President Jacob Zuma ’s recent announcement that the government will establish a R1bn fund to support increased private sector investment in low- to-middle income housing, and will provide an additional 6000ha of public land for affordable housing, is a welcome exception to this general rule.

Financial institutions should embrace this opportunity to demonstrate that financial innovation can just as easily be used to solve difficult social problems as create the next fancy derivative. One exciting way to do this is to leverage Zuma’s proposal into support for a social bond.

This retail bond, supported by a partnership between the public sector, the private sector and civil society, would help to finance informal settlement upgrades, which benefit the urban poor, as well as affordable home loans to lower-middle income people.The whole social bond transaction offers each party a benefit and requires a contribution from each of them.

It will provide lower-middle income earners enhanced access to affordable housing finance, communities in informal settlements funding on acceptable terms for settlement upgrades, financial institutions a reasonably secure and profitable business opportunity, and the government a sustainable and scalable model for resolving the housing problems in our country.

In return, each party will have to put up some money and be held accountable for meeting all its commitments in the transaction.The social bonds also offers two other benefits. An opportunity for all South Africans to contribute to solving the problems of poverty and inequality that plague our country, as well as to strengthening the weak social bonds that unite us as South Africans.

How can this be done? The key is to recognise that debt is an effective way to finance poor people’s efforts to help themselves. It is certainly a more sustainable financing strategy than the alternatives.Grants, which seem to be the most obvious form for such financing, risk leaving poor people dependent on the goodwill of the donors, and undercutting their goal of achieving independence and self-sufficiency.

While equity’s risk-sharing characteristic suggests that it could be an attractive option for financing low-income housing projects, it has two drawbacks.The investors may exercise undue control over their investment partners, which would undermine the goal of promoting self-sufficiency. It may also result in situations in which the investors appear to profit from the hard work of the poor, thereby worsening social tensions in our complex society.

On the other hand, debt creates fixed- term contractual relationships. This leaves debtors, after they have fully performed their contractual obligations, with a credit history that should enhance their prospects for accessing future financing. Thus it contributes to improving the debtors’ material situation and promotes their independence.The challenge is structuring debt transactions that are commensurate with the recipient’s ability to pay as well as the creditor’s financial needs.

Usually, because of the risks involved, affordable housing projects and projects in informal settlements are considered unsuitable for commercial debt funding.Zuma’s promised support for the private sector, combined with the participation of civil society, makes it possible to overcome this obstacle.

First, the government can use one part of its promised funds to provide guarantees for home loans to lower-middle income borrowers and another portion to support loans to organised communities in informal settlements for housing upgrades.The government can also use some of the revenues from the sale of the public lands it is allocating for affordable housing to boost this “informal settlement support fund”.

In addition, the government can commit to ensuring that the current long and relatively unpredictable delays in disbursing housing subsidies become more predictable. This would enable the lenders to better assess the risks associated with lending to organised communities in informal settlements.

Second, the private sector should commit a stipulated amount (perhaps some of the unspent portion of its financial sector charter commitments) for lower-middle income housing loans and for informal settlement upgrades.

These commitments, at least until they are actually disbursed, can be invested in a separate account (“a help build SA account”).In addition, the financial sector, supported by the government’s “informal settlement support fund” and their own “help build SA fund” can commit to issuing social bonds that allow the public to help deal with the serious housing problem facing our country.

The existence of these support funds and the enhanced ability to assess risk due to the greater predictability in the disbursement of the housing subsidies should make it possible for banks to offer financing to lower-middle income people and communities in informal settlements on terms that are both affordable to the borrowers and income generating for the lenders.They should also be sufficient to encourage South Africans with disposable income to make an investment in a better future for all South Africans.

There are other creative ways to further enhance the attractiveness of these bonds.Third, organised groups in informal settlements can agree to contribute a stipulated portion of the total funding to be spent on projects supported by the social bond.

This is not an unrealistic proposition. Some of the participating organisations in the nationwide Informal Settlement Network are already collecting savings that support housing or community development funds.In addition, some of them, for example the uTshani Fund, have had experience working with substantial sums to support housing schemes.

They have also, unfortunately, experienced the challenges of getting the government to disburse the funds — primarily housing subsidies — that it owes them.Zuma has challenged our financial institutions to work with the government and civil society to creatively address the tragic housing Legacy in our country. The social bond shows this can be done. Is our financial sector ready to meet the challenge?

- Bradlow is professor of international development law and African economic relations in the faculty of law at the University of Pretoria.

Published: 2010/03/10 08:02:23 AM

Also available at: http://www.businessday.co.za/Articles/Content.aspx?id=95834