Finance for SMMEs: the Role of Banks (both sessions)

Meeting report

TRADE AND INDUSTRY PORTFOLIO COMMITTEE
14 June 2000
FINANCE FOR SMMES: THE ROLE OF BANKS
 

Absa Bank
The Banking Council
Nedcor
Standard Bank
South Cape Investment Network
Western Cape Black Business and Professionals Alliance
Eyethu Butcheries
Citizens Finance Corporation of South Africa

SUMMARY
The hearings were held to identify the issues around the lack of financing of SMMEs. The banking sector in the form of Nedcor, Absa Bank , Standard Bank and The Banking Council presented in the morning. Their point is that a bank is accountable to all its depositors and functions within the international global financial system. The bank cannot jeopardise its relationship to stakeholders and its shareholders by increasing the risk factor. That means that a bank has to be quite careful about its decisions especially when the risk factor is high as it is with start-up businesses.

The strategies they suggested were: Government must initiate more development programs with banks. Government should make starting subsidies available to small firms. Banks should not be the only institution involved in the financing of SMMEs. Community-based loans services such as those that operate in the United States should be developed in South Africa.

The SMME presenters followed in the afternoon. They stated that banks were not sensitive to the needs of black business in the Small, Medium and Micro Enterprises sector. They said that bank staff where rude, unhelpful, disparaging and deliberately undermining. Perceptions of the business environment in the townships lead to banks rating black businesses as high risk. This makes it more difficult for black businesses to successfully compete. Banks were not seen as being sufficiently sensitive to the unique historical experiences of black businesses. Parliamentarians asked the SMME delegates what could be done to overcome the perception that their industry was high-risk and to provide possible solutions to the problems they faced. The hearings will continue the following week.

MINUTES
The Chairperson, Dr Rob Davies, briefly noted the outcomes of the previous meeting held on SMMEs. The Co-Chairperson set the tone for days discussion saying that it should take the form of constructive engagement rather than a malicious witch hunt. He noted that these issues have been around for sometime and hopefully at the end of the process a broad strategy or direction would emerge.

The Banking Council
Mr Bob Tucker noted that the Banking Council has taken measures to restructure the banking industry as a result of the previous discussions held on SMMEs. He explained the challenges that the banking industry was faced with in trying to maintain a sound financial sector in the high tide of South African transformation. He emphasised that a shift in job creation from previous areas such as the mines to small enterprises was necessary to improve the lives of many people. A South African transformation would only be effective if it would redistribute income more fairly and if the adverse consequences of Apartheid could be dealt with efficiently.

Tucker noted that the South African Banks had to maintain the standing that it held in the international sector. In order to do so, it had to be more profitable. This indicated that there was a pressure on the banks to withdraw from activities that were less profitable. Tucker went on to clarify what SMME financing meant. He showed that financing a Medium-sized business meant a loan of R2 and 5 million. This is contrary to what people think such loans involve. A Small-sized business would require a loan of between R50 000 and R2 million.

The requirements for a loan are a viable business and a sustainable loan and collateral security as a last measure. A viable business entails entrepreneurial energy, managerial skills, a sound business proposition and adequate capital in the right ratios. Here Tucker drew attention to the poor managerial and entrepreneurial skills that characterised the SMME sector as a result of Apartheid. He detailed the necessities for managerial skills and a sound business proposition and explained what he meant by adequate capital in right ratios.

He outlined the costs of very small, small and micro-business loans. In doing so, he showed that a bank loan to a micro business would not be in the best interests of the bank or the business and that other options for funding SMME should be considered. He also noted that the business might be viable but the loan is not sustainable because of relative costs of administering and recovering, mentoring and bad debt losses. He stated that instead of trying to justify loans to SMMEs that banks were not prepared to finance, other means of financing SMMEs should be explored. As formal community-based banking services did not exist, banks had to fill that role which was beneficial neither to the bank nor the business. Tucker urged a review of the entire issue.

The difference between funding a properly capitalised going concern and a start-up business with inadequate capital was highlighted. Banks lend to medium, small, very small and even micro businesses that are going concerns and have capital in appropriate ratios. A bank loan would not be granted to a micro business with in-adequate start-up capital. However a very small business with inadequate start up capital may be granted a loan as part of a special initiative.

