Mark Darroch (Supervisor), Faculty of Agricultural Sciences and Agribusiness, University of Natal, for his supervision and guidance in this study. To Professor Gerald Ortmann (Co-Supervisor), Faculty of Agricultural Sciences and Agribusiness, University of Natal, for his guidance and constant motivation throughout this study.
The Importance of Financial Intermediation in Economic Development
Financial intermediaries can reduce the transaction costs of the search and match process by issuing their liabilities (deposit facilities) to serve as assets for savers, with the assets earning competitive returns, and providing these assets to investors by purchasing their primary securities (loans). Financial intermediaries thus indirectly contribute to economic growth by facilitating the flow of funds into productive investments, managing risks and encouraging savings in financial form by offering suitable lending and savings facilities.
Traditional Finance Programmes
- The Usury Argument
- Cheap Credit as an Income Transfer Mechanism
- The Importance of Savings Mobilisation
This is achieved by shifting a significant portion of the non-interest costs onto borrowers, thereby increasing borrower transaction costs (Adams and Vogel, 1986). In addition, transaction costs (travel costs, cash costs of depositing and withdrawing money and the opportunity cost of time) can affect the net return obtained from deposit interest rates and thus incentives for low-income individuals to deposit.
The New View on Providing Financial Services to the Poor
This "new view" has called for policies that promote the liberalization of interest rates so that lenders can achieve an adequate interest rate spread to cover the costs and risks of lending, reduce borrowers' rent-seeking behavior, and increase financial independence from donor and government funds. Improved financial performance also requires better loan recovery and improved enforcement of loan contracts, which together with an appropriate interest rate spread, promote long-term provision of financial services (Adams and Graham, 1981; Robinson, 1994; Gonzalez-Vega, 1993; Yaron et al., 1997 ; Schreiner, 1997).
Concluding Comments
This chapter covers the agency problem that arises between borrowers (agents) and lenders (principals) as a result of asymmetric information. The consequences of asymmetric information are explored in Section 2.2 where low-risk borrowers may be erroneously denied credit while high-risk borrowers may be granted credit at the expense of the lender's income.
The Principal-Agent Problem
The principal must ensure that the agent receives at least this reservation service in the contract. Second, a contract must motivate the agent to align his interests with those of the principal.
The Problem of Asymmetric Information in Credit Markets
- Consequences of Asymmetric Information for Microfinance
- The Role of Collateral
- Multi-period Contracts and Borrower Reputation
- Information Processing and Screening Mechanisms
- Joint Liability Groups
- Other Incentive and Contract Enforcement Mechanisms
- Effective Staff Incentive Mechanisms
- Quality Management Information Systems
- Appropriate Financial Policies
- Interest Rate Policy
- High Loan Collection Rates
- The Economic Policy Environment
Thus, the project must generate sufficient returns at a given interest rate to induce the borrower to invest in the project (ie the lender must satisfy the borrower's participation constraint). Thus, low-risk loan applicants will leave the loan market first, leaving a pool of riskier applicants. In order to create the right incentives for the borrower to act in the interest of the lender, two aspects must be considered in the loan contract.
Collateral reduces this incentive to default as the borrower can take possession of the collateral to reduce loan losses. In the markets where many of the best practice MFOs operate, this has not been a problem. In the event of default of the borrower, the lender can effectively take possession of the underlying goods or their monetary equivalent.
Concluding Comments
The social mechanisms used by many successful MFOs to overcome information asymmetry and contract enforcement difficulties require careful examination. Gonzalez-Vega (1998) highlights important future challenges for current and new MFOs, which can be classified into four categories, namely: dealing with systemic risks; increased competition; excessive regulation, and returning postures. Ideally, the role of the state should be to establish an institutional framework that reduces the transaction costs of market participants.
Limited outreach and continued subsidy dependency by development microfinance institutions in SA led to a review of these programs and the adoption of the principles of the 'new view' of the role of microfinance institutions.
Traditional Credit Programmes in South Mrica
Targeted, sector-specific rural development programmes, such as the Farmer Support Program (FSP), have been launched as part of SA government initiatives to promote structural change, based on the assumption that this change can be achieved by providing a comprehensive set of support services. including subsidized credit to economically and geographically isolated areas (Singini and Sibisi, 1992). This included MFOs such as the Ithala Finance and Investment Corporation (Ithala), Agriwane, Agricultural Bank of the Transkei (ABT), Agricultural Bank of the Ciskei (ABC), and Agribank, as well as Development Finance Corporations (DFCs) such as Gazankulu Development Corporation (GDC), KwaNdebele National Development Corporation (KNDC), KwaNdebele Agricultural Company (KAC), KwaNdebele Utility Company (KUC) and the North West Development Corporation (NWDC) (Coetzee and Vink, 1996). Cash tended to be disbursed in kind, with MFOs located further from clients than informal lenders.
Microfinance markets in SA therefore tended to be segmented and underserved with government-funded supply-led institutions providing targeted credit while private sector institutions mobilized savings.
