Hearings on increase in bank transaction charges & activities of small loan organisations

If we look at:

• the costs of providing banking services;

• the prices that the consumers are being charged for those services;

• the comparisons with the price of those services in developed countries; and

• the returns of 20 percent odd that the shareholders are earning on their capital tied up in the provision of those services – accepting that they could be earning 32 percent ROE in companies like Pick n Pay and Shoprite with a similar risk profile

it is, in the view of the Banking Council, clear that consumers are being fairly treated, given the existing structure of the industry. If they were to get a better deal within the existing structure, it would be at the expense of the shareholders, and the strength of the industry itself would be severely eroded.

But that does not mean that the public shouldn't have better disclosure of what the different options are, how their contracts are being varied, the benefit of a sound code of conduct as to how banks should conduct their business, and quick and cheap redress when they are unfairly treated. It is also clear that the industry has a heavy responsibility in relation to the education of consumers in relation to banking.

But this responsibility cannot be left solely to the banks. An understanding of the basics of commerce and of the laws that underpin commerce in the whole of the developed world, must be the primary responsibility of the education authorities.

Appendix B sets out some common misunderstandings about banking and banks. It also contains a synopsis of the Banking Council's position in relation to the development of the Banking Code of Conduct and an Independent Ombudsman.

Nor does it mean to say that the structure of the industry should remain static. There is good reason to believe that the provision of banking services would benefit by more, and not less, participants. It is also clear, that, given the appropriate dispensation and support, there are many new "institutions" which can and should play a significant and increasingly competitive role in the provision of those services.

New entrants, using modern technology and methods, with low overheads and who can maintain relationships with the communities they are attempting to serve, should be encouraged and assisted. The real answer therefore is not to make this market less attractive, but more so, and to remove the barriers to entry. Some of these new entrants could include:

The needs of this market should be met by a new class of deposit-taker, with much lower overheads and which is much closer to the people which it intends to serve. For some time into the future it is likely that the formal banks will transmit the cash to the points that it is needed, using the distribution network that has been built up for that purpose. But the recording of small amounts of individual savings for the saver requiring a 24 hour a day, on-call facility does not need or warrant a nation-wide and very expensive computer and branch network.

At the deposit taking level, the current dispensation is:

• With less than R10 million of deposits there is an exemption, provided the institution is of the nature of a club, and is a member of a regulatory type of body;

• A mutual bank with a minimum capital requirement of R10 million, or 8 percent of its assets, whichever is higher; or

• A bank with a minimum capital requirement of R50 million, or 10 percent of its assets, whichever is higher.

These are not friendly or helpful dispensations. The Board of Directors of the Banking Council has therefore resolved to commit the Banking Council to playing a constructive role in formulating a dispensation, which will be more friendly to and supportive of new and emergent institutions. Barriers to entry must be lowered and red tape will have to be removed.

At the transaction handling level, transaction handlers, using the best that modern technology can offer, should be encouraged to enter the market and provide transaction handling services. The qualification should be that they are not incurring systemic risk and are not creating money. That would mean that the money that they are transacting should be deposited in a registered bank at all times - the newly established service providers are currently doing this.

It would also be appropriate to stipulate that the money must be held in a "Trust Company" which has no other assets and no other liabilities than the money it is transacting for clients and a contract with the Technology Company, which handles the electronic transmissions. This new class of transaction handler should therefore be an "add-on" to the payment system of the country, and there should be totally free competition.

In addition, the Strauss Commission into the provision of rural financial services recommended a significant role for the Post Bank in providing competitive and user-friendly services in the lower-end of the market. However, the Post Office is at present contracting its branch network, and the development of an efficient and technologically advanced Post Bank will require significant resources and attention.

In recent years there has been very robust growth of the "micro-lending" industry. There are two main types of lending carried out by "micro-lenders", namely:

• Secured loans which are paid off the salary role of the employer; and

• Unsecured loans, which depend on the borrower for payment. Frequently the client's bankcard (and sometimes the client’s ID document) is taken so that the micro-lender can access the client's bank account at the time that the salary is credited.

It cannot be denied that the micro-lenders have provided access to credit at a level that the banks could not offer. Since access itself is frequently more critical than the cost of access at the low end of the market, it is hardly surprising that the industry has flourished.

However, there are a number of specific abuses and general practices which give rise to concern. Among these is the rate of interest that is paid for the loan. It is not uncommon for that rate to be 40 percent per month for an unsecured loan. The practice of taking the clients ATM card, and at times even his ID document, is patently undesirable.

But the general practice to make these loans available to people in employment in order to "bridge" them in relation to other debt, and solely for purposes of consumption, is very dangerous. Once on the debt "treadmill" it is very difficult for the consumer to get off. The result is that a high percentage of take-home pay is going to cover the interest on the loan because at some time in the past, bridging finance had to be obtained.

For the above reasons it is reasonably clear that the major banks would not engage this business themselves. If they were to enter the market, it would almost certainly be through existing micro-lenders. It is also unlikely that they would, to any significant extent, take advantage of an increase in the Usury exemption to R50, 000 loans.

At the same time there is, in the view of the banking industry, a measure of confusion in the purposes of different pieces of existing and proposed legislation. In our view, the Usury Act never afforded any real protection to the consumer. It was used to "persecute" institutions for technical non-compliance where they were charging way below the maximum rate (no matter how that rate was calculated). At the same time the real rogues were severely abusing the low-income communities.

A Usury Act on its own is not real protection to the public. There is vastly more to protection, including the way in which the Credit Bureaux function, prohibition of discriminatory lending practices, and so on.

That basic protection to which the public is entitled is as relevant to the banks as it is to the furniture retailers and the micro lenders. And protection of the public is not something which should be attached to an exemption from an archaic piece of legislation, or which is abrogated by the State in favour of an informal association of a particular group of lenders, which affords no real protection and frequently frustrates access to credit for the poor.

Borrowing by the public should be protected by a single piece of integrated legislation, regardless of who is the lender. Moreover there should not be any exemptions from such legislation. The Banking Council is aware that the Department of Trade and Industry has researched best practices in relation to consumer protection around the world, and we understand they will soon be making proposals in that regard. In the meantime, no further exemptions should be granted until those proposals have been debated and implemented.

The State cannot be allowed to abrogate its responsibility for the protection of the public. There may, however, be good reason, including the cost and efficiency in carrying out the regulation and supervision, to "privatise". However, such an approach would have to ensure that the State maintained ultimate authority and responsibility, similar to what has occurred with the Financial Services Board. It is our belief that this constitutes a sound model for the regulation and supervision of consumer lending.

The establishment and development of micro-lenders is important, and in the view of the banking industry they will play an ever-increasing role in the provision of credit to the lower-income communities. And, if nurtured carefully there is no reason why, in the future, they should not provide all-important competition to the higher value markets as well. Micro-lenders should therefore be encouraged to form their own associations and to develop them. Such associations are, in the view of the Banking Council, no substitute for the State's responsibility.

