THE WORLD BANK GROUP SOUTH AFRICA FINANCIAL SECTOR ASSESSMENT PROGRAM 2020 2022 January July June 2021 TECHNICAL NOTE June 2020 FINANCIAL INCLUSION Prepared by Harish This Technical Note was prepared in the context of a joint IMF-World Bank Financial Sector Assessment Natarajan, Douglas Program (FSAP) mission in South Africa during Randall, and Rekha September 2020 to June 2021 led by Jennifer Elliott, Reddy IMF and Eva M. Gutierrez, World Bank, and overseen Finance, Competitiveness, and by the Monetary and Capital Markets Department. Innovation Global Practice, IMF, and the Finance, Competitiveness, and WBG Innovation Global Practice, World Bank Group. The note contains the technical analysis and detailed information underpinning the FSAP assessment’s findings and recommendations. Further information on the FSAP program can be found at www.worldbank.org/fsap. SOUTH AFRICA CONTENTS ABBREVIATIONS AND ACRONYMS ................................................................................................................ 5 EXECUTIVE SUMMARY.................................................................................................................................. 7 I. CURRENT STATE OF FINANCIAL INCLUSION ....................................................................................... 14 A. Financial Inclusion for Individuals ............................................................................................. 14 B. Access to Finance for MSMEs ................................................................................................... 21 II. PUBLIC AND PRIVATE SECTOR COMMITMENT AND STRATEGY .......................................................... 26 A. Financial Inclusion for Individuals ............................................................................................. 26 B. Access to Finance for MSMEs ................................................................................................... 28 C. Fintech ........................................................................................................................................ 29 III. PROVIDER DIVERSITY AND INNOVATION ............................................................................................ 30 A. Overview of Provider Ecosystem ............................................................................................... 30 B. Banking Sector ........................................................................................................................... 31 C. Payment Service Providers ......................................................................................................... 32 D. Venture Capital/Private Equity ................................................................................................... 34 E. Cooperative Banking Institutions ............................................................................................... 34 F. Stokvels ...................................................................................................................................... 35 IV. PHYSICAL REACH AND ACCESS POINTS.............................................................................................. 37 V. FINANCIAL INFRASTRUCTURE............................................................................................................. 39 A. National Payments System ......................................................................................................... 39 B. Credit Information and Secured Transactions ............................................................................ 44 VI. PRODUCT DESIGN AND DIGITIZATION ................................................................................................ 47 A. Transaction and Savings Accounts ............................................................................................. 47 B. Payment Services and Instruments ............................................................................................. 50 C. Remittances ................................................................................................................................ 53 VII. KEY GOVERNMENT INITIATIVES AND PROGRAMS .............................................................................. 54 A. Government-to-person payments................................................................................................ 54 B. Financing for MSMEs through DFIs and government programs ............................................... 58 VIII. MARKET CONDUCT, RESPONSIBLE LENDING, AND FINANCIAL EDUCATION ..................................... 61 A. Legal Framework and Institutional Arrangements ..................................................................... 61 B. Trends in Consumer Credit and Over indebtedness ................................................................... 64 C. Approaches to Promote Responsible Lending ............................................................................ 71 D. Alternative Dispute Resolution................................................................................................... 76 E. Financial Education .................................................................................................................... 77 ANNEX I: REGRESSION ANALYSIS .............................................................................................................. 81 2 SOUTH AFRICA FIGURES Figure 1: South Africa has achieved steady growth in financial inclusion between 2010 and 2019 .......... 14 Figure 2: Financial inclusion in South Africa is in line with its overall economic development ............... 15 Figure 3: The financially excluded are disproportionately male, young, in lower LSM categories, and with lower education ........................................................................................................................................... 16 Figure 4: South Africans rely on cash for common transactions ................................................................ 16 Figure 5: Consumers rely on ATMs and retail agents for common transactions, with limited uptake of banking apps and internet banking.............................................................................................................. 17 Figure 6: Bank accounts are most commonly used savings mechanism..................................................... 18 Figure 7: Most savers do not mix formal and informal savings mechanisms ............................................. 19 Figure 8: Borrowing is most prevalent among middle-aged consumers, those in higher LSM categories, and those with more education.................................................................................................................... 20 Figure 9: Most borrowing by individuals is for consumption and day-to-day living expenses ................. 21 Figure 10: Evolution of Private Sector Credit in South Africa ................................................................... 22 Figure 11: International Comparison of MSME Use of Finance ................................................................ 23 Figure 12: Effects of Covid-19 on South African Firms............................................................................ 24 Figure 13: Evolution of Non-Credit Financing .......................................................................................... 25 Figure 14: Banks non-performing loans to SMEs (as % of total loans to SMEs, 2019)............................. 26 Figure 15: ‘Big Five’ banks represent 77 percent of banked consumers .................................................... 31 Figure 16: Physical access points have decreased in recent years and lag behind comparator economies 37 Figure 17: Agents comprise a significant share of access points in countries with available data ............. 38 Figure 18: Account costs relative to monthly income ................................................................................ 48 Figure 19: Comparison of payment instrument usage patterns with select countries ................................. 51 Figure 20: Government Financing for MSMEs .......................................................................................... 59 Figure 21: Providers of consumer credit by volume and number of accounts ............................................ 65 Figure 22: Credit granted per credit type by volume and account .............................................................. 66 Figure 23: Household debt to disposable income had been decreasing prior to Covid-19 ......................... 66 Figure 24: Increase in access to consumer credit accompanied by high and sustained level of credit record impairment .................................................................................................................................................. 68 Figure 25: Judgements and administration orders have declined as a share of credit-active consumers with impaired records.......................................................................................................................................... 68 Figure 26: Unsecured and short-term credit portfolios have elevated non-performing loans..................... 69 Figure 27: The average size of unsecured loans has increased since 2015 ................................................. 70 Figure 28: Self-reported financial behaviors indicate room to improve financial capabilities ................... 79 TABLES Table 1: Key Recommendations ................................................................................................................. 11 Table 2: Relevant Acts and Regulations ..................................................................................................... 41 Table 3: Account costs relative to monthly income .................................................................................... 49 Table 4: Compliance-based vs. Risk-based Supervision ............................................................................ 73 3 SOUTH AFRICA BOXES Box 1: Key Success Factors for NFIS Development and Operationalization............................................. 28 Box 2: Malaysia’s Credit Guarantee Corporation...................................................................................... 60 Box 3: Good Practices for Financial Consumer Protection – Institutional Arrangements and Mandates (selected) ..................................................................................................................................................... 63 Box 4: Suptech Solutions for Market Conduct Supervision ...................................................................... 74 Box 5: Options for Regulatory Approaches to Address Consumer Risks in Digital Credit ...................... 76 4 SOUTH AFRICA ABBREVIATIONS AND ACRONYMS ACH Automated Clearing House ADR Alternative Dispute Resolution AML Anti Money Laundering ATM Automated Teller Machine CBDA Cooperative Banks Development Agency CDD Customer Due Diligence COFI Conduct of Financial Institutions CFT Combatting the Financing of Terrorism DFI Development Finance Institution DSBD Department of Small Business Development DSD Department of Social Development DTICC Department of Trade, Industry and Competition FAS Financial Access Survey FIC Financial Intelligence Center FSCA Financial Sector Conduct Authority G-20 Group of Twenty IFWG Inter-governmental Fintech Working Group IMF International Monetary Fund KCG Khula Credit Guarantee LSM Living Standards Measure MoU Memorandum of Understanding MSME/SMME Micro-, Small-, and Medium-sized Enterprise/Small, Medium and Microenterprise MTO Money Transfer Operator NASASA National Stokvel Association of South Africa NCA National Credit Act NCR National Credit Regulator NFIS National Financial Inclusion Strategy NPL Non-Performing Loan NPS National Payment System NPSA National Payment Systems Act NT National Treasury PA Prudential Authority PAD Payment Account Directive PASA Payment Association of South Africa PCG Partial Credit Guarantee PCH Payment Clearing House POPIA Protection of Personal Information Act PSP Payment Service Provider PSMB Payment System Management Body RTGS Real Time Gross Settlement RTP Real Time Payments SACRRA South African Credit & Risk Reporting Association 5 SOUTH AFRICA SAPO South Africa Post Office SARB South African Reserve Bank SASSA South Africa Social Security Agency SEFA Small Enterprise Finance Agency SME Small- and Medium-sized Enterprise SO System Operator TPPP Third Party Payment Provider UMC Upper-middle income country VC Venture Capital WBG World Bank Group 6 SOUTH AFRICA EXECUTIVE SUMMARY Assessment of Issues South Africa has made significant progress in expanding access to financial services for individuals but active usage of digital financial services remains low. Approximately four in five South African adults report owning a bank account. A broader metric that includes access to regulated, non-bank financial services indicates that 91 percent of adults are “formally included.” Both indicators have risen substantially in the past decade but progress has slowed. The more than 3.5 million South African adults that remain financially excluded are disproportionately male, young, and live in low-income households. Increased uptake of bank accounts has not translated to widespread use of digital financial services: for example, only one in three banked adults report using their account or making digital payments on a daily or weekly basis. Greater competition and innovation can improve the availability, affordability, convenience of digital financial services and facilitate their integration into the daily lives of South Africans. While overall credit to the private sector in South Africa remains robust, the micro, small and medium-sized enterprise (MSME) segment remains underserved by the formal financial sector. Just 4.8 percent of small firms and 5.6 percent of medium sized firms reported having a bank loan or line of credit, and investments are largely financed by internal funds. Total outstanding business loans have increased in the last decade in nominal terms, but the share of bank lending to SME finance stands at 12 percent in 2020. SMEs report access to finance as a main business constraint, second only to access to electricity, made more pressing by the impacts of Covid-19. Estimates of the MSME credit gap between supply and demand are substantial, varying between US$30 to 54 billion12. South Africa’s retail financial services market is dominated by large banks. The vast majority of financially included adults in South Africa are bank customers and the ‘big five’ banks jointly account for 77 percent of banked customers. The banking sector is also the dominant player in the consumer credit market, accounting for 83 percent of the loan portfolio by volume. Bank lending is the most common source of financing for MSMEs, with development finance institutions and Fintechs playing a relatively limited role. Banks maintain the largest distribution networks of financial access points, comprising mainly branches, ATMs, and retail stores that serve as agents. As of 2019, South Africa reported a total of 75 bank branches and ATMs per 100,000 adults, lower than that of Brazil, China, Russia, and Turkey. This metric of access point availability peaked in 2015 and has since declined. The use of small retail shops (more common in townships and rural areas) as agents is not common nor are agent aggregator models. The financial services ecosystem is constrained by the limited role of non-banks in the provision of payment services and limitations on interoperability. The banking sector is investing significant resources in digitization and disruptive innovation has seen several “digital banks” enter the market, although the reach of these new entrants remains relatively limited. However, there is lack of interoperability of mobile payment QR code based solutions that are finding some traction in the market. Unlike many of its regional peers, South Africa does not currently have a regulatory framework in place for non-bank payment service providers (or e-money issuers). Proposed amendments to the National Payment Systems Act to provide a direct role for non-banks in the provision of payment services can help to address the gaps in usage of digital payments across income segments. International experience from China, India, and Kenya has demonstrated that non-banks can play a key role in addressing barriers to the greater use of digital financial services, including related to costs, physical access, and product design. 1 Finfind. Inaugural South African SMME Access to Finance Report. 2018. 2 IFC. The Unseen Sector: A Report on the MSME Opportunity in South Africa. 2018. 7 SOUTH AFRICA The Government of South Africa has several institutions managing government financing programs to reduce the MSME finance gap, yet several schemes remain underutilized and without documented evidence of effectiveness. Government programs include both direct and wholesale lending and guarantees and amount to 0.36 percent of GDP or 2.8 percent of outstanding credit to SMEs.3 Most government finance for MSMEs is provided through debt finance, and there is scope to expand the availability of instruments deployed. Public partial credit guarantees are available from the Small Enterprise Finance Agency, operating under the Department of Small Business Development (DSBD), via the Khula Credit Guarantee scheme and were also made available under the emergency support program COVID-19 loan guarantee scheme.4 However, experience shows that the schemes have been underutilized due to many firms not meeting the eligibility criteria or the bank’s risk criteria. In government financing, equity is the least used instrument and is only offered in combination with debt finance. Overall effectiveness of public support programs is generally unclear in the absence of published data on NPLs and monitoring and evaluation frameworks that include rigorous impact evaluation studies on their effect on firm productivity and employment. Gaps in credit information systems hamper access to finance for MSMEs. Credit data sharing in South Africa is almost entirely focused on consumers, with provision of data for MSMEs and commercial credits largely voluntary and consequently limited. Although registered credit providers are required to submit data on all consumer credit agreements, the National Credit Act (NCA) has a limited scope with respect to sharing of credit data on businesses. Some initiatives have been established to improve the availability of MSME data but a more systematic approach is needed. Gaps in the current framework for secured transactions impede the use of movable assets as collateral. The World Bank 2015 Secured Transactions Collateral Registries Diagnostic for South Africa noted that the current framework provides for immovable as well as movable security to be used as collateral, yet in practice South African lenders are experiencing challenges with the perfection of interests in movable property (which often requires a court process) and absence of centralized, computerized nation-wide movable assets registry. The opportunities to fully leverage the well-established social protection programs to enhance financial inclusion are being hampered by government policies. The South African Social Security Agency (SASSA) administers the social protection program that collectively cover around 11 million individuals. Government policies, while enabling direct transfer to recipients’ accounts with Postbank (default option) and other banks chosen by the recipient, restricts the range of services that Postbank can offer to only credit or benefit transfer and withdrawal of the transfer amount in full. Further, SASSA is not allowed to engage non-bank entities to offer payment services. Thus, limiting the potential of fintech companies and other non-bank players to contribute to digitization of the social benefit transfers and greater usage of accounts. The legal, regulatory and institutional framework for market conduct is under development. The market conduct framework for the consumer credit market has been in place since 2005, as established in the National Credit Act and administered by the National Credit Regulator. The market conduct framework for the broader financial sector has been under development over the past decade, beginning with the 2011 Treating Customers Fairly roadmap and progressing substantially with the 2017 Financial Sector Regulation Act which established a ‘twin peaks’ approach to financial sector supervision and regulation. The Financial Sector Conduct Authority (FSCA) was formally established in 2018 with a mandate to regulate and supervise the conduct of financial institutions in relation to providing financial products and services to consumers. The Conduct of Financial Institutions (CoFI) Bill will serve as the overarching legal 3 A 2019 World Bank report on Financing Small Business in South Africa showed that more than 52 programs targeting MSMEs were available through these institutions, ranging in annual commitment sizes from less than R100,000 to R50 million 4 The COVID-19 Loan Guarantee Scheme, established in 2020 by the National Treasury, the South African Reserve Bank (SARB) and the Banking Association South Africa (BASA), closed at end-June 2021. 