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Global Learning Process for Scaling Up Poverty Reduction

and Conference in Shanghai, May 25-27, 2004

SCALING UP POVERTY REDUCTIONCase Studies in Microfinance

Consultative Group to Assist the PoorWorld Bank Financial Sector Network

Washington, D.C.

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Administrator

31164

Case Studies

Published 2004 by CGAP, the Consultative Group to Assist the Poor

Copyright © 2004 CGAP / The World Bank Group

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Washington, DC 20433 USA

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Manufactured in the United States of America

First printing May 2004

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i i iSca l ing Up Pover ty Reduct ion

Running Head

Contents

Foreword ................................................................................................................v— Marilou Uy and Carlos Cuevas, World Bank Financial

Sector Network

— Elizabeth Littlefield, Director and CEO, CGAP

Authors ....................................................................................................................ix

Struggling Through the “Growth versus Best Practice”Tradeoff:..........................................1

The CrediAmigo Program of the Banco do Nordeste, Brazil

Robert Peck Christen

Equity Building Society: A Domestic Financial Institution ..........................................................15Scales up Microfinance

Tamara Cook

The Agricultural Bank of Mongolia ................................................................................................27Jay Dyer, J. Peter Morrow, and Robin Young

Microfinance in Bangladesh: Growth, Achievements, and Lessons ..........................................47Hassan Zaman

Madagascar: Credit with Education Program in the TIAVO..........................................................65Savings and Loan Associations Network

Herminia Martinez

Managing Scaling Up Challenges of a Program for the Poorest:................................................77Case Study of BRAC’s IGVGD Program

Imran Matin and Rabeya Yasmin

Bank Rakyat Indonesia: Twenty Years of Large-Scale Microfinance ..........................................95Klaus Maurer

Integrating the Poor into the Mainstream Financial System: ....................................................107The BANSEFI and SAGARPA Programs in Mexico

Lisa Taber

The Kazakhstan Small Business Program: Commercial Banks ..............................................125Entering Micro and Small Business Finance

Eva Terberger and Anja Lepp

The Case of K-Rep—Naairobi, Kenya ..........................................................................................139John Nyerere

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For ward

The international development community has rallied around the Millennium DevelopmentGoals in an unprecedented way. Microfinance supports the MDGs for the simple but powerfulreason that many of the MDGs—especially those for improved nutrition, health care, and edu-cation—are the priorities of poor people themselves all over the world. Study after study con-firms that poor families with access to financial services eat better, keep their children in schoollonger, receive better medical care, and live in safer housing than those who do not have suchaccess, other factors being equal. Access to financial services hands poor people the tools to solvetheir own problems and to chart their own paths out of poverty.

The problem, then, is not establishing whether microfinance works. The problem is how toincrease its scale exponentially. Today microfinance is only reaching about four percent of theestimated demand for financial services by poor households. Annual rates of increase are alsostuck in single digits. We cannot reach the hundreds of millions of poor people who urgentlyneed access to finance by replicating nonprofit microfinance institutions one branch at a time.Rather, to achieve massive scale and fulfill its huge potential, microfinance must become fullyintegrated into developing countries’ mainstream financial systems, rather than being isolatedin a niche of the development community. After all, poor people are the overwhelming major-ity in those countries. It is illogical, as well as unjust, that any country’s formal financial systemwould serve a handful of elites while excluding most of its citizens.

The cases prepared for the “Scaling Up Solutions to Poverty Reduction” conference in Shang-hai (May 2004) represent some of the most powerful examples of scaling up in the history ofthe modern microfinance industry. The cases provide notable diversity in terms of both geog-raphy and institutional type. They range from Central Asia, South Asia, Latin America, andAfrica, and include traditional non-governmental organizations, commercial banks, agriculturalbanks, and building societies. The commonalities, however, are perhaps even more striking thanthe differences. All the institutions made a conscious management decision to pursue scale whileserving poor clienteles. All demonstrated creativity and a willingness to take calculated risk. Andall operate in accordance with commercial business principles, regardless of governance struc-ture or legal status.