In considering the way forward, there was a firm recognition that banks cannot provide loans for micro-businesses. For very small start-up businesses, banks may be able to provide loans but they would have to aligned to government initiatives or such as Sizanani. For small and medium businesses, there should be agreement on the basis on which statistics should be kept. There should also be a monitoring of financing activities of the banks and all other financial and lending institutions.

The Banking Council stated that the government has to bring large numbers of people into the mainstream of the economy and there was an obligation to maintain the stability of the financial sector. Government intervention in the banking community should not occur unless accompanied by Government guarantee or risk mitigation. Tucker concluded that the over-riding objective must be the establishment of a framework for banks to play a constructive role in the development of a vibrant SMME sector while maintaining the strength and integrity of South Africa's financial sector. The framework must be defined at national level and must also involve the Department of Trade and Industry, the Department of Finance, the bank regulator, other financial institutions and other private and public sector stakeholders in the SMME environment.

ABSA
Johan Coetzee, General Manager: ABSA Credit and Risk Management, stated the vision of ABSA was to be partners in growing South African prosperity by being South Africa' s leading financial services group. The purpose was to serve all ABSA's stakeholders - its clients and the community and government. He clarified the mission of ABSA, noting the 331 branches, 452 mini-branches around the country that made ABSA accessible to a very wide range of people. Currently there are more than 800 people working on providing funding to SMMEs. There was in excess of 3 billion Rands in loan at present to SMMEs and operations such as Africa Equity facilitated the process. ABSA's direct initiatives were the ABSA Foundation, Equity Africa and the Black Economic Empowerment. ABSA also had investment initiatives and business partners such as CGIC and the New Farmers Development Company.

NEDCOR
Alan Mukoki of Nedcor was direct in pointing out that the picture was grim. The input costs of small business were higher than larger business making it much more difficult for the small business. A start-up business would experience many difficulties that it would blame the bank for when it is not actually the bank's problem. An example was when a small business rents premises, the landlord asks for a bank guarantee that there are funds that will enable further payment of the premises. When the small business asks the bank for a guarantee, the answer is negative because of the risk factor and the lack of history that the small business has. Thus the small business owner cannot obtain premises from which to start his business and acquire the money that would provide the bank with reason to grant him the guarantee in the first place. Another problem that Mukoki identified was that South Africa does not have a culture of entrepreneurial skills. South Africa has a very definite culture of blame. When things do not go well then the government is blamed and people want to know what the government is doing to fix them.

The small entrepreneur needs advice and support and the bank does not provide this facility. The small business has to compete with larger businesses in terms of technology of production as well as break into the markets and form market relationships. In order to gain access in the markets requires a confirmation of your guarantee. However a small business cannot guarantee this in the future.

Standard Bank
Keith Fuller emphasised Standard Bank's commitment to a strong and successful SMME focus. While more people across all races groups of the SMME sector were choosing to bank with Standard Bank there was a marked increase in the Black group (see presentation document).

Mr Fuller noted that Standard Bank makes a large number of loans in the less than R50 000 category; 19,1% of which are non-performing loans. This is a costly business. Fuller emphasised the need to develop a better understanding of SMME financing. He assured the Committee that Standard Bank is committed to imparting banking services to more people and would support the government in finding solutions to the financing of SMMEs and to national job creation initiatives. He felt that the government needs to broaden their assistance with projects such as Sizanani. Although Khula is small they have increasingly played the leading role in the processing and support of its guaranteed business. Fuller admitted that Standard Bank had a long way to go in structuring and implementing their proposition to become even more inclusive. He recognised that obstacles need to be addressed in terms of the public opinion on the risk-based pricing in the formal banking sector. The way forward for Standard Bank requires a necessary partnership approach, which would include alliance partners and government.

Questions and comments by committee members
Mr Moosa questioned the granting of loans only to viable businesses. He was concerned about start-up businesses surviving without loans. He also expressed great concern about the distribution of loans along racial lines. He commented on Nedcor concentrating largely on the white SMME market , ABSA's small percentage dedicated to SMME financing and Standard Bank's small portion dedicated to black business. He asked that the banks get to the bottom line with small businesses.