8 SOUTH AFRICA framework for FSCA’s market conduct functions. The Banking Conduct Standard was published by FSCA in July 2020 as the first of a series of sector-specific conduct standards. Persistently high levels of credit impairment in the consumer credit market impede efforts to ensure sustainable financial inclusion. South Africa’s consumer credit market is highly regulated and conforms with several “good practices” for financial consumer protection. The number of credit -active consumers has steadily increased in recent years but this trend has been accompanied by persistently high levels of credit impairment. Unsecured credit and credit facilities jointly represent 50 percent of past-due loans despite comprising only 24 percent of the total loan portfolio (by volume), however data limitations and the absence of a risk-based supervisory framework applied to the retail credit market limit an analysis of the market dynamics in the product segment. Survey data confirms that many borrowers are in financial distress, with 31 percent of borrowers reporting that “[my] credit or borrowing commitments are a heavy burden.” Trends of financial distress and over-indebtedness are inextricably linked to national social and economic conditions, as well as the Covid-19 pandemic. Recommendations The Financial Inclusion Implementation Strategy currently under development will require a focused and well-coordinated effort to effectively address barriers to financial inclusion. The Strategy should address persistent and structural barriers to financial inclusion, including related to provider diversity and innovation, improving financial infrastructure, reducing barriers to the integration of formal financial services in the daily lives of South Africans, reaching ‘last mile’ consumers, and the responsible provision of productive credit and insurance. While international experience has shown that effective national financial inclusion strategies are generated from an inclusive consultation process, complex governance arrangements can also serve as an obstacle to implementation. Focused institutional leadership and a delineated action plan can help to reduce implementation roadblocks. A monitoring and evaluation framework supported by a robust data infrastructure is necessary to monitor progress and identify bottlenecks in expanding financial inclusion. Reforms to enable the provision of payment services by non-banks and greater use of retail agents can help to foster an ecosystem for digital financial services. Authorities should enact the transformational changes to the legal and regulatory framework governing the National Payments System – including allowing for the direct participation of non-banks in the provision of payment services - as proposed by the SARB. Authorities should also consider giving a greater role to non-banks in the governance of retail payment systems. Efforts to expand the use of retail agents can also help support the development of an ecosystem for digital financial services. Authorities are encouraged to prioritize these reforms in the Financial Inclusion Implementation Strategy currently under development. The SARB could encourage the Payment Association of South Africa (PASA) and BankServ to adopt a common QR code standard and interoperability framework for mobile payments. Given the proliferation of proprietary payment instruments and payment solutions which are not interoperable, SARB needs to take steps to convert existing closed-loop systems to become open-loop systems or to be able to become interoperable with the open loop systems. While there is a growing convergence on QR code standards used in South Africa, there is still some fragmentation and developing a common QR code standard for South Africa would be useful. Lack of standardization of QR codes could limit the impact of the upcoming Rapid Payments system. SASSA should work with all the relevant stakeholders in the Government on expanding the range of payment service providers it can engage and improve product functionality for beneficiaries. The SASSA could work with the SARB and PASA to develop some objective criteria for selecting payment service providers. Further, the current flexibility given to recipients to choose between different commercial banks, could be extended to all licensed issuers offering transaction account services be it through bank 9 SOUTH AFRICA accounts or e-money accounts. The SASSA could work with the SARB and the banking and payments industry to develop specific initiatives to promote digital payments and facilitate access to other financial services for the benefit transfer recipients. The Postbank account features should be enhanced with new functionalities and SASSA could also evaluate lifting the restrictions on using the benefit transfer account for receiving other incoming transfers and removing the fees for balance enquiry and declined transactions. Reform of South Africa’s financial infrastructure should be prioritized in the Financial Inclusion Implementation Strategy. Comprehensive and well-functioning credit reporting systems are critical to support credit origination for individuals and SMEs. The current credit information environment can be strengthened by (i) mandating the reporting of MSMEs and commercial credit information to credit bureaus; (ii) enhancing the use of alternative data;5 and (iii) providing an enabling legal framework for the planned central credit register. A reform of the secured transactions framework is needed to unlock receivables financing and facilitate its electronic trading. Public MSME credit support programs should be redesigned in line with international best practices to improve their effectiveness. Authorities should consider consolidation of smaller programs and redesign program features, especially for guarantee programs and those involving direct credit, in line with international best practices. New programs, except in crisis circumstances, should be piloted, evaluated and scaled up if proved effective. Also, there is a need to improve coordination of public credit support programs and business development services to enhance firm performance. The authorities could consider allowing fintech companies to tap the existing MSME credit programs of the Government to deliver credit to specific MSME segments that might be better reached by fintechs and phase out direct lending programs. Enactment of the Conduct of Financial Institutions Bill, enhanced institutional capacity, and clear delineation of its institutional mandates relative to the NCR are necessary to enable the effectiveness of the FSCA as a market conduct supervisor. The enactment of the CoFI Bill should be prioritized following the ongoing public consultation process. The FSCA is in the process of developing a risk-based supervisory framework, which is necessary to facilitate effective and efficient market conduct supervision. The FSCA will need to build institutional capacity through the hiring of supervisory staff who can drive implementation of the proactive, data-driven and risk-based supervisory approach, particularly for banking institutions and fintechs which were not covered under the FSB. Improved coordination and clear delineation between the institutional mandates of FSCA and NCR is necessary to enable effective market conduct regulation and supervision. Efforts to ensure responsible lending are critical to ensure that consumers benefit from access to financial services. An in-depth analysis of the unsecured credit and credit facilities markets is needed to determine drivers of irresponsible lending and over-indebtedness. NCR is encouraged to shift towards a data-driven and risk-based supervisory approach to identify and address lending practices that contribute to over-indebtedness; this will require enhanced resources and the recruitment and retention of staff with critical skills. NCR should accelerate efforts to improve credit bureau reporting, particularly among small credit providers. Ensuring the proper conduct of debt counsellors and improving the existing financial ombudsman system in South Africa can support a healthy consumer credit market. Targeted and evidence- based financial education efforts can also help promote responsible and sustainable financial inclusion. 5 Alternative data are data that are not traditionally housed within a credit bureau environment and could include information such as data generated using mobile phones, metadata from the Internet and app usage. 10 SOUTH AFRICA Table 1: Key Recommendations Responsible Time- Recommendation Authority frame1 Strategy and Data Establish a financial inclusion implementation strategy with an action plan NT ST and monitoring and evaluation system NT, FSCA, Strengthen financial inclusion data infrastructure, including through NCR, PA, MT collection of data on retail agents and geospatial data on access points SARB NT, FSCA, Issue an annual report with comprehensive cross-sectoral indicators to NCR, PA, ST monitor financial inclusion progress and bottlenecks SARB Provider Diversity, Innovation, and Reach NT, Parliament Enact reforms to the National Payment System Act to provide a direct role With the support I for non-banks in the provision of payment services of SARB Finalize discussions and implement a strategy to develop the Cooperative CBDA ST Banking Institutions sector Identify market and legal/regulatory barriers to the greater use of Spaza NT, FSCA, ST shops as retail agents for financial service providers Industry Financial Infrastructure Consider giving a greater role to non-banks in the governance of retail SARB ST payment systems Develop and issue regulations mandating interoperability and adoption of open standards for mobile payments linked to both bank and mobile money SARB ST accounts. Improve the credit information environment by improving credit bureau NCR, FSCA, reporting coverage among small lenders and incorporating alternative data ST SACCRA sources for consumers and MSMEs into credit reports Expand the coverage of credit data for businesses by mandating sharing of business credit, enforcing credit information sharing for businesses currently NCR, DTIC, covered by the NCA, increasing the threshold delineating small juristic with the support I/ST persons with the NCA and providing an enabling legal framework for the of SARB planned Central Credit Register Review the secured transaction framework to ensure extrajudicial execution DSBD, NT, NCR, MT and create a computerized nationwide register for movable collateral DOJ Product Design and Digitization Support the development of MSME products beyond credit, for example by reviewing the current legal framework for financial leasing services and NT ST factoring law 11 SOUTH AFRICA Responsible Time- Recommendation Authority frame1 Establish or support the establishment of a centralized website to facilitate FSCA ST comparison of prices and features of common retail products Monitor the effects of pro-competition and market conduct reforms on account costs, and consider more direct affordability measures if costs NT, FSCA MT remain high for low-income consumers Key Government Programs and Initiatives Expand the range of payment service providers used to distribute SASSA social grants and extend uniform subsidies to all licensed payment service DSD, SASSA ST providers offering transactional account services to SASSA beneficiaries Develop initiatives to promote digital payments and facilitate access to other financial services for SASSA beneficiaries and specifically for POST bank DSD, NT, enhance account functionalities and review balance enquiry and decline SASSA, ST fees that deter more active usage and if feasible offer alternative Postbank solutions to monitor balance in account. Review and redesign public credit support programs to phase out direct lending and introduce transparent M&E frameworks and consider NT, DSBD, IDC ST consolidating some of the smaller, less utilized government finance support programs to MSMEs Consider adjustments to the parameters and participants in the existing partial NT, SARB, credit guarantee schemes to increase outreach and additionality, as well as I SEFA additional channels and more flexible lending criteria DFIs should consider a broader range of financing instruments such as equity DSBD, SEFA, ST or blended instruments to better meet the needs of the SME lifecycle. IDC Market Conduct, Responsible Lending, and Financial Education Enact the Conduct of Financial Institutions (CoFI) Bill NT, FSCA, I Parliament Minimize overlaps in legal mandates and licensing/reporting requirements of NT, DTICC, I NCR and FSCA, and strengthen coordination and data sharing mechanisms NCR, FSCA Develop and implement a risk-based supervisory framework to enable FSCA, NCR ST proactive, data-driven, and efficient market conduct supervision Ensure adequate resources and build institutional capacity for market conduct supervision, including via development of supervisory technology NT, DTICC, ST (“Suptech”) solutions and recruitment and retention of staff with critical FSCA, NCR skills (e.g., data, analytics, information technology, fintech models) Work with credit providers to facilitate innovative approaches to responsibly expand access to credit (e.g., product suitability, the use of alternative data to NCR ST inform affordability assessments; effective disclosure for digital credit) Conduct in-depth market research and targeted supervisory activities (e.g., thematic surveillance) to identify the drivers of irresponsible lending in the NCR I consumer credit market for unsecured loans and credit facilities 12 SOUTH AFRICA Responsible Time- Recommendation Authority frame1 Conduct a detailed review of the personal insolvency and debt review and NCR ST restructuring system Adapt data collection, supervisory, and regulatory approaches to identify and FSCA, NCR ST address emerging consumer risks from digital and fintech models Establish a new, consolidated, and independent National Financial Ombud to NT, Ombud cover all financial service providers authorized by the PA, FSCA, and NCR Council, PA, MT (excluding pension funds) FSCA, NCR Develop approaches to ensure high-level alignment of content of financial NT, FSCA ST education initiatives to promote consistency and clarity of messaging Establish clear institutional mandates for the provision of financial education to SASSA grant recipients and improve the accessibility and relevance of DSD, SASSA, ST NT financial education content for these beneficiaries 1 I-Immediate” is within one year; “ST-short-term” is 1–3 years; “MT-medium-term” is 3–5 years. 13 SOUTH AFRICA I. CURRENT STATE OF FINANCIAL INCLUSION A. Financial Inclusion for Individuals 1. South Africa has achieved significant progress in expanding financial inclusion in recent years but there is a significant “last mile” of individuals without access to bank accounts or other financial services. The vast majority of South Africans have access to basic financial products and services from regulated providers. According to 2019 data from FinScope, 81 percent of South Africans (age 16+) report owning a bank account, a basic metric of financial inclusion.6 This represents an 18 percentage point increase from 63 percent “banked” in 2010 (Figure 1). A broader definition of financial inclusion accounting for the uptake of any product or service from a regulated provider (i.e. including non-banks) yields a 2019 “formally included” value of 91 percent, up from 68 percent in 2010. Most formally included South Africans use a mix of bank, non-bank, and informal financial services. Despite recent progress, more than 3.5 million South Africans remain completely excluded from the formal financial sector, 7 and 7.5 million adults are unbanked (i.e. lack a bank account). This represents a significant ‘last mile’ challenge for policymakers. Figure 1: South Africa has achieved steady growth in financial inclusion between 2010 and 2019 100 89 89 90 86 91 84 79 80 80 81 % of individuals (age 16+) 73 80 68 75 77 77 77 70 68 75 67 60 63 63 50 40 30 27 23 20 19 16 14 13 11 10 6 8 7 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Formally included Bank account Excluded (formal or informal) Source: FinScope Consumer Surveys (2010-2019) 2. South Africa performs relatively well on basic metrics of financial inclusion as compared to regional and income group peers. According to Global Findex data, the level of account ownership in South Africa is well above the average for the region and is in line with other upper-middle income economies. At a global level, there is a strong correlation between account ownership and economic development across 6 The 2020 FinScope Consumer Survey was delayed due to Covid-19 restrictions. A key caveat in this analysis is that the trends discussed are based on 2019 data and therefore do not reflect changes in financial behaviors as a result of the Covid-19 pandemic. 7 Corresponding to 7 percent of adults who do not use any formal or informal financial service and two percent who use only informal services, for a total of 9 percent of adults (or approximately 3.5 million adults) 14 SOUTH AFRICA economies8, with economic development explaining approximately 72 percent of the cross-country variation in financial inclusion. As viewed through this basic correlation, South Africa’s rate of financial inclusion is in line with level of economic development, that is, South Africa is slightly above the trend line in Figure 2. However, several comparator economies – including Kenya, India, and China - have been able to significantly “overperform” on financial inclusion relative to their level of economic development by enabling a digital financial services ecosystem that serves low-income consumers. (South Africa’s relative performance appears better when using data from recent FinScope surveys, but this limits cross-country comparability.) Figure 2: Financial inclusion in South Africa is in line with its overall economic development 100 % adults owning a transaction account 90 Kenya 80 India China R² = 0.7215 70 South Africa 60 50 40 30 20 10 0 5 6 7 8 9 10 11 12 Log GNI per capita (constant 2010) Source: World Bank Global Findex (2017); World Bank World Development Indicators (2017) 3. Financially excluded South Africans are disproportionately male, young, in lower Living Standards Measure (LSM) categories, and have lower levels of education. Patterns of financial exclusion in South Africa mirror the broader dynamics of social and economic exclusion: youth and young adults, those in lower LSM categories, and those with less education are less likely to be financially included, that is, report using any financial product or service from a regulated provider (Figure 3). Unlike many other economies, however, men in South Africa are more likely than women to be financially excluded (11 percent vs. 6 percent). FinScope data also reveals significant variation across provinces: while just five percent of the adult population is financially excluded in Gauteng, Limpopo and the Western Cape provinces, more than 10 percent of the adult population is financially excluded in Free State (22 percent), North West (15 percent), Eastern Cape (13 percent), and Northern Cape (12 percent) provinces. These demographic, socioeconomic, and geographic difference are found to be statistically significant in multivariate regression analysis (Annex 1).9 8 As measured by GNI per capita (constant 2010) 9 The results are similar for “unbanked” and “financially excluded”. 15 SOUTH AFRICA Figure 3: The financially excluded are disproportionately male, young, in lower LSM categories, and with lower education 25 22 % of adults not formally served 20 17 15 15 15 15 13 12 11 10 10 6 5 4 5 5 1 2 2 0 Less than secondary Secondary Men Women 60+ 9-10 Free State North West 30-59 University 16-29 1-4 5-6 7-8 Northern Cape Eastern Cape Gender Age LSM Education Province (selected) Source: FinScope Consumer Survey (2019) Note: The figure includes only Provinces in which more than 10 percent of the adult population is financially excluded. 4. Just one in three banked South Africans report using their account on a daily or weekly basis. Despite the fact that 83 percent of banked South Africans have a debit card, just two percent of banked South Africans report using their account on a daily basis (Figure 4). Thirty-one percent report using their account on a weekly basis but the vast majority of banked South Africans report using their account only on a monthly basis (60 percent). Low-income adults and SASSA grant recipients are particularly likely to report “mailbox” account behavior, i.e. using their account only once per month. The continued reliance on cash for day-to-day transactions is also confirmed by use case oriented data: cash is by far the most common method for paying for food or groceries, reported by 89 percent of adults, followed by debit cards, reported by 33 percent of adults. Similarly, 83 percent of adults report using cash to pay household bills, as compared to 17 percent who report using a debit card and three percent who report using EFT transfers via internet banking or banking apps. Figure 4: South Africans rely on cash for common transactions 100 % of adults using payment instrumentt (of 90 those who report payment type) 80 70 60 50 40 30 20 10 0 Cash Debit card Credit card Banking app or internet (swipe or pin) (swipe or pin) banking Purchasing food or groceries Paying household bills Source: FinScope Consumer Survey (2019) 16 SOUTH AFRICA 5. High fees, a general preference for cash, and lack of funds are cited as key barriers to more frequent account use. Banked South Africans who report using their account less often than monthly cite high fees (11 percent), a general preference for cash (36 percent), and lack of sufficient funds (54 percent) as the main reasons for not using their account more frequently. 6. When making banking transactions, South African consumers rely heavily on ATMs and retail agents, with limited uptake of banking apps and internet banking (prior to Covid-19). Banks offer a wide range of electronic payment instruments (payment cards, electronic fund transfers etc) and the volume of electronic transactions is on the rise over the past years. When asked which channels they use to make common transactions (e.g., transfers, balance enquiries, withdrawals, deposits, etc.), most South African consumers report relying on in-person transactions at ATMs (66 percent), retail store tills (30 percent), and bank branches (22 percent). Usage of remote and/or digital channels is relatively less common with 19 percent of consumers reporting using cellphone banking via a feature phone, nine percent reporting using banking apps, and six percent reporting using internet banking via websites (Figure 5). Multivariate regression analysis indicates that consumers in lower LSM categories and those with less education are less likely to report using banking apps or internet banking for common transactions (Annex 1). It is important to note that the availability and innovation of transaction channels are constrained by the absence of non-bank payment service providers in the market (e.g. mobile money account). Costs – both direct and those resulting from data and internet charges – are also a relevant constraining factor, as further discussed in Section VII.A. Figure 5: Consumers rely on ATMs and retail agents for common transactions, with limited uptake of banking apps and internet banking 70 66 60 % of adults age 16+ 50 40 30 30 22 19 20 9 10 6 0 ATM Retail store till Branch Cellphone Banking app Internet banking banking (feature (website) phone) Source: FinScope Consumer Survey, 2019 7. Wages and social grant transfers have been almost fully digitized, while remittances are largely sent via over-the-counter transfers at retail outlets. Over 90 percent of those receiving wages (from public or private sector) report receiving their wage payments directly into a bank account. A key caveat is that most South Africans are not formally employed. Among those receiving social grants, 83 percent report receiving their payment via a card and 15 percent report receiving their payment directly into a bank account. The most 17 SOUTH AFRICA commonly reported means of sending money to family or friends outside of a respondent’s household is via money transfers at supermarkets or retailers (55 percent), followed by sending cash directly with a relative or friend (18 percent) and ATM transfers (18 percent). 