FOREWORD

MARILOU UY AND CARLOS CUEVAS

WORLD BANK FINANCIAL SECTOR NETWORK

v i Case Studies

For ward

Last year in CGAP’s annual report, I wrote about CGAP’s vision of the day when “[t]heterm ‘microfinance’ will no longer be necessary as we remove the walls—real and imaginary —that separate the microfinance community from the much broader world of financial systems,markets, and development.” Today we already hear the term microfinance much less often. Allover the world, it is being replaced by the phrase “financial systems for the poor.”

The difference is more than semantic. “Microfinance” suggests that there is something in-herently different about poor people’s financial needs, something that is— and should be—seg-regated from the financial mainstream. “Financial systems for the poor” describes a self-evidenttruth: that it is neither just nor economically logical that any country’s financial system shouldexclude the majority of its population. In partnership with likeminded financial institutions,donors, service providers, policymakers, and opinion-shapers, CGAP is working to help builddemocratic, inclusive financial systems all over the entire developing world that serve the ma-jority—the poor.

We are finally beginning to see promising examples of a financial democratization that washard to imagine even a few years ago. In Kazakhstan, commercial and state savings banks arecompeting to deliver microfinance products to the poor. In Mongolia, the state agriculturalbank restructured, privatized, and moved into microfinance. It now serves half of all the ruralhouseholds in Mongolia through 350 branches. And it is making money. India’s second-largestbank is building a network of thousands of village internet kiosks with low-cost card readers,point of sale devices and automatic teller machines to deliver banking and insurance services topoor families throughout rural India. Similar experiments are underway in Latin America andCentral Asia.

Working partnerships are springing up between institutions who would never even have en-tered dialogues a few years before. In places as different as Haiti, Georgia, and Mexico, part-nerships between banks and microfinance institutions enable the microfinance providers to usebanks' branch networks to transfer funds and collect payments.

Microfinance institutions are working with insurance carriers to develop and deliver new linesof pro-poor insurance products. Information technology providers and software developers arewaking up to the huge market for automation in the microfinance sector—and microfinancepractitioners are waking up to the huge efficiency gains they can achieve through technology.Credit bureaux are being established to track—and potentially reward—the financial behaviorsof clients who a few years ago were considered beneath notice.

Mainstream socially responsible investors are stepping up their investments in microfinance.Ten new funds will be launched in 2004, and the total amount invested is expected to more than double. Governments, too, are keeping pace with this rapid evolution. More than

ELIZABETH LITTLEFIELD, DIRECTOR AND CEO, CGAP

v i iSca l ing Up Pover ty Reduct ion

Foreword

50 countries are developing or implementing new microfinance regulatory frameworks to en-sure that their poor citizens’ financial assets are protected.

CGAP works to increase the capacity of existing microfinance institutions, to encourage newentrants into the sector, and to broker partnerships that graft the collective wisdom of the mi-crofinance industry—how to make uncollateralized loans and get paid back—onto institutionalmodels that can reach the poor on a much more massive scale.

CGAP’s flexible approach—strengthening what needs to be strengthened, building whatneeds to be built—is informed by a sense of urgency. More than a billion people still lack accessto basic financial services. Our approach is systemic. In developing countries, we believe the en-tire financial system should serve the poor majority. Our aim is to strengthen a wide range ofcomplementary and competing providers that might serve the poor. In developed countries weaim to help improve aid effectiveness, addressing systemic problems that hinder donor effec-tiveness, especially in supporting the financial and private sectors.

And at a global level, we aim to help build the architecture that will underpin large scale, ro-bust and healthy financial systems for the poor—a supportive legal and policy environment andready availability of high quality financial information.

The next phase of microfinance will succeed as the best of different worlds are integrated:the mission focus from the development origins of microfinance with the efficiencies of thebanking sector and the force multiplier of commercial capital. It is deeply exciting to see so muchof CGAP’s vision—the dismantling of the walls—starting to be realized. But as with any wallthat finally comes down, it’s not so much the final blow that does the job as the accumu-latedimpact of all the blows that came before it.

Many groups have shared and continue to share CGAP’s vision of financial democrati-za-tion: microfinance practitioners, donors, service providers, governments, and not least, the poorthemselves. It is CGAP’s honor to serve them all.

