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Idealism and Realism
South African Bank Serving Poor Goes Bust

Bloomberg has a fascinating profile of the collapse of a South African bank set up to serve the poor. The article depicts the bank’s founder as an idealist who made a few too many risky decisions:

Leon Kirkinis, described as one of the sharpest minds in banking, changed South Africa by expanding credit to the poor. He also underestimated the risks, wrecked his company, rattled financial markets and left many of his 3.2 million clients drowning in debt.

Kirkinis, 54, co-founded African Bank Investments Ltd. in 1999 and built it into the country’s largest maker of loans not backed by collateral. He resigned Aug. 6, the same day the company said it would post a record loss and need 8.5 billion rand ($790 million) to survive. The South African Reserve Bank stepped in four days later to salvage what it could. […]

Styling himself a visionary for lending to South Africans ignored or deemed too risky by conventional banks, Kirkinis fueled profits making loans at annual interest rates as high as 60 percent. Like U.S. subprime lenders half a world away, he overestimated his customers’ ability to repay their loans when the economy soured.

The bank’s failure has caused a ripple effect throughout South Africa’s financial system:

Moody’s Investors Service lowered its credit ratings on South Africa’s four largest banks, cutting billions of rand from their market value. The bank’s demise may also bring closer a ratings downgrade of South Africa itself, Standard Bank said in a note on Aug. 20.

(Read the whole thing here.)

Getting banking services to the poor is and remains one of the most important elements of 21st-century development strategy. But it is a lot harder than it looks. In South Africa, where a sophisticated financial system and strong legal and regulatory systems already exist, banks have an easier time taking on new missions.

Two items in this story scream out for attention: first, that the bank was charging interest rates as high as 60 percent, and, second, that it went under due to a cascade of loans turning bad. That so many South Africans were willing to pay interest rates this high testifies both to the value of money to the desperately poor and to the difficulty of getting it to them on commercial terms.

Loan rates on small amounts to poor, non-collateralized borrowers are expensive, not so much (normally) due to default risk, as small borrowers try hard to keep current on loans they badly need, but because transaction and service costs are very high on small loans. It costs almost as much to lend someone $100 and to service the payments for that loan as it costs to make and manage a loan for $100,000.

In this particular case, it appears from what we know now that the effect of South Africa’s recent mine strikes pushed the bank over the cliff. This wouldn’t just be because many strikers couldn’t service their loans during the labor dispute; there would also have been a devastating effect on the small businesses that serve the miners and their families. That the strikes had such an impact may mean that the bank’s business model had flaws: Could it have concentrated too much on the low hanging fruit represented by mining employees and the communities immediately around them—both because these communities are more easily bankable, given the formal labor market around mining and the relatively high wages in the sector, and because the mine companies would cooperate with efforts to get their workers in the banking system? Rural workers and communities, or communities without the presence of large and (despite disputes over wages) helpful employers would be harder to serve, but might have helped diversify risks.

In any case, the collapse of this bank should not mean the end of efforts to get credit access for poor people around the world. The information revolution is steadily reducing the cost of managing data; that should help reduce transaction costs and make lower interest rates possible, both reducing default risk and expanding the potential market of clients. Smarter regulation better tailored to the specific risks and needs of the sector would also help.

The world’s poor today are not, in general, poor because capitalism exploits them; they are poor because, for a variety of reasons, they don’t have adequate access to the tools capitalism offers for improving their economic conditions. The reforms that would open the doors to greater opportunity for those left behind need to address conditions ranging from lack of access to services the rest of us take for granted (education, clean water, power, physical safety, equality before the law, health care) to the absence of economic and commercial services that can meet their needs. These are not the only reasons for poverty in the world today, but progress on these issues would do much to give the bottom billions what they most want and need: The chance to take their place in humanity’s march toward, we hope, better times.

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