As far as the Usury Act itself is concerned, it should be repealed and those components of it which are useful as instruments for the protection of the public should be incorporated into the new consumer lending protection legislation. Until then, we will work with the Department to find workable solutions to the difficulties that arise from the provisions of this outdated legislation – e.g. such as a formula to determine the maximum interest rates.

We would like to thank the Portfolio Committee for creating this opportunity for us to disclose more about the intricacies of banking in South Africa than has ever been done before.

We acknowledge that there is much to be done, and that the image of the banking industry in the eyes of the banking public "leaves much to be desired". Patently this is either due to:

• genuine grievances, which we need, as an industry to address; or

• a lack of understanding, for which we also bear heavy responsibility.

At the same time, we believe that as a nation we have very strong formal banks and the beginnings of very strong new institutions which can play a meaningful and significant role in the provision of banking services for all South Africans.

We need to look after both sets of institutions and find ways in which they can complement each other.

Annexure A: Can commercial banking in South Africa earn a satisfactory ROE?

INTRODUCTION

Branch banking, which takes in the savings and deposits of the public, handles their transactions, and makes loans, is under severe pressure at present, especially as far as the four major banks are concerned. This sector of banking is commonly referred to as "commercial banking". If the full cost of capital used in commercial banking activities is taken into account, the Return on the Shareholders' Equity ("ROE") on that portion of the major banks' business is inadequate and dilutes their overall results. The overall ROE and capital ratio of the major banks at the present time is set out in Table 1.

Table A1: The ROE and capital ratio of the major banks, 1998

Over the past few years, the management teams of the big banks have become increasingly concerned about the need to increase the ROE. Any decision to operate in a particular market depends, crucially, on whether or not a business can earn a satisfactory - and sustainable - return on shareholders' investment.

Where money is already invested, shareholders have the option, if they feel that they are getting an inadequate return, of selling their shares, and that will tend to depress the share price. This makes it all the more difficult, and expensive, for the bank to raise new capital when it is required. A bank must (by law) hold a minimum ratio of capital to total assets, so, if a bank is not to contract in real terms, new capital will always be required. Without a strong banking industry, South Africa cannot participate effectively in the global village, nor raise the capital internationally that is vital for our continued economic growth.

Banks can be in a variety of different businesses. One of the more common categorisations is into two main areas:

Commercial banking is that portion of a bank’s business which involves deposit-taking from, lending to, and handling the transactions of the general public and corporations. Because it takes deposits, a bank has to comply with the Banks Act and maintain a high ratio of capital to total assets. Although the capital is required to protect the depositors, it has to be calculated at the rate of 8% on "risk-weighted" assets - international best practice, however, dictates a rate more like 12%. Since the commercial bank does all of a bank's lending to the general public and corporations, the bulk of its capital is related to its commercial banking activity. Currently, more than 85% of the commercial banking in South Africa is done by the four major banks. It’s worth noting that, apart from the convergence between the old building societies and banks in the late 1980s, no new banks have entered this market on any scale in the last 40 years.

Investment and Merchant Banking describes that portion of a bank’s business which does not involve deposit taking or lending to the general public or corporations. Because the total value of assets involved here is much lower, so is the related capital.

Historically, commercial banking in South Africa has suffered from high cost ratios due to its dependence on large branch networks, combined with rising staff and information technology (IT) costs. Furthermore, commercial banking has been reliant on margin income as its main source of revenue. This has been exacerbated by the fact that a large proportion of the funds held by the banks to finance the loans they grant, is short-term, with wholesale characteristics. Those funds are generally more expensive and re-price more quickly than retail deposits. Some banks have initiated successful restructuring programmes diversifying revenues and reducing costs. But by and large commercial banking is still operating at a significantly lower ROE than investment and merchant banking.

In November, 1998, KPMG obtained figures from the four major banks distinguishing between "lending" and "non-lending" activities, and did calculations of the performance of those different businesses. The Banking Council requested KPMG to make those calculations available for the purposes of this report.

KPMG confirm that the most significant performance measure is ROE, as it focuses on management's ability to generate profits per Rand of shareholders' equity. They further advise that the minimum return expected by shareholders can be estimated by using the Capital Asset Pricing Model (CAPM) which specifies the relationship between risk and required rates of return on assets when they are held in well-diversified portfolios. The calculated return is the minimum return required to persuade investors to purchase the share, or to hold it. The required rate of return equals a "risk-free" rate plus a "risk premium".

The "risk-free" return is a satisfactory return on the actual money that is invested by the shareholders. They could have put their money "risk-free" and easily liquidated into RSA stocks (which are tradable and in which there is no risk) at a return of approximately 15% over the last couple of years.

The "risk premium" is the "profit" over and above the risk-free return that the shareholders expect to get. This "risk premium" is the return for taking risk that they would not take if they invested their money in RSA stocks. According to a recent study by KPMG, the estimated benchmark of the risk premium for the banking industry in South Africa is between 4 and 6%. So the required minimum ROE of a bank in South Africa is the aggregate of the risk-free return and the risk premium, and is therefore between 19 and 21%.

The overall ROE and the actual capital ratios of three major banks are reflected in Table 1 on page 1.

Bearing in mind that the international benchmark for a bank's capital ratio is more like 12%, the four major banks are barely meeting the minimum ROE expectations of their shareholders.

Comparisons can be drawn with banks in other countries - developing and developed.

Table A2: ROE & Capital Adequacy ratios – developed & developing countries

It should be borne in mind that there are different segments within the different businesses of a bank, and those different segments themselves have different profitability profiles. Within the commercial banking business, the corporate and high-value personal markets are much more profitable than the low-value markets. That is mainly because the average balance on an account (whether deposit or loan) is much bigger in the corporate and high- value personal markets, and so the net interest income on the account is also bigger and more than covers the cost of administering the account.

That is not true in the lower-value markets where the average balance on an account is frequently inadequate to cover the costs of administering it, let alone to make a contribution to the costs of the transactions on the account. It should be borne in mind that if no interest income was earned by the banks, the transaction charges would have to be more than four times higher than they are for the banks to make the same profit.

The return of a bank can be broken down into the following elements :

Interest income

• Add : Transaction fee income

• Less : Operating costs

• Less : Bad debts written off

Profit (before tax)

While each of these elements is dealt with individually below, they are all interrelated. Although this submission addresses the question of transaction charges, the different elements cannot be dealt with in isolation. If the interest income were higher, it would not be necessary to charge so much for transactions to make the same profits. Likewise, if the operational costs or the bad debts were not so high, the charges could be reduced.

The interest income is defined as the difference between the interest earned and the interest paid by a bank. This is traditionally the most significant component of earnings generated by the four major South African banks.

Table A5: Interest income as a % of total income

One of the biggest drives of the major banks over the last four years has been to bring the costs of branch banking down. Branches have been closed, administration systems have been computerised and centralised, as have credit granting systems. Wherever possible staff has been reduced, and this is particularly noticeable in the branches. South African banks are renowned in the world for their use of modern technology to provide banking services for low-income communities and they have won a number of prestigious awards, including no less than three Smithsonian Institution Awards.