8. Bank customers place a high value on low fees and convenient access to reliable banking infrastructure. When asked to identify the features of their bank account that are most important to them, banked adults cite “conveniently located ATMs” (51 percent), “ATMs are always working and always open” (45 percent), “total fees / monthly charges” (45 percent) and “conveniently located bank branches” (32 percent). Despite the ongoing digital transformation of the banking sector and the entrance of new “digital-only” banks, most consumers do not yet place a high value on digital banking services; just eight percent of consumer selected “a fully digital banking service” as an important feature for them. 9. Approximately one-third of South African adults report some type of saving behavior. Overall, 36 percent of South African adults report saving. Multivariate regression analysis indicates that women, those in higher LSM groups, adults above age 30, and those with more education are more likely to report using at least one type of savings instrument. 10. Bank accounts are the most commonly used savings mechanism, and most savers do not mix formal and informal savings mechanisms. Bank accounts are the most commonly reported saving instruments among South African adults (reported by 15 percent of adults), followed by saving cash at home (13 percent) and investment products (nine percent), and stokvels or umgalelos10 (nine percent). Overall, a roughly equivalent share of South Africans report using informal savings mechanisms only (14 percent) versus formal savings mechanisms only (13 percent). Just eight percent report using a mix of formal and informal savings mechanisms (Figures 6 and 7). Figure 6: Bank accounts are most commonly used savings mechanism Stokvel account with bank 1 3 Via family 1 4 Savings club/group 2 5 Stokvel or umgalelo 6 9 Main saving mechanism Investment product 6 9 Currently uses to save At home 8 13 Bank account 9 15 0 2 4 6 8 10 12 14 16 % of adults age 16+ Source: FinScope Consumer Survey, 2019 10 Stokvels are informal saving clubs. 18 SOUTH AFRICA Figure 7: Most savers do not mix formal and informal savings mechanisms Formal and informal 8% Formal only 13% Informal only 14% None 65% Source: FinScope Consumer Survey, 2019 11. Food and funeral expenses are the most commonly reported reasons for saving. South Africans report saving for a diverse set of purposes, but the most commonly reported reasons for saving are for food (15 percent), saving for funeral costs (11 percent),11 saving for school fees and education (eight percent), and saving to provide for their family in case of death (eight percent). Relatively few South Africans report saving for retirement / old age (five percent). 12. One in five South Africans reports that he or she has borrowed in the past year or is currently paying off debt. Twenty-two percent of adults report having borrowed money in the past year (including goods on credit) or that they are currently paying off debt, from any source (Figure 8). Overall borrowing behavior is more prevalent among adults age 30-59, those who are employed, adults in higher LSM categories, and adults with more education. These differences are statistically significant in multivariate regression analysis (Annex 1). 11 Not necessarily equivalent to uptake of funeral cover. 19 SOUTH AFRICA Figure 8: Borrowing is most prevalent among middle-aged consumers, those in higher LSM categories, and those with more education Source: FinScope Consumer Survey, 2019 13. Family and friends are the most commonly reported source of borrowing, followed by banks. Six percent of adults report having borrowed money from family or friends and five percent report having borrowed money from a bank in the past year. Three percent report having borrowed from a retail store, and two percent from a mashonisa12 (self-reported borrowing from the latter can be difficult to measure). 14. Most borrowing by individuals is oriented towards consumption and day-to-day living expenses. The most commonly reported reasons for taking out a loan among South African borrowers are food (32 percent), clothes (20 percent), and home repair, construction, or purchase (19 percent). 13 Overall, borrowing for consumption and day-to-day needs (marked in orange in Figure 9) is significantly more prevalent than borrowing for investment or productive purposes (marked in blue in Figure 9). The need to borrow for day-to-day living expenses undoubtedly reflects the financial stresses and economic exclusion challenges faced by most South African households. The 2019 FinScope found that about 2 in 5 adults experience challenges with income not covering their living expenses, although the primary means of addressing such shortfalls was to reduce spending or draw on savings. A more detailed discussion on trends in consumer credit and over-indebtedness is included in Section IX. 12 The mashonisa are informal money lenders that are not registered with NCR. 13 Corresponding to the source from which the borrower has the largest loan. 20 SOUTH AFRICA Figure 9: Most borrowing by individuals is for consumption and day-to-day living expenses Food 32 Clothes 20 Home repair, construction or purchase 19 Buy or repair motor vehicle 13 Transport fees or car repair 13 Bills 12 Education (child or own) 11 Just to last until I get money next 10 Consumer good (TV, fridge, phone) 9 Give to another family member 7 Start or invest own business 5 Monthly fees, eg burial, stokvel 5 Medical / hospital expenses 4 Funeral expenses 3 0 5 10 15 20 25 30 35 % of borrowers reporting loan purpose Source: FinScope Consumer Survey, 2019 15. Almost three in five South Africans report having some type of insurance, with funeral cover provided by non-banks representing the most commonly held insurance product. According to the 2019 FinScope survey, 21 percent of South African adults report having insurance from a bank, 37 percent report having insurance from a regulated non-bank provider, and 33 percent report having insurance from an unregulated provider (e.g., funeral parlour or burial society). Funeral cover is the most commonly held insurance product, reported by 53 percent of adults. When excluding funeral cover, the share of South Africans with an insurance product drops to 21 percent, largely comprising life insurance (12 percent of adults), physical asset insurance (11 percent of adults), and health insurance (nine percent). The prevalence of funeral cover has increased significantly in recent years. South Africans without non-funeral insurance cite affordability as the key barrier to taking up an insurance product. B. Access to Finance for MSMEs 16. While overall credit to the private sector in South Africa remains robust, the micro, small and medium-sized enterprise (MSME) segment remains underserved by the formal financial sector. South Africa’s share of private sector credit to GDP was 66.7 percent in 2019, well above the median value for Sub- Saharan African countries of 15.9 percent and other upper-middle income countries of 48.2 percent (Figure 10a), but slightly lower than its level in 2010.14 Total outstanding business loans have increased in the last decade in nominal terms, but the share of bank lending to SME finance has declined from 28 percent in 2010 to 12 percent in 2020 (Figure 10b). MSMEs are vitally important to the economy, employing between 50-60 percent of South Africa’s work force and contributing around 34 percent of GDP.15 Yet estimates of the MSME credit gap between supply and demand are substantial, ranging from US$5.2 to US$20.7 billion in a 2018 Finfind study16 14 IMF. International Financial Statistics (IFS). 2019. 15 IFC. The Unseen Sector: A Report on the MSME Opportunity in South Africa. 2018. 16 Finfind. Inaugural South African SMME Access to Finance Report. 2018. 21 SOUTH AFRICA to US$30 billion (US$24 billion for the informal sector and US$6 billion for the formal sector) in a 2018 IFC report, which amounts to 9 percent of GDP.17 Figure 10: Evolution of Private Sector Credit in South Africa a. Private Sector Credit to GDP (%) b. SME Loans and Total Outstanding Business Loans (million Rand, percent) Source: IMF International Financial Statistics; FSAP Analysis of SARB data 17. There are multiple definitions of what constitutes an MSME in South Africa that make reporting and comparison of data challenging. • South Africa’s Small Business Act of 1995, as amended in 2003, classifies firms based on number of employees, level of turnover and level of assets, with different thresholds for different sectors.18 • The South African Reserve Bank (SARB) requires banks to report exposure to MSME borrowers, defined as corporate SMEs that have reported sales of less than ZAR400 million and retail SMEs with a credit exposure equal to or less than ZAR12.5 million. • The COVID-19 loan guarantee scheme to support small and medium enterprises in South Africa, initiated by the National Treasury, the South African Reserve Bank (SARB) and the Banking Association South Africa (BASA) targeted businesses with a turnover of under ZAR300 million In addition, global firm surveys also apply different definitions, such as 2020 World Bank Enterprise Survey data which covered registered establishments applying a standard definition used globally based upon number of employees: small (5 to 19 employees), medium (20 to 99 employees), and large (100 or more employees).19 18. What constitutes formality in South Africa also varies. Some adopt the payment of income tax in a binary definition with others looking at multiple factors such as business registration, compliance with VAT and other taxes, ownership structure and customer base. Estimates of the share of formal firms in South Africa vary from 14 percent20 to 32 percent.21 Although this note covers the challenges of MSMEs, data are presented for SMEs if broader data are not available. 17 IFC. The Unseen Sector: A Report on the MSME Opportunity in South Africa. 2018. 18 The Act (available at https://www.gov.za/documents/national-small-business-act ) distinguishes between categories by number of employees include micro enterprises (less than five employees), very small enterprises (five to less than 20 employees), small enterprises (20 to less than 50 employees) and medium enterprises (50 to less than 200 employees) and includes annual revenue and asset thresholds vary depending on industry, for example community, social and personal services and the wholesale sector. 19 The World Bank. 2021. “The South Africa 2020 Enterprise Surveys Data Set.” 20IFC. The Unseen Sector: A Report on the MSME Opportunity in South Africa. 2018. 21 Small, Medium and Micro Enterprise Sector of South Africa, Research Note No. 1. 2016 No 1, commissioned by SEDA 22 SOUTH AFRICA 19. The share of SMEs with credit is much lower in South Africa than in income and regional peers. World Bank Enterprise Survey data from 2020 (Figure 11a) show that most formal SMEs have transactional accounts, but less than 4 percent of formal SMEs in South Africa report having a credit line, well below regional and income peer levels for SMEs (20 and almost 40 percent respectively). Just 4.8 percent of small firms and 5.6 percent of medium sized firms reported having a bank loan or line of credit in the 2020 World Bank Enterprise Surveys, similar to the 4 percent of business owners who reporting a personal loan in the Finscope 2019 consumer survey and the 3 percent of MSMEs reporting credit in the Finscope SMME 2010 study. 20. Use of transaction accounts is far higher than use of formal credit. World Bank Enterprise Survey data also show that SME access to checking or savings accounts exceeds 90 percent for both small and medium sized firms. The Finscope SMME22 2010 study which included informal firms across a range of sectors indicated that only 49 percent of small businesses have a business bank account, but part of this discrepancy may be explained by smaller or informal firms preferring to use their personal accounts to make business transactions. A Finscope 2019 study of use of finance by consumers showed that 70 percent of those who owned a business had a transaction or savings account, which increased to 82 percent for those with registered businesses. Figure 11: International Comparison of MSME Use of Finance a. SME Use of Financial Accounts and Credit b. Sources of Funds for Investments Source: World Bank Enterprise Surveys 2020 21. SME investments are largely financed by internal funds. Figure 11b shows the sources of investment finance for South African small and medium sized South African firms in comparison to their regional and income group comparators. Small South African firms that invest are highly dependent on internal sources, using them to finance 87 percent of their investments, in contrast to the average firm in upper middle income countries which finances 68 percent. External sources such as credit from banks (6 and 13 percent for small and medium sized firms respectively) or suppliers (1 and 5 percent for small and medium firms) may be limited by the capacity of the firm to guarantee its obligations (i.e. provide collateral). WB Enterprise Survey data indicate that 35.6 percent of loans to firms require collateral, with an average collateral value of 115.4 percent of the loan amount, both of which are lower levels on average than in the region. External equity is largely dependent on the legal form of the firm and its ownership structure, on the degree of involvement of the owners into the management of the firm and their willingness to take on new partners and the effectiveness of the stock market. 22 The term SMME (Small, Micro and Medium-sized enterprise) is often used in South Africa interchangeably with MSME. 23 SOUTH AFRICA It does not register as a funding source for small firms and is used to finance 2 percent of the investments by medium firms. 22. Firms perceive access to finance as a major constraint indicating challenges in the supply of financial services. The registered (formal) SMEs in the 2020 World Bank Enterprise Survey23 in South Africa perceived the lack of access to finance as a major obstacle, second only to access to electricity in a ranking of obstacles in the business environment. Predictably, small firms report access to finance as a problem more frequently than medium and large firms. National data mask regional socio-economic disparities, as banking infrastructure are primarily concentrated in Gauteng province, location of 56 percent of SMEs (as well as economic and political capitals Johannesburg and Pretoria.) 23. Access to finance has remained a core challenge for MSMEs during the COVID-19 period. As shown in Figure 12a, most firms, including 88 percent of small firms and 81 percent of medium sized firms, reported decreased liquidity or cash flow due to the Covid-19 outbreak. When firms were then asked how they dealt with this decreased cashflow, 4.8 percent of firms indicated that they made use of loans from commercial banks; 2 percent made use of equity finance; 1.67 percent delayed payments to workers or suppliers; 2.46 percent used government grants; while 88.7 percent of firms indicated that they had used none of the above. More than 40 percent of small and medium sized firms reported receiving government assistance, of which wage subsidies were the most common support (Figure 12b). Similarly, the Finfind Covid-19 SMME Impact Report found that existing debt, lack of cash reserves, outdated financials, no access to relief funding and an inability to operate during the lockdown has forced the closure of 42.7 percent of small businesses. For the 57.3 percent of businesses that survived lockdown, the number one business challenge identified is inability to get access to funding.24 Figure 12: Effects of Covid-19 on South African Firms a. Firms with decreased liquidity or cash flow by firm b. Forms of Government Assistance Utilized size (%) 90 88.17 83.78 Other 37.37 85 80.93 Wage Subsidies 98.14 80 Fiscal exemptions or… 0.7 74.1 75 Access to new credit 0.93 70 Deferral of credit… 1.17 65 Cash transfers for… 1.17 South Small Medium Large Africa 0 50 100 150 Source: World Bank. The Effects of COVID-19 on South African Firms: Evidence from the World Bank Group’s Enterprise Survey. 2021 (unpublished), Note multiple options permitted in Figure 12b. 24. Vehicle finance and short-term credit are the dominant products for South African MSMEs. Nearly half (49%) of bank credit volume goes to vehicle finance while 26% of credit volume goes to short-term 23 Business owners and top managers of 1097 firms were interviewed between December 2019 and February 2021 as part of the standard ES, with an additional component added to the survey instrument to focus on the effects of Covid-19. 24 Finfind. The SA SMME COVID-19 Impact Report. November 2020. 24 SOUTH AFRICA credit products such as overdraft facilities and credit cards.25 Commercial property finance (15%) and other term loans (10%) are also common credit products. Banks typically price MSME finance as high-risk in the absence of more complete credit information, relative to larger firms. 25. Invoice based financing has been gradually increasing, with both traditional factoring by banks and invoice finance by Fintech firms. According to Factors Chain International, total factoring turnover in 2019 was US$24.2 bn, up from US$22.4bn in 2013, and factoring volume as a share of GDP was 6.7 percent in 2019, far higher than the share of GDP for the median upper middle-income country. (Figure 13a). Most (83 percent) factoring volume in South Africa is domestic.26 Factoring firms in South Africa have traditionally purchased companies accounts receivable at a discount, with the leading local factors being specialist divisions of the major domestic or foreign banks. Three factoring fintechs are providing funding to SMEs through invoice financing. Figure 13: Evolution of Non-Credit Financing a. Factoring: Total Volume and Volume/ GDP (%) b. Leasing: Total Volume/GDP (%) Source: Factoring Chains International 2020 Annual Review and World Bank Finstats (2021) 26. Financing leasing is available at most major banks. Leasing volume was 1 percent of GDP in 2018 (Figure 13b). Leasing is used primarily to finance vehicles and equipment. A comprehensive review of the current legal framework for financial leasing services and factoring law would be helpful to identifying impediments to growth of these products. 27. NPLs for SMEs are relatively low compared to other countries and had been declining before Covid-19. SME NPLs had been declining from 5.2 percent in 2010 to 2.53 percent in 2017, albeit the impact of Covid-19 has led to increase in level of NPLs systemwide from end-2019 to end-2020. South Africa has a low share of NPLs to SMEs compared to other countries (Figure 14), which may signal that its financial institutions are relatively more risk-averse, which may limit the potential to finance viable firms, particularly risker firms that are innovative and have higher growth potential. 25 IFC. The Unseen Sector: A Report on the MSME Opportunity in South Africa. 2018. 26 Factoring Chains International. Annual Review: 2020. 25 SOUTH AFRICA Figure 14: Banks non-performing loans to SMEs (as % of total loans to SMEs, 2019) 45 Banks' NPLs to SMEs (% of loans to SMEs) 40 35 30 25 20 15 10 5 0 Source: WBG on OECD Financing SMEs and Entrepreneurs (2019)27 II. PUBLIC AND PRIVATE SECTOR COMMITMENT AND STRATEGY A. Financial Inclusion for Individuals 28. Financial inclusion has been a policy priority in South Africa since at least 2004. The Financial Sector Charter was established in 2004 as a voluntary effort through which financial sector stakeholders from the public sector, private sector, and civil society set collaborative financial inclusion targets.28 The Charter was replaced by the Financial Sector Code in 2012 and later aligned with Broad-Based Black Economic Empowerment (B-BBEE). The Financial Sector Code is legally binding and governed via the Financial Sector Transformation Council. The 2012 National Development Plan (NDP) acknowledged financial inclusion as enabler of the national goals of eliminating poverty, reducing inequality, and achieving full employment, decent work, and sustainable livelihoods for all. The 2012 NDP included a target of 90 percent “banked” by 2030 (according to FinScope, this value was 81 percent as of 2019). 29. The 2017 Financial Sector Regulation Act (FSR Act) further establishes financial inclusion as a key policy and institutional objective. FSR Act identifies financial inclusion as one of the eight objectives of the revamped financial sector regulatory and supervisory framework. The FSR Act defines financial inclusion as a key objective of both the Prudential Authority and Financial Sector Conduct Authority. The FSR Act also 27 OECD, Financing SMEs and Entrepreneurs, 2019 (Figure 1.24: SME non-performing loans). 28A key initiative of the Financial Sector Charter was the introduction of Mzansi accounts in 2004, a joint initiative by large banks to improve access to basic bank accounts. 