Khula Enterprise Finance, the government’s small business finance agency, is planning to stick its toe into the turbulent water of direct lending to owner-managed businesses this year.
It’s a sore toe, stepped upon by critics for being ineffective, stubbed by failed microcredit schemes and some internal fraud, and pinched by the constraints of having to finance South Africa’s most risky businesses through the country’s most conservative institutions — the big four banks.
The agency started its second decade this year with board approval, in principle, of a radical move away from its role as a pure wholesale financier. Up till now, it has never lent directly to small businesses, but provided wholesale finance to the South African small business sector in three ways.
First, it guarantees bank loans on behalf of small businesses that lack sufficient collateral. This accounts for roughly half of Khula’s business. Second, it lends money in bulk to development-minded small business finance organisations that “on-lend” it to small businesses. Most of these “retail finance intermediaries” have been NGOs, but recently, a few for-profit businesses have been lending Khula money to their small-business clients. Third, Khula has set up targeted lending funds, such as the one run by the small business finance firm Business Partners specifically to help small black start-up businesses.
The wholesale model is based on the wisdom that a government agency has no business doing direct business with small business. Rather, it should only provide risk cover and cheap money to organisations that are set up to lend sustainably, in other words, that are brutal enough to say no to certain types, and get tough when borrowers default.
Over the past 10 years Khula has experienced the downside of this model. The wholesale agency gets the blame for the weak performance of its retail partners, who get the credit when the system does work. Small business owners, who generally couldn’t care less about the politics behind finance, would say “Absa”, when asked where they got their initial funding. Very seldom would they say “Absa, guaranteed by Khula”.
There has been plenty of blame, mainly over Khula’s drop-in-the-ocean profile. The agency has so far guaranteed between 600 and 700 bank loans annually, amounting to between R200-and R300-million. It remains insignificant against South Africa’s 800 000 finance-hungry small businesses in a growing economy.
As if that’s not enough pressure, the government carefully watches the racial and rural-urban profile of Khula’s beneficiaries, but it’s the banks who choose the clients.
“We’ve been trying to get our destiny in our own hands, to have better control over the funding that we have,” says Khula CEO Xola Sithole. “The next logical step” is to start lending directly to small businesses, but he stresses that Khula is avoiding a big-bang approach. The agency first has to obtain the go-ahead from the department of trade and industry, treasury, Parliament and the Cabinet. Then, it wants to limit its direct lending to businesses that tend to be shunned by the banks and lending organisations, specifically those that need finance of less than R250 000 in rural areas.
The organisation plans to partner with community-based small business lending organisations and rebrand them “Khula”. “You don’t want to reinvent the wheel. You want what’s working. You want to scale it up, and then you want to use it as a platform for organic growth later,” says Sithole.
Although he hopes that the new direction will diminish Khula’s dependence on the banks, he does not view direct lending as replacing Khula’s bank loan guarantee scheme.
In fact, the agency achieved a breakthrough recently when Nedbank became the first of the four banks to sign a new agreement with Khula, committing itself to tripling its use of Khula guarantees from about 100 a year to 300. For the past two years Khula has been trying to convince the banks in collective negotiations at the banking association to accept new targets and conditions.
Sibongiseni Ngundze, Nedbank’s head of small business, says it decided to “break ranks” with the other banks and signed an individual agreement with Khula, according to which Nedbank would write at least 300 Khula-guaranteed loans a year, half of which would be to rural businesses.
Given the fact that the four banks together have been writing less than 700 Khula-guaranteed loans a year, Nedbank’s promised 300 a year is a major boost for the scheme, especially if the other banks follow suit.
Absa’s general manager for small business market development, Obakeng Kutsoane, says the bank is determined to remain the top user of the scheme. Over the past few years Absa had issued about half of all Khula loans.
Cynical watchers of small business finance may scoff at these developments. Also, the banks seem to take turns to embrace the scheme, only to withdraw as soon as the loan book starts to default. Standard Bank, for example, was a major user of Khula in the early years. Today, it scarcely facilitates 80 Khula loans a year.
Yet Khula has a lot going for it. Banks seem to have become better at identifying good borrowers. Sithole says defaults have come down from 7,5% in 2004 to 4,5% today.
At the same time, banks are feeling the pressure of the Financial Services Charter targets for increased lending to emerging black and small businesses.
Khula has also managed to shake off the burden of having to service the survivalist micro-finance sector after government learned that poverty relief requires a different skill set to small-business development. This function, which cost Khula millions in the past as the micro-finance NGOs it funded collapsed, has been taken over by a new agency, the Apex Fund.
Khula is the only one of the government’s original small-business development organisations to have survived a decade.
The question now is, can it scale up its efforts to make a meaningful contribution to 6% growth? Sithole describes Khula as poised at “the crest of the wave”, but warns that mistakes can be made when trying to ride it.
Of course, one of them could be to stand there with your toe in the water. Time to take the plunge.