High real interest rates in South Africa have an adverse effect on bad debt. This is a severe problem for the major banks and they have been keen to avoid increasing interest rates despite the upward market pressure on those rates. For instance, at the height of the emerging market crisis last year, banks provided some relief to home owners by allowing the differential between the higher prime rate and the mortgage rate to widen to two percentage points.. Household debt in South Africa as a percentage of personal disposable income is approximately 70% (1993-54%). Consequently, high interest rates result in a higher default rate that in turn has a negative effect on the bottom line.

The extent of bad debt write-offs by banks is measured by the bad debt ratio :

Table A 17 : Bad Debts - South Africa’s major banks

Bank %

ABSA 0.60

FNB 0.94*

SBSA 0.55

Nedcor Bank 0.52

(Source : Banking Survey Africa 1998, KPMG).

* A significant portion of the FNB relates to their furniture financing operations which were subsequently disposed of.

Table A 18 : Bad Debts - comparative countries

Country %

Argentina 1.8

India 0.7

Mexico 1.1

(Source : Asli Demirguc-Kunt and Harry Huizinga : Determinants of Commercial Bank interest margins and profitability : Some international evidence)

Table A 19 : Bad Debts - developed countries

Country %

USA 0.80

Canada 0.30

United Kingdom 0.40

Australia 0.22

(Source: 1998 Financial Institutions Performance Survey, KPMG - Australia).

South African banks tend to experience higher levels of bad debts than the developed countries. There are a number of factors specific to South Africa which aggravate the level of bad debts and losses:

A significant proportion of the population is unemployed or is vulnerable to retrenchment.

South Africa continues to be a relatively high inflation and high real interest rate environment.

There are some communities where non-payment of service charges, rates and loan instalments has become endemic. There are well in excess of 31,000 non-performing loans in the low income housing market. Apart from not recovering interest on those loans, banks also have to carry the cost of security, service charges and rates.

KPMG conclude their report to the Banking Council as follows:-

The results of our study highlights the fact that, after making adjustment for cost of capital, the traditional intermediation function of the banks is not profitable.

The revenues from providing commercial banking services come from the net interest income and transaction charges. But net interest income is substantially determined in the market place, and if anything that margin is going to be further squeezed by the entry of new players like SA Home Loans. And transaction charges are bumping into increasing public resistance to further hikes.

The expenses are made up of the operational expenses of running the branch network and systems, bad debts and the cost of the capital that is employed in doing that business.

Operating costs are determined by forces largely beyond the control of the banks and have a lot to do with the historic development of the banking industry and environment in which they currently conduct this part of their business.

Bad debts are at a higher level than in developed countries, although not as high as in some other comparable countries. But the indications are that there has been a serious deterioration in the level of debt default and of debt write-off in the recent past. So, far from anticipating a reduction in bad debts and losses, it is likely that that figure will increase and negatively impact on the already poor ROE in the sector.

So there is no easy solution to the banks' dilemma in relation to their commercial banking activities. It is not as easy as just pushing up their prices or cutting their costs. They really only have two real options:

Get out of the market - which none of the major banks has yet done, or

Develop focused strategies, which improve the profitability of their business in this segment.

arrangements to protect clients

and

some common misunderstandings as to how banks function

The banks have a bewildering array and variety of products and services which they provide. These are complicated by variations for specific target markets, and then specific clients within those markets. The Banking Council has recently tried to prepare a comparison of the charges of the 4 major banks for a simple range of the most common products, and found it to be impossible!

However, the Board of Directors of the Banking Council have agreed that as a matter of principle all clients should:

be notified of the most common charges for which they will be liable;

be communicated with in a fashion which is readily understood; and

be able to access information in the branches - i.e. information should be displayed.

They have also agreed that these principles should be enshrined in the Revised Banking Code at present under negotiation.

However, when it comes to information on charges on all products and services, the banks face the same challenge when dealing with their clients as the Banking Council did when trying to create a table. They would totally overwhelm the client with confusing and useless detail if they attempted to convey everything.

The same problem arises with notifying clients of changes in the various fees and charges. There is already consumer resistance to the perceived high banking charges. The costs associated with providing every client with details of every changed fee or charge, would be astronomical and make banking even more unaffordable. Clients are therefore currently advised of changes via the media and ATM and statement messages that the fees are changing, and that they can get more details from their branch. Some banks also print small brochures detailing the most common new fees.

The Board of Directors of the Banking Council have resolved that its members should give their clients as much notice as is reasonably possible. However, banks operate in extremely volatile international and local financial markets, with the majority of their deposits (which fund all loans) of a short term, wholesale nature. These deposits re-price almost immediately in line with local and international market pressures. So where they are vulnerable to sudden and major increases in their costs, they cannot expose themselves to fixed rates of revenue.

The Board of the Banking Council has agreed that the new Banking Code of Conduct should enshrine the principle that, at the very least, members should be obliged to give notice in the national media, on the day on which they vary the rates. This notice should also be communicated in writing to the client, whether in a statement or other document, at the first opportunity after this. In terms of the Usury Act, this notice should be sent within 90 days.

The Banking Ombudsman is responsible for:

Intermediating between banks and the clients of banks whenever the client feels that he or she has been treated "unfairly". The Ombudsman is guided in his intermediation by the Banking Code of Conduct.

Making a recommendation if his intermediation is not successful. If the client does not like the recommendation, the client is free to go to court.

Making public his recommendation (and the fact that the bank has declined to follow it) in cases where the bank does not accept the recommendation.

The Ombudsman is not a substitute for the courts. He is there in a complementary role, and he is meant to be guided by what is fair, rather than what is the strict law. Moreover he is meant to act quickly and with very little or no cost to the client.

Despite the fact that the Ombudsman enjoys absolute security of office, the Board resolved that, by the time the new Banking Code of Conduct is brought into operation - which must happen before the end of 1999 - an independent juristic entity must be brought into being to select the ombudsman and oversee the conduct of that office. The banks will only be permitted a minority voice on the board of that entity.

We are currently going through the process of defining the new entity and how it will function. There is a workshop of the Financial Services Board in this connection on the 9th March.

The Banking Code of Conduct is at present being radically revised, based in large part on the new banking code introduced in the UK in 1997. The new Code will be much more readable, and will spell out the responsibilities of both bank and client more clearly. The Banking Council, in conjunction with the Ombudsman, has already negotiated a number of major concessions from the banks. The process of discussing and negotiating the revised Banking Code with consumer representative groups will begin in March 1999.

There have been calls for Codes of Conduct to be given legally binding status. This would be a serious mistake, as a Code of Conduct is an aspirational document that reflects the intention of the banks to do better than the law prescribes. Any legalisation of this commitment introduces serious risk and cost elements, and would restrict the freedom of both bank and client to strive for "fair and just" behaviour outside of the narrower limits provided for in terms of the law.