26 SOUTH AFRICA requires the formation of a financial inclusion working group within the Financial System Council of Regulators.29 30. A 2020 draft Policy Paper by National Treasury outlines a policy framework for financial inclusion. The Policy Paper, “An Inclusive Financial Sector For All,” establishes eight principles, covering, inter alia, universal access and responsible usage; competition and diversity in service providers; technological innovation; proportionality in regulation and supervision; effective stakeholder coordination; and data infrastructure. The Policy Paper also establishes three key pillars to structure the national financial inclusion reform agenda: (1) Deepen financial inclusion for individuals; (2) Extend access to financial services for SMMEs; and (3) Leverage a more diversified provider and distribution base. The Policy Paper identifies a range of potential reforms to pursue under each pillar. As of May 2021, the consultation process for the Policy Paper is ongoing. 31. A Financial Inclusion Implementation Strategy is under development. The National Treasury is leading the development of a Financial Inclusion Implementation Strategy (referred to as a “National Financial Inclusion Strategy” in many countries) following the three-pillar framework established in the Policy Paper. The Financial Inclusion Implementation Strategy is expected to contain a detailed action plan, as well as monitoring and evaluation system to track progress and identify implementation bottlenecks. The National Treasury is in the process of establishing the National Financial Inclusion Sub-Working Group – comprised of relevant public sector authorities - to guide the development of the Strategy. A complementary Financial Inclusion Forum (FIF) is expected to be established as a platform where industry and other non-governmental stakeholders can engage with policymakers and regulators. 32. The effective design and implementation of a Financial Inclusion Implementation Strategy will require a focused and well-coordinated effort. More than 50 countries have launched a National Financial Inclusion Strategy (NFIS) and many more are in the process of developing such an approach. South Africa’s Financial Inclusion Implementation Strategy should address obstacles and opportunities in a complex institutional environment where financial inclusion has long been a policy priority. International experience has shown that effective NFISs are generated from an inclusive consultation process. Yet complex governance arrangements can also serve as an obstacle to implementation; focused institutional leadership and a delineated action plan with clear responsibilities for relevant stakeholders can help to reduce roadblocks during implementation. The Financial Inclusion Implementation Strategy should address persistent and structural barriers to financial inclusion, including related to provider diversity and innovation, reaching ‘last mile’ consumers, reducing barriers to the integration of formal financial services in the daily lives of South Africans, and the responsible le provision of productive credit. These topics are discussed in more detail in this note. 33. A robust data infrastructure is necessary to monitor progress and identify bottlenecks in expanding financial inclusion. The annual FinScope Consumer and MSME Surveys provide rich, demand-side data on the uptake and usage of informal and financial services by individuals and firms. The FinScope Surveys also generates useful data on the views and preferences of financial consumers. However, there are significant limitations in the supply-side financial inclusion data infrastructure, including related to retail agents, geospatial- 29Members of this Financial System Council of Regulators includes the National Treasury, the FSCA, the PA, the Department of Trade and Industry, the National Credit Regulator, the National Consumer Commission, the Department of Health, and the Council for Medical Schemes. 27 SOUTH AFRICA linked data on financial access points, the unsecured credit and credit facilities market, and over-indebtedness. Similarly, collecting and sharing aggregate data on the number of those applying for consumer and MSME loans, rejection rates and reasons for rejections, financing terms (including use of collateral) for those who received credit as well as credit quality information (ex: NPLs) disaggregated by firm size would be useful to better assess financing constraints. These gaps constrain the ability of financial sector authorities to identify constraints to achieving key financial inclusion objectives (e.g., physical access) and design responsive policy, regulatory, and supervisory approaches. Financial sector authorities should prioritize improvements in financial inclusion data infrastructure at the institutional level, as well as coordinate to generate comprehensive datasets and reports that can provide regular, national, and cross-sectoral overviews of key supply-side and demand-side financial inclusion indicators. Box 1: Key Success Factors for NFIS Development and Operationalization The World Bank’s Toolkit for Developing and Operationalizing a National Financial Inclusion Strategy identifies ten success factors based on the NFIS experiences of dozens of countries: 1. Early and sustained engagement of relevant stakeholders—including the private sector—to create broad buy- in and align efforts across financial and nonfinancial policy areas 2. Investment in data and diagnostics work to ensure that the NFIS is grounded in a robust evidence base and accurately identifies constraints and opportunities relevant to the achievement of greater financial inclusion 3. Identification of high-level champions within key institutions who can integrate relevant NFIS actions into institutional work plans and advance their implementation 4. Clear articulation of NFIS objectives and targets to ensure a shared understanding of expected outcomes 5. Prioritization of forward-looking NFIS actions that emphasize digital approaches, proportionality, and the needs of financial consumers 6. Establishment of inclusive but efficient governance arrangements to facilitate collaboration and consultation throughout the NFIS implementation period 7. Mobilization of resources prior to NFIS launch —including those needed for “quick win” actions and Secretariat staff—to build momentum and demonstrate credibility 8. Effective communication and branding of the NFIS, including the signaling of early implementation successes 9. Flexibility to adapt NFIS elements during implementation to reflect market developments and emerging policy priorities 10. A well-resourced and robust M&E system to track implementation progress, identify bottlenecks, and inform course corrections Source: World Bank, 2018. Toolkit for the Developing and Operationalizing a National Financial Inclusion Strategy. B. Access to Finance for MSMEs 34. Expanding access to and quality of financial services for MSMEs is a goal encompassed in South African development strategies. To support economic growth and job creation, South Africa’s National Development Plan 203030 emphasizes the importance of strengthened financial services to bring down their cost and improve access for small and medium sized businesses. Similarly, extending access to financial services for MSMEs is one of the three pillars of the draft Financial Inclusion policy framework: An Inclusive Financial 30 National Development Plan 2030: Our future - make it work, August 15 2012 28 SOUTH AFRICA Sector for All. In addition, National Treasury, in partnership with the Department of Small Business Development, has conducted a series of consultations with stakeholders around priority areas to enhance financing to the MSME sector which gave rise to the SMME Access to Finance Action Plan. 35. The Government of South Africa has several institutions which manage government financing programs to reduce the MSME finance gap. National government financing for MSMEs in South Africa is managed by the Industrial Development Corporation (IDC), the Department of Trade, Industry and Competition (DTIC), the Department of Science and Technology, and the Department of Small Business Development (DSBD), which includes the Small Enterprise Finance Agency (SEFA). A 2019 World Bank report on Financing Small Business in South Africa showed that more than 52 programs targeting MSMEs were available through these institutions, ranging in annual commitment sizes from less than ZAR100,000 to 50 million. In FY2018, these government programs had an estimated annual budget of about ZAR18 billion (0.36 percent of GDP, or 2.8 percent of outstanding business lending to SMEs), supporting more than 46,000 small businesses.31 36. The government plays a role in promoting credit to MSMEs through direct and wholesale lending and guarantees. IDC debt financing programs provide direct MSME financing only. Indirect financing options, where the government provides financial resources to commercial financial providers, include SEFA‘s wholesale lending and guarantee programs. The total SEFA loan portfolio in the 2019/20 financial year including funds was ZAR1.9 billion, 63 percent of which was wholesale lending.32 A relatively small guarantee program (ZAR248 million in 2019/20 guarantees issued) is administered by SEFA’s Khula Credit Guarantee Fund to reduce the risk of lending in that segment, while a ZAR200 bn COVID-19 loan guarantee scheme was initiated in 2020 as an emergency support to SMEs and was closed in June 2021 (discussed in greater detail in the section on Key Government Initiatives). C. Fintech 37. South Africa has a relatively small but growing Fintech market and ecosystem, and the South African regulators have taken several initiatives in response to the Fintech developments. The substantial gaps in uptake and usage of traditional financial services is creating a demand for innovations. The Fintech market is benefiting from several accelerators – both independent and ones managed by incumbents - and venture capital firms. The financial sector regulators have adopted a balanced position of harnessing the potential of Fintech whilst mitigating risks. A dedicated unit has been established in the SARB and FSCA to monitor and shape the respective regulators policy response, this has been followed by launch of a “Fintech Program”, which is focused on analyzing and tracking market developments and assisting regulators in developing suitable policy responses. The SARB launched “Project Khokha” - their exploration on usage of Distributed Ledger Technology (DLT) for the core functions of SARB in the payments and settlements arena. The regulators and public agencies have also established an Inter-governmental Fintech Working Group (IFWG) to collectively study, deliberate and initiate coordinated actions. The activities of the fintechs and incumbents using fintech approaches has been focused more on the underbanked rather than un-banked; there are however some early signs of efforts to develop tailored products and services targeting the un-banked. 31 World Bank. Financing Small Business in South Africa: A Snapshot of Government Programs. 2019. 32 Small Enterprise Finance Ageboxncy (SEFA). Annual Report. 2020 29 SOUTH AFRICA 38. The IFWG was created in 2016 as a mechanism for regulators and public authorities to collaborate in promoting responsible innovation in the financial sector. The founding members of IFWG included the SARB, FSCA, National Treasury (NT) and Financial Intelligence Center (FIC). The membership was expanded subsequently to include National Credit Regulator (NCR), South African Revenue Service (SARS), and Competition Commission (CC). The IFWG published a Fintech vision document in August 2020. The IFWG established an Innovation Hub in April 2020 offering three sets of services: Regulatory Guidance Unit (RGU), Regulatory Sandbox and Accelerator. The IFWG also organizes – Hub Talks – which provides a forum for the IFWG members, fintech industry and public at large to hear perspectives of domestic and international experts on various topical issues. The IFWG developed a Fintech vision document and conducted a fintech landscaping exercise. Summary of Main Recommendations: • Establish a financial inclusion implementation strategy with an action plan and monitoring and evaluation system • Strengthen financial inclusion data infrastructure, including through collection of data on retail agents and geospatial data on access points • Issue an annual report with comprehensive demand-side, supply-side and cross-sectoral indicators to monitor financial inclusion progress and bottlenecks III. PROVIDER DIVERSITY AND INNOVATION A. Overview of Provider Ecosystem 39. The South African financial sector is bank-centric. The vast majority of financially included adults in South Africa are bank customers. Cooperative Banks and Cooperative Financial Institutions have a very limited reach, jointly accounting for just 30,000 members. Unlike many of its regional peers, South Africa does not currently have a regulatory framework in place for non-bank payment service providers (or e-money issuers). The following subsections provide a brief overview of the financial service providers relevant to financial inclusion in South Africa. A more detailed discussion of Fintech providers can be found in the FSAP Background Note on Fintech. Type of financial service provider Number of Total assets Number of institutions (R millions) customers Registered banks and mutual banks* 23 6,121,334 33,100,000** Co-operative banks 4 210 4,280 Registered co-operative financial institutions 23 213 25,911 Credit providers 7,837 n/a 25,200,000*** Non-life insurers 83 199,929 Life insurers 76 3,136,346 Source: NCR (2019); Prudential Authority Annual Report (2019/2020); Notes: *There are also 17 local branches of foreign banks; **Author estimate based on 2019 FinScope data; ***Refers to credit- active consumers; 30 SOUTH AFRICA B. Banking Sector 40. The banking sector is highly concentrated among the ‘big five’ banks. As of March 2020, the five largest banks (i.e. the ‘big five’) hold 89 percent of total assets. (See the FSAP Technical/Background Note on Competition for a more extensive discussion on banking sector concentration.) 2019 FinScope data confirms that the ‘big five’ also dominate the financial inclusion landscape, jointly accounting for 77 percent of banked customers’ “main bank” (self-reported). Figure 15. ‘Big Five’ banks represent 77 percent of banked consumers XA: Share of customers reporting as their “main bank” XB: Share of total assets Other Capitec Other Nedbank banks SASSA 2% banks 2% 9% FirstRand 21% 15% Standard 21% 9% Absa Nedbank 11% 18% Absa 20% Capitec FirstRand 34% 14% Standard 24% Source: NCR (2019); Prudential Authority Annual Report (2019/2020) 41. The banking sector is investing significant resources in digitization. Many banks have digital strategies to modernize their products and delivery channels and to enable the use of digital data for decision making purposes.33 Banks offer a wide range of electronic payment instruments (payment cards, electronic fund transfers etc) and the volume of electronic transactions is on the rise over the past years. 42. Disruptive innovation in the banking sector has seen more digital banks enter the market. Three new “digital banks” - Tyme Bank, Discovery Bank, and Bank Zero – have entered the retail banking market in the past several years. TymeBank began as a fintech focused on mobile payments but following a shift in strategy and ownership changes, began operating as a bank in November 2018. TymeBank offers transactional and savings accounts that can be opened via kiosks Pick n’ Pay locations. Discovery Bank began operations in June 2019 focused on consumer lending via credit cards, and has since expanded to transaction and savings accounts that can be opened remotely via mobile phone. Bank Zero received a mutual bank license in August 2018 but has not yet fully launched. The business models of the new “digital bank” entrants have benefitted from the shift towards a risk-based approach to KYC in the 2017 FIC Amendment Act that has enabled greater automation the 33 As per estimates in 2016, major banks in South Africa spend between 10 percent and 18 percent of operating costs on IT expenditure according to the COEFS “Impact on Fourth Industrial Revolution on South Africa Financial Services” report. 31 SOUTH AFRICA customer onboarding process (including via remote processes), as well as partnerships with large retailers to facilitate account opening and basic transactions. The current reach of these new entrants is not reflected in the 2019 FinScope data used in Figure 13. 43. Among large, incumbent banks, Capitec stands out for its retail banking strategy and strong customer growth in recent years. Capitec is the youngest bank among the ‘big five’ and accounts for just two percent of banking sector assets. However, 34 percent of banking customers in South Africa report that Capitec is their ‘main bank’ – the next largest bank by this metric is FirstRand, with 14 percent of banking customers.34 Among those that report having opened their first bank account in the past two years, 47 percent report being a Capitec customer. 44. The banking sector is also the dominant player in the retail credit market, although retailers play a significant role. Despite the large number of registered credit providers, banks are the dominant provider of consumer credit in South Africa, accounting for 83 percent of the loan portfolio by volume and 44 percent of the number of loan accounts. The other categories of lenders used by NCR are retailers, non-bank vehicle financiers and other credit providers. The respective market shares of each category of lender have been relatively stable over time. 45. Bank lending is the most common source of financing for MSMEs. Banks represent about 70 percent of the current loan volume to formal MSMEs. Commercial banks cite common challenges to serving MSMEs such as: i) business risk being too high/not sustainable, ii) inadequate business plan depicting the business model, iii) requests for funding that do not match evidence of work commitments, and iv) business owner’s personal track record. New business models and the use of alternative data may offer the solution to some of these challenges. Alternative lenders serving SMEs that are unregulated in terms of the NCR/NCA such as Merchant Capital, Retail Capital, Lulalend, and Prizm, focus on unsecured lending products, and are discussed in greater detail in the Fintech background note. C. Payment Service Providers 46. The existing legal framework in South Africa allows only banks, Mutual Banks or Cooperative Banking Institutions to handle customer funds in a bank account or as an e-money account. As a result, only these institutions can offer payment services to payers. The South Africa Banks Act limits the activities of taking deposits and of provision of payment services to banks. The Banks Act (No. 94/1990), as amended, provides for the regulation and supervision of the business of taking deposits from the public. Article 1 of the Act sets out definitions for a deposit and the business of a bank. In the context of payment services, a deposit is a ‘particular type of payment’ and can only be intermediated by an entity that is defined as a bank. In other words, a ‘non-bank’ cannot accept deposits, unless sponsored by a bank. Mutual Banks and co-operative financial institutions are also expressly allowed to manage customer funds and offer payment services to payers. 47. Amendments to the National Payment System Act (NPSA) and subsequent directives issued by SARB in 2007 allowed non-banks to offer services incidental to making payments to the payers and payees and this has allowed non-banks to play a role in e-commerce, bill payments and merchant payments. The 34The vast majority of banked customers report having only one banking relationship, with just 12 percent reporting having an account with more than one bank. 32 SOUTH AFRICA Section 7 of the NPSA, allows a person, as a regular feature of that person’s business, to accept money or payment instructions from any other person for purposes of making a payment on behalf of the first person, to a third person, to whom the payment is due. This provision was further elaborated in the Directive No. 1 of 2007, for the conduct within the National Payment System in respect of payments to Third Persons, explicitly allowing non-banks to offer such services and the entity providing such services were called Third Party Payment Providers (TPPPs). There are now several TPPPs in South Africa operating as payment gateways for e- commerce, bill payment aggregators and also as merchant aggregators – signing up and servicing merchants on behalf of acquiring banks for accepting card payments and other digital payments. A subsequent Directive No 2 of 2007, created an additional category called “System Operator” (SO) that can provide services to the payers and payees in processing payment instructions. Non-banks were explicitly allowed to offer SO services and this is being used by Fintechs that want to provide services to merchants without handling funds. 48. The SARB has proposed to expand the role of non-banks in the national payments system. The SARB has issued a policy paper reviewing the current legal and regulatory framework governing the NPS and has proposed several transformational changes. This is currently being discussed with the Government and other financial sector regulators. The changes include opening the NPS to non-banks allowing them to issue e-money, process domestic remittances, offer payment services independently, be eligible for membership of PASA and be eligible for becoming a clearing participant and to maintain settlement account at SARB. 49. Legislative reforms to provide a direct role to non-banks in the provision of payments services should be fast tracked. The reform agenda outlined in the payment systems vision 2025 and the position paper on the changes required in the NPS Act are comprehensive. However, while the system enhancements are well- underway the legislative changes are still pending and will need to be fast tracked. The legislative reforms seeking to provide a direct role to non-banks in the provision of payment services are directly related to addressing the gaps in usage of digital payments across income segments. The related reforms of streamlining access to payment systems for non-banks goes hand-in-hand with allowing non-banks to play a direct role. Globally there are two routes that have been followed for enabling a direct role for non-banks in payment services: (i) create a distinct category of e-money as a prepaid payment product which is distinct from bank accounts and not considered a “banking activity”; and (ii) develop a new tier of banks that are only allowed to offer payment services – also called narrow banks or payment banks. Countries that have adopted option (i) include Kenya, Uganda, Tanzania, Indonesia and Hong Kong. Nigeria, India and Brazil are some of the recent examples of countries following option (ii). Some countries have taken both options – for example, India allows both non-bank issuance of e-money and payment banks. These changes will need to be accompanied by enabling the non-bank entities to engage agents and apply tiered customer due diligence requirements for both customers, agents and merchants. 