Lessons from the fall of African Bank

African Bank Investments Ltd was placed under curatorship on 10 August 2014 by South Africa’s central bank. African Bank (ABIL), which provided cash loans to lower-income group South Africans would have needed R8.5 billion rand to keep afloat.

What went wrong?

After the economic downturn in 2008, big banks that had been over-generous with credit cards and cheap mortgages saw the margins being made by African Bank and newer entrant Capitec, and followed suit. The result was that the market was flooded with credit and risk management was no longer as important as it had once been.

But where big rivals served multiple markets and could open and shut credit taps at will, ABIL did not adapt its business model. It continued lending cash loans without taking in deposits, serving customers who were the most likely to take strain in an economic crisis. The result was a loss of better-quality customers to other banks that could provide them with a wider service of banking products.

Another crushing blow was African Bank’s acquisition of low-price furniture retailer Ellerine Holdings Ltd in 2008, just before the global financial crisis saw sales fall dramatically and dented the unit’s value. Ellerine needed some R70 million a month in funding to remain operational.

A failed business model

 When ABIL went into curatorship, Gill Marcus, governor of the South African Reserve Bank said, “The problems that have beset African Bank are, in our view, largely specific to their current business model, which does not include a diversified set of products and income streams. This has made African Bank and the ABIL Group uniquely vulnerable to a changing or challenging business environment.”

Market conditions in South Africa have deteriorated in recent months with 25.5% unemployment and rising inflation which has cut South African borrowers’ ability to repay cash loans carrying interest of as much as 60 percent a year. It has been a case of adapt or die for many cash loan lenders and African Bank has been unable to respond to changes in the marketplace.

Taking on deposits

Since African Bank did not take deposits, it extended cash loans to low-income earners without collateral, funding the business by raising money in debt or equity markets.

Capitec, African Bank’s closest competitor, began taking deposits in 2002 and has not had to sell debt to boost funding in more than a year, according to Bloomberg data. Capitec’s retail deposits had, by February this year, increased to R23.6 billion.

Unsecured lending accounted for a tenth of total credit in South Africa when it peaked in 2012, with economists warning that relying on high-interest loans to over-indebted consumers could end in a heap of bad debt. In response, banks like Standard Bank and Rand Merchant Bank reduced their unsecured portfolios. But these concerns hampered African Bank’s ability to raise the financing it relies on to extend loans to customers without taking in deposits.

Now the Central Bank will split ABIL into a bad bank with soured loans, and a good bank with a group of lenders agreeing to underwrite a R10 billion rand capital raising.

Room for further growth in unsecured lending

South Africa’s financial sector is the most sophisticated on the continent and one of the world’s best regulated. Economists predict that the likelihood of African Bank’s troubles infecting larger and more-diversified lenders is low.

Business Day Live financial services editor, Phakamisa Ndzamela wrote late last year in a Banking Association South Africa article, Unsecured lending a buoy‚ not a bubble, about the importance of unsecured cash loans in South Africa’s economy. He went so far as to say that if the sector had grown at the same rate as the country’s gross domestic product after the recession, the economy would have been R219 billion smaller in mid-2013. His findings were based on research commissioned by unsecured cash loan lender Wonga.co.za. . Where South Africa’s economic growth rate has been lower than 3%, unsecured lending has grown in the double digits.

Unsecured cash loans for working capital is often needed by small and medium enterprises that create jobs in South Africa. Roelof Botha, economist and lecturer at the Gordon Institute of Business Science believes that without unsecured cash loans, the South African economy would have been a fraction of what it is today. He disputes the notion of a credit bubble in the lending of unsecured cash loans and suggests that there is room for new players and further growth in unsecured lending, particularly if new entrants provide innovative solutions like Wonga.co.za’s offering of digitally based short-term cash loans with a maximum loan size of R2500 for first-time borrowers and up to R8000 for returning consumers.

If we are to learn anything from the demise of African Bank, the conversation will need to be around the responsible, transparent and ethical lending of unsecured cash loans.