SOME COMMON MISUNDERSTANDINGS AS TO HOW BANKS FUNCTION

There are many misunderstandings about how banks function. It is acknowledged that in many respects the banks themselves have failed to educate the public or their clients about these issues. But there are also clearly problems with the education system itself, for example where large numbers of people (who have been through twelve years of "privileged" education) have no understanding of the most basic legal principles relating to financial services.

No. When the client deposits a cheque, the bank undertakes to collect the money for the client by presenting the cheque for payment. But if the cheque "bounces" or is not paid for any reason, the collecting bank in which the client deposited the cheque has no further obligation. However, since most cheques are paid when presented, interest is calculated from the day that the deposit is made and credited to the client depositing the cheque. If the cheque is not paid the credit is reversed, together with any interest calculated and paid on the amount of the cheque.

It takes time for the physical cheque that was deposited to be processed through the cheque clearing system to the bank branch at which the account is held. Only then can value be transferred from the cheque account holder to the collecting bank (which has already given the depositor value in good faith). In order to balance the system, the debit in the account holder’s account is backdated to the date of the original deposit. All related transactions between the 2 banks are similarly dated. In effect, therefore, this represents a simulated instantaneous deposit and withdrawal, with neither of the banks concerned being able to use the funds for their own "float" purposes.

The actual time to clear a cheque and pass value from one bank to the other varies, depending mainly on the geographic location of the banks concerned, and the arrangements used to process the cheques - e.g. collating them, transporting them, processing them. Cheques deposited in small rural branches, and from bank branches in Swaziland, Lesotho and Namibia - all part of the Common Monetary Area - take much longer to clear than local cheques deposited in the main urban areas.

Dishonest individuals, knowing that there is a time difference between crediting the account of the depositor of the cheque and the actual passing of value, or in the return of a dishonoured cheque, deposit dud or stolen cheques. They then draw down on the credit in their account before the bank becomes aware that the deposited cheque will not be paid. This leaves the depositor bank with a debit on the account, which it cannot recover. Last year alone, 3.2 million cheques were "Returned to Drawer", leaving the banks with R150 million losses on cheque fraud.

Banks have therefore adopted a policy that (even though they have credited the account for interest earning purposes) they will not allow that credit to be accessed until they are confident that they will receive value for the credit that they made available to the depositor. This "holding period for un-cleared effects" varies between 7 and 14 days following the deposit and depends on the bank's experience with receiving value and returned unpaid cheques. This ensures that there is a reasonable chance that before the money is drawn down, the bank will have been advised as to whether the cheque will be paid or not.

In sum there are 3 distinctly different dates:

The date from which the interest will be calculated. This is the date that the cheque is deposited on;

The date from which the client will be allowed to withdraw the funds. This is usually between 7 and 14 days, unless the client has made special arrangements with the bank; and

The date from which the funds actually belong to the client and no reversal can be made from the account. This is the date when, in terms of the cheque clearing rules between the banks, the drawer’s bank may no longer dispute the validity of the cheque. This date will never be the day that the deposit is made, but it might be before or after the client is allowed to draw down on the funds.

Banks have invested considerable resources in the cheque processing and clearing systems so that their clients can have the convenience of making and receiving payments without the disadvantages and risks of cash. These systems are also "on-line real-time" and the client can interface with account information and ATM systems 24 hours a day, 365 days a year. The client issuing a cheque pays for this facility.

As mentioned above, fraud is rife. Most of this fraud occurs when stolen or forged cheques are processed through the system, and the client has drawn down on the credit before it is discovered that the cheque is stolen of forged.

The reality is that every time the bank acts to collect or pay a cheque on behalf of a client, the bank is taking a risk. The greater the value of the cheque, the higher the risk for the bank. Losses from fraud are now so high that it has become common practice for the paying bank to phone and check with its client when cheques for large amounts are presented for payment.

This risk management system is expensive, and difficult to automate. In order to cover these additional costs and risks, clients are charged an "ad valorem" charge on their cheques, whereby the actual charge per cheque increases (to a certain maximum) according to the value of the cheque.

There are a number of reasons for levying administrative charges:

A bank incurs a number of ongoing expenses in relation to an account, even if no transactions are being conducted against the account. For example, even if the account is dormant and is generating no income, the bank has to maintain the computer systems and networks available nation-wide, 24 hours a day, 365 days a year, in case the client wants to access the account.

A bank has to hold liquid assets and cash reserves in respect of an account. These compulsory investments in lower or non-paying government financial instruments or institutions are estimated to cost the banks between 0.5 and 0.6% per year on the funds involved.

A bank has to render returns to the SA Revenue Services in respect of an account and therefore has to keep track of all interest credited to that account.

Dormant accounts are an open invitation to the fraudsters to see what they can do to usurp the money. Considerable cost is therefore incurred in monitoring dormant accounts.

For cheque accounts, the bank has to constantly monitor the account in relation to the facilities on the account. Other facilities (which vary regularly) such as the ATM and other withdrawal limits also have to be monitored.

Every time the bank does anything on the computer system, including the debiting or crediting of an amount to any other account, the computer has to check across all the accounts. This has become such a problem that it takes as long as 8 hours for the major banks to run the month end processes, and at times they do not have enough time to complete those runs before the start of the next day’s business.

All records and information pertaining to the account have to be kept until at least 5 years after the account is closed (to facilitate possible money laundering investigations). Current legislation relating to what may be considered as evidence in a court limits much of this to expensive hard copy, which has to be stored in secure facilities.

In addition, a bank derives no benefit from an account with a small balance on it. It is therefore clear that there are significant costs associated with maintaining an account, and these costs continue even when the account is dormant.

WHY IS THERE SUCH A PROBLEM WHEN DEPOSITED CHEQUES ARE LOST?

Unfortunately lost cheques have become a major problem in our crime-ridden society. Last year 3.2 million cheques were lost, many of them were stolen. Try as they might, the banks have not yet been able to come up with a solution which remotely satisfies all the conflicting interests.

The moment a cheque, which is being cleared is lost, the banks and their clients are at considerable risk and the banks dare not process the transaction further. If they do, and it subsequently transpires that the cheque was not lost but stolen, and the thief presents the cheque for payment and it is paid, the bank will bear the full loss.

Initially it was thought that the banks could continue to process the clearing transactions on the strength of the electronic details of the cheque (where these had already been captured), and leave it to the account holder to check the bank statement and advise the bank if the cheque concerned had been incorrectly processed.

There is now a realisation that this would have put an undue onus on the account holder, and in particular, many public sector bodies.

It would also have opened a major opportunity for fraud syndicates to perpetrate stolen cheque fraud in the knowledge that the transaction would be processed and not discovered for many months. The owner of the cheque account would be unlikely to pick up the false debit to his account before the fraudster had withdrawn the credit that had been processed and disappeared with the proceeds. The banks are now doing everything they can to minimise the risk, costs and inconvenience resulting from this problem.