50. Remittance services are provided by Money Transfer Operators (MTOs) which can be further categorized into cross-border MTOs and Domestic MTOs. While cross-border MTOs can operate as independent entities (without partnering with banks), domestic MTOs are required to partner with registered banks to be able to provide such services. There are several such domestic MTOs in operation engaged in person- to-person remittances operating in a closed loop environment. 33 SOUTH AFRICA D. Venture Capital/Private Equity 51. Venture capital is growing quickly from a low base, but there remains a gap for early-stage financing. For venture capital, which tends to be invested in early-stage investments, 162 deals totalling 1.23 billion were reported in 2019, 35 with the average round for all active deals stands at R8.43 million. Funding for start-ups remains limited. Venture capital – also considered early-stage investment – is different from private equity in that funds are provided to start-ups or small businesses that are expected to show exponential growth. This form of investment can be considered higher risk than private equity since those businesses often still have to fully prove their model. Although South Africa has a developed PE/VC market, the vast majority of funds are channelled into late-stage investments – less than 4 percent of PE funds under management go towards early- stage investments, and VC funds earmarked for start-ups equate to less than 2 percent of funds committed to later stage investments.36 Private equity investments are also considered to include venture capital funds and angel investors, as well as crowdfunding, which is at a nascent stage in South Africa, with just one active firm. 52. Section 12J of the Income Tax Act, was introduced in 2008 to encourage investments in start-ups and SMEs that could help to create jobs and stimulate economic growth, was abolished in 2021. Rather than investing in small businesses and riskier ventures, the majority of the S12J investments were “low risk” in sectors such as property that offered more guaranteed returns. Some government programs offer equity finance to MSME, typically blended with debt financing, as discussed in the section on Government initiatives. Challenges to the expansion of equity finance sources include competition for a limited pool of funding and few specialized fund managers that focus on early-stage SMEs. E. Cooperative Banking Institutions 53. Cooperative Banking Institutions do not currently play a meaningful role in financial inclusion in South Africa. Cooperative Banking Institutions in South Africa comprise 31 registered Cooperative Financial Institutions (CFIs) and six licensed Cooperative Banks (CBs).37 While cooperative financial institutions play an important financial inclusion role in many countries in Sub-Saharan Africa (e.g., Rwanda, Lesotho) and worldwide (e.g., Ecuador, Ireland), Cooperative Banking Institutions in South Africa reach only an estimated 30,000 members, representing less than 0.1% of the customer base of banks. One Cooperative Bank accounts for approximately one-third of all Cooperative Banking Institution members. The membership base of Cooperative Banking Institutions has remained relatively stagnant over the past decade (0.7 percent annual growth), although asset growth has been more significant (18 percent annual growth). Cooperative Banking Institutions typically serve small, well-defined communities including labor unions or affiliated groups of public sector workers (e.g. teachers or police). Most Cooperative Banking Institutions offer basic deposit and loan products. 54. Cooperative Banking Institutions have a well-developed legal and supervisory framework. Cooperative Banking Institutions are governed under the 2008 Co-operative Banking Act, which also established the Cooperative Bank’s Development Agency (CBDA) within National Treasury. For several years the CBDA 35 South African Venture Capital and Private Equity Association (SAVCA). SAVCA 2020 Venture Capital Industry Survey. 2020. 36 IFC. The Unseen Sector: A Report on the MSME Opportunity in South Africa. 2018. 37 A CFI must have at least 200 members and R100,000 in shares to be registered. A CB must have R5 million in deposits and meet more stringent prudential requirements. Many of the registered CFIs have applied for a CB license but have not been able to meet the requirements, e.g. related to capital adequacy. 34 SOUTH AFRICA played a dual role as a development agency and supervisor for Cooperative Banking Institutions, however following the “twin peaks” reform in 2018 the supervisory function was shifted entirely to the Prudential Authority. The CBDA currently focuses on the training and development for Cooperative Banking Institutions. (A CBDA initiative to establish a shared core banking platform for the industry was recently abandoned.) The existence of a dedicated development agency and legal and supervisory framework for Cooperative Banking Institutions in South Africa represents a significant indication of government support for the sector and is a notable advantage relative to similar institutions in other countries.38 55. Several factors constrain the development and growth of the Cooperative Banking Institution sector in South Africa. Recent diagnostic work by the World Bank identified several challenges that constrain the development and growth of the Cooperative Banking Institution sector in South Africa. These challenges include: (i) lack of public awareness; (ii) lack of desire for growth among some existing members and institutions; (iii) competition from banks and stokvels; (iv) lack of product diversity (e.g. payment services) and digitization; (v) limited investment in core financial management and IT systems; (vi) difficulties in the hiring and retention of mangers and staff with critical skills in retail financial services; (vii) lack of access to the national payment system; and (viii) difficulties securing a credit provider license from NCR. 56. A shared and strategic vision with effective industry leadership is needed to realize the potential of Cooperative Banking Institutions to contribute to financial inclusion. A recent survey of CB/CFI membership revealed several value propositions for Cooperative Banking Institutions relative to other financial service providers in South Africa, including shared ownership and control, economic empowerment and solidarity, and good service. Further, Cooperative Banking Institutions have the potential to reach “last mile” consumers who are currently excluded from the formal financial sector, as well as to provide banked customers with additional options for borrowing and saving. A recent World Bank report, based on consultations with Cooperative Banking Institution members and stakeholders, outlined three potential visions for the sector: (1) Improve broad-based black economic empowerment in the financial sector and expand financial inclusion to vulnerable communities; or (2) Provide a competitive, cooperatively-owned alternative to the commercial banking sector to lower the cost, and improve the quality of banking services; or (3) Improve financial literacy and community engagement through local or national government-led initiatives and cooperative institutions/stokvels. Sector stakeholders have begun discussing these options, including at a recent Indaba in March 2021. Each vision represents a viable path forward for the sector but will require effective and focused industry leadership. F. Stokvels 57. Stokvels are a key pillar of the informal financial sector. According to the 2019 FinScope Consumer Survey, 14 percent of South Africa adults belong to a stokvel or savings group. Stokvel membership is higher among women than men (16 percent vs. 11 percent). Those in LSM categories 7-8 are most likely to be stokvel members (17 percent), although membership is still above 10 percent of adults in categories 1-4, 5-6, and 9-10. 38Only 29 percent of jurisdictions report that financial cooperatives are supervised by a financial sector authority according to the 2020 International Credit Union Regulators Network Members Survey. 35 SOUTH AFRICA The National Stokvel Association of South Africa (NASASA) estimates that there are 800,00 stokvels in the country, although NASASA counts just 125,000 stokvels among its members. 58. Stokvel are primarily used for savings. Twelve percent of adults reporting that they are currently using a stokvel to save money, while just two percent report having borrowed money from a stokvel in the past year.39 NASASA estimates that roughly 10 percent of stokvels are general savings club (in which each member receives his/her accumulated savings at the end of the cycle); 20 percent of stokvels are specifically oriented towards saving for bulk grocery purchases; 25 percent of stokvels are specifically oriented towards saving for funeral and burial costs; and 45 percent of stokvels are structured as rotational savings clubs (in which members rotate receiving the accumulated savings from each meeting). 59. Most members use stokvels as a complement to products from banks and other financial service providers. 2019 FinScope data indicates that 95 percent of stokvel members have an account with a bank in their own name, a higher share than the general adult population. The use of multiple providers may reflect a tendency to rely on banks for transactional services and stokvels for savings. 60. Innovative product design and business models oriented towards the specific needs of stokvels can help stokvel members to save in a community-based but secure manner. NASASA estimates that approximately one quarter of stokvels hold an account with a bank, with each of the ‘big five’ banks holding a roughly equivalent share of this market. However there has been limited innovation in product design for stokvels, and stokvel accounts are frequently flagged for ML/FT risks because of transaction patterns. A further limitation is that ordinary members are not listed as owners on the account and therefore have limited redress rights in the case of fraud. Stokvel members also cannot leverage the stokvel’s active banking relationship to access a broader array of products and services. Innovative product design by banks to accommodate stokvel accounts and sustained engagement with stokvels could help to address some of these challenges and improve the security of stokvel savings. Financial institutions specifically oriented towards serving stokvels can also play an important role: NASASA has registered a Cooperative Financial Institution and is in the process of applying for a Cooperative Bank license. Summary of Main Recommendations: • Fast track reforms to the National Payment System act to provide a direct role to non-banks in the provision of payment services • Finalize discussions and implement a strategy to develop the Cooperative Banking Institutions sector • Assess feasibility of integrating cooperative banking institutions into the national payment system and forthcoming deposit protection scheme, with a short/medium-term focus on cooperative banks. 39 In the 2019 FinScope survey, this category also includes borrowing from burial societies. 36 SOUTH AFRICA IV. PHYSICAL REACH AND ACCESS POINTS 61. Convenient access to low-cost access points and distribution channels is necessary to enable greater usage of digital financial services. The integration of digital financial services into the daily lives of South Africans requires an ecosystem that includes a wide range of convenient and low-cost access points and distribution channels, including bank branches, ATMs, point-of-sale devices, retail agents, and mobile- and internet-enabled platforms. 62. South Africa has a lower penetration of bank branches and ATMs than many comparator economies. Banks maintain the largest distribution networks of physical financial access points in South Africa, comprising mainly branches, ATMs, and retail stores that serve as bank agents (e.g., Pick n Pay, Shoprite, etc.). Time-series and comparable cross-country data are available only for branches and ATMs. As of 2019, South Africa reported a total of 75 bank branches and ATMs per 100,000 adults, lower than that of Brazil (120), China (104), Russia (191) and Turkey (100), but above that of India (36) (Figure 16). 63. The penetration of bank branches and ATMs peaked in 2015 and has since declined. The penetration of bank distribution networks as measured by bank branches and ATMs (relative to population) more than doubled between 2004 and 2015, reaching an all-time high of 75 access points per 100,000 adults. Between 2015 and 2019 the penetration of bank branches and ATMs contracted by five percent, reflecting an industry shift towards digital distribution models (e.g., mobile and internet banking) and low-cost access points (e.g., retail stores). There are approximately 6.5 ATMs for every bank branch in South Africa. Figure 16. Physical access points have decreased in recent years and lag behind comparator economies A: Bank branches and ATMs per 100,000 adults B: Bank branches and ATMs per 100,000 adults (2019) 90 250 # of access points per 100,000 adults # of access points per 100,000 adults 80 70 200 60 150 50 65 69 69 68 67 65 40 55 57 57 58 165 51 100 30 43 102 20 29 25 26 30 96 84 50 65 10 21 10 10 10 10 11 10 10 10 10 10 0 5 7 7 6 8 9 10 19 9 15 26 16 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 South Brazil China India Russia Turkey Africa Bank branches ATMs Bank branches ATMs Source: IMF Financial Access Survey (2020) 37 SOUTH AFRICA 64. Several banks use third-party agents to facilitate customer acquisition and product usage while several banks use retail stores (e.g. Shoprite, Pep, Pick’n Pay) to facilitate transactions. Services provided by these retailers consist essentially of domestic money transfers, cash back from bank accounts (including social grant payouts), third-party bill payments, and the sale of co-branded access-type accounts. For example, ABSA bank has a relationship with Pep whereby co-branded PEP plus debit cards can be purchased at Pep as an off- the-shelf product. The Pep staff at the till undertake the necessary customer due diligence requirements; while Tyme Bank has teamed up with South Africa’s second largest supermarket chain Pick n Pay to roll out a money transfer service for the retailer’s loyalty programme customers. The reach of these retail stores is however limited and are largely present in only urban and sub-urban locations. 65. A lack of national and comparable cross-country data on retail agents prevents a comprehensive analysis of the penetration of financial access points. Financial sector authorities in South Africa do not currently collect data on retail agents used by banks, thus limiting a comprehensive analysis of the density and distribution of financial access points. However, retail agents account for a significant share of financial access points in many countries (Figure 17). Both Brazil and China have a roughly equivalent share of ATMs and banking retail agents. In Colombia and Indonesia, there are approximately five times as many banking retail agents as bank branches and ATMs combined. In countries with a mature ecosystem of non-bank payment providers (e.g., e-money issuers), agents of these providers are often the most prevalent financial access point. In Ghana and Zambia, for example, there are roughly fifty times as many non-bank e-money issuer agents as bank branches and ATMs combined. Improved data collection (including geospatial-tagged data) can assist financial sector authorities to identify geographic areas underserved by financial institutions, and enable comprehensive time-series and cross-country analysis of trends in physical access. Figure 17. Agents comprise a significant share of access points in countries with available data 1400 # access points per 100,000 adults 1200 1000 800 600 400 200 0 Bank branches ATMs Retail agents: banks Retail agents: e-money issuers (active) Source: IMF Financial Access Survey (2020) 38 SOUTH AFRICA 66. The use of small shops as agents and other agent models are not prevalent in South Africa due to a combination of business dynamics and expected higher compliance costs. This segment is however now attracting some attention from Banks in partnership with Fintechs. The use of small shops – also referred to as “Spaza” shops - that are more common in townships, peri-urban and rural areas, as agents is not common, and neither are agent aggregator models that are common in other Sub-Saharan African markets. As per estimates40 only 1% of such shops accept digital payments and these are largely informal with only about 50% having a bank account. This appears to be related to the challenge of reaching a “long tail” of such establishments that are not organized and hence need to be reached one by one and the underwriting costs higher relative to the likely business. Though this situation might change in the near future, as some Fintechs and banks are beginning to explore options to enable digital payments for these shops and could eventually also become agents along the lines of the more established retail store chains. In 2018, FNB bank partnered with a fintech - SelPal – which digitizes the inventory ordering of the Spaza shops41. The data on inventory ordering is expected to give better insights on the business potential of the shop and also in conducting the required due diligence before opening bank accounts and offering financial services to them. In March 202142 FNB acquired SelPal and committed itself to growing its penetration in this segment. JP Morgan is exploring solutions for Spaza merchants as well in partnership with BFA Global43. There is no dedicated legal or regulatory framework for retail agents in South Africa. A review of relevant regulatory provisions and consideration of a dedicated framework could provide clarity on existing legal or regulatory barriers that are constraining development of retail agent networks. Summary of Main Recommendations: • Identify market and legal/regulatory barriers to the greater use of Spaza shops as retail agents and agent aggregator models • Improve data collection on retail agents and geolocation data of all financial access points V. FINANCIAL INFRASTRUCTURE A. National Payments System Institutional Arrangements 67. The regulatory, supervisory and oversight powers over the National Payments System (NPS) in South Africa are allocated across four different bodies - South African Reserve Bank (SARB), Financial Sector Conduct Authority (FSCA), the Financial Intelligence Center (FIC) and the Payments Association of South Africa (PASA). • SARB – the overseer of the NPS and regulator of payment systems: The South African Reserve Bank Act, 1989 (SARB Act) defines the role and responsibilities of the SARB in the domestic payment and settlement systems. Specifically, the Act empowers SARB to “perform such functions, implement 40 https://www.ifc.org/wps/wcm/connect/region__ext_content/ifc_external_corporate_site/sub-saharan+africa/resources/202002- south-africa-msme-voice 41 https://www.reuters.com/places/africa/article/us-safrica-unbanked/in-south-african-townships-unseen-businesses-catch-a-big- banks-eye-idUSKCN1UQ0E3 42 https://businesstech.co.za/news/banking/477656/fnb-acquires-fintech-company-selpal-in-township-push/ 43 https://techmoran.com/2021/03/04/bfa-global-j-p-morgan-partner-to-digitize-spaza-shops-in-south-africas-townships/ 39 SOUTH AFRICA such rules and procedures and, in general, take such steps as may be necessary to establish, conduct, monitor, regulate and supervise payment, clearing and settlement systems”. These powers are further supplemented by the National Payment Systems Act, 1998 (NPS Act). Oversight of the NPS in South Africa to ensure its safe and efficient operations are carried out by SARB under these two framework legal statutes. • FSCA – the regulator and supervisor of payment services: The FSR Act provides for among other things the regulation and supervision of a ‘payment service’ by the FSCA to address evident conduct issues that impact customers in the payment environment. However, FSCA is required to seek the concurrence of the SARB in respect to issuance of conduct standards relating to PSPs. The SARB is working closely with National Treasury and FSCA to define the scope of FSCA in NPS that would then be included in relevant legislation.44 • FIC – oversight of the financial integrity aspects: Payment service providers are considered a “responsible entity” for the purposes of AML/CFT reporting. • PASA – self-regulatory organization for payment systems: In line with the powers in the NPS Act, the SARB has recognized the PASA as a Payment System Management Body (PSMB). PASA, as a PSMB is structured as a Self-Regulatory Organization (SRO) and its governance structure is managed by PASA Council. PASA’s mandate is to develop rules, criteria and governance structures for its members’ specific payment activities through legal agreements such as payment clearing house (PCH) agreements, PCH clearing rules and service level agreements. Currently PASA has 28 members, all of which are banks with two exceptions: Diners Club and Postbank which are “designated clearing system participants”. In addition, PASA has authorized 4 PCH system operators (Visa, MasterCard, BankservAfrica and Strate) and 80 payment system operators. The SARB in its policy paper on legal and regulatory aspects of NPS45, has proposed to do away with the SRO powers of PASA. 68. BankServ – structured as a banking consortium - is licensed as a Payment System Operator (PSO) and operates all the inter-bank retail payment systems processing credit transfers, direct debits and payment card transactions. The four largest South African Banks – First Rand, Standard Bank, ABSA and NedBank collectively own 92.5% (split equally) and the remaining share is held by a consortium of the other banks. 