Ms Ntuli (ANC) referred to the Standard Bank's outreach programs which takes the bank out to rural areas and makes ATMs accessible to the public. This showed that the bank was taking the initiative to help people gain access to banks. This was especially remarkable of Standard Bank . She said that banks should consider how white communities started and the assistance they required when they first began. People were living in poverty yet the banks turned their loan applications down as they lacked skills and guarantees - even when their only source of income could be the money earned from starting a business. She urged the banks to consider the starving people who would not be in that position had a loan gone through and a business was able to flourish. She asked that the banks share their skills and money with those who were in desperate need of it. She questioned the motive of a bank as a purely profit-making organisation who did not care for the welfare of the people. She suggested that the banks look at how people can be helped and be honest with themselves in their response to the financing of SMMEs.

Mr Andrew (DP) identified as a problem the need to encourage people to find work in the form of small business and entrepreneurial activities. He reckoned that South Africa needs to look more closely at the response of other countries and the resulting consequences to problems of this nature. He suggested that we look at South East Asia scenarios in which the government makes loans to SMME.

The Chairperson, Dr Rob Davies, agreed and described the Missouri policy in which the government certifies loans. He enquired about further incentives that could be applicable. He noted that there was a problem with disclosure of the number of SMMEs with which the banks were dealing and asked whether more or less was being loaned.

Ms Mahomed (ANC) expressed concern over racism and sexism that was implied in banking policies such as those that enquire how much one's spouse earns. She asked whether there was a mechanism in place to assist those that did not know much about banking as she was worried about how one may become burdened with debt and as a result work oneself further into debt and poverty. Ms Mahomed was curious about whether banks had made any effort to get in touch with international institutions to further nation-building projects. She asked if a bank was merely a moneymaking institution or if it was a social institution committed to the transformation of South Africa.

Ms September (ANC) asked if there was any other option that would address the problem of lack of financing. She stated that this problem would not go away and wondered if the banks saw the strategy they were using was a bad strategy. She agreed that banks could not be forced to do something that they were not keen on.

Ms Hajaij pointed out that banks complained that their profit margins were low and yet the banks were not prepared to alleviate their risk by taking what Khula has to offer. She asked that this paradox be explained. She asked that the relevant banks answer how they intend to increase accessibility if their loan centres were being moved out of reach of those needing to use it. She enquired as to whether the banks actually cared about the rebuilding and reconstruction of micro businesses.

Mr Durr (ACDP) wondered how one arrives at a defining whether a business is Black, Coloured, Indian or White. If there were 1000 Black employees at a firm and the shareholders were White, then what would the firm be classified as? He noted that defining a firm racially is meaningless in economic terms.

Response from The Banking Council, ABSA, Nedcor and Standard Bank.
The Banking Council noted the following:
· SMME is not only about micro businesses. It is not about small businesses or very small businesses. It is essentially about start-up and small businesses.
· If a particular race group was not receiving adequate attention / loans due to the characteristics of the group, that is, it was a black group or it is not a white group, then that was discrimination. Discrimination is a criminal offence and such matter may be dealt with in the Court of Law. Such matters should not be dealt with at such a forum. Nevertheless, Tucker firmly believed that this is about discrimination.
· Banking is a business. A Bank is accountable to all its stakeholders and depositors. It functions within a reality, which is the international global market. It is integrated in the global financial system. The profit is small and is paid to the shareholders. The Bank cannot jeopardise its relationship to its stakeholders and shareholders by increasing the risk factor with regard to SMME financing. That means that the Bank has to be quite careful about its decisions especially when the risk factor is high as it is with start-up businesses.
· On a micro-level, there are positive propositions on the table. There needs to be a re-examination of the NGO's erosion. There are fundamental issues that need to be discussed. One important issue is community-based banking.
· The future of the Banks lies in a prosperous South Africa. Banks are all for the support of small businesses and the growth of SMMEs.

ABSA responded as follows:
· Banks need to develop better relationships with provincial governments to facilitate joint ventures such as Khula.
Initiatives, such as the Equity Africa and New Farmers Initiative, must continue and there should be more developments such as these.