When a client buys a home with a loan from a bank, the property is usually mortgaged as security for the loan in case the borrower’s disposable cash flow becomes too small to continue servicing the loan repayments. A mortgage is nothing other than a pledge that is registered formally through the Deeds Office, to protect the rights of the lender. This means that the homeowner cannot offer the same property as security to someone else without first disclosing that it has already been offered (or mortgaged) to the previous lender, and that he or she cannot sell the property and pocket the proceeds without first paying back the outstanding loan.

This being the case, the home belongs totally to the homeowner. He or she is responsible for maintaining it, and he or she will benefit from the capital appreciation of the property. The bank’s sole interest in it is as security or collateral for the outstanding loan balance. There is therefore no justification for the claims that banks are the "owners" of these properties, and that they are therefore not entitled to change the interest rates on the grounds that they get the benefit of the capital appreciation.

The client decides what property to buy and at what price. All he or she asks the bank to do is to grant a loan to finance the purchase. The property belongs to the client and not to the bank. All the bank does is look at the property to see if it is satisfied with the security that it will hold for the loan. It does not look at the property to decide if the client made a good purchase.

However, if the client fails to repay the loan the law prescribes that the only way that the bank may recover the loan is to get a court judgement and, in terms of that judgement, ask the Deputy Sheriff or Messenger of the Court to sell the property at a public auction to the highest bidder. The proceeds of the sale are then distributed in accordance with law relating to the preference rating of creditors. In most instances the first creditor to be paid is the Local Authority for arrear rates and charges. Should there still be any surplus after that it is applied to the outstanding balance on the home loan. Any proceeds still left after that are paid to the homeowner. Likewise, if the proceeds of the sale are not sufficient to cover the outstanding loan balance then the client still has an obligation to repay that outstanding amount to the bank.

The bank can go to the sale like anyone else, and the sale must be extensively advertised. At the sale the bank can take a decision like anyone else that it would like to buy that property as an investment, or to protect its interest as a creditor. Once that decision is taken all the risk of profit and loss in that investment is for the bank's account and has nothing to do with the client to whom the property belonged. This due process of law is as old as the Roman Empire, and applies equally in our law as it does in the law of all developed nations. Without it there would be no basis on which the banks could do the business of 20-30 year lending to the public for the purposes of home ownership.Appendix 1

Presented to the Portfolio Committee on Trade and Industry,

2 March 1999

__________________________________

1. Introduction 1

2. Impact of high interest rates 2

3. Regulation of Commercial banks 4

4. Regulation of Micro Lending 5

5. Summary of Recommendations 8

1. Introduction

COSATU welcomes this opportunity to make a presentation to the Parliamentary Committee on Trade and Industry on the need for improved regulation of the financial services industry in South Africa. Workers and their families are sick and tired of bearing the brunt of high interest rates, high bank charges, under-servicing and regulatory failure with regard to micro-lending.

These are issues of deep concern to working people throughout South Africa, as so many of us find ourselves paying large amounts of hard earned monies to banks and unscrupulous money lenders. Furthermore, continuing high interest rates have a debilitating impact on our economy – draining the state coffers, increasing the cost of investment and contributing to economic stagnation and rising unemployment.

While we applaud the Portfolio Committee’s decision to focus on the issues of bank charges, micro-lending and usury regulation, it is COSATU’s view that these are all aspects of the broader question concerning the need for the re-regulation of South Africa’s financial institutions to ensure that they are more accountable to the communities which they purport to serve and to ensure that their policies and practices are more appropriately oriented towards economic reconstruction and development. We are also of the view that the high cost of borrowing is made more acute by the Reserve Bank’s restrictive monetary policies and the lack of effective competition within the banking sector, we believe that these matters also require more detailed consideration by Portfolio Committee members.

This submission will be structured as follows. Problems associated with:

- high interest rates,

regulation of banks,

regulation of microlenders,

And will conclude with a summary of our policy recommendations.

2. Impact of high interest rates

It is widely accepted that South Africa’s high real interest rates have a number of negative effects on economic growth and development. As can be seen from the following chart, as of July 1998, South Africa’s real interest rate of around 15% is extremely high real by international standards.

Note: The two extreme cases (Turkey with a real interest rate of –20.6% and Russia with a real interest rate of 73.6%) have been omitted from this chart as their inclusion would have distorted the scale of the chart.

Source: Economist Vol.348 No.8076 July 11-17 1998.

High interest rates cause various problems, including the following:

High interest rates increase the costs of productive investment. This applies particularly to enterprises reliant on external credit, such as Small, Medium, and Micro Enterprises. The dampening of productive investment has obvious negative results for employment. (See attached Annexure A: Research by Naledi.)

High interest rates put upward pressure on public debt servicing costs, thus reducing the resources available for social spending. (See attached Annexure B)

At the same time, high interest rates attract speculative investment. This is because high interest rates relative to other countries raise the short-term returns on lending money in South Africa, hence encouraging capital inflows. These inflows, however, can be destabilising and can transfer volatility in international money markets to domestic markets. The movement of short-term capital can also exert a "disciplining influence" on domestic policy options, narrowing the parameters of which policies can be pursued without destabilisation.

COSATU has long campaigned for policies which would lead to the lowering of interest rates and has, therefore, welcomed recent statements that government intends achieving greater co-ordination between monetary policy and other aspects of economic policy, including job creation and investment promotion. Such improved co-ordination could be achieved through a range of policy and institutional reforms, including inflation targeting. Whichever mechanisms are used, priority should be given to lowering interest rates and the promotion of a monetary policy, which will be conducive to employment creation. Inflation targeting should not be pursued as a tool of restrictive or inappropriate monetary policies.

While we are aware that broader monetary policy matters fall beyond the immediate scope of these Hearings, COSATU is concerned that:

Increased public scrutiny is required regarding the operation of the Reserve Bank’s repurchase rate - or repo rate – mechanism. Despite certain market driven aspects of the repo mechanism, it should not be operationalised in such a way as to disempower the monetary authorities from being able to adjust the repo rate where necessary, for example, at appropriate times increases in the money supply can be used to stimulate a reduction in the repo rate; and

Certain conduct of the commercial banks – in maintaining lending rates significantly above the Reserve Bank’s repo rate – contributes to exorbitant interest rate levels and thus contributes to the restrictive monetary environment. Any recommendations by the Parliamentary Committee with regard to regulating aspects of the conduct of actors in the financial sector, should directly address the problem of the persistent spread between the repo rate and bank lending rates.