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The writers of the cases are microfinance experts affiliated with or employed by leadingpractitioner or support institutions. The views expressed are the authors’ own and maynot necessarily reflect those of their clients or employers.

Robert P. Christen is Senior Adviser to the Consultative Group to Assist the Poor(CGAP). He works on issues related to commercialization and regulation and supervi-sion. He is also the Director of Microfinance Training Program (at Naropa University inBoulder, Colorado) and is the Chair of the editorial board of The Microbanking Bulletin,an industry publication devoted to financial sustainability and benchmarking. Beforejoining CGAP in 1998, Mr. Christen advised commercial banks interested in microfi-nance, central banks and bank superintendencies interested in the regulatory frameworkfor microfinance, and donors interested in performance standards. Mr. Christen alsoworked for ACCION International. He is the author of several publications related tosustainable microfinance. Mr. Christen received a master’s degree from The Ohio StateUniversity.

Tamara Cook is a Microfinance Analyst with the Consultative Group to Assist the Poor(CGAP). Her work at CGAP over the last seven years includes monitoring CGAP’sinvestments, conducting institutional appraisals, contributing to CGAP’s network initia-tive, research for CGAP publications and programs, writing numerous CGAP reports,and working with CGAP senior management on corporate priorities. In October 2003,Ms. Cook was seconded to Equity Building Society in Kenya for a five-month assignmentin the credit department. Ms. Cook is currently working on CGAP’s scaling up and diver-sification strategies. Ms. Cook graduated from The George Washington University whereshe studied international development and business administration. She has also takensubstantial training courses in microfinance and related topics.

Jay Dyer is Senior Development Specialist with Development Alternatives, Inc. (DAI).He has 16 years of experience in commercial banking and financial institution develop-ment, and currently oversees banking projects and contracts for DAI’s Finance, Bankingand Enterprise Group. He also provides ongoing technical assistance to financial institu-tions. Mr. Dyer has implemented and managed projects that facilitate lending tomicroentrepreneurs, small and medium-sized businesses, and large companies. Prior tojoining DAI, Mr. Dyer spent eight years working in U.S. commercial banking. Hereceived his undergraduate degree in business administration from the University ofRichmond.

AUTHORS AND CONTRIBUTORS

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Authors and Contr ibutors

Anja Lepp is Managing Director of Internationale Projekt Consult, a German consult-ing firm that provides long-term management and consulting services to microfinanceinstitutions and commercial banks. Dr. Lepp, who has twenty years of experience inmicrofinance, has implemented and managed numerous long-term institution-buildingprojects. Among them are some of the most successful microfinance projects in theworld. She has also conducted financial sector studies in various countries in Africa, Asia,Latin America, and Eastern Europe. Dr. Lepp currently serves as General Manager ofProCredit Bank Ukraine. She received her doctorate in economics from Johann WolfgangGoethe University, Frankfurt.

Herminia Martinez has been with the World Bank in various capacities since 1970where her work has focused on banking and finance, privatization and regulation, andbusiness environments. She currently serves as a consultant to the Bank’s Africa PrivateSector and Financial Sector Units and to the Financial Sector Operations and PolicyDepartment. Prior to joining the World Bank, Ms. Martinez was an assistant professor ofeconomics at Georgetown University. She received her doctorate in economics fromGeorgetown University.

Imran Matin is director of the Research and Evaluation division at BRAC in Bangladesh.His work focuses on developing and managing research activities to help BRAC identifyand effectively serve extremely poor clients. Prior to joining BRAC, Dr. Matin workedwith the Consultative Group to Assist the Poor (CGAP) and served a research fellowshipin the Poverty Research Unit at the University of Sussex. He has published extensively onmicrofinance issues. Dr. Matin received his doctorate in economics from the Universityof Sussex.

Klaus Maurer is an independent consultant with almost 20 years experience in the fieldsof rural and microfinance and financial systems development. His clients include multi-lateral and bilateral development organizations such as the Asian Development Bank(AsDB); the International Fund for Agricultural Developmen (IFAD)t; the ConsultativeGroup to Assist the Poor (CGAP); the Swiss Agency for Development and Cooperation(SDC); the German Agency for Technical Cooperation (GTZ); the German Bank forReconstruction (KfW) and others. Dr. Maurer’s work focuses on research, technical assis-tance, training, and designing major projects in support of financial sector development,with a particular emphasis on microfinance. Prior to his work as an independent consult-ant, he was a staff member of KfW and later served GTZ as an advisor in Indonesia. Hereceived a doctorate in Financial Economics from the Free University Berlin.