Nedcor's response:
· If government is really serious about small business development then they will make an effort to accelerate its growth by initiating more development programs with Banks.
· Government should also make initial up-front subsidies to small firms. This should include starting subsidies.
· Government should not develop land in an area of no economic activity.
· The problem of paying bills and paying the loan is a very serious problem that should not be glossed over lightly. If the small business is unable to acquire hardware as easily as a larger business, then the small business will not be able to compete efficiently with the larger business. Such constraints can weigh heavily on the small business and impacts on its ability to make loan repayments.
· The Banks should not be the only institution that is involved in the financing of SMMEs. Community-based loans services such as those that operate in the United States should be developed in South Africa. This will be to the benefit of the SMME since it would provide support and advice. Further the cost involved for the SMME would be lower than the costs for a bank loan.

Standard Bank's response:
· There was an acknowledgement that previously there were fewer loans to BCI groups. There was a definite increase and the move towards granting more loans to BCI was growing very fast. There was a significant change in the ratios with the BCI comprising R38 million of the R73 million used to finance SMME.
· Banks are continually under pressure and forced to make available electronic banking to South Africans.
· The figures do not show the number of loans in terms of race.
· Banks internationally have paved the way. The definition of these boundaries delivers a platform from which the Banks may deliver. Already one does not have to work in order to have a bank account. This is a vast improvement and there will continue to be greater improvements.
· He concluded that it was time to evolve strategies, a process which Standard Bank was committed to.

The Chairperson closed the morning session noting that these issues could have been discussed in greater detail had there not been time constraints.

Afternoon session
South Cape Investment Network
Mr J Stoffel noted that the banks had been discussing the hard issues of numbers of loans made and the ratio of lending to the SMME sector. Mr Stoffel said that he wanted to discuss "soft issues" such as the way that Blacks were treated by the banks when they applied for loans.

He said that there is a Eurocentric banking environment which is hostile to Black loan applicants. Especially in the rural areas, banks are staffed by White predominantly Afrikaans staff who are personally hostile to Blacks. For instance, Mr Stoffel established an investment company with R300 000 in shareholders capital. A bank in George had refused to let him open a cheque account to deposit the money into. He said that he and the George branch of the ANC where reporting the bank to the Human Rights Commission. He said that generally whites in the banking sector are hostile about lending money to Blacks.

Mr Stoffel asked why Blacks should not be lent money in the same way that Afrikaners where lent money after 1948 when lending criteria for Afrikaners eased. Banks always require that Blacks provide collateral which in light of the past, they do not have. This means that banks do not lend money to members of the previously disadvantaged communities.

Mr Stoffel said that unless the government applies pressure on the banks, they will not do anything. They will merely carry on acting against Blacks with impunity. He concluded by saying that the facts and figures that the banks provided earlier in the discussion were meaningless since they where so open to manipulation.

Dr Rob Davies (ANC) commented that media representatives had left after the banks had concluded their presentations. This implied that they valued the contribution that the banks were making to the hearing more highly than that of small business. Other members commented that this was a further indication of prejudice and racism in the media.

Western Cape Black Business and Professionals Alliance
Mr Thabo Mashologu spoke in his role as convenor of the Alliance whose members are:
Black Management Forum of the Western Cape
Foundation for African Business and Consumer Services
SABTACO Western Cape
African Builders Association
Black Lawyers Association
National Black Contractors and Allied Traders Forum
Association for the Advancement of Black Accountants in Southern Africa

Mr Mashologu noted that presenters were only given two days notice of the hearing. This meant that only alliance members from the construction industry sector had participated in discussions leading to the compilation of the submission. The Alliance submission discussed the obstacles put in the way of Black business by banks. The legal discrimination of the past regime has been removed. Banks though, still have the perception that Black business is high risk. The recent proliferation of SMME desks at banks merely represents a marketing ploy. In fact the banks have done very little to provide start-up capital, guarantees and bridging finance for small businesses. The three main problem areas are:
- provision of bank guarantees
- access to bridging finance
- credit ratings provided to black owned construction businesses

Provision of bank guarantees
When a construction firm is awarded a tender a bank needs to guarantee that the construction firm will have access to the finance it needs to complete the construction work. Banks demand collateral from black contractors before they grant such guarantees to them. Black contractors complain that banks view them as being particularly high-risk businesses and are more stringent about the acceptable level of collateral for black businesses than for white businesses. Banks often refer the contractors to Khula. Khula sends contractors through the same rigorous procedure as the banks and furthermore only guarantees 80% of the amount required. The result is that contractors cannot secure the guarantee. Contractors are often forced into joint ventures with white business purely in order to receive bank guarantees. These white businesses charge a management fee and take a cut of any profits. This makes a mockery of black empowerment.

