Update on Merger of Khula, SAMAF and IDC small business activities; Progress on Khula Direct Model: Department of Economic Development briefing

Economic Development

22 August 2011
Chairperson: Ms E Coleman (ANC)
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Meeting Summary

The Committee was briefed on progress in implementing the proposed merger of Khula Enterprise Finance Ltd, the South African Micro-finance Apex Fund, and small business activities of the Industrial Development Corporation, which was seen as a means of improving access to finance for small, medium and micro enterprises.

The advantages and drawbacks of locating the merged entity within the Corporation's organisation were discussed, with some Members feeling it should be placed within the Economic Development Department  so that there would be greater control and access to grant funding, while others contended that the Corporation's expertise and financial muscle provided the better option.

There was general consensus that, because of the repeated failure of previous attempts to promote job creation and sustainable livelihoods through financial support to small businesses and emerging entrepreneurs, it was essential to ensure the whole merger process was properly thought through. This included considering the regulatory framework necessary to guarantee a clear accountability relationship between the Corporation and the Department. 

The Department agreed to reconsider its proposal that the merged entity retain the name “Khula” after several Members suggested the new vision and mandate required an alternative choice.

The Committee supported suggestions that additional emphasis should be placed on supporting cooperatives, particularly as women formed a large component of these groups, and also urged greater focus on the agricultural sector in rural areas.

The Department undertook to continue its interactions with the Credit Regulator in order to address problems specifically pertaining to the difficulties small businesses encountered in trying to access loan finance.

The Department gave an update of Khula Direct's progress during the May–July quarter, and drew criticism for the small number of applications received and approvals completed.  Khula Direct’s response was that the pilot stage required a cautious approach, and, building on the lessons learnt during this period, it expected to disburse between 80% and 90% of its budget during the year. Other issues discussed related to maintaining monitoring and mentorship as an in-house function, to ensure control over performance levels, the time taken to grant approvals, and the need to educate potential clients on how to submit applications on time.

Meeting report

Prof Richard Levin, Director-General, Economic Development Department (EDD), briefed the Committee on progress in implementing the proposed merger of Khula Enterprise Finance Ltd, the South African Micro-finance Apex Fund (SAMAF) and small business activities of the Industrial Development Corporation (IDC).

He said the EDD’s programme for improving access to finance for small, medium and micro enterprises (SMMEs) was based, firstly, on enhancing institutional performance – a continuous government objective – through the merger, as well as improving the EDD’s oversight role and performance monitoring.  The strategy was also to improve information on the sector, and to unlock the impediments to commercial financial institutions lending to SMMEs.  There was a need for the EDD, in conjunction with other relevant departments, such as the Department of Trade and Industry and the National Treasury, to find ways of improving the regulatory environment for small businesses.  He forecast that there would be some developments in this regard within the next few months.

He said that the President had announced the Government’s intention to merge the three entities during this year’s State of the Nation Address (SONA) and this was reinforced by the Minister during the SONA debate

and subsequent discussions with the entities involved.  There was an important context for the merger, in that there was a growing realisation that SMMEs were going to play a fundamental role in job creation and economic development.

The IDC had been providing support for Small and Medium Enterprises (SMEs), ideally offering loans of more than R1 million, and this comprised 10% of its annual lending.  However, it was primarily structured for bigger sized projects, so there was a need for its SME activities to be handed over to the merged entity.  The aim of Khula, on the other hand, was to complement the private sector through credit guarantee schemes, wholesale lending and limited joint ventures.  Its impact had been limited, however, as it was under-capitalised and lacked resources.  SAMAF was initially established as a pilot to focus on micro lending, wholesale lending and working with financial service cooperatives (FSCs), but although some success had been shown with the group lending approach, the high cost to lending ratio was a drawback.  Merging these entities would provide financial and efficiency benefits, as well as a more comprehensive and integrated approach to dealing with small business.

The new merged entity would continue to serve the small loan sector and the SMME market, but its mandate, scope of influence and impact on South African society would be markedly improved.  It was proposed that the name “Khula” be retained for the proposed organisation, mainly because of the brand recognition and cost implications, but a fresh name might be beneficial to identify with the new organisation’s vision and mandate.

The majority of the small business activities of the IDC would migrate to the new entity, which would itself be a wholly owned subsidiary of the IDC.

Prof Levin spelt out several benefits of the merger, such as improvements in the cost to lending ratios through a reduction in overhead costs and central functions, efficiencies in areas such as provincial co-location and research, synergies with the IDC through project linkages and access to significantly more resources, and the ability to make a much bigger impact on the sector.