69. South Africa’s RTC system is operated by BankServAfrica and is offered on a 24/7/365 basis and transactions are cleared within 60 seconds. Settlement is deferred and is run 7 times a day on weekdays; twice on Saturdays; and once on Sundays and public holidays. This service is priced high by the banks and is positioned as a premium service with not all the banks offering this service. However, with the aggressive pricing adopted by some new entrants over the last few years the usage of RTC has expanded and industry wide the pricing has come down from the range of ZAR 50 per transaction to around ZAR10 and some banks even offering it free. 44 Review of the National Payment System Act 78 of 1998, Policy Paper, September 2018, SARB. 45 ibid 40 SOUTH AFRICA 70. The NPSA gives the SARB the authority to allow non-banks to join the retail payment systems as a “clearing participant”. The NPSA and associated directives allows only banks and mutual funds to hold settlement accounts and be settlement participants in the payment systems in South Africa and additionally co- operative banks as clearing participants. The SARB however is given the discretion to allow and designate non- banks to become clearing participants of payment systems. The SARB can exercise this discretion on a case-by- case basis and is required to be guided by such designation being important for maintaining the stability, integrity, effectiveness or safety of the payment system. Thus far only three non-bank institutions have been allowed to become a clearing participant – Postbank (it is an off shoot of the South African Post Office and not yet been licensed as a bank), Diners Club and Retail Assist. 71. A TPPP getting designation as a clearing participant can effectively function as an acquirer and operate independently, though it will need to appoint a settlement bank to settle on its behalf. A TPSP without a clearing participant designation, will need to partner with a bank or mutual bank to participate in a retail payment system and accept payment instruments of other institutions that participate in the payment system. Without that designation a TPPP will be required to partner with a bank or a mutual bank or offer only acceptance of proprietary and closed-loop payment instruments. 72. The payment systems in South Africa have a few gaps hampering their ability to support financial inclusion products. These gaps are intended to be addressed as part of the ongoing Rapid Payments Program (RPP). The gaps include lack of a QR code standard; standardized process for “request to pay” – wherein the payment initiation is shifted from the payee to payer; interoperability framework for mobile payments; and features like alias-based payments and third party initiated payments associated with fast payment systems. The ongoing RPP aims to address all these gaps from an infrastructure perspective and this will need to be coupled with the legal and regulatory aspects discussed below and the role of non-banks discussed above. Legal and Regulatory Framework The extant legal and regulatory framework is encapsulated in the table 2 below: Table 1: Relevant Acts and Regulations 1. South African Reserve Bank Act, No. 90 of 1989 ➢ Mandates the Central Bank to create enabling legal framework & policy in respect of payments. 2. National Payments System Act, No. 78 of 1998 ➢ The NPS Act provide for the management, administration, operation, regulation and supervision of payment, clearing and settlement systems in the Republic of South Africa; and to provide for connected matters. ➢ The NPS Act recognizes the Payments Association of South Africa (PASA) as a Payment System Management Body (PSMB). 3. Other key policies, laws and regulations for payments: ➢ Banks Act, No. 94 of 1990 that governs the issuing of banking licenses to banking institutions and monitoring their activities. ➢ Competition Act, No. 89 of 1998 to control and evaluate fair competition in South Africa Protection of Personal Information (POPI) Act which regulate the processing and protection of personal Information. ➢ The Financial Intelligence Centre Act (FICA), No. 38 of 2001 introduced to fight financial crime, such as money laundering, tax evasion, and terrorist financing activities. ➢ Electronic Communications and Transactions (ECT) Act of 2002 that regulates electronic communications and transactions. 41 SOUTH AFRICA 73. The SARB’s roles and responsibilities in the domestic payment and settlement systems are defined in the South African Reserve Bank Act, 1989 (SARB Act) and further delineated in the National Payment Systems Act, 1998 (NPS Act) and secondary legal measures issued by the SARB. The NPS act provides for the management, administration, operation, regulation and oversight of the payment, clearing and settlement system in South Africa. The key public policy objective of SARB in carrying out the Oversight of the NPS in South Africa is to ensure the safety and efficiency of the NPS under these two statutes and provision contained in other relevant pieces of legislation. 74. The FSR Act provides for among other things the regulation and supervision of a ‘payment service’ by the FSCA. However, FSCA is required to seek the concurrence of the SARB in respect to issuance of conduct standards relating to PSPs. The SARB is working closely with National Treasury and FSCA to define the scope of FSCA in NPS that would then be included in relevant legislation.46 75. The Payments Association of South Africa (PASA) was designated as a payment system management body by SARB under the NPS Act and SARB has oversight powers over PASA. PASA’s mandate under delegated authority from the SARB is to authorize retail payments system operators to operate in the South African NPS. PASA is governed by a constitution that defines its functions, structures and activities as a self-regulatory body. Currently PASA has 28 members, all of which are banks with two exceptions: Diners Club and Postbank which are “designated clearing system participants”. In addition, PASA has authorized 4 payment clearing house (PCH) system operators (Visa, MasterCard, BankservAfrica and Strate) and 80 payment system operators. 76. The PCH rules issued by the PASA govern the operation of the relevant PCH’s including on the allocation of responsibilities and liabilities. PCH Agreements govern the specific transaction types and applicable clearing rules relevant to each PCH which are agreed amongst members forming part of a participant group. The PCH Participant Group (PCH PG) is also responsible for the appointment of one or more PCH Systems Operators (PSO) for each PCH, which would be authorized by PASA to clear interbank payment instructions. These are further supplemented by Service Level Agreements (SLA) which govern the participation of members and the PSO. 77. The SARB has issued a policy paper reviewing the current legal and regulatory framework governing the NPS and has proposed several transformational changes. This is currently being discussed with the Government and other financial sector regulators. The review identifies twenty recommendations covering several themes notably – • SARB Powers: Clarifying and providing direct regulatory, supervisory and oversight powers over the NPS to the SARB to be exercised in consultation with FSCA on aspects related to financial conduct. The SARB is recommended to also have the powers to issue penalties and other punitive measures on entities in the NPS. • Non-banks: opening the NPS to non-banks allowing them to issue e-money, process domestic remittances, offer payment services independently, be eligible for membership of PASA and be eligible for becoming a clearing participant and to maintain settlement account at SARB. 46 Review of the National Payment System Act 78 of 1998, Policy Paper, September 2018, SARB 42 SOUTH AFRICA • Remove the PSMB structure: Dissolve the PSMB structure and convert the PASA into a purely consultative body. • Digital currencies: Empower SARB to regulate and provide settlement services for digital currency ecosystems including those involving Central Bank Digital Currency. • International Standards: Provisions related to recovery and resolution of financial market infrastructures in line with the CPMI-IOSCO Principles of Financial Market Infrastructures. 78. As part of implementing the legislative reforms, the SARB needs to consider giving more role to non-banks in the Governance of retail payment systems. Currently, the PASA as an SRO for the payments market and BankServ as an operator of key payment systems are fully controlled by banks. As non-banks take on more active roles in direct provision of payment services, they will need to have adequate say in the governance of these bodies. In the case of BankServ – this need not necessarily be in the form of non-banks becoming shareholders. Changes in the composition of the board of directors and board committees; and market consultation processes could be adequate. In the case of board of directors – the SARB could consider requiring a minimum number of independent directors on the board of BankServ– who can represent the wider interest of the payment system community. Similarly, critical board committees like the rules and membership committees could be required to be chaired by an independent director and have adequate representation of independent directors. 79. The SARB could adopt suitable policy and legal measures to encourage the interoperability of the various closed-loop proprietary solutions. This would need to be supplemented by QR code standardization and framework for indirect access to payment systems. The proliferation of proprietary payment instruments and payment solutions which are not interoperable is leading to fragmentation of the payments market reducing the utility of the payment instruments as only a subset of their payment needs can be met. Further, it is increasing the cost for the payment service providers and merchants to maintain multiple proprietary payment interfaces. All of this has a negative impact on the growth in acceptance of digital payments. To address this the SARB needs to develop and issue regulation mandating interoperability and adoption of open standards to enable existing closed-loop systems to become open-loop systems or to be able to become interoperable with the open loop systems. While there is a growing convergence on QR code standards used in South Africa, there is still some fragmentation and developing a common QR code standard for South Africa would be useful. Lack of standardization of QR codes could limit the impact of the upcoming Rapid Payments system and PASA and BankServ can play a coordinating role in adoption of QR code standards. There are reforms underway on allowing non-bank entities to offer payment services independently and have direct access to payment systems, this will have a positive impact on interoperability. In addition, the PASA and BankServ should facilitate the closed-loop services to become interoperable by providing them options to have indirect access and encouraging development of a code of conduct that safeguards the safety and integrity of NPS and at the same time also safeguarding the interests of indirect participants. 80. The SARB should encourage BankServ and PASA to incorporate features in the upcoming Rapid Payments product to make it an effective alternative to “Instant EFT”. The RPP program seeks to introduce alias-based and low-cost fast payment services. This might not be enough to limit the attractiveness of “Instant EFT” product. There would be a need to consider allowing third-party initiated payments either through a common API hub or standardized APIs that each participant is required to expose. Further, payment gateways and aggregators will need to be able to integrate their systems with the rapid payments system. 43 SOUTH AFRICA B. Credit Information and Secured Transactions Credit Reporting Systems 81. Comprehensive and well-functioning credit reporting systems are critical to support credit origination for individuals and SMEs. Credit reporting systems should collect in-depth positive and negative data to support the evaluation of creditworthiness of individuals and firms from all relevant credit providers, including non-financial credit providers.47 Increasingly, alternative sources of data, from sources such as companies registries, utility companies, rent, trade credit, and tuition are increasingly relevant to both Fintech and traditional credit providers to enhance decision-making and to support elements of open banking. 82. South Africa’s credit reporting system has a variety of providers offering services. There were 43 credit bureaus registered with NCR in May 2021, of which 6 are primary credit bureaus and the remainder niche operators.48 As of December 2020, credit bureaus held records for 27.41 million credit-active consumers49 as well as providing credit scoring and other services. According to the World Bank 2020 Doing Business Report for South Africa, this represents approximately 67 percent of the South African adult population, which is similar to the average for OECD countries.50 A proposal for a public central credit register which would integrate more data is under consideration. 83. Credit information sharing in South Africa is primarily governed by the National Credit Act (2005) (NCA). NCR regulates and monitors registered credit bureaus and the quality of their data based on the NCA and Regulation 19 (13) published in March 2015 which requires registered credit providers to submit data on all consumer credit agreements to a central data transmission hub, including positive and negative data, in a manner and form prescribed by NCR as submission for juristic persons for facilities of up to ZAR1 million. To assist with the implementation of the regulations, the NCR entered into a Memorandum of Agreement (MOA) with the South African Credit & Risk Reporting Association (SACRRA) and the Credit Bureau Association (CBA), as co-owner of the Data Transmission Hub (DTH), to adopt and prescribe the current SACRRA data sharing environment as the industry standard.51 Credit bureaus create consumer credit profiles based on credit information received from credit providers, courts, utility service providers and other sources. As the credit bureaus and SACRRA do not fall under the Financial Sector Regulation Act they do not provide SARB with ability to instruct SACRRA and credit bureaus to share information. 84. Credit data sharing is almost entirely focused on consumers, with provision of data for MSMEs and commercial credits largely voluntary and consequently limited. Although registered credit providers are required to submit data on all consumer credit agreements, the NCA has a limited scope with respect to sharing of credit data on businesses. The NCA requires lenders who grant loans to small juristic persons that are considered consumers to share that data. It applies to companies, close corporations, and partnerships whose asset value or annual turnover is below R1 million (US$70,000) and where the credit amount is less than R250 47 Key references for an access to finance analysis of credit reporting systems are the World Bank General Principles for Credit Reporting (in particular GP1, GP4 and GP5) 2011 and the ICCR Facilitating SME Finance Through Improved Credit Reporting Systems, 2014 and Credit Reporting Systems as an Enabler to Responsible Access to Finance (2016). 48 Accessed at http://www.ncr.org.za/register_of_registrants/registered_cb1.php May 2021. 49 NCR. Credit Bureau Monitor. Fourth quarter. December 2020. 50 World Bank Group. South Africa Economy Profile Doing Business 2020. 51 SACCRA. Reporting of Credit Information in Terms of Regulation 19. June 2017. 44 SOUTH AFRICA 000 (US$18,000). These thresholds have not been adjusted since 2006,52 and as a result, MSMEs with facilities over the threshold are not reported in the credit reporting environment thus impacting on their ability to create credit history. Legislative amendments to the scope of the NCA could expand the coverage of the NCA for businesses, while the Department of Trade and Industry could increase the threshold associated with small juristic persons through a procedural change. 85. Some initiatives have been established to improve the availability of MSME data. The South African SME Finance Association (SASFA), which supports finance companies who lend to SMEs, and are thus not subject to regulatory requirements, has created a closed user group with Experian to create a database of negative data among SME lenders, although not more broadly with other non-member entities. They are also in the first stages of seeing how positive data could be incorporated. In addition, in 2011 the Business Credit and Risk Information Sharing Initiative (BUSCRI) program was established with NT support to encourage the sharing of more business data. SACRRA and CBA are allowing transmission of data through the hub, and are currently working with cooperatives in the agricultural sector to get their data, but progress has been slow relative to initial targets. 86. Overall, many credit providers are not reporting credit data. Although the NCA requires lenders who grant loans to share their consumer data, in many cases, this is neither adhered to nor enforced. The share of credit providers registered at NCR that were reporting to credit bureaus has increased from 18 percent in June 2020 to roughly one-third (2300 of the approximately 7000 plus registered) in February 2021, with additional efforts ongoing with the NCR to raise this percentage further. 87. Encouraging the development of alternative data could provide further insight into both consumer and business activity. An IFC diagnostic on alternative data in South Africa suggests sources for alternative data for consumers, including bank accounts (e.g., related to account activity, failed transactions, returned debit orders), rent payments, and municipal accounts (e.g., related to payment plans).53 On the MSME side, these data could include information on business bank accounts, supply chain data and key indicators from merchant payments solutions. Ongoing pilot initiatives on alternative data, such as the one involving Finfind, NCR, IFC and others, will provide insights on how these data could be utilized. Such reforms should also enable consumers and MSMEs to consent to access and sharing of their own data with authenticated third parties, in the support of an eventual framework to support elements of open banking.54 88. Recent inter-agency efforts to establish a central credit register have the potential to substantially expand the scope of data provided. SARB, DTIC, NT, NCR, Financial Intelligence Center (FIC) and FSCA have been in discussion on a five-year initiative to establish a Central Credit Register that is envisioned to include all categories of consumer and business data, plus alternative data sources such as municipality data, government loans etc. In terms of project implementation, it is envisioned that SARB will lead the development of IT and data requirements, with DTIC collaborating with the industry on stakeholder management aspects. The NCA provides for a National Credit Register, but additional legal amendments may be needed to provide the mandate for data sharing, which would initially be limited to consumer credit only, but are eventually envisioned to include business data, municipality data and DFI data. The Central Credit Register would help fill the gap for 52 World Bank Group. Credit Reporting: A Closer Look at Small and Medium-sized Enterprises. February 2019 53 World Bank. Diagnostic: Alternative Data Landscape in South Africa. April 2021 54 World Bank. Diagnostic: Alternative Data Landscape in South Africa. April 2021 45 SOUTH AFRICA additional credit data were needed to support the analysis of financial inclusion and stability objectives, and which are in some cases being sourced from separate surveys of the banking system. Secured Transactions Systems 89. The use of movable assets as collateral has the potential to improve the availability and cost of credit in South Africa, particularly for MSMEs that do not have long standing businesses and credit histories. In many cases, a firm’s wealth is largely concentrated in movable assets, including receivables, but lending is more commonly focused on real property as collateral, because there is a legal and registry framework seen as less risky. Weakness and uncertainty of the movable property legal framework means that these types of goods are taken as security to a much lesser extent. Just one-third of firms with credit reported utilizing collateral, with a median value of R200,000 (US$14,225). Personal assets and accounts were most frequently cited as forms of collateral utilized, with land and buildings and equipment mentioned less frequently. 90. Secured transactions laws and registries help local businesses get the capital they need. They are intended to provide greater flexibility in the loan transaction; greater flexibility in the property that can be used as collateral; uniformity in the registry system and in the notice provided to third parties; certainty and transparency in the priority of creditors (including insolvency proceedings); certainty in the rights of third parties; and greater flexibility and agility in the enforcement of a security interest in case of default. 91. The World Bank 2015 Secured Transactions Collateral Registries Diagnostic for South Africa noted that gaps in the current framework for secured transactions impede the use of movable assets as collateral. While immovable assets, such as land and property, are often not available to micro and small businesses, movable assets are widely used in SME lending internationally. The reluctance of South African lenders related to difficulties in the perfection of interests in movable property (which relies on a court process or on taking possession by agreement between parties), and the lack of a centralized and computerized nation- wide movable assets registry. In addition, the enforcement of movable security was associated with considerable delays due to a lack of special courts for such cases. 