Illana Melzer

The Dark Side of Financial Inclusion: Financial services companies in South Africa are monetizing financial illiteracy

FinMark Trust’s* recently launched findings of the 2013 FinScope survey highlight a significant increase in adoption of formal financial products in South Africa. Banking penetration increased noticeably from 67 percent last year to 75 percent this year. Likewise, the proportion of adults with a funeral policy increased from 25 percent to 31 percent.

On the face of it, this is good news for society as a whole. Access to formal financial products can enable individuals to meet a range of day-to-day financial management needs, accumulate savings securely, insure themselves against risks and facilitate access to capital to fund asset accumulation or business start-ups.

Altogether, more access to financial services should enable those who have been previously excluded from the formal financial sector to live more financially secure and sustainable lives.

This also should help address inequality and contribute to broad-based growth.

While the numbers are compelling, it is of course critical to assess whether this increase in access has, in fact, created more sustainable livelihoods. Sadly, there is much evidence to suggest that it has not done that.

Credit made available to households in South Africa is anything but developmental. With regard to consumer credit, there are deep problems reflected by high levels of indebtedness and default.

In the case of microloans, 45 percent of borrowers are 90 days or more in arrears on at least one account. Lenders routinely rely on insurance products that deliver no value to customers to drive profitability.

In addition, collection practices are nothing short of disgraceful. A recent audit of garnishee orders at a mining company conducted by the law firm ENSafrica found that 59 percent of them were irregular. Thirty-nine percent were withdrawn as soon as the account was queried because it was in fact paid up.

This is inexcusable and a stain on the entire industry. It is too easy for larger lenders to claim that they do not engage in dubious practices when they sell books of bad debt to collectors who do. In addition, the dramatic shift away from mortgages towards unsecured credit is also cause for concern, especially for the emerging middle class. Surely we cannot have a society that puts the car before the house?

Practices within the insurance industry are also worthy of greater scrutiny. The same customers who are overindebted are often visibly overinsured with multiple funeral policies. At best, this reflects poor product design, at worst predatory sales practices. It will take brave community leaders to put an end to the destructive practice of diverting so much money towards burying the dead rather than sustaining the living.

In the meantime, insurers incentivise frontline staff with commissions and push aggressive sales targets. You do not have to be an actuary to predict the outcome.

With regard to banking, many people with a bank account appear to be involuntarily banked, coerced either by employers or the state into having the product. FinScope indicates that almost half of those in Living Standards Measure groups one to five (the lower end of the market) who have a bank account say they withdraw all funds immediately. One wonders whose need this is serving — the banks’ need for realized access targets, or the customers’ need for financial services? In some cases, usage patterns reflect a fundamental lack of trust in banks — one that may be well-deserved. A history of high fees is hard to erase in the memory of customers.

Trust is also eroded by banks who sell customer contact details to providers of dubious services and facilitate business by debit order rogues.

Finally, with regard to savings, there is sadly nothing to say. FinScope shows that many more South Africans use informal savings mechanisms such as stokvels rather than formal savings products offered by banks and other providers. It would appear that there is simply too much money to be made in consumer credit for formal product providers to bother much about designing and marketing decent savings products.

In summary, it appears that financial services companies in South Africa are best at monetizing financial illiteracy. And their response: consumer financial education, a solution for which there is scant, if any, evidence of effect.

To paraphrase a gentleman at the FinScope launch, it might seem more appropriate for providers to get some financial education.

*Full Disclosure: FinMark Trust has been a client of Eighty20 Consulting, a company co-founded by this post’s author.

Editor’s note: this post was originally published on Business Day Live. It is cross-posted with permission.

Illana Melzer is a co-founder of Eighty20 Consulting, an independent consulting company that focuses on customer value analysis and database analysis.

financial inclusion, microfinance, research