J. Peter Morrow has been chief executive officer since 2000of the Agricultural Bank ofMongolia (“Khan Bank”) which the Financial Times Group, London named “MongolianBank of the Year” in September 2003. He has 34 years of experience as a banker andfinancial consultant in the United States and developing countries, overseeing insolven-cies and reorganizations, complex debt restructurings, and troubled company workouts..In addition to his responsibilities at Khan Bank, Mr. Morrow currently serves as ViceChair of the Arts Council of Mongolia and as a board member of the Mongolian BankersAssociation and the Police-Public Review Board. He was honored as “Entrepreneur ofthe Year” in 2001 by the Mongolian National Chamber of Commerce; as “Banker of the

x iSca l ing Up Pover ty Reduct ion


Year” in 2002 by Mongolia’s Central Bank; and as “Investment Envoy of the Year” in2003 by the Foreign Investment and Foreign Trade Agency (FIFTA). He speaks fre-quently to international groups on development and financial reform issues.

Lisa Taber is a Technical Specialist with the World Bank’s Financial Sector Operationsand Policy group. She is responsible for helping develop and execute strategies forimproving permanent access to financial services for poor people in World Bank-clientcountries, with a current focus on Mexico, Nicaragua and Colombia. She also providespolicy and technical advice in the areas of microfinance regulation and supervision. Priorto her current position, Ms. Taber served the World Bank’s Latin American andCaribbean Region unit as a research analyst and later as an operations analyst. Shereceived an undergraduate degree in economics from Stanford University and is complet-ing work on a Masters of Business Administration from the University of Maryland(degree expected 2006).

Eva Terberger is Professor of Banking and Finance at the University of Heidelberg,Germany. She received a doctorate in economics from the University of Frankfurt,Germany. Dr. Terberger’s main research interests are development finance with a specialfocus on microfinance, development of financial markets, corporate finance, and corpo-rate governance. She has participated in numerous conferences and studies on micro- anddevelopment finance and has worked as a short-term expert consultant evaluating proj-ects in the financial sector in several countries. She has been a member of the ScientificAdvisory Board to the Federal Ministry for Economic Cooperation and Developmentsince 1998, and has chaired that body since 2000. Dr. Terberger has published extensive-ly on key issues of development policy.

Rebeya Yasmin has been working with BRAC Development Programme since 1995. Sheis currently a program manager responsible for all BRAC programs for the ultra-poor.

Robin Young is senior microfinance specialist in the Finance, Agriculture and BusinessGroup of Development Alternatives, Inc.(DAI). She provides technical assistance andtraining to micro and small enterprise finance programs in policy, strategic planning,institutional development, organizational restructuring, financial management andmicrofinance credit technology. In addition, she conducts designs, evaluations, assess-ments, and financial analyses of microfinance programs. Currently she is the researchleader for a large commercial banks in microfinance study. She has written several publi-cations on the regulation and commercialization of microfinance. Before joining DAI,Ms. Young worked as a consultant to the Microenterprise Unit of the Inter-AmericanDevelopment Bank, conducting research on guarantee funds for microfinance institu-tions, and as an Associate of Resource Development for ACCION International. Ms.Young holds a master’s degree in business administration from Georgetown University.

Hassan Zaman is a Senior Economist with the Finance and Private Sector Developmentgroup in the South Asia region of the World Bank. During the last five years at the WorldBank, he has worked on various issues, ranging from structural reforms to microfinance,in Malawi, Pakistan, Nepal, and Bangladesh. Prior to joining the World Bank, Dr. Zamanworked for four years on microfinance issues for BRAC in Bangladesh. He holds a doc-

x i i Case Studies


torate in economics from the University of Sussex with earlier degrees in economics fromthe London School of Economics. Dr. Zaman’s doctoral research focused on the impactof microcredit on poverty in Bangladesh, and he is the author of numerous publicationson microfinance issues.