He presented a comprehensive “critical path” analysis of the steps towards establishing the merger, and said it would start functioning as a new entity by the end of 2011, although its formal establishment would be completed by March next year.

Mr Malose Kekana, Chairperson, Khula, commented on some of the issues raised during the presentation.

He said that when one considered all the entities involved, including the National Empowerment Fund (NEF), the Small Enterprise Development Agency (SEDA), and Postbank, he believed it was necessary to think through the various regulatory and policy responsibilities in order to create a conducive environment for a streamlined new structure.  Failure to do this could create future challenges.

Integration of Khula into the IDC provided certain advantages in terms of access to its balance sheet, but Khula also needed access to grant finance, and the IDC had limitations in this regard.  While the IDC could fund the loan book, it would be up to the Government to provide grant financing. There was a lot of scepticism in the small business market regarding the creation of a new institution through the merger, as it was seen as merely a replacement for a failed entity.  After 17 years, lessons should have been learnt, and an over-arching financial programme covering all aspects of access to finance should be developed, otherwise the new merged entity would be seen as a panacea for access to finance, and, when it could not meet these expectations, it would be regarded as another failure.  A number of other issues needed to be thought through, such as IDC procedures, cost limitations, and the establishment of a close shareholders’ compact.

Ultimately, sustainable access to finance did not depend on the Government.  One had to work with entrepreneurs to mobilise savings, so that one could move away from the “promise and expectations” paradigm – the Government provided and small business expected.  Afrikaners in the 1930s did not have access to Government funding, and relied on their own savings to build up their businesses.  It was therefore very important to create a platform for effectively mobilising small businesses, rather than to promise that the Government would provide.  While the proposed merger was a good first step, there were a number of key policy issues which still needed to be considered.

Discussion

Mr Z Ntuli (ANC) said Mr Kekana had raised issues which needed to be considered by the EDD, looking at both the problems and advantages of the merger.  He felt it would be preferable if the merged entity fell directly under the EDD, rather than the IDC, so that its activities could be monitored more closely.

Mr S Marais (DA) described the merger as a huge task,and the magnitude of doing it correctly meant those involved could not afford to rush the process.  He had no doubt that clustering the new entity into the IDC would be far more effective than the fragmentation of the past.  He said the Committee needed more information on the Treasury’s proposed review of DFIs, as it was important that the merger should be conducted in tandem with the Treasury’s objectives.  While the IDC was an excellent example of a successful and sustainable state-owned enterprise (SOE), he was concerned that its location in Johannesburg could create problems for the new entity, which could see itself becoming merely an item tacked on to the IDC balance sheet.

Mr S Ngonyama (COPE) said that grant finance was needed to ensure that all small businesses benefited, so the Government had a big role to play.  He asked how the board of the merged entity would be appointed – by the EDD, or by the various stakeholders.  The way in which the entity’s effectiveness would be evaluated had not been clearly spelt out, and time frames should have been set for the achievement of objectives.  He suggested that a new name, and not “Khula”, should be developed prior to the launch of the entity.

Dr P Rabie (DA) said the feedback from a recent oversight visit to small businesses in Soweto had highlighted the problem of obtaining financing through the private banking sector to expand, owing to the current credit regulations.  He wondered if it were not possible for state institutions to provide credit guarantees for small entrepreneurs, or for credit regulations to be made less stringent.

Mr X Mabasa (ANC) bemoaned the fact that when institutions like Khula invited target groups to workshops, they no longer attended because they considered them merely “talk shops.”  Against this background, Members of the Committee needed to be convinced themselves that the new entity was suitable for the people they were trying to serve, and he asked whether the relevant stakeholders and the community had been properly consulted, or had it been assumed that their needs were understood.  He also urged that cooperatives be included alongside SMMEs to ensure that the new structure benefited as many of the “have nots” as possible, and said it was essential for the merged entity to have the capacity to deliver effective mentoring and monitoring.

Mr N Gcwabaza (ANC) asked if a time-frame had been established for the formulation of regulations that would govern the new entity, as it was essential for there to be a clear accountability relationship between it and the Department.  He based this observation on the fact that many existing entities were “loose cannons” over which Ministers could exercise little control because of inadequate regulations.  The new entity would need to focus on rural economic development, rather than the SMMEs in the major metropolitan areas, in order to properly address unemployment and poverty, and the plight of women and children.  At a time when the country was already importing food, and with food shortages threatening, little attention was being paid to rural farmers.

Ms D Tsotetsi (ANC) supported the call to assist emerging farmers, but cautioned that an audit of all black and white farmers should be conducted to ensure that financial assistance was not made available to those who did not need it.