55 92. The diagnostic identified challenges in the legal framework that would need to be addressed. The diagnostic noted that the existing legal framework was not integrated or uniform. For example, concepts and terminology were not uniform, different dates of enactment of legislation were utilized, Common law devices not integrated with Statutory Devices, and similar devices treated differently for individuals and companies. In addition, there was the difficulty of discovering unregistered but effective security interests (e.g. finance leases; ownership retention, field warehouse pledges). Furthermore, the fragmented approach overlooked underserviced business sectors (e.g. cultural property; intellectual property; agricultural products), and integration of secured transaction law and insolvency law was incomplete.56 93. The 2015 diagnostic also noted the challenges with respect to the registry framework. For example, the lack of uniform legal devices translated to a lack of registry uniformity and priorities. The lack of a centralized registry for secured transactions over movable assets creates considerable difficulties. Another issue was the required registration of functional equivalents, with no registration of leases, ownership retention, field 55World Bank. Secured Transactions Systems: Draft Diagnostic, Republic of South Africa, June 2015 56World Bank. Secured Transactions Systems: Draft Diagnostic, Republic of South Africa, June 2015 46 SOUTH AFRICA warehouse pledges, other “secret liens”. Given that there is no public searchable index or database of registration, amendments and cancelations, no electronic payment, filing or searching equals antiquated paper-based system and process.57 94. Previous efforts to support a secured transaction framework did not achieve momentum, but the engagement has been revived. Previous consultations with the banking sector following the 2015 diagnostic did not result in this reform being pursued. One of the working groups to support access to finance plans to engage in a stakeholder consultation in 2021 and to consider developing a draft law for secured transactions and movable collateral registration taking into account international best practices58 and standards developed by the United Nations Commission on International Trade Law (UNCITRAL). Summary of Main Recommendations: Payments • Consider giving more role to non-banks in the governance of retail payment systems • Develop and issue regulations mandating interoperability and adoption of open standards • Incorporate features in the upcoming Rapid Payments product to make it an effective alternative to “Instant EFT” (BankServ, PASA) Credit Information and Secured Transactions • Expand the coverage of credit data for businesses by: i) mandating sharing to the bureaus of business credit for businesses of all sizes ii) enforcing credit information sharing for businesses currently covered by the NCA and iii) increasing the threshold delineating small juristic persons with the NCA iv) Improve the credit information environment by incorporating alternative data sources for consumers and MSMEs into credit reports v) providing an enabling legal framework for the planned Central Credit Register • Support the establishment of a modern centralized collateral registry system, including an enabling legal framework for secured transactions that ensures extrajudicial execution and creates a computerized nationwide register for movable guarantees VI. PRODUCT DESIGN AND DIGITIZATION A. Transaction and Savings Accounts 95. Affordability, convenience, and product design are key considerations in promoting greater usage of bank accounts and digital financial services. As noted in Section II, just one in three banked South Africans 57 World Bank. Secured Transactions Systems: Draft Diagnostic, Republic of South Africa, June 2015 58A modern secured transactions law generally has four major substantive features: a simple, flexible and enforceable security interest created by agreement between the secured creditor and the debtor; a clear and comprehensive scheme for determining the priorities of competing interests in movable property; a simple and effective means of publicizing interests in movables to facilitate assurance of a creditor’s priority; and a quick and effective enforcement process upon default of the debtor. The World Bank Group’s Doing Business Report captures these within its “getting credit” indicator, specifically with respect to the strength of the legal rights index, which covers aspects of laws on security interests and bankruptcy laws. 47 SOUTH AFRICA report using their account on a daily or weekly basis. High fees, lack of funds, and a general preference for cash are cited as key barriers to more frequent account use. 96. While survey data reveals broad satisfaction with bank accounts among bank customers, there is notable scope for improvement on disclosure of product features and pricing. Among banked consumers, 89 percent agree that their main bank account is “good value for money,” and 87 report that they would recommend their account to family or friends (Figure 18). While most consumers also agree with various statements regarding satisfaction with the transparency of product features and fees, there are several notable areas for improvement. For example, just 71 percent of bank customers agree that they were given all the details on account fees when opening their account, and 67 percent report that bank staff showed them different options when they were opening their account. More concerningly, more than half of banked customers report that they are surprised at the monthly fees on their account. These trends are broadly in line with the findings from the 2018 World Bank Retail Banking Diagnostic, which identified several regulatory and supervisory approaches to improve product disclosure including short-form disclosure documents, overall cost indicators, and a product comparison website (discussed further below). Figure 18: Account costs relative to monthly income 100 89 % of banked adults that agree with statement 87 90 83 80 71 67 70 57 60 50 40 30 20 10 0 Account is good Would recommend Fees and charges Given all key Bank staff showed Surprised at value for money your account to are clear or easy to details on account you different monthly fees on family/friends determine fees when opening options when your account account opening account Source: FinScope Consumer Survey (2019) 97. The annual Bank Charges Report by Solidarity indicates that bank charges can comprise a high share of monthly income for South Africans with low incomes. The 2020 report covers transaction accounts offered by the ‘big five’ banks and summarizes account costs according to several standardized transaction profiles. The average monthly account cost of a low-transaction customer profiles (12 transactions of varying types) is approximately R35, which represents 4.7 percent of income for an adult receiving R750 per month and 2.3 percent of income for an adult receiving R1,500 per month (Table 3). The average monthly account cost rises to approximately R137 for higher-transaction customer profiles (25 transactions of varying types), equivalent to 6.1 percent of income for an adult receiving R2,250 per month and 2.1 percent of income for an adult receiving R6,500 per month. Given the large share of South African adults receiving R1,500 or less per month, the relative 48 SOUTH AFRICA costs of bank transactions may explain why many South Africans continue to rely on cash to manage their day- to-day financial lives. Table 2: Account costs relative to monthly income Account cost as % of monthly income Monthly income Share of Segment Low-transaction profile Standard profile range adults (12) (25) 1: Low Income R15.1K Source: Consumer Credit Market Report (December 2020) Note: Values reflect Q4 for each year 156. NCR does not publish disaggregated statistics on unsecured credit or credit facilities by lender category. NCR does not publish data on the distribution of the unsecured credit portfolio across types of lenders, which limits the identification of the types of lenders that may be driving high levels of financial distress among borrowers of unsecured credit. Anecdotal data suggests that banks have shifted away from unsecured lending in recent years but given the overall dominant position of banks in the consumer credit market, it remains unclear which lenders account for the largest share of non-performing loans in the unsecured credit and credit facilities product areas. 157. An in-depth analysis of the unsecured credit and credit facilities markets is needed to determine drivers of irresponsible lending and over indebtedness. As part of its supervisory and market research functions, NCR should prioritize conducting an in-depth analysis of the unsecured credit and credit facilities markets. The analysis should include dialogue with industry as well as consumer research (e.g., focus groups, targeted surveys). Mystery shopping could also be leveraged to determine to what degree the high rates of credit impairment are due to contraventions of NCA requirements related to disclosure, pricing, affordability assessments, etc. 158. Informal sector lending also poses a significant challenge to generating a sustainable and responsible credit culture in South Africa. Loan sharks or mashonisas are unregistered and illegal lenders that typically offer small, short-term and quick-disbursing cash loans. Loans from mashonisas are typically used to manage monthly cash flows and finance immediate needs such as food, transport, airtime, and pre-paid 70 SOUTH AFRICA electricity. Many borrowers view mashonisas as a complement to formal sector borrowing. Although just two percent of South African adults report having borrowed money from a mashonisa in the past year, this may underestimate the actual prevalence of informal sector borrowing. A 2018 report on informal sector lending estimates that there may be 40,000 mashonisas operating in South Africa, more than five times the number of registered credit providers.79 The research noted that borrowers are attracted by the convenience and accessibility of mashonisas, in addition to many borrowers who have impaired credit records are therefore limited access to formal lenders. The research also confirmed that mashonisa loans are expensive, with interest rates up to 50 percent regardless of the term of the loan (which translates into an annual interest rate of 600 percent for a month- long loan). Mashonisas are known to apply aggressive and sometimes violent debt collection practices. The 2018 study did not conclude that affordability requirements or other responsible lending requirements have resulted in an increased reliance on informal sector borrowing. 159. Trends of financial distress and over indebtedness are inextricably linked to national social and economic conditions, as well as the Covid-19 pandemic. There are several opportunities to improve responsible lending conditions in the consumer credit market in South Africa, as detailed in the following section. However, it should also be acknowledged that national social and economic conditions play an important role in the current credit environment. Economic growth has been stagnant in recent years and the unemployment rate in South Africa reached an all-time of 30.1 percent in the first quarter of 2020. South Africans have also experienced price increases for petrol, food, and other basic cost of living goods and services. These trends have a significant impact on the credit needs of South African and their ability to meet their financial obligations. The Covid-19 pandemic has added further stresses to financial health of many South Africans and in many cases has exacerbated financial distress of borrowers and reliance on informal borrowing. C. Approaches to Promote Responsible Lending 160. South Africa’s consumer credit market is highly regulated and conforms with several “good practices” for financial consumer protection. South Africa’s consumer credit market has several features associated with an effective regulatory and supervisory approach to responsible lending, including a dedicated market conduct supervisor (NCR) and a legal and regulatory framework that addresses sales practices (e.g. prohibitions on credit sales at a person’s home), disclosure (e.g. plain language requirements and required use of key information documents), product design and suitability (e.g. affordability assessments, prohibitions on automatic credit limit increases), fair treatment (e.g. prohibitions against discrimination), credit information infrastructure (e.g. regulation of credit bureaus), debt collection (e.g. prohibitions on abusive practices), and dispute resolution. Yet there remain opportunities to improve responsible lending via greater registration of credit providers, improved credit bureau reporting, the facilitation of innovations including alternative data, data- driven and risk-based supervision, aggressive enforcement, improved coordination among financial sector regulators, and financial education. 161. NCR should continue to prioritize registration of small credit providers. NCR regularly conducts registration campaigns to foster formal registration among small credit providers. For example, in 2019/2020, NCR conducted registration campaigns the Gauteng, the Eastern Cape, and Mpumulanga Provinces. In 2019/2020, NCR registered 1,416 new credit providers (in addition to renewing 6,421 existing registrations). No 79 “Informal Lending Report: Understanding the role of mashonisas in the South Africa credit market”. Wonga. 2018. 71 SOUTH AFRICA reliable estimates exist on the number of unregistered credit providers but most stakeholders agree that these informal credit providers account for a significant share of lending (by loan accounts if not by volume), particularly among low-income South Africans 162. Despite recent progress, new approaches are needed to address low levels credit bureau reporting among registered credit providers. The NCA requires registered credit providers to submit both positive and negative information to credit bureaus via a standard format prescribed by NCR.80 Yet as of February 2021, only 30 percent of registered credit providers report to credit bureaus. This value is up from 18 percent in June 2020 which represents meaningful progress but low levels of credit bureau reporting continue to be a constraint on the promotion of responsible lending. NCR and credit bureaus should prioritize the development of an automated and user-friendly data submission platform that reduces frictions and indirect costs for small providers to comply with credit reporting requirements. See Section VI.B for a broader discussion of Credit Information. 163. The inclusion of alternative data sources in the credit bureau environment can promote responsible lending. A more diverse set of information on consumers can help lenders to make responsible lending decisions and generate stronger incentives for consumers to meet their financial obligations. As noted in a 2021 IFC diagnostic on alternative data in South Africa, there is potential to incorporate additional alternative data on consumers, including related to bank accounts (e.g., related to account activity, failed transactions, returned debit orders), rent payments, and municipal accounts (e.g., related to payment plans). Such reforms should also enable to consumers to access and share their own data, for example related to data retained by MNOs on pre-paid customers and lay-by payments. 164. A data-driven and risk-based supervisory framework can help to promote responsible lending and reduce financial distress among borrowers. The effective use of limited resources to cover such a large and geographically dispersed set of credit providers (7,895) requires a data-driven and risk-based approach. NCR does not report having a specific methodology in place to determine the deployment of supervisory actions; the supervisory approach appears to be largely reactive and driven by consumer complaints and media coverage. While complaints data and media sources are invaluable inputs into an effective supervisory approach, a more comprehensive risk-based supervisory framework that draws from a range of granular data sources and indicators (including “early warning indicators”) can support the systematic identification and monitoring of risk, which can in turn support a more proactive supervisory approach and the efficient use of limited resources. A risk- based framework for market conduct in the consumer credit market should also account for the observable trends that indicate unsecured loans and credit facilities account for 50 percent of past-due loans; that is, a risk-based framework would guide supervisors to closely monitor and supervise lenders who are active in these loan categories and display significant past-due portfolios. 165. The adoption of a risk-based supervisory framework requires a shift away from compliance-based approaches and towards continual intelligence gathering and dialogue with industry. Table 3 provides a high-level summary of the differences between compliance-based and risk-based supervision. While compliance-based supervision relies on one-size-fits-all procedures and standard examination frequency, a risk- based approach requires continual intelligence gathering and dialogue with industry to assess how providers 80Consumers have a right to access their reports and correct any errors, and can also access one free credit report from each bureau every 12 months. 72 SOUTH AFRICA manage risk. The objective of risk-based supervision is to monitor how risks are evolving, identify emerging risks, and preemptively address them. Table 3: Compliance-based vs. Risk-based Supervision Compliance-based Approach Risk-based Approach Process-oriented with focus on assessing institution's Audit-oriented with excessive transaction testing risk and management framework Point-in-time risk assessment Continuously updating risk profiles Flexible procedures and supervisory interventions Standard procedures and examination frequency determined by risk profiles One-size-fits-all Tailored to individual institutions Focus on risk avoidance Focus on risk mitigation Source: Risk-based Supervision in Low-Capacity Environments (CGAP, 2019) 166. Investments in critical skills of staff is necessary to enhance the quality and efficiency of market conduct supervision. Both FSCA and NCR have highlighted the hiring and retention of skilled supervisory staff as a key institutional challenge. The challenge is particularly acute as the pace of innovation in the financial sector continues to accelerate, generating new consumer risks. The successful deployment of a risk-based supervisory framework for market conduct also requires supervisors with deep knowledge of the market and providers as well as critical thinking and subjective judgement skills. 167. Data limitations constrain the NCR’s ability to identify the drivers of reckless lending. NCR publishes a range of data via its quarterly Credit Bureau Monitor and Consumer Credit Market Report; however the available data provides a limited view into the drivers of credit impairment and constrains more proactive, risk-based supervisory and enforcement approach. For example, NCR does not collect data from credit bureaus on the number of outstanding loans per credit-active consumer nor the percentage of credit-active consumers with multiple loans. More granular data on borrowers and lenders active in the unsecured credit market would also provide NCR with a valuable tool to undertake proactive, risk-based supervision. Data on the credit extended via digital channels would also allow NCR to identify and monitor emerging risks related to digital credit. 168. Adoption of supervisory technology (i.e. “Suptech”) can improve the effectiveness and efficiency of market conduct supervision. In the case of NCR, the effective and efficient supervision of nearly 7,000 credit providers cannot be accomplished without the use of technology and automated processes. Yet several key supervisory functions of NCR rely on manual processes: for example, offsite supervision reports are submitted physically or via Excel rather than through an automated reporting system. There is also scope to better leverage supervisory technology to improve NCR’s analytical processes, including related to complaints analysis. See Box 4 for Suptech solutions for market conduct supervision. 73 SOUTH AFRICA Box 4: Suptech Solutions for Market Conduct Supervision A 2021 report by the World Bank Group, “The Next Wave of Suptech Innovation: Suptech Solutions for Market Conduct Supervision,” showcases new Suptech solutions specific to market conduct supervision. The report notes that financial sector supervisors around the world are experiencing a profound shift to data-driven supervision enabled by the next wave of technology and data solutions, for example in the realm of unstructured data and text analysis. The report includes four key insights for market conduct authorities: (1) Increasing operational efficiency and enhancing supervisory effectiveness are two of the primary motivations for adopting Suptech solutions for market conduct. (2) Suptech solutions for market conduct can be grouped into four main categories: (i) solutions for regulatory reporting by supervised institutions; (ii) solutions for collection and processing of complaints data; (iii) solutions for non-traditional market monitoring; and (iv) solutions for document and business analysis. (3) Suptech implementation is about more than just the technology, requiring investments in three key enablers: people, process, and IT infrastructure. (4) Various strategies can be used to help accelerate the development and implementation of Suptech solutions, including both formal, multi-year Suptech strategies as well as case-specific experimentation and iteration. Suptech Solutions for Market Conduct Supervision and Key Enablers for Implementation Source: “The Next Wave of Suptech Innovation: Suptech Solutions for Market Conduct Supervision.” 2021. The World Bank 74 SOUTH AFRICA 169. Aggressive and consistent enforcement of contraventions against the NCA are a necessary complement to risk-based supervision. As part of its enforcement activities, the NCR conducts raids on small credit providers (often jointly with the South African Police Service and local authorities) with a priority focus on unregistered providers, credit providers engaged in reckless lending, and those that illegally retain consumers’ identify documents and other personal items. In 2019/2020, these raids resulted in the recovery of 2,601 items belonging to consumers. Such raids may result in criminal charges and/or referrals to the National Consumer Tribunal. The NCR also enforces the NCA via referrals to the National Consumer Tribunal and High Court (64 such referrals were made in 2019/2020). It is critical that NCR continue to aggressively undertake enforcement activities and that these efforts be well-resourced, consistently applied, and linked to supervisory processes (e.g. onsite supervision and mystery shopping). 