It would be expected that if there were effective competition within the banking sector then competitive forces would see to it that a drop in the repo rate would be followed by a decline in the effective lending rate offered by the banks. We believe that there needs to be a public investigation as to why this has not been the case. In particular, we call on the Trade and Industry Portfolio Committee to recommend to the Competition Board that such an investigation in to competitiveness in the banking industry be urgently undertaken.1

3. Regulation of Commercial banks

The commercial banking sector is failing to provide an adequate service to the bulk of the South African public. It is under-servicing poorer communities and in so doing is limiting access to savings, transmission and credit facilities. A direct effect of this under-servicing is the mushrooming of the kind of formal and informal micro-lending practices, which are discussed in more detail below. A most telling fact, which says a lot about the present culture, priorities and policies of South Africa’s banks is that since 1990, "the banks have opened more offices in ‘hot money centers’ – Panama, the Isle of Man, Guernsey, Jersey and the Cayman Islands – than in black townships where most of their potential customer base rests".2

Government’s response to the reality of the under-provision of properly regulated financial services to the bulk of South Africans, should be two fold:

Firstly, there needs to be a reform of the regulatory environment in which the financial sector operates, including both banks and non-bank financial institutions. Public discussion is required on an improved regulatory environment for the financial sector including questions of bank charges, fair lending criteria, disclosure requirements, and improved social responsibility. A collaborative Task Team including civil society and relevant government departments (including DTI, Housing and Finance) should be established to look at a more appropriate regulatory framework for the banking sector.

Secondly, the role of public sector entities in providing financial services to the people should be expanded. For example, the restructuring of the Post Office to provide improved public sector bank through PostBank and TeleBank is welcomed and must be explored further as provides a basis for the public sector to involve itself in the extension of services to historically disadvantaged communities and far flung rural areas.

With particular reference to bank charges: According to the Consumer Institute of South Africa (CISA), bank charges amounted to about R8,7 billion of the total banking industry’s earnings last year. CISA says that the banks are free to charge whatever they feel is in the interest of them on current accounts and savings account. If these commercial institutions are not regulated in terms of what they can charge and disclose to consumers when they open accounts with them, then this puts the consumer at the mercy of the institution when in essence this should not be the case.

Some of the key problems with regard to bank charges are as follows:

Exorbitant increases in bank charges e.g. Standard Bank of South Africa Limited has increased its lost-card charge fee from R6 to R10 which is a 67% increase at the beginning of the year, the majority of the people do not have sufficient information regarding the negotiation of banking fees with service providers, and

cheaper services, such as electronic banking, is usually only available to rich individuals who can afford to buy personal computers and modems to be connected to the bank’s electronic banking system.

4. Regulation of Micro Lending

It is widely recognised that the unscrupulous practices of some operators in the rapidly expanding micro-lending industry3 is causing hardship for many. As Finance Minister Trevor Manuel stated in this year’s Budget Speech:

"[T]oo many people have become hostage to unscrupulous money-lenders. There is a place for the micro-lending industry. But we will not tolerate the blatant exploitation that appears to be taking place at the moment. It is illegal to take people’s Identity Document as collateral, it is illegal to charge people usurious interest rates and it is bad practice to lend to the point where a person’s entire wage is consumed by the repayment of the loans."

COSATU welcomes the spirit of Manuel’s intervention. It is a clear statement of government’s intention to correct the failure of regulation and enforcement with regard to the micro-lending industry. Unfortunately, this intention is only partly reflected in the Minister of Trade and Industry’s Notice with regard to the Usury Act4 ("the Notice"). The positive aspect of the Notice is that:

it provides for the establishment of a Ministerially approved Regulatory Institution, composed of representatives of consumers and the micro-lending industry, which will seek to monitor and set standards for the industry, and it outlines basic principles to guide the Code of Conduct to be followed by micro-lenders, including maintenance of confidentiality, information disclosure requirements aimed at empowering borrowers, limitations on money lenders charges and collection methods, and the implementation of cooling off periods.

A fundamental weakness with the Notice is that it intends to increase the size of loans (from R6 000 to R50 000) that will be exempted from the bulk of protections offered to borrowers by the Usury Act. In particular, the Notice intends removing borrowers’ protection from the ‘usurious interest rates’ which Minister Manuel reminded money lenders were illegal and which could open them to prosecution.

COSATU believes that parliament’s Trade and Industry Portfolio Committee should strongly reject a situation where, in the name of offering greater protection to the victims of unscrupulous money lenders, the protection against exorbitant, usurious interest rates is removed. Any argument that subject to the Minister’s approval, the Regulatory Institution can set interest rates for loans of less than R50 0005, should be strongly rejected by the Portfolio Committee. When there is evidence of gross exploitation of borrowers such as there is today, it is the right and responsibility of Parliament to have the final say as to what maximum interest rates are to be paid by small scale borrowers. In fact, instead of increasing the exemption to R50 000, consideration should be given to the feasibility of reducing or abolishing the current R6 000 exemption, which was first introduced in 1992.

Research shows that some poor borrowers are charged around 30% interest a month on a loan, which amounts to 360% interest per annum. This translates to the following exploitative situations:

Last year the Finance Ministry was forced to revise its medium term budget because of high rates of interest payable towards the state debt. The following is a statement taken from this year’s Budget Review, "Unanticipated high interest rates over the past year have impacted sharply on the fiscus, adding about R2,7 billion to projected state debt costs in 1999/00 and it further states that "a reduction in interest rates will lead to a reduction in cost to the fiscus of government debt, and that this will lead to or contribute to a formulation of fiscal policy that will encourage investments and employment creation in the wider economy". It is through these high rates that government spending in relevant or important areas is impeded because of high debt service cost that takes about 22,1% of our national budget (R48,5 billion from a budget of R219, 6 billion for the year 99/00).

Comparison items in the Budget that are in cost close to the interest bill of R2,7 billion that the government had to pay because of increases in interest rates are as follows. The interest bill was:

More than the Justice Department Budget (R2, 545bl) for the year 1999/00;

More that the Trade and Industry Department Budget (R2, 065bl) for the year 1999/00;

More than the Department of Foreign Affairs budget for the years 1999/00 and 00/01 combined;

Almost equal to the Public Works Budget (R2, 875bl) for the year 1999/00; and

Almost equal to the Budget allocated for the Training and Research on health for the years 1999/00 and 00/01 combined and the provision of primary school nutrition programme for 1999/00.

The interest on the State Debt is the fastest growing item on our budget and this year it was our second highest item on the budget behind Education. The following Table is an analysis of the interest bill in our Medium Term Expenditure Estimates:

Table 3:

Submission to the Trade and Industry Portfolio Committee Hearings on Bank Charges, Microlenders and Consumer Protection

Cape Town

1-3 March 1999

Chief Directorate: Business Regulation and Consumer Services

Department of Trade and Industry

1. Introduction

Good morning, Chairperson of the Committee, Dr Rob Davies, members of the Committee, colleagues and members of the public. I would like to congratulate the committee for taking the initiative to host these hearings and thank the Committee for the opportunity to make two presentations. The first part will sketch a overview of the overall financial services sector, focussing in particular on the banking sector and consumer protection issues. In our second presentation tomorrow we will focus on the microlending industry, outline some of the problems and make policy proposals for both the banking sector and the microlending sector.

These hearings come at a critical time in our history. The banking sector is at a cross roads prompted by a set of new developments which include:

1. the emergence of a whole new set of financial services players;

2. consumers being confronted with bank assurance mergers, demutualisation, international listing, highest levels of interest rates, record profits;

3. the fuelling of a high appetite for credit by banks over the past few years, which has resulted in the highest levels of consumer debt in South Africa's history;

4. the increasing questioning of the role of regulatory institutions in protecting consumers,

5. the fact that consumers are beginning to organise themselves and are becoming more vocal in expressing outrage at the behaviour of banks and the exploitation by micro-lenders.