The Chairperson said one of the intentions of the new measure was to try to redress the imbalances of the past, so the focus should be on the previously disadvantaged communities such as the youth, women and the disabled.  Women continued to be marginalised, yet they formed the majority of those involved with cooperatives.  The new structure should ensure that they should not have to pay interest rates ranging from 14% to as high as 40%, as in the past.

She criticised the fact that the new entity was scheduled to be operative by the end of the year, and yet the board would be appointed only in January.  As things were unfolding, she had the feeling the challenges of the past might have to be faced again, and it was essential not to falter, because expectations had been created and they needed to be fulfilled.

The presentation indicated that most of the IDC’s small business entities would migrate to the merged organisation, and she wanted to know why not all of them would move across.  She also supported the call for a change of name.

Prof Levin said a broad response to the range of comments and questions would be that, as a public service department, the EDD was guided by the policy and strategy direction of the Executive, and had to translate this into implementable plans.  Economic inclusion was at the centre of what guided its activities, hence the elevation of job creation, and the creation of sustainable livelihoods, to the very centre of its policy objectives.  The EDD operated in a context that spoke to many of the issues raised by the Committee, such as a regulatory adjustment that needed to be made in the area of small business development.  He agreed with comments that the merger would not solve all the problems, but it was still a major step forward, and would draw institutions such as the Department of Trade and Industry (DTI) and National Treasury (NT) into a process of evolution.  He welcomed the proposal that the EDD place greater emphasis on rural development initiatives.

Mr Saul Levin, Chief Director: Development Finance Institutions (DFIs), EDD, gave more detailed responses to the issues raised during the discussion.

The National Empowerment Fund (NEF) and SEDA remained outside the framework of the merged entity in the first phase of the project, but as the process moved into the next phase, consideration would be given to better aligning them to the new body, although not necessarily becoming a part of it.

A commitment had been made that nobody would lose a job as a result of the merger, but because it was recognised that SAMAF was currently over-staffed, some staff would move to Khula, while others would be redeployed.

There were very real advantages to the entity being merged into the IDC organisation, rather than falling under the direct control of the EDD.  While the IDC itself was not structured to deal with small businesses, it could provide the framework of support and systems to oversee an entity involved specifically with small businesses. Combined with its financial backing, this provided the best of both worlds.

Referring to the relationship between Postbank and Khula Direct, he said Postbank still had to be established through pending legislation, but preliminary discussions had been held.  At this stage, the two entities would be looking at similar markets, but with Khula focusing on business financing and Postbank moving into the consumer area.  The objective was to ensure there was no overlap in future, with Postbank possibly being used as a channel to deliver an essential product to all areas of the country, using their footprint.

He assured the Committee that there would be a strong component of grants coming from the state for the new entity.  Two budgets would be combined to provide it with an initial amount of almost R160 million, and this would increase in the future.  The grants would enable the entity to deal with loss-making areas such as operational costs, and also allow it to offer concessionary interest rates.  By moving into direct financing, some of the risks would be mitigated, and it would be possible to ensure that better rates were passed on to end users.

The board of the merged organisation would be appointed in consultation with the Minister.  The people with the right skills would be sought, using an open process.

The strategic outcomes of the organisation would be translated into tangible deliverables, and these would be incorporated into performance agreements so that there could be effective monitoring and evaluation.

The comments on the “Khula” name had been noted, and would be referred to consultative forums.

While the issue of stringent credit regulations was not specifically related to the merger, the EDD was currently in negotiations with the Credit Regulator.  A major problem was that when a micro business applied for bank financing, it was treated as a individual, and all the stringent requirements which an individual would attract were applied to the business.  This treating of a company as an individual needed to be eliminated.

Answering criticism that there had been inadequate consultation with stakeholders regarding the proposed merger, he said it had been difficult for the EDD to go out to the public with too much detail before presenting to the Portfolio Committee.  It was preferable to complete the process to ensure that when the new entity was launched, it was ready to deliver effectively.

The DTI was working on a cooperative development agency, with legislation in the pipeline, because it recognised the difference between cooperatives and SMMEs, and their need for specialised support.  The EDD would continue to work closely with the DTI in this area.

The reason not all of the IDC’s small businesses would go to the merged entity related to the small number of specialised niche operations with unique technical requirements, such as film production companies.

Mr Kekana said that although Khula had a programme specifically aimed at rural development, it was not working effectively, and new approaches were currently being discussed with the Department of Agriculture, Forestry and Fisheries.