The New View on the Provision of Microfin3nce in South Afri~3
This new view of the role of microfinance required a review of the role of government in rural finance. However, such intervention had limited success, as evidenced by the poor performance of the aforementioned MFOs and the inability of the sector credit programs to achieve substantial economic development and technology adoption (Krafft, 1996). These policy proposals regarding the future direction of rural finance in South Africa formed the basis of the work of the Strauss Commission in 1996.
The Strauss Commission's interim report focused largely on the development of multi-sector institutions that are well diversified and place equal emphasis on savings and credit mobilization, given reviews of targeted South African lending programs such as the.
The Microfinance Policy Environment
Regarding the exemption, the following money lending transactions were exempted from the interest law: 1) the term of the loan did not exceed 36 months; While commercial banks have been less successful in extending financial services to SMEs, their interest in the micro-lending sector increased significantly after the establishment of the MFRC. Commercial banks began buying, buying many of the micro-lenders that were very profitable.
AN ASSESSMENT OF FOUR SOUTH AFRICAN MICRO'S FINANCIAL TECHNOLOGIES, SCOPE AND FINANCIAL SUSTAINABILITY.
The Evaluation Framework
This chapter is organized as follows: Section 4.1 outlines the evaluation framework for assessing the four study MFOs. The general characteristics of the study MFOs are discussed in Section 4.7 with the assessment of the financial technologies of the four study MFOs given in Section 4.8. The outreach and financial sustainability achieved by the four study MFOs are reviewed in Sections 4.9 and 4.10, while Section 4.11 highlights some key future issues for the four study MFOs and the provision of microfinance in SA.
Since it is difficult to measure the direct impact of credit programs, the framework to answer this question has evolved into a measure of the performance of MFOs.
Defining Performance and Performance Measures
- The Outreach Concept
- Depth of Outreach
- Worth to User
- Sustainability of Performance
A benchmark is developed for each of the stakeholders based on cost-effectiveness analysis for assessing the performance of MFOs. Navajas et al., (2000) define outreach as the social value of an MFO's output and identify six dimensions along which outreach is measured: depth, value to users, cost to users, breadth, length and scope. Achieving a degree of sustainability is important for several reasons: first, it provides an indication of the costs to society in the form of subsidies to keep the MFO sustainable.
Secondly, sustainability in the financial market is an important condition to encourage responsible and wider use of an MFO's financial services.
Measures of Outreach and Sustainability
- Outreach Dimensions
- Depth of Outreach
- Breadth of Outreach
- Length of Outreach
- Scope of Outreach
- Appropriate Interest Rates
- Costs Control
The important premise of FDI is that an opportunity cost is attached to capital on the MFO balance sheet (Yaron, 1994). These should not necessarily be recorded as expenses in the CFO's income statement. This increases equity and thus increases the opportunity cost of equity in the FDI calculation.
Another shortcoming of the SDI is that it equates subsidy independence, which amounts to self-sufficiency.
The Framework for Evaluating Financial Technologies
In addition, transaction costs can represent a high proportion of the country individual's total costs of accessing and using financial services. The evaluation framework thus documents how the loan technologies accommodate the customer's financial management process and overcome information asymmetries and contract enforcement problems, while containing both borrower's and lender's transaction costs. Loan disbursements in kind through input suppliers necessarily increase the borrower's transaction costs (increased time required to access the loan) while reducing the flexibility of loan products (borrowers can claim loans for consumption smoothing purposes).
The MISs can also reduce the administrative burden of loan tracking, potentially lowering lenders' transaction costs (Chaves and Gonzalez-Vega, 1996; Yaronet al., 1998).
The Microfinance Policy Environment
While the real, positive interest rates offered by deposit accounts influence an individual's decision to save, it is less clear whether an increase in interest is the only motivating factor that promotes savings mobilization (Meyer, 1989). The evaluation framework will thus document the type of savings products, access to savings and interest rates paid. The existence of targeted credit programs that provide loans at subsidized interest rates can make it difficult for MFOs to enter the market sustainably.
Well-functioning and sustainable micro-enterprises make it easier for financial institutions to penetrate this market and improve reach (Christen et al., 1994; Zander, 1997).
Survey Design and Data Collection
Commercial banks, cooperatives and many other microlenders did not want to participate in this study due to the perceived sensitivity of some of the information requested. In each case, two interviews were conducted: The first interview in 1997 established a baseline of information on financial technologies, outreach and sustainability indicators. Information on awareness and sustainability was particularly difficult to obtain, as MIS MFOs either did not store information in the past or certain required indicators were not available.
Encouragingly, the MIS systems at three of the MFOs had evolved to the point where some information on reach and sustainability was available by the end of 2002.
General Characteristics of the Four Study MFOs
- Cost to Borrower and Lender: Loan Application, Approval, Disbursal and Collection Process
- Management Information Systems (MISs)
This amount is divided by the duration of the loan to calculate the monthly installment. In addition to the fact that there is no formal collateral, the loans are paid out in cash within one to two hours of the loan application. It is paid monthly in equal installments, with the remaining amount reduced by the installment value.
Due to the nature of the type of financing offered by MF02, the loan application form is necessarily complicated and relatively long. While it imposes relatively less administrative burden on the MF03, it increases the borrower's transaction costs as multiple visits to the extension office or factory are required. The loan verification procedure required the MF04 loan officer to visit the premises of each of the loan applicants.