Mainstreaming the Microfinance Practice Challenges

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Mainstreaming the Microfinance PracticeChallenge
s Opportunities for Commercial Banks as Lenders
to Micro-enterprises
Finance Forum 2002 June 19, 2002
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Characteristics of Micro-enterprises

• Micro-enterprises are very small and mostly in
  the informal sector, semi-legal, often
  low-productivity, frequently family-based, lack
  transparency
• Micro-enterprises are much more vulnerable to the
  vagaries of economic cycles
• Little is known of the micro-enterprises/entrepren
  eurs, their markets, and their business dealings
• Mostly cash-based markets
• Informal contracts/agreements not recorded, not
  legally enforceable
• Property rights are weak or non-existent
• Rural-based businesses are dispersed over large
  geographical areas
• High cost to formalize micro-businesses
  (registrations, taxes, labor regulations, payroll
  charges)
• Informal businesses maintain a low profile in
  order to avoid high cost of formalization and
  enforcement of regulations by authorities

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Implications for Commercial Banks

• Micro-enterprises
• Very small transaction sizes (credit, savings,
  payments) --- Very high transaction costs
• No formal status cant transact
• Lack of formal properties no collaterals
• Little prospects for growth fearing formalization
  
• Fearful of banks and dont trust them
• Banks
• Lack experience of transacting with the poor,
  have a negative pre-disposition, dont trust
  micro-entrepreneurs
• Lack knowledge and understanding of markets of
  micro-enterprises
• Lack credit information, unable to assess credit
  risk and thus perceive micro-enterprises as high
  risk
• Distrust NGOs that provide financial services to
  the poor

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Globalization of the Financial Services Industry

• Globalization and technology are fundamentally
  changing the financial services industry
  worldwide
• Competition has accelerated and is fierce for
  best credits/corporates in most countries
• New competitors have entered the market
• Margins and fees are narrowing significantly
• Development of securities markets is providing
  additional competition for banks

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What are the Opportunities for Banks?

• Large underserved market estimated by some at 500
  million micro-entrepreneurs in emerging and
  transition economies
• Banks are increasingly facing stiff competition
  in their traditional businesses (e.g. large
  corporates trade finance) and are starting to
  pursue other market segments including SMEs and
  consumers in order to achieve growth and
  profitability
• Microfinance as well as SME finance are prospects
  to consider but how to target these markets
  profitably?
• Financial and information technologies can be
  leveraged to reduce transaction costs and improve
  portfolio risk management

Right pre-conditions to develop a microfinance
business line?
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What are the pre-requisites for Banks to enter
the microfinance market?

• Sound macro-economic policies and appropriate
  regulatory and prudential framework
• Improved legal framework and effective public
  institutions to enhance business viability (e.g.
  property registries, contract and collateral
  enforcement, security of land tenure for low
  income populations, simplified processes for
  licenses, customs, tax, labor) eliminate
  corruption, to reduce constraint on
  micro-enterprises to formalize and grow
• Reliable credit information on micro-entrepreneurs
  
• Information on past payment history, level of
  indebtedness
• Default information
• Understanding the markets of the
  micro-enterprises
• primary secondary market research to better
  understand the businesses
• Segmentation (size industries)

Are these pre-requisites enough to interest banks?
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The Theoretical FrameworkShifting the
Productivity Frontier
How?
What are FIs trying to do?
New financial, information communication
technologies
Productivity Frontier (Future state of Best
Practice)
Better credit risk decisions efficient
distribution channels
Lower unit costs per transaction or service
Limited services to limited number of
customers Unprofitable
Sustained profitability
Broader service offerings higher asset quality
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Reaching Sustained Profitability in Microfinance
Marketing Strategy
Growth
Operating Efficiency
Asset Quality
Technological Innovation
RiskManagement
Small Mid Banks
MicrofinanceInstitutions
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What do Banks need to do?

• Better understand client needs
• Develop appropriate products and services
• Develop effective and efficient distribution
  channels
• Implement new risk management technologies,
  decisioning techniques and appropriate credit
  allocation processes
• Adopt global technologies to local markets

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Examples

• Bolivian MFIs becoming competitive banks e.g.
  BancoSol
• ProFund in Latin America actively building and
  seeking linkages with commercial banks (e.g.
  BancaSol merging with NGO Genesis in Guatemala,
  Sogesol microfinance subsidiary of Sogebank in
  Haiti, Mibanco in Peru)
• AfriCap in Africa driving its investment strategy
  on integrating microfinance in commercial banks
• Accion has been an active player in building
  strong MFIs that are converting to commercial
  banks assisting banks create and manage
  microfinance subsidiaries
• Internationale Projekt Consult (IPC) and its
  investment vehicle IMI 17 microfinance banks
• Few commercial banks in Asia see microfinance as
  a profitable core business e.g. BRI in Indonesia,
  Hatton National Bank in Sri Lanka

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The Future?

• Will banks move down-market?
• First to the SME market
• Then to the micro-enterprise segment
• How?
• Establish separate subsidiaries?
• Acquire existing MFIs and keep them as separate
  businesses?
• Integrate more fully into regular bank
  operations?
• When?
• As macro-environment improves, risk profile of
  micro-enterprises will improve
• When banks see that it can be profitable to lend
  to micro-entrepreneurs (demonstration effect)
• As competition increases, pace of change will
  speed up

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What are the Developmental Goals to pursue?

• Increase the number of MFIs that are part of the
  formal financial sector, able to offer a
  comprehensive set of products and services to
  micro-enterprises
• Establish linkages between MFIs and the formal
  financial sector and capital markets
• Support banks moving into the microfinance market
  demonstration effect
• Identify and develop financial technologies that
  improve risk management and profitability and
  increase efficiency