Financial exclusion fuels growth of informal borrowing

Amid rising living costs and an increase in decline rates from formal lenders, many consumers are being forced into accessing high-cost credit from unregulated lenders. This trend highlights the urgent need for more inclusive financial services.

Due to increased compliance requirements and a reduced appetite for risk among formal credit providers, loan decline rates in the formal lending industry have risen significantly. This situation is pushing consumers towards illegal lenders as they seek alternative sources of credit to meet their financial needs.

Alarmingly, recent reports from our 1 500 members in the micro-lending industry reflect that the rejection rate from regulated lenders has increased significantly. This directly impacts borrowers who are then forced into taking out credit through informal lenders that are under-regulated and do not comply with the National Credit Act.

The increase in consumers turning to illegal lenders can be attributed to the fact that fees charged by regulated credit providers have not been reviewed in nearly a decade.

This stagnation has made it challenging for these regulated businesses to maintain financial sustainability, leading to a decreased appetite for risk. The urgent need for a fee review in the regulated credit sector is evident, as it would enhance the sustainability of these businesses, enable them to serve a broader range of consumers, and protect borrowers from the predatory practices prevalent in the illegal lending market.

In 2018, short-term lender Wonga published an informal lending report exploring the impact of restrictive regulations on consumers who cannot access credit from formal providers. The report revealed approximately 40 000 informal lenders – known as mashonisas – operating in South Africa at a ratio of 1:100 households in informal settlements. Both mashonisas and borrowers indicate that this practice has grown significantly over the years, and shows no signs of abating.

Unfortunately, these illegal lenders operate outside the bounds of regulatory oversight, often exploiting borrowers with exorbitant interest rates, hidden fees, and harsh repayment terms. This exploitation not only traps consumers in a cycle of debt but also exacerbates financial exclusion, as borrowers are unable to build a positive credit history or access the protections and benefits offered by regulated institutions.

It is important that consumers have access to credit from regulated lending institutions, as this offers them a number of benefits. First and foremost, regulated lenders are bound by the National Credit Act, ensuring transparency and fairness in lending practices. This means that borrowers are fully informed about interest rates, fees, and repayment schedules, protecting them from hidden charges and predatory terms often associated with unregulated lenders.

Access to regulated credit also enables consumers to improve their credit scores, which is crucial for securing better financial opportunities in the future. Moreover, regulated lenders offer flexible borrowing limits and terms tailored to individual financial situations, providing quick access to cash for unforeseen expenses or the ability to pay for significant purchases over time without falling into unmanageable debt.

This structured and fair approach not only supports financial stability but also promotes responsible borrowing and long-term economic health for consumers. Ensuring access to credit through regulated institutions is thus essential for safeguarding consumers from exploitation and helping them achieve financial resilience.

Other factors that we believe are driving the increase in informal lending include convenience, speed, and limited or no credit checks. Unfortunately, because these informal lenders are unregulated, there’s nothing preventing them from charging hidden fees and often they charge a penalty if a loan is settled early.

Typically, these loans are very short term, a month or less, and can range from as little as R50 to R5 000 or more. Because they are unregulated, the trustworthiness of a mashonisa (loan shark) is always a gamble, as they set their own fees and interest rates.

It is very important that the micro-lending industry is regulated and priced correctly, so that people can gain access to credit in a legal format where there are rights, obligations, and protections. Creating awareness of the pitfalls of informal lending will curb the trend of people being forced to go to mashonisas, and ultimately prevent them from being caught in a debt trap.

Taking a loan from credit providers registered with the NCR and members of MFSA is crucial for ensuring consumer protection and financial stability, as they adhere to strict guidelines designed to safeguard borrowers’ rights. Additionally, engaging registered credit providers can help individuals build and improve their credit scores, opening up further opportunities for financial growth and stability in the future.

* Pletzen is chief executive of MicroFinance South Africa.

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