories of microcredit as models for poverty alleviation.

“The same outcome is being achieved, it’s just the method of doing it that has changed”, he says. 

“Instead of seeing human rights as a goal to be achieved for everyone, we have moved into a model whereby the poor are expected to fight for those rights as individuals. Yet the singular escape from poverty is a myth, history shows we escape poverty because we work together”, says Bateman. 

“Seeing the poor as a commodity that you can pile up with credit as a way to extract value from them is the exact opposite of extending human rights”.

Much of Bateman’s work has focused on the manifold failures of theories of microcredit as a means to alleviate poverty. He has often zeroed-in on South Africa a case in which the global-trend of over-lending, one might argue, has been “taken to a new extreme”. 

The unavoidable reality in South Africa is that the exploitation of the poor via the credit markets has a racial dimension, whereby a largely black demographic is being exploited by mainly male white Afrikaner elites, says Bateman. 

This view is echoed by other academics which have extensively studied indebtedness in South Africa and concluded that segregation is being re-established in the guise of ‘financial inclusion’. 

“I know its controversial but it’s the reality, sadly”, says Bateman. 

Despite this bleak outlook, it is not to say that debt per se is destructive and even unsecured credit may, in limited situations, be beneficial to individual borrowers according says academic, Dr. Shane Lavagna Slater. 

“There are some noble causes”, for lending to the poor and there are examples globally where developmental lending systems predicated on “responsible lending and responsible spending have been really good”, says academic Dr. Shane Lavagna-Slater.

“However, in South Africa the market outcomes are not similar to microfinance programs such as Grameen Bank. The South African unsecured lending market is not sustainable in its current form. To have a sustainable market means having cheaper credit and lower defaults, currently you have the opposite”, he says.

“The market really boomed when its usefulness as a tool to include previously excluded credit consumers without historical credit activity and security became apparent. However, this goal has long since fallen away and the market has moved further away from sustainability in all forms being, credit provision, its use and its collection”. 

The prevailing over-indebtedness among millions of lower income South African borrowers compounded by aggressive debt collections practices and the preying on social grants recipients has the effect of marginalising the marginalised. It works to entrench inequality and denies the poor a hope of a meaningful future participation in the economy. 

There is a small but growing call from concerned experts within South Africa’s financial sector, who are championing ethical and responsible investing, to desist from investing in unsecured lenders. Such experts argue that trustees and other allocators of capital are entrusted to safeguard funds under their custody and should therefore act in instances where those funds are invested in unsustainable and ”immoral or abusive or exploitative” business practices. 

The call to desist would understandably be uncomfortable for institutional investors which have seen massive returns from investing in major lenders. Yet, there are early signs that it is starting to gain traction. 

As citizens, too, we need to ask whether the profits we make today have come at the expense of the financial futures of the poor. The Bill of Rights places on onus on us to question whether the profits extracted via our lending institutions are not only sustainable, but also ethical.

  • Malcolm Rees is an independent financial journalist with a special interest in the South African credit markets, which was the subject of his Masters thesis. He made a submission in response to the Independent Expert, Juan Pablo Bohoslavsky’s, call for contributions to his report and was invited as an expert in discussion rounds held in Geneva, which informed the report.. 
  • After having been requested to do so, Visio Fund Management (‘Visio’), has provided financial assistance towards this research. Visio has for a number of years been negative on micro-lending operators in South Africa. Visio is of the view that the persistent rolling of expensive loans has a destructive impact on the country’s social fabric notably for the lower income bands. Visio has voiced its concerns to regulators and to senior government officials over the past few years even prior to the collapse of African Bank and continues do so currently where possible. Visio is also actively engaging its institutional clients, fund allocators and many key decision makers in business to create greater awareness of the industry’s practices. In the interest of transparency, Visio long short funds were short African Bank in the months leading up to its collapse. Visio long-short funds currently have short positions in Capitec. There are no Capitec or PSG shares in the Visio long-only funds. Visio’s investment view is that the Capitec share i significantly overvalued primarily due to the risk of rising bad debts in excess of the stock market’s expectations and the impact this would have on the expected earnings growth rate implicit in the rating of the share.
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