Over the next few days we will be accused of bank bashing as you have been over the past few weeks because you chose to host these hearings. Similar, but more intensive and extended inquiries into the Financial services sector and consumer protection has occurred in Canada, Australia, the UK and the EU. South Africa therefore should not be seen as an exception. We are now at a time when we need to assess and review the role of financial services in South Africa.

2. Why Examine the Financial Services Sector in Particular?

Every consumer has a need for a safe place to save money, to deposit and transmit their income and to obtain credit for the purchase of a house, car or to tide them over difficult times. Consumers need access to these services to participate in the mainstream economy. The financial services sector affects us in our day to day lives, as an employee, as a student, as a business person, as a pensioner and as a consumer.

3. The Role of The Financial Services Sector in Society

Banks are not neutral agents. They have played both a positive and a negative role in society. Swiss banks assisted the war efforts of Germany in the 1930s and 1940s. Evidence of South African banks support of the apartheid government has emerged.

On the positive side, banks supported the reconstruction and development of post war Europe. The positive role of the Chicago South Shore Bank in making loans for housing projects in inner city areas is also well known.

The key question is what is the role for South African banks now? What are their responsibilities in a context of transformation, in developing society and in creating acceptable practices towards consumers. Some people would argue that an attitude change is necessary. We would argue that a change in behaviour, not just attitude, is critical.

4. The Orientation of South African Banks

Banks have in effect already made their strategic choices. This is evidenced by the following trends:

· A re-focusing of bank activities away from the low income markets;

· An attempt by the formal banking sector to make traditional provision of financial services more profitable through cutting costs and raising banks charges;

· The emergence of new financial services providers in markets neglected by the formal banking sector;

· An attempt to keep the overall market and regulatory framework for financial services segmented;

· And no acceptance of responsibility for consumer protection measures.

I discuss each of these trends in turn.

4.1 Refocusing of Bank Activities

With South Africa's integration with a world economy marked by a high degree of financial interdependence, the domestic banking industry has followed international trends. In part, this has meant a re-focusing of their activities toward offering more investment, high-income banking, foreign exchange, and a wider variety of products which traditionally have been offered by other types of firms within the financial services industry, including varieties of insurance products. All of these activities have in common the provision of extended, and sometimes new, services to the upper-income end of the market.

As part of this attempt to re-focus, banks have sought to reduce their exposure to certain markets reduce their overall profitability. Hence, the formal banking sector has moved, and is continuing to move, away from the provision of services to the lower-income segments of the overall market. This shift away from provision of services to the lower-income segments is achieved primarily by discouraging clients through closing branches, increasing over the counter fees in particular and service fees in general, and by imposing onerous requirement for opening accounts and accessing credit. Where the traditional conservatism of the banking sector made access to credit and saving instruments difficult, the new rules effectively make access virtually impossible - even in the expanding market for provision of services to previously disadvantaged people who now earn a decent living.

Banks, therefore, are failing to meet the needs of all South Africans in at least three respects:

· providing a safe place to deposit savings;

· providing a facility for receiving and transmitting income;

· providing access to credit.

4.1.1 Access to Savings

Banks have increasingly over the last few years, as competition from foreign banks in the high end of the market has increased, limited savings facilities to the lower income population. Most banks have minimum deposit requirements and also require proof of minimum income to open accounts. In some cases, banks have unilaterally closed accounts or have refused to open new accounts. We have received statements from some pensioners that banks have unilaterally closed accounts without even informing the client. Considering the high levels of self-employment in the South African economy, as well as the number of low-income formal sector employees, banks are effectively limiting access to saving instruments.

One bank has even gone so far as to end banking services to thousands of its less profitable customers. Whereas in the pre-democracy era a "cross subsidy" on these high-volume, low-amount accounts would have assured that, for example, white low-income customers (especially pensioners) would have retained access to at least a "lifeline" banking service, this cross-subsidy has been phased out -- along with numerous branches that served low- and middle-income customers -- apparently as a matter of policy.

This leaves a large segment of the population unbanked. There are a number of alternatives, such as the Post Bank, Pick 'n Pay Financial Services, Teba Cash, Stokvels, and a limited number of credit unions and village banks. But of these, only the Post Bank and Teba Cash, which provides savings and transmission services to mineworkers and their dependents, are alternatives of significant scale. It is estimated that Pick 'n Pay Financial Services has only about 120,000 accounts, while credit unions have an estimated 4 000 members. Stokvels generally do not provide longer term savings facilities, but rather operate on a rotating basis. However, the large number of stokvel members (estimated at 6 million) indicate the need for these types of services.

Of the alternative banking institutions, only Teba Cash is regulated by the Registrar of Banks. It would appear thus that only those institutions that serve the higher end of the market merit supervision from the SARB, implying that lower income and rural consumers do not have access to "safe" institutions to deposit savings.

4.1.2 Access to Transmission Services

Access to a facility to deposit and withdraw funds, i.e. a form of transmission mechanisms, is a basic need for all consumers. With the rationalisation of bank infrastructure and the withdrawal of access to bank accounts and other services, the mechanisms to access wages and transmit income are contracting. Furthermore, by limiting access to bank branches and forcing consumers that have access to use ATMs, often on a street front, banks are effectively exposing consumers to greater risk, without accepting any liability.

With respect to the contraction of banking services in the form of transmission accounts, it is again only the Post Bank and Teba Cash that provide alternatives. Entry of new market players is further limited by the new National Payments System Act, which only grants banks access to the Payments System through the Payments Association of South Africa (PASA). While provision is made for Customer Payment Service Providers (CPSPs), which effectively act as agents for banks, these CPSPs will not be able to become deposit takers. Nowhere is there an indication or disclosure of any fees that banks may charge for these agency relationships, nor the net cost effects on end users. If ATM fees are an indication of what can be expected in future, it would appear that heavy fees will be imposed on end users.

The implications of the Payments Systems Act thus have to be carefully examined. Furthermore, transparency and disclosure must be increased on the part of PASA, banks and the SARB. Systemic risk and financial stability cannot be used as excuses for limiting access to banking services for the majority of South Africans. As an alternative, serious consideration must be given to universal banking or "life line banking" issues. These issues have been under discussion in a number of countries. In Australia and Canada, for example, the Payment System was opened up to a greater number of players, without introducing systemic risk issues. In Europe, on the other hand, universal banking requirements on banks are being hotly debated.

4.1.3 Access to Credit

As with other banking services, banks are not addressing the needs of the low income population. and in particular, of the previously disadvantaged. Most complaints raised publicly since 1994 have related to the lack of commercial bank lending activity in low-income markets. This has been an issue particularly with respect to low-cost housing, with only around 15% of housing subsidies receiving the top-up credit that is generally required to assure construction of a decent living environment, notwithstanding generous Department of Housing schemes to guarantee loans. Our own Department of Trade and Industry programmes -- particularly the Khula Credit Guarantee fund -- have witnessed a surprising apathy from banks, which publicly claim to be very supportive of (and active in) the Small, Micro and Medium Enterprise (SMME) sector, but which have shunned programmes that would lower risk, raise profitability and hence justify more reasonable lending rates in the sector.

