Successful MFOs have managed to overcome information asYIDmetries and loan contract incentive and enforcement problems by employing innovative loan applicant screening and loan monitoring procedures that involve local community structures and self-help groups.
They have made effective use of collateral substitutes such as joint liability mechanisms relying on peer pressure, warehouse receipts, co-signers, savings and reputational capital to overcome contract enforcement and incentive problems. Financial technologies have been improved with decentralised decision-making structures combined with an extensive branch network and loan and savings products that meet the needs of the clientele. While not all best practice MFOs in developing countries have reached full financial self-sustainability, most have attained some degree of operational viability. Flexible interest rate policies are important in enabling these institutions to cover their operating costs.
Best practice MFOs have also been able to control their administrative costs while achieving high loan collection rates, which further improves fmancial viability. Good management information systems are important to facilitate financial control and loan tracking. Although donor funding has been important in establishing many successful MFOs, it seems that this funding should be aimed at the institutions and not the borrower, and be phased out over a definite time period. Savings mobilisation has been actively pursued by successful MFOs and
helps to reduce dependence on donors and to provide a more complete fmancial intermediation system. Attempts to replicate the mode of operations of successful MFOs in other developing areas to improve access by low-income households pose a major challenge.
A solution that functions adequately in one socio-economic environment, where a specific set of social values exist, may not be suitable in providing rural fmancial services in another socio-economic environment (Yaron, 1992; Gurgand et al., 1994). Social mechanisms used by many of the successful MFOs to overcome information asymmetries and contract enforcement problems require careful consideration. Local cultural barriers, population densities, and existing physical and human infrastructure may make it difficult to implement such an approach (Yaron, 1992). Group lending technologies, while suitable for smaller short-term micro-enterprise loans, may be difficult to implement for larger medium- and long-term loans which tend to be more individual specific (Gurgand et al., 1994; Riley, 1996).
Gonzalez-Vega (1998) highlights important future challenges for current and new MFOs that can be grouped into four categories, namely: coping with systemic risks; increased competition; excessive regulation, and the return of the state. Systemic risks result from events that simultaneously affect all clients of an MFO and all MFOs in a given sector. Macro economic disequilibria, political instability, and unpredictable weather patterns are factors contributing to systemic risk. Only those MFOs with well-diversified portfolios and established credit lines can survive exogenous shocks brought on by systemic risk. The increased success of MFOs in profitably serving microfinance markets has attracted new actors. Commercial banks in South Africa, through acquisitions of MFOs, have shown increased interest in becoming involved in this sector. While increased competition encourages efficiency, it can also impact on a key area of contract design on which many
successful MFOs have been built. Increased alternative sources of credit make it harder to enforce contracts and incentivise borrowers with a gradual improvement in the terms and conditions of the loan contract. Loan repayment may no longer reflect the true repayment performance, since borrowers may use money borrowed elsewhere to repay their loans. To address contractual risks, MFOs will have to revisit the incentive structures built into their contracts.
Increased competition may also bring increased loan repayment tolerance levels. The success of controlling ex post moral hazard has been based on the denial of future access to credit.
Where weakened tolerance levels are built into this mechanism, loan default is difficult to control. Successful MFOs have had zero bad payment tolerance (Gonzalez-Vega, 1998). This raises the question of whether or not the regulation of MFOs may be desirable. Gonzalez- Vega (1998) argues that some degree of regulation is justified for deposit-taking institutions, since appropriate regulation that cannot be enforced is just as harmful. He further cautions most against intervention by the state in microfinance markets, as historical interventions that have targeted subsidised credit at low-income individuals to alleviate poverty and stimulate economic growth in developing areas, have seldom achieved their objective. At best, the role of the state should be to establish an institutional framework that reduces the transaction costs of market participants.
Given the above review of the characteristics of successful MFOs, the next chapter outlines past government-supported rural and urban fmance programmes in SA, focusing on credit programmes, recommendations by the Commission of Inquiry into the Provision of Rural Financial Services (Strauss Commission), current developments and key future challenges.
CHAPTER THREE
MICROFINANCE MARKETS IN SOUTH AFRICA - PAST POLICIES AND FUTURE DIRECTIONS
The first section of this chapter reVIews the function and pitfalls of targeted credit programmes that were implemented to encourage economic development in low-income rural and urban areas of SA. Limited outreach and continued subsidy dependence by development microfinance institutions in SA resulted in a review of these programmes and the adoption of the principles of the 'new view' of the role of microfmance institutions. The emergence and adoption of the 'new view' in SA is discussed in section two while sections three and four outline some the key challenges facing microfmance in SA.