How private lending works

Most confusion about private lending comes from skipping the structure and going straight to the rate. There is no single structure — there are several, and which one you are in decides who owes you money, what you can enforce, and who you complain to. Work out your own structure first and the questions that matter become obvious.

01 — Four positionsThe role maps

Below are the five shapes private lending takes. In each, the same four functions appear — capital, credit decision, servicing, and distribution — but they sit with different parties, and sometimes several of them sit with one entity. That combination is not improper; it just needs to be visible, because it decides who you are relying on.

02 — One worked exampleMoney and paper in an administered structure

The diagram below follows the administered model, because it has the most moving parts. In a direct loan, most of these boxes collapse into two.

03 — The registration questionWho needs to be registered

The first answer most people find sounds like a closed door: anybody lending money at interest in South Africa must register as a credit provider. The missing words matter, and so does a change most published material has not caught up with.

The prescribed registration threshold is R0. Section 40 turns on outstanding principal debt, and the 2014 amendment removed the old alternative trigger based on how many credit agreements a lender had. A single ordinary interest-bearing loan to which the Act applies can therefore require registration. Lending only occasionally is not a general exemption, and a great deal of South African material still repeats the superseded figure from the 2006 notice.

The question is therefore not whether private lending requires registration in general. It is whether the Act reaches this agreement, and if it does, which party is granting the credit. Both are answered from the documents rather than from how the arrangement is described in marketing material.

When the law applies sets out the registration test, the three thresholds that are routinely confused with each other, the cases where the Act applies to a business borrower, and how FAIS and the Banks Act sit beside it. It is not a substitute for your own advice: whether a particular structure makes you a credit provider depends on what the documents say you are doing, and arrangements that look similar in marketing material can differ materially in the paperwork.

04 — The documentsThe paperwork that should exist

A private-lending arrangement is made of documents. If the documents are thin, the arrangement is thin, whatever the rate says. At a minimum a prospective lender should expect to see, and be able to keep:

1. A written agreement naming the exact legal entity that receives the capital, with its registration number, and setting out the amount, the rate, how and when interest is paid, and on what basis capital is returned.
2. A statement of what secures the arrangement, if anything, and in whose favour the security is registered or ceded. “Secured” on a brochure is not security; a registered bond, a notarial bond, a cession or a suretyship is.
3. Evidence of the credit provider’s registration — the NCRCP number, checked by you against the NCR register rather than taken on trust.
4. Identity verification, where it applies. Where a party is an accountable institution, expect risk-based customer-due-diligence procedures under FICA. The precise checks depend on the institution, client and transaction. An unexplained absence of identity checks where they should apply is a warning sign.
5. A clear statement of the risks, including what happens if the borrower does not pay and what the lender’s remedies actually are.

05 — PricingHow the rate is set

In rand arrangements the anchor is the prime lending rate. Prime moves with the repo rate, which the Reserve Bank’s Monetary Policy Committee sets at scheduled meetings through the year. A margin is then added to reflect three things: who is borrowing, what stands behind the loan, and for how long the capital is committed.

A prime-linked return therefore floats. When rates rise the return rises; when they fall it eases. Over a full rate cycle the movements tend to average out, but at any single moment the quoted return is a function of where the cycle is — which is why a headline number without a date and a base is not a meaningful comparison with anything.

Fixed-rate arrangements make the opposite trade: the rate is agreed at the outset and does not move, so the lender carries the risk of rates rising above it and keeps the benefit if they fall below. Neither shape is better; they allocate the same uncertainty differently. The local and offshore comparison sets out where each is typically used.

06 — The flowHow money actually moves

In outline, and in order: capital is transferred to the named entity under the agreement; the credit provider deploys it into loans to borrowers; borrowers repay capital and interest, usually monthly; the provider administers collections, applies the agreed priority of payments, and pays the lender their interest on the agreed cycle; capital is returned at the end of the term or as underlying loans are repaid.

Two details in that sequence are worth pressing on. The first is timing: the gap between a borrower repaying and a lender being paid is an administration process, and processes have failure modes. The second is priority: when money is short, the agreement decides who is paid first. A lender who ranks behind other creditors is in a materially different position from one who does not, however similar the headline rate looks.

07 — Return of capitalHow capital comes back

There are broadly two shapes, and confusing them is the commonest and most consequential misunderstanding in this subject.

Neither is a defect. A structure with no maturity date is not a worse deal than one with a date — it is a different deal, and it is unsuitable for anyone who may need the money in a particular month. The question to ask is never “how long is the term” but “on what does the return of my capital actually depend”. The four shapes this comes in, and the reason an average recovery period is not a term, are set out in the shape of a private loan.

08 — The borrowersWho the borrowers are

A lender’s outcome is decided by the borrower class more than by anything else on the term sheet, so it deserves more than a line in a brochure. In South African private lending the recurring borrower types are:

• Community schemes. Body corporates running sectional-title complexes borrow against arrear levies — money owners already owe the scheme. The scheme has continuing obligations whether or not every owner pays, which is what creates the funding gap in the first place.
• Small and mid-sized businesses. Borrowing against invoices, equipment or property where a bank will not lend quickly enough or at all.
• Property developers and bridging borrowers. Short-term, asset-backed, and highly sensitive to whether the exit — a sale or a refinance — actually happens.

For each of them the useful question is the same: where does the money to repay come from, and what happens to that source in a bad year? A borrower class whose repayment depends on a single sale is in a different position from one whose repayment depends on many small, legally owed amounts being collected over time.

09 — Before committingWhat to check before committing

1. Which legal entity receives the capital, and what is its registration number?
2. Whose name is on the credit agreement with the borrower, and is that party registered with the NCR?
3. What secures the loan, in whose favour, and is that security registered or merely described?
4. What is the priority of payments if money is short, and where do you rank?
5. Is the return fixed or prime-linked, and what is it as at today’s rate?
6. On what does the return of capital depend — a date, or a recovery?
7. What are the fees and commissions, who pays them, and out of what?
8. What happens, step by step, if a borrower does not pay?

A counterparty who answers all eight in writing without irritation is behaving the way a professional counterparty should. The risk, security and repayment page sets out what the answers to questions three, four and eight should look like.

10 — QuestionsCommon questions

Who has to register with the National Credit Regulator?

It depends on the arrangement. The National Credit Act does not apply identically to every private-lending arrangement: its application depends on the parties, whether the agreement is at arm's length, the borrower's legal form and size, and the type and amount of the agreement. Where the Act applies, the party granting the credit may be required to register with the National Credit Regulator. Which party that is, and whether the Act reaches the agreement at all, are legal questions about your documents and worth confirming with your own adviser.

How is the interest rate on a private loan decided?

In rand arrangements the anchor is the prime lending rate, which moves with the South African Reserve Bank's repo rate. A margin is added on top to reflect the borrower class, the security and the term. A return quoted as prime plus a margin is therefore a floating return: it rises when rates rise and eases when they fall.

When do I get my capital back?

That depends on the structure and is one of the most important things to establish before committing. Some arrangements have a fixed term with a stated end date. Others have no maturity date at all, and capital returns only as the underlying loans are repaid. The second kind suits capital that is not needed back on a particular date, and suits nothing else.

Who actually holds my money?

In a properly structured arrangement, capital moves to a named entity under a written agreement, and that entity is identified in the documents with a registration number you can verify. If you cannot tell from the paperwork which legal entity holds the capital and on what terms, that is the first thing to resolve, not a detail to sort out later.