170. Affordability assessments are a key tool to ensure responsible lending but accommodations should be made to enable the use of alternative data and digital lending models, and the effectiveness of the affordability assessments should be re-examined for unsecured credit and credit facilities. Affordability assessment regulations were introduced in 2015 to strengthen and clarify the reckless lending provisions in the National Credit Act. The affordability assessment regulations require all credit providers to validate borrower income via bank statements and documented proof of income and assess a borrower’s potential debt burden via defined minimum monthly expense norms and accounting for statutory deductions (e.g., employee taxes) and existing credit obligations (via credit bureau checks). However, several industry participants note that NCR does not clearly communicate its interpretation of some affordability assessment requirements which can limit the innovative use of alternative data and digital lending models. NCR often does not grant flexibility or guidance to allow supervised experimentation (e.g. via a sandbox) with these requirements.81 A targeted review of the effectiveness of affordability assessments in the unsecured credit and credit facility product areas is warranted given current NPL trends. 171. Market conduct authorities should closely monitor the development of digital credit models and begin to assess how responsible lending requirements can be adapted for digital channels. Although limited data exists, the development of digital credit models in South Africa appear to be in a nascent stage. However, the experience of digital credit in East Africa has demonstrated that digital credit can rapidly reach scale and can exacerbate the drivers of over indebtedness (e.g. push marketing, impulsive borrowing, present bias, poor transparency). Disaggregated data on the prevalence of digital credit is a key first step to identify and monitor emerging over indebtedness risks. NCR should also prioritize research and engage with industry on how to adapt key responsible lending requirements (e.g. related to disclosure) for digital channels. A recent World Bank publication provides a summary of global experience to date in managing consumers risks associated with digital credit, and includes a menu of regulatory and supervisory measures to address these risks (Box 5). 81 NCR is receiving technical assistance from the International Financial Corporation (IFC) to pilot aspects of the G20 Financial Inclusion Policy Guide on the collection, processing, and use of alternative data sources and the development of digital technologies to enable small credit providers to collect and share data. 75 SOUTH AFRICA Box 5: Options for Regulatory Approaches to Address Consumer Risks in Digital Credit • Require disclosure of key terms and conditions in channel being used for transaction • Require order and flow of information to enhance transparency and comprehension, providing an intuitive “digital journey” through a transaction process • Leverage behavioral insights to encourage consumers to engage with information (e.g., require confirmation to move to next stage of transaction) • Encourage consumer testing of user interface • Require explicit warnings on risks of short-term, high-cost credit, and information on alternatives to such loans and helpful resources • Ban sales practices that focus on ease of obtaining credit, trivialize credit, or target vulnerable consumers • Slow down process of transacting digitally to allow consumers more time for reflection and deliberation or appropriate cooling-off period • Apply product design and governance rules for digital credit, including designing processes and customer acquisition plans to ensure that potential harms and risks to consumers are considered and mitigated • Require regular auditing of algorithmic systems by external experts to assess and manage risks related to bias and discrimination Source: “Consumer Risks in Fintech: New Manifestations of Consumer Risks and Emerging Regulatory Approaches.” 2021. The World Bank 172. Ensuring access to appropriate and fair debt relief measures is necessary for a healthy consumer credit market. Distressed borrowers have several options to seek debt relief, including debt review options under the National Credit Act (via debt counsellors), statutory discharge of debts under the Insolvency Act (via courts) and administration orders under the Magistrates Court (via courts). Debt counsellors in particular play a key role in supporting financially distressed borrowers to improve their financial management and/or restructure their debt obligations. As of 2019, 1,495 debt counsellors were registered with NCR. However there have been several recent cases in which debt counsellors have acted improperly to persuade borrowers into entering debt review or have not acted in the best interests of the borrower (e.g., related to substitution of credit life insurance). NCR has noted a concern with misleading marketing or advertising by some debt counsellors, particularly via social media.82 A detailed review of the personal insolvency and debt review and restructuring system could shed light on challenges experienced by distressed borrowers seeking debt relief, including related to conduct issues, pathways out of debt review, and options for debt discharge under certain circumstances. D. Alternative Dispute Resolution 173. Alternative dispute resolution mechanisms are a core pillar of financial consumer protection. Principle 9 of the G-20 High-Level Principles for Financial Consumer Protection states that jurisdictions should ensure consumers have access to adequate complaints-handling a redress mechanism that are accessible, affordable, independent, fair, accountable, timely and efficient. The 2017 Good Practices for Financial Consumer 82 NCR Circular 10 2020 – Debt Counselling: Misleading Market Practices (November 2020) 76 SOUTH AFRICA Protection further state that if consumers are unsatisfied with the decision resulting from a financial service provider’s internal complaint handling process, they should be given the right to appeal, with a reasonable timeframe, to an out-of-court alternative dispute resolution mechanism. 174. The existing financial Ombud system in South Africa provides an important alternative dispute resolution (ADR) service for many financial consumers.83 ADR in the South African financial sector is provided through an ombuds system comprising seven Ombud schemes (two statutory schemes and five industry schemes). The system also includes a dedicated oversight regulator for financial ombuds schemes: the statutory Ombuds Council. The existing system provides free access to ADR services for many consumers, is generally considered by stakeholders as professional, with rules and processes that incorporate fair and equitable principles. 175. However, the existing system is complex and fragmented, thereby limiting accessibility and consistency for financial consumers across provider and product subsectors. The existing system is largely based on subsector-specific Ombud schemes with additional statutory schemes. The system is characterized by unclear and overlapping jurisdictional boundaries; gaps in coverage and mismatch with new products; significant variations in eligibility, processes, rules, powers, and governance structures; differential funding models; and lack of coordination and coherence in outreach and accessibility activities. 176. A new, consolidated, and independent National Financial Ombud can improve accessibility, efficiency, and responsiveness to financial sector developments and innovations. A recent World Bank diagnostic recommends the establishment of a new National Financial Ombud (NFO), independent of both industry and government, to cover all financial providers and products licensed by the PA, FSCA, and NCR – with the exception of pension funds.84 The new NFO should absorb the functions of all the industry Ombud schemes (the Banking, Credit, LTI, STI and JSE Ombud’s) plus the statutory FAIS Ombuds. The new NFO should be independent and non-statutory, possibly following the model of the South African Consumers Good and Services Ombud. The diagnostic recommends that the consolidation be managed by a new NFO board, which will require recognition and empowerment from the Ombud’s Council. The diagnostic acknowledges that a carefully-planned and managed transition to a reformed system is crucial to achieving the benefits of reform without disrupting the ongoing work of complaints handling. It will be important to retain the expertise of existing personnel, maintain broad stakeholder support, and minimize the need for legislative reforms. E. Financial Education 177. Improvements in the financial capabilities of consumers are necessary to ensure that access to financial products and services contributes to their financial wellbeing. Financially capable consumers possess the knowledge, skills, attitudes, and behaviors to make informed decisions that enhance their financial wellbeing. Improvements in the financial capabilities of South African consumers are necessary to achieve responsible and sustainable financial inclusion, in alignment with broader financial sector objectives of financial stability and integrity. Gaps in the financial capabilities of consumers likely play a role in several of the 83 The FSAP’s discussion of the financial ombuds system serves as a brief summary of the main findings a nd recommendations of the Financial Ombud System Diagnostic recently conducted by the World Bank Group. 84 See the above referenced diagnostic for a discussion of the rationale of reforming the Pension Fund Ombud and maintaining its separation from the proposed National Financial Ombud. 77 SOUTH AFRICA challenges that constrain financial inclusion in South Africa, including low usage of digital financial services, over indebtedness, and difficulties reaching ‘last mile’ consumers. 178. Financial sector stakeholders in South Africa recognize the importance of improving the financial capabilities of consumers. The importance of financial education has been recognized since the first financial inclusion efforts in South Africa. For example, the Financial Sector Code requires its member financial institutions to allocate 0.4% of Net Profit After Tax (NPAT) towards consumer education. In 2012, the National Consumer Financial Education Committee (NCFEC) was established, comprising entities from the public, private, and civil society sectors and chaired by National Treasury. The objective of the NCFEC is to foster coordination and consistency across financial education initiatives. A National Strategy for Consumer Financial Education was approved in 2013, although implementation and coordination of the strategy was not considered to be effective. 179. Financial sector regulators currently maintain several financial education initiatives. The NCR deploys a variety of financial education initiatives, including participation in gatherings or “imbizos” with Local Tribal Authorities and theatre roadshows at high schools and universities in collaboration with the Credit Bureau Association. The content of NCR’s financial education activities focuses on the rights and responsibilities of consumers under the NCA, including with respect to credit reports and role of credit bureaus, evaluating the cost of credit, and preventing over indebtedness. The provision of financial education and promotion of financial literacy is one of the four key objectives of the FSCA’s institutional mandate, as defined by the 2017 FSR Act. The FSR Act further empowers FSCA to issue conduct standards for consumer education. The FSCA’s flagship financial education initiative is its MyMoney Learning Series, which focuses on personal financial management. The MyMoney Learning Series e-learning materials were developed based on extensive consumer research and review of international evidence on effective financial education approaches. The materials are hosted on a dedicated website and are intended to be adapted by facilitators in an engaging and interactive setting. 180. Survey data indicates that there remains significant scope to improve the financial capabilities of South African financial consumers. Data from the 2019 FinScope Survey show that most South Africans do not consistently assess the affordability of something before they make a purchase (41 percent report doing so). Less than a third of adults reports keeping a close watch on their personal finances or having a budget. Further, just one in five adults reports setting long-term financial goals and working hard to achieve them. Low-income individuals are particularly likely to report lower levels of financial capabilities as measured by these indicators. However, there are also some bright spots: survey research undertaken to inform the MyMoney Learning Series found that the financially excluded and partially included demonstrate the greatest demand for financial education. 78 SOUTH AFRICA Figure 28: Self-reported financial behaviors indicate room to improve financial capabilities 45 41 40 35 % of adutls indicating "yes" 35 30 29 30 25 20 20 15 10 5 0 Consider Pay bills on time Keep a close Have a budget Set long-term affordability before personal watch on financial goals and buying something own finances work hard to achieve them Source: FinScope Consumer Survey, 2019 181. As a starting point, global evidence shows that financial education interventions should be actionable, personalized, timely, convenient, and entertaining. A recent review of international evidence by Innovations for Poverty Action on effective approaches to financial education finds that interventions should simple and actionable, personalized for individuals’ needs and situations, timed to coincide with financial decisions, convenient to access, and entertaining to participate in. Evidence also shows that financial education interventions can have the greatest impact for those that are “primed to learn,” i.e. youth and young adults. The existing evidence base is a promising starting point to inform program design, but financial education practitioners should innovate based on specific audiences and market settings and rigorously evaluate interventions to assess impact and make adjustments. 182. The evidence base for what works in improving the financial capabilities of South African consumers is relatively weak. Most financial education initiatives run by public, private, and civil society sector stakeholders in South Africa have not been evaluated using rigorous impact evaluation methodologies (e.g. randomized-controlled trials), resulting in a dearth of knowledge about what really works to improve the financial skills, attitudes, knowledge, and behaviors of consumers. Many stakeholders have strongly held priors about effective approaches for delivering financial education (e.g. face-to-face education vs. community radio vs. social media) but little evidence exists to support these hypotheses. Existing evidence from impact evaluations in South Africa indicate that ‘edutainment’ approaches can generate positive impacts on financial knowledge and behaviors in a relatively cost-effective manner.85 However, investments in rigorous evaluations are needed to undertake comparative assessment of various approaches. Evaluations may be particularly useful in contexts where financial education is provided directly by financial institutions (including under the FSC requirements) in order to determine whether such interventions are distinguishing between education and branding/marketing. 183. Light-touch coordination approaches may be most effective given the complex institutional environment in South Africa. Given the disappointing outcomes of recent efforts to proactively coordinate 85 An impact evaluation of the integration of financial education themes into the soap opera, Scandal!, showed positive impacts on financial knowledge as well as increased likelihood to borrow for productive purposes and decreased propensity to borrow for consumption and to gamble. 79 SOUTH AFRICA national financial education programs across stakeholders, a more effective approach may be to issue high-level content guidelines and establish an online platform for sharing experiences, curriculum content, and evaluation results. A conduct standard for financial education may be an effective way to achieve these objectives but such standards should not constrain innovative approaches. 184. Focused and systematized interinstitutional efforts are warranted in cases where the government directly interacts with financial inclusion target groups, including SASSA grant programs. A recent FinMark Trust report on improving the financial capability of grant recipients found significant scope for improving the scale and relevance of financial education programs for this segment. The receipt of social transfers represents a key “teachable moment”, in that it is closely linked with decisions on how to manage personal finances and use financial products and services. The history of financial frauds and other predatory behavior affecting social grant recipients further strengthens the case for robust financial education interventions. A key constraint appears to be the lack of explicit mandate of Department of Social Development, SASSA or the Post Office to provide financial education to SASSA beneficiaries. Authorities should clearly establish an institutional mandate for the provision of financial education for SASSA beneficiaries and scale-up interventions that have demonstrated impact. Summary of Main Recommendations • Enact the Conduct of Financial Institutions (CoFI) Bill • Minimize overlaps in legal mandates and licensing/reporting requirements of NCR and FSCA, and strengthen coordination mechanisms • Develop and implement a risk-based framework to enable proactive, data-driven, and efficient market conduct supervision • Ensure adequate resources and build institutional capacity for market conduct supervision, including via recruitment and retention of staff with critical skills (e.g., data, analytics, information technology, fintech models) • Develop and implement supervisory technology (“Suptech”) solutions to enhance the efficiency and effectiveness of market conduct supervision • Work with credit providers to facilitate innovative approaches to responsibly expand access to credit (e.g., the use of alternative data to inform affordability assessments; effective disclosure for digital credit) • Conduct in-depth market research and targeted supervisory activities (e.g., mystery shopping) to identify the drivers of irresponsible lending in the consumer credit market for unsecured loans and credit facilities • Conduct a detailed review of the personal insolvency and debt review and restructuring system • Adapt data collection, supervisory, and regulatory approaches to identify and address emerging consumer risks from digital and fintech models • Establish a new, consolidated, and independent National Financial Ombud to cover all financial service providers authorized by the PA, FSCA, and NCR (excluding pension funds) • Develop approaches to ensure high-level alignment of content of financial education initiatives to promote consistency and clarity of messaging • Prioritize rigorous evaluations of financial education interventions to determine impact, including those offered by financial institutions under the FSC obligations • Establish clear institutional mandates for the provision of financial education to SASSA grant recipients and improve the accessibility and relevance of financial education content for these beneficiaries 80 SOUTH AFRICA ANNEX I: REGRESSION ANALYSIS Has 4+ Missed 2+ Uses online Formally Borrows Saves credit VARIABLES Banked months of banking or included (any source) (any instr) loan payments commitment app s 0.056*** 0.113*** 0.026* 0.040** -0.025 0.057** -0.007 Woman (0.011) (0.015) (0.014) (0.017) (0.032) (0.026) (0.010) -0.079*** -0.125*** -0.090*** -0.112*** 0.019 -0.014 0.010 Age: 16-29 (0.011) (0.016) (0.017) (0.020) (0.038) (0.028) (0.012) 0.122*** 0.265*** -0.044* 0.001 -0.071 -0.091* -0.024 Age: 60+ (0.021) (0.027) (0.027) (0.032) (0.064) (0.054) (0.017) -0.046** -0.063** -0.044 -0.079** 0.007 -0.075* -0.041** LSM: 1-4 (0.023) (0.029) (0.031) (0.035) (0.058) (0.045) (0.018) -0.007 0.001 -0.043* -0.041 0.045 -0.038 -0.044*** LSM: 5-6 (0.012) (0.018) (0.024) (0.027) (0.035) (0.037) (0.015) -0.001 0.009 0.060** 0.059* -0.030 0.036 0.113*** LSM: 9+ (0.011) (0.015) (0.029) (0.032) (0.033) (0.043) (0.026) Education: Did not -0.091*** -0.138*** -0.039** -0.091*** 0.134*** 0.014 -0.022*** matriculate (0.012) (0.018) (0.017) (0.022) (0.051) (0.031) (0.008) Education: -0.003 0.035** 0.121*** 0.114*** -0.016 0.034 0.086*** University (0.012) (0.014) (0.026) (0.029) (0.029) (0.031) (0.020) Language at home: 0.003 0.014 0.057 0.129** -0.011 -0.194 -0.026 Not English or Afrikaans (0.036) (0.045) (0.059) (0.059) (0.101) (0.121) (0.033) Employment: Self- -0.074*** -0.135*** -0.042 0.078** -0.032 -0.027 0.031 employed (0.019) (0.026) (0.033) (0.035) (0.048) (0.042) (0.022) Employment: -0.104*** -0.252*** -0.151*** -0.182*** 0.086 -0.041 -0.023* Unemployed (0.015) (0.020) (0.019) (0.023) (0.057) (0.038) (0.014) -0.108*** -0.250*** -0.152*** -0.114*** 0.009 0.012 -0.035** Employment: Other (0.019) (0.024) (0.019) (0.028) (0.062) (0.059) (0.015) 0.996*** 0.945*** 0.336*** 0.518*** 0.173*** 0.120** 0.140*** Constant (0.014) (0.022) (0.037) (0.043) (0.046) (0.047) (0.030) Observations 4,969 4,967 4,969 4,969 1,024 1,020 4,187 R-squared 0.133 0.243 0.105 0.120 0.077 0.061 0.122 N 4969 4967 4969 4969 1024 1020 4187 Note: Standard errors in parentheses; ***p<0.01, **p<0.05, p<0.1; includes race and provincial fixed effects; excluded binary/categorical variables are “Male”, “Age 35-59”, “LSM: 7-8”, “Education: matriculated”, “Language at home: English or Afrikaans”, “Employment: employed” Source: FinScope Consumer Survey (2019) 81