Assistant ombudsman for South African Financial Service Providers Thobile Masina warned that small and mid-sized businesses (SMEs) are at risk of predatory lending practices by financial services providers.
She said SMEs could avoid falling for this practice by becoming financially literate.
Predatory lending refers to targeting individuals or businesses for lending when they are not in a position to receive the financial assistance offered.
Speaking to Vutivi News as part of Money Smart Week, Masina said that SMEs with inadequate financial literacy open themselves up to avoidable risks.
“When small businesses are not financially literate, it makes them vulnerable to scams, predatory lending, and acquiring inappropriate financial products or services that do not suit their specific needs,” she said.
Factors that define predatory lending include unfair or abusive loan terms such as high-interest rates, high fees, and terms that make it unfair for a business.
Why financial literacy is important in mitigating the risk of predatory lending
Financial literacy is understanding your business’ finances. It entails having sound knowledge of financial terminologies, theories, concepts, practices, and statements.
A lack of financial literacy in a business makes it very hard for financial service providers to ascertain whether or not the company can be trusted to pay back the loan.
“A business that is unable to provide a track record of other credit facilities under their name exposes themselves to very high interest rates, which is used to mitigate the effect if the lender is unable to recover the money,” Masina said.
“When a small business is financially literate and can talk and behave in a way that shows financial literacy, it will encourage financial institutions to consider it for financial assistance,” she added.
Financial literacy makes it easier for lenders to identify whether SMMEs will use the funds provided effectively and efficiently.
Government institutions exacerbate the risk of predatory lending
Masina noted that SMEs were predominantly the victims of predatory lending because they struggled to obtain funding from financial institutions.
Government policies are partly responsible for this, and Masina criticised government institutions for not making it easier for SMEs to access critical funding.
“The requirements that government institutions put on SMMEs to access funding are strenuous, and the same institutions created to assist small businesses are themselves creating barriers for these small businesses to be assisted,” she said.
Areas to address to become more financially literate
Businesses can focus on three important factors to become more financially literate:
- Financial Behaviour – This relates to a business’s behaviour regarding its financial management of day-to-day operations, including how well the business manages cash, debt, savings and other expenses.
- Financial Socialisation – Knowledge of finance can be obtained through financial socialisation, such as seminars and training on financial reporting. It can also be obtained by attending informal education courses related to accounting.
- Bookkeeping System – A tidy and effective bookkeeping system in a business gives lenders a clear and accurate understanding of the company’s financial transactions, income and expenses, which is crucial in applying for financial assistance.
Masina noted that financial literacy is essential for SMEs to understand and negotiate the financial landscape.
It will help SMMEs prove to financial service providers that they can manage risks and understand the financial principles and information needed to adopt good financial habits.