When considering entrepreneurship, three major areas needed to be dealt with.  These were support and development of the entrepreneur, such as training and mentoring; empowerment, which was provided through access to finance and procurement; and the environment, which included legal requirements, incentives and taxation.  The current proposal addressed only the empowerment area, and what the country had failed to do over the past 17 years was to link the three areas effectively together.  This was a prerequisite for success, and should be seriously considered by the Committee.

Mr Ngonyama said the merged entity was intended as a catalyst which should make a strong impact in furthering the objectives of a developmental state.  However, there had been no talk of redress, or reflections on the kind of interventions that needed to be made.  The Committee’s oversight role was being compromised by the lack of detailed information based on an accurate business case.  It needed to know what it was letting itself in for.  There was no clear strategy which would lead to the achievement of the ultimate objective of social and economic justice.

Mr Ntuli suggested that the EDD should employ a “Reconstruction and Development Programme (RDP)” approach, using community involvement to develop solutions.

Mr Mabasa supported the idea of community involvement, and warned against repeating the mistakes of the past.

Ms Tsotetsi said that, as cooperatives had the potential to create more jobs than small businesses, it was important for them to receive greater assistance.

The Chairperson said the meeting had presented the Committee with an opportunity to assist the EDD to shape the merger in accordance with its mandate and vision.

Update on Khula Direct

Prof Levin updated the Committee on the main activities of Khula Direct during the period May to July 2011.

Regional offices had been opened in Pretoria and the Eastern Cape; training of staff in the systems and processes to deal with applications had taken place; and the processing of applications had started.  At this stage, the facility had not been advertised, as it was still being run as a limited pilot project.  Its products were term loans, asset backed finance, working capital/bridging finance and revolving credit, with loan sizes focused on the R50 000 to R500 000 bracket, but stretching to R1.5 million for the pilot. 

During the period under review, 134 enquiries had been received, with 27 resulting in applications.  Of these, three had been approved – with a total value of R414 754 – and one had been rejected.

Immediate action items included revising Khula Direct’s organisational structure to ensure support for the pilot sites, revising processes based on lessons learnt, exploring post-loan group mentoring for clients, ensuring the continuation of wholesale work, and the conclusion of an internal audit.

Discussion

Mr Mabasa referred to the fact that only 27 applications had been received in three months, and asked how long it took the institution to process applications. 

Mr Marais asked why only three applications had been approved, and also queried whether Khula Direct could provide effective monitoring and mentoring, as his impression from an oversight visit was that Development Finance Institutions (DFIs), acting as intermediaries, might be preferred.

Mr Ntuli asked whether the maximum loan amount of R1.5m applied only to the pilot stage, or whether it would change when the entity was fully operational.

Mr Mabasa expressed concern at the prospect of outsourcing expertise, and suggested it was preferable for the Department to employ more staff in order to ensure “hands on” control of Khula’s operations.  He also asked whether the Department followed up with workshop attendees to ensure they remained within its sphere of influence.

The Chairperson asked for additional information on the loan application and rejection process, and expressed her dismay at the fact that only R414 754 had been approved for disbursement so far, against a budget of R55 million.  She wanted to know why the Eastern Cape regional office had been opened three months after Pretoria.

Prof Levin said he agreed with Mr Mabasa’s comments on outsourcing, as it was important for the Department to build the capacity of its own institutions.  He also endorsed the need for follow-up with workshop attendees, as failure to do so often resulted in unfulfilled expectations.

Mr Don Mashele, Retail Manager for Khula Direct, responded to Members’ comments and queries.

He said that the main reason for applications being rejected was that the projects for which loans were sought, were found to be non-viable.  Approvals amounting to around R415 000 did indeed represent a slow start, but a further 11 deals worth R5.7m were now in the pipeline, although this had not been recorded in the presentation.

The main lesson learnt during the pilot period was the need to educate potential clients on how to submit their applications on time, as many applications could not be processed when loans were required the day after they had been submitted.

Whereas staff at the regional office in Pretoria had been trained on the job, the opening of the Eastern Cape office had been delayed to allow for staff to be trained beforehand.

The turnaround time for loan applications was originally in the region of 25 days, but this had now been reduced to ten to 15 days.

Mr Kekana said it had been decided to start cautiously, as Khula was embarking into new territory for the first time, and needed to learn as it went along.  With many applications now in the pipeline, he was confident that 80% to 90% of the R55 million budget would be spent during the 12-month period.  This would be helped by the fact that the maximum loan limit had been increased from R1.5 million to R3 million.

The Chairperson thanked the EDD and Khula delegations for their participation, and adjourned the meeting.

 

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