Access to Bridging Finance
Banks also demand collateral before they offer bridging finance to black contractors. The contractors thus face similar problems trying to get bridging finance as when they try to get bank guarantees. Some contractors do not have collateral to offer to the banks and so cannot get any bridging finance. The open tendering system that is in place for government contracts pushes margins down. This means that the high interest rate charged by banks has the potential to offset any profit expected from future projects.

Credit Ratings
Before appointing a contractor to a project, the adjudicating consultant is requested by the client to obtain the contractor's credit rating. The result is that contractors with poor or unknown credit rating are disqualified from projects even though they may have submitted a competitive tender. Two reasons for black contractors being perceived as high risk are:
· New black companies are given a credit rating of F (unknown) even if the individual members of the company have good credit ratings.
· The government (the main client for many black contractors) is notoriously slow for paying interim monthly payment claims. The result is that black contractors exceed their 30-day credit extensions (and banks have reportedly been unwilling to assist contractors by speeding up the clearing of government cheques). The result is that suppliers rate the contractor's reliability poorly when consulted by banks.

Contractors only become aware of their bad ratings when they are disqualified from future projects. The main problem is that banks are unwilling to engage, negotiate and understand the circumstances of the contractors.

Financial institutions attitudes to financing property development in black areas
Financial institutions are reluctant to finance retail property development in the townships. This is true even when strong feasibility studies and national chain stores support the development. This is in contrast to the enthusiasm that greets the development of neighborhood shopping malls in white suburbia.

Mr Mashologu concluded that the Alliance regards their forum as being the start of a very important process of engagement through which solutions can be found to the problems facing small black businesses.

Eyethu Butcheries
Ms Noluthando Lungeni said that the first question that banks ask loan applicants is whether or not they have collateral. Many business people have lost their homes in political violence and so do not have any collateral. Financial institutions do not consider historically disadvantaged peoples past experiences when deciding whether to grant loan applications.

Ms Lungeni runs a number of small butcheries that employ 48 people with approximately 480 dependents. She pays R31 000 a month in rentals. Her business also provides meat to other businesses such as restaurants as well as large tertiary educational institutions. She noted that banks do not take into account the huge social costs that would result if she has to close an outlet. Furthermore the banks say her business is a cash business and therefore show a reluctance to offer finance. Her business though is not a cash business as it provides products to large enteprises such as the Technicon that are not cash clients. In this way the banks undermine her business. She said that banks should do the same for Blacks as they did for Afrikaners after 1948.

Banks practice gender discrimination against women. For instance when a group of rural farmers requested finance, the women farmers where far more stringently questioned. She said that a woman's view is needed in the banks.

Ms Lungeni said that banks had been unwilling to fund the construction of a new shopping centre that she wanted to construct in partnership with other business people in a township. She said that instead of allowing the business people to develop the property, large property developers develop it and then let it to the business people. Bnks are more willing to lend money to the property developers because they are less of a financial risk than the SMMEs.

Citizens Finance: Financial and Business Consulting
Mr Bertin Badiata said the SMME sector needs funding as they are the driving force of the economy as well as being crucial to future job creation.

The past policies of banks discriminated against the previously disadvantaged groups. One example of this is that in the past only 2% of bank credit went to the previously disadvantaged community. Thus banks played a role in disempowering Black people and should now play a role in empowering Black people. Banks should be forced to change lending practices.

A number of initiatives have been instituted since 1994 to provide finance to the SMME sector. These have succeeded to an extent but not enough to satisfy expectations.

Banks do not understand the SMME market. It is a high risk and low return sector that banks are not positive about entering. The banks though must look at the turnaround of SAA. SAA made a loss of R100 million a year ago and now it is making profit of R500 million. The banks must try to achieve a similar turnaround in the SMME sector.

