PRINCE NWADEYI: Lending to the informal economy demands innovation

The maxim that financial inclusion is essential to development as well as to the achievement of a number of the UN sustainable development goals, is one that can be said, in the words of Shakespeare, to be “more honoured in the breach than the observance”.

As my participation at the US—Africa Financial Inclusion Conference hosted by the US Trade & Development Agency in Cape Town in July reminded me, the global financial sector is still struggling to drive financial inclusion in Africa and elsewhere. The World Bank estimates that only 23% of adults in Africa have a banking account — varying from 51% of adults in Southern Africa to 11% in Central Africa.

In SA that affects many of the estimated 4.8-million people employed in the informal sector. On top of this, most of SA’s small and medium enterprises (SMEs), much celebrated as the true engine room for economies, are “unbanked” and face significant obstacles to securing finance.

It’s hard to wrap your head around the fact that the problem is still so pervasive. In a paper published in 2000, when SA was still basking in the glow of its newfound democracy, one commentator boldly argued that “SA’s informal economy is in the process of coming out of the dark shadows cast by 40 years of apartheid planning”. New policy objectives, the writer continued, along with promotion of job opportunities, poverty alleviation measures and local economic development interventions, hinted that “policy focus has been in favour of initiatives directly supporting informal economy growth”.

It turns out this may have been overly optimistic. The informal sector remains one of the least supported and most vulnerable sectors in the economy. For instance, as media reports showed at the time and a report by the UN Development Programme (UNDP) in SA would confirm, the informal sector was among the hardest hit during the Covid lockdowns.

Lack of access to finance is the core of this problem. In SA a large chunk of SMEs are owned or run by previously disadvantaged individuals, with one estimate suggesting they are responsible for 87% of survivalist businesses. These businesses are characterised by little to no savings, little or no access to family or neighbourhood finance, and little to no valuable investment in residential property that can be used as collateral in accessing finance from the formal financial sector. As a result, many have no choice but to turn to a ravenous informal financial sector — including loan sharks.

Some say this is a result of the failure of the formal financial sector to serve a certain segment of the potential market. While for obvious reasons the number and scale of informal lending in SA is difficult to measure, one estimate suggested that there could be more than 40,000 mashonisas (loan sharks) operating in SA townships.

For many informal businesses the appeal of the informal market can be obvious. Despite the often exorbitant interest rates (50% per month, or more) and risk of debt spirals, there are no lengthy bureaucracies to deal with and the money is made available immediately. Research suggests that some informal entrepreneurs may prefer informal funding because it’s what they are familiar with, as the bureaucracies of the formal finance sector may be intimidating and insurmountable.

Time for innovation — and a change in mindset

It doesn’t help that the formal financial sector knows little about informal businesses, especially when compared to informal lenders. As a result, the  narrative is that the risks in lending to the informal sector are just too great. (Even if it can be argued that banks make risky loans all the time.)

According to the task group of the Policy Board for Financial Services & Regulation, access to SA’s capital markets are still underdeveloped. Among the numerous recommendations the task group made is the need for “greater institutional variety, for increased innovation and a greater emphasis on mentoring”. Groups such as the Center for Global Development have pushed for the exploration of such innovative funding mechanisms, including the issuing of “informal bonds” dedicated to financing informal business activities.

But there also needs to be a change in how the formal sector looks at the informal economy. If formal lenders take the time to learn more about the sector they may be surprised to find that SMEs in the informal sector are often viable, good paying customers and you don’t need extensive tech innovation to win there.

I have seen the power the right kind of credit can play in the lives of informal traders. It can fuel exponential growth that many formal businesses can only dream of. I have dealt with entrepreneurs who have lost it all — spaza shops, businesses, cars, family — over the Covid lockdowns. But I have then seen how, thanks to formal credit for stock, they have been able to not only reignite their businesses but quickly scale up again. A litany of such stories can be told.

What’s clear to me is that driving financial inclusion has less to do with fancy tech and sweeping policy changes and more to do with willing hearts and fair funding. With this approach the narrative as it relates to informal SMEs can be changed, and by putting those 87% of survivalist businesses to work for our economy more strategically we can change the narrative of our country too.

• Nwadeyi, a Bertha Scholar who holds an MPhil in Inclusive Innovation from the UCT GSB, is a founding partner in Setana Capital, which provides working capital finance to informal businesses, backed by Allan Gray’s empowerment arm, E-Squared.