SMMEs receive approximately 2,6% of investment capital flows, through both formal and informal agents. According to the Council of South African Banks, there were 375 000 loans on the books of commercial banks in 1998, that can be considered micro-enterprise credit (R4 billion, averaging R11 700 per loan). Yet as of late 1998, just over 1 000 indemnities were granted by Khula's Credit Guarantee scheme, confirming a lack of activity in areas government has prioritised need. A key factor mitigating against increased investment in the SMME sector is the structure of the financial sector. The sector is composed of a concentrated formal banking sector targeting corporate accounts and competing with smaller niche banks and investment banks. Few second tier banking institutions exist that can absorb savings and extend credit to SMMEs. Furthermore, there is a dearth of strong alternative financial institutions providing credit to the self-employed for productive purposes.

4.2 Making Traditional Banking More Profitable

At this point, of course, the formal banking industry still retains a considerable capacity to provide services to the retail market. But alongside the restriction of its activities in that market, the banks have embarked on an attempt to make what remains of those services more profitable. This takes two basic forms - reducing the costs to banks of providing services and increasing the prices charged for services.

To reduce costs, the banking industry has closed and/or changed infrastructure. The explosion of ATM facilities and the closing of branch offices are the primary signs of this trend. By closing branches, the industry is able to economise on personnel costs, costs related to renting and/or owning property, and cost per transaction. While the increase in ATM facilities does represent an attempt by the banks to continue to offer some services at a lower cost, it needs to be recognised that ATM and other electronic banking facilities cannot at this time offer the same level of service provision to retail banking consumers. Moreover, while an ATM may give an individual access to an already existing account, it obviously cannot enable an individual to open an account or request credit. An ATM cannot be seen as a substitute for a branch office. Furthermore, there have been no coherent efforts on the part of banks to provide education to clients on the use of ATMs or electronic banking.

At the same time, it is important to recognise that by reducing costs by closing branch offices, the banking industry is also reinforcing the trend toward limiting the access of lower-income segments of the market to financial services.

The second element of making traditional banking more profitable is to increase the prices charged for the provision of services. Bank user charges, as we all know, have increased dramatically over the last few years. Increases in user charges have become the fashionable way for banks to increase prices for services. When interest rates are high and normal banking activity (extending loans) decreases, an increase in user charges enables banks to cushion the fall in profitability arising from the high interest rates.

The user charges apply to all segments of the traditional retail market, from high-income to low-income, but as fixed charges, they weigh most heavily on individuals with lower incomes and smaller accounts. Hence the user charges are regressive and fall disproportionately on those less able to afford them.

As with the closure of bank branches, the increase in user charges reinforces the trend toward limiting the provision of services to lower-income segments of the market. But because individuals who are fortunate enough to have access to financial services also rely on them, the increase in user charges ensures that the impact of the charges increases profitability, even if it may cause people to withdraw from the formal banking system altogether.

For the higher-income end of the market, the increase in user charges feeds directly into profitability as few, if any, of those consumers are likely to find the charges so onerous as to force them to drop out of the market.

4.3 The Emergence of New Financial Service Providers in Markets Neglected by the Formal Banking Sector

Thc shift in the formal banking industry away from retail banking and away from lower-income, previously-disadvantaged segments of the market has not been without impact on the overall market for financial services.

Because the banking sector does not cater for most South Africans, and because bank savings and lending services are the cause of consistent consumer complaints and high user charges, an alternative banking industry has emerged in the formal and informal sectors. This alternative industry is composed of Non-Governmental Organisations, mashonisas, formal cash lenders, medium term lenders, housing lenders, and small business lenders.

The emergence of these financial service providers is a direct consequence of the unwillingness of the formal banking industry to enter new markets for deposits and credit as well as their steady withdrawal from providing retail services. Facilitating this new industry was the 1992 exemption of money-lending transactions up to R6,000 from the provisions of the Usury Act. By taking advantage of that exemption, money-lenders of both the informal and formal variety have mushroomed into a profitable, widespread industry which serves the demand for credit among the lower-income segments of the market.

The 1992 exemption from the Usury Act had, amongst others, one very significant flaw. It provided no mechanism for regulating this burgeoning industry. As Finance Minister Trevor Manuel noted in his recent budget speech, this in turn has led to extreme exploitation in the form of interest rate charges and debt collection practices.

The consequences of these developments for the overall market for financial services have been extreme. As already noted, individuals accessing this emerging market for financial services have become the victims of an industry which is free to pursue notorious and damaging practices which leave consumers heavily indebted and robbed of fundamental consumer rights. Because the overall market is so deeply segmented by the practices of both the formal banking industry and the emerging industry as well as the regulatory frameworks which keep the market divided, there is no way by which competition between financial service providers can ameliorate the worst practices.

4.4 Keeping the Overall Market for Financial Services Segmented

The final major trend which we want to highlight at this point is that both the emerging financial services industry as well as the formal banking industry appear to want to maintain the high degree of market segmentation which currently exists in South Africa. Such segmentation only serves to maintain the current state of affairs in the overall market extensive bad practice, excessively high interest rates charged for some types of loans, increasing user charges, and a growing middle segment of the market which is increasingly under-banked at high cost. More and more of this latter segment of the market is turning to the emerging industry to serve its demand for financial services.

It is unacceptable that lower-income segments of the South African population are every day more and more exposed to the high rates and bad practices that prevail in the emerging industry. It is also unacceptable that the banking industry can leave behind consumers of traditional retail banking services, while at the same time sealing itself off from competition from emerging financial services firms.

Market segmentation in effect perpetuates the unacceptable aspects of the financial services market overall, and ensures that the trends which we have highlighted can continue unimpeded.

5. Key Issues

What do we think are some of the key questions that the Portfolio Committee should be considering in their policy deliberations over the next three days:

1) Do banks have a role in society or are they just accountable to shareholders?

2) Do banks have a responsibility in educating consumers?

3) What is the role of government and regulators in protecting consumers in the financial services area? Do we need to review the regulatory structure for consumer protection and financial services?

4) How much public disclosure and information do consumers need to make informed decisions?

5) How should Micro lenders be regulated?

6) What are the costs of lending and can the high interest rates, both in the Banking sector and the microlending industry, be justified? Are there alternative institutions?

7) What is the role and function of consumer groups?

8) In balancing access and consumer protection, where do we draw the line?

And, finally, may I leave you with this point:

For years, the government and banks deliberately misinformed, excluded and kept consumers in the dark. Now they have the audacity to take advantage of the situation, a situation that they had a part in creating. They tell us we should negotiate better deals with them on an individual basis. Yes, that suits me fine - as long as they let me in through the front door.