On the other hand the SMME sector must be more proactive in acquiring the business skills and knowledge necessary to achieve success. Small businesses, for instance, often do not know where to find Khula.

Consulting firms are not targeting small businesses. They target large corporate clients. Government should fund Ntsika so that it can provide much needed business consulting advice to small and medium sized enterprises.

Customer consultants in banks are not understanding and helpful. Banks need to give them more training.

SMMEs need to be more proactive in acquiring the skills that they need.

Discussion
The Co-Chair, Mr M Moosa, noted that the Banks' submission to the committee said that the SMME sector was a high-risk sector. This was reflected by the fact that 80% of new products fail in the first 18 months and 8 out of 10 new ventures collapse within a similar time period. In light of the need for banks to satisfy their shareholders that they are investing in a financially prudent way, banks are reluctant to invest heavily in the SMME sector. Mr Moosa asked how SMMEs could change the perception that banks have of the SMME sector as a high risk area or how SMME's could change the reality that lending to that sector was risky.

Ms Langeni said that the reason that small businesses fail is that they do not receive sufficient funding from banks. Small businesses often close purely due to cash flow problems.

Mr Stoffel said that there was both good and bad in all walks of life. The problem was that banks are prejudging the likelihood of success of new businesses by refusing to give them loans. They do this without looking into the specific chances of success of each particular business. In the past banks lent money indiscriminately, without considering the probability of success of the business and many bad investments were made. Few recipients paid back the money. The results of such indiscriminate action by banks contribute to the perception that the SMME sector is high risk sector.

Mr Bruce (DP) responded to Dr Davies criticism of the media for listening only to the banks' submissions and leaving before the SMME sector made its submissions. Mr Bruce said that the fact that the media had left does not necessarily indicate that the media is prejudiced or homogenous. He explained that there could be various reasons why the media had left. For instance some of the banks may have requested that journalists come and cover their submissions. He noted that in a free society you cannot tell the press what to do just as you cannot tell banks where to lend their money. Mr Bruce asked why would banks be racist. Banks are trying to earn a return like any business. Why would the CEO of Nedbank tell his staff to be rude to black clients? Mr Bruce said that this would be against the banks own self-interest. He said that it was obvious that banks are not suited to provide finance to parts of the SMME sector. He stated that red lining probably reflected a failure of government rather than a failure of the banking system. He asked what solutions Black businesses where asking for. For instance, are Black businesses asking to pay below market interest rates and so be subsidized?

Dr Davies, the co-chair, replied to Mr Bruce saying that he merely noted that the media revealed a preference for the views of some stakeholders over the views of others.

Mr Moosa repeated his earlier comment that the hearings were not intended to be a trial of the banking sector. They were meant to be a process of constructive engagement between the different stakeholders.

An ANC member asked if the government should institutionalize contact between the SMMEs and the banks. In light of the high failure rate of SMMEs, what role is there for local government. The member commented that he wondered whether the Government should not look for financing for SMMEs in the international arena in light of the attitude of the banks toward SMME's and the failure of Khula to help.

Mr Badiata from the Citizens Finance Corporation said that meetings such as that day's presentations should occur at a provincial level.

An ANC member commented that the Government cannot legislate away racist attitudes, only racist behavior. If your behaviour changes then hopefully that affects your attitude in time. He said that Government has not done enough to change the attitudes of banks and the Government needs to come up with a solution to the antiquated lending criteria of banks.

Ms Mahomed (ANC) asked if there was discrimination against women in business.

Mr Mashologu responded that women made up a small but successful part of the Alliance in the Western Cape.

Dr Davies said that banks have acknowledged that they should be involved in the small and medium sector. The major problem that they had was with serving the micro sector. He commented that banks should be involved with providing financial assistance to small or medium sized business. Mr Davies noted that Mr Stoffel was taking his complaints to the Human Rights Commission and asked Mr Stoffel if anything more than the Promotion of Equality Act was needed to protect SMME's from racism. Mr Davies asked if the Code of Banking Conduct was a route that could be used to solve the problems that Mr Stoffel had come across.

Mr Stoffel replied that the bank employees are not even aware of their own criteria for opening a bank account let alone the Banking Code of Conduct.

Due to time constraints, the meeting was concluded.