1Sca l ing Up Pover ty Reduct ion

Executive Summary

The CrediAmigo microfinance program mounted by Brazil’s Banco do Nordeste (BN)shows how an international financial institution like the World Bank can be a useful cata-lyst in the development of microfinance retail capacity. The World Bank’s patient, phasedsupport to BN as it designed, launched, and nurtured CrediAmigo goes against the com-mon perception that multilateral banks always focus on large near-term disbursements tothe detriment of longer-term capacity building.

In five years, the CrediAmigo program has provided microcredit to over 300,000 ofBrazil’s working poor and is financially sustainable. Most of these families live on less thantwo dollars per day, and work in the cities and towns of the northeast region. Even moreimportantly, CrediAmigo has demonstrated to the development community throughoutBrazil that microcredit can be delivered sustainably, on a large scale, and with great impacton low income families. Prior to the success of CrediAmigo, no microcredit program inBrazil over the past 30 years reached more than a few thousand clients. Today, althoughthere are a large number of well-funded public and private initiatives throughout Brazil,CrediAmigo stands alone in the scale and effectiveness of its achievement.

Progress so far suggests some lessons for multilateral donors in microfinance:■ Freedom from dogmatic presuppositions (for instance, “large state-owned banks can

never do good microfinance”) allows an opportunistic approach that is more likely toyield results.

■ After proper pilot work, a bank with a large pre-existing branch network can roll out mi-crofinance much more rapidly than a new microfinance-only institution. In the case of manypublic development financial institutions (DFIs), they also have the mandate to do so.

Struggling Through the “Growth versus Best Practice”Tradeoff: The CrediAmigo Program of the Banco doNordeste, Brazil

ROBERT PECK CHRISTEN, WITH STEVEN SCHONBERGER AND

RICHARD ROSENBERG

Chapter 1

2 Case Studies

Str uggl ing Through the “Growth versus best Pract ice” Tradeof f

■ Outcomes may be better when largeamounts of lending follow, rather thanprecede, the development of provenretail capacity.

■ Donors must help DFIs stay focusedon best practice finance principles, es-pecially when the short term interestsof both donor and DFI lie in disburs-ing large amounts of credit with littleregard for loan recovery.

■ Donors MUST counter the ultimatetendency of DFIs to grow too quicklyand with too little financial discipline.

■ Donors can be effective with a limitedtechnical role—setting benchmarks con-sistent with international best practice,and putting the client institution in con-tact with top microfinance practitioners.

■ To accomplish this, generalist donorstaff working on microfinance activitiesshould get a basic grounding in the el-ements of sustainable microfinance,preferably through training or, at aminimum, close work with specialists.

Throughout the five years that Banco doNordeste developed its CrediAmigo pro-gram, it has struggled to balance its desireto expand the program quickly and reach amaximum number of clients with the con-strictions imposed by maintaining high lev-els of loan repayment and full cost recovery.This tension has been characterized by re-peated episodes of rapid expansion, deteri-oration in the quality of its loan portfolio,and low staff productivity, followed by pe-riods of consolidation and reversal of these

negative operational and financial trends.Overall, until now, CrediAmigo has largelystayed the course and, as a result, is consid-ered to be a world-class microenterprisecredit program. This standing, however, isthreatened by the Brazilian government’srecent interest rate policy, that could de-prive CrediAmigo of important financial re-sources necessary to re-invest in its futuregrowth and stay in keeping with its mission.

Implementation Process

Brazil has long been considered one of theworld’s great untapped microfinance mar-kets. Because of the country’s large popula-tion, high rate of poverty, and open econ-omy, it has the largest concentration ofmicroenterprises in Latin America—esti-mated at more than 9 million, with at least2 million in the Northeast Region alone.1

Despite this large potential market and scantoutreach by the banking sector, in 1998 noBrazilian microfinance program had morethan 5,000 clients. And only two programs,both nongovernmental organizations(NGOs), could even be considered to be ona path to full sustainability.

In 1996 the World Bank decided to ex-plore the development of microfinance aspart of its poverty reduction efforts inBrazil’s Northeast Region, the poorest inthe country. Since the Inter-American De-velopment Bank was planning a US $150-million microfinance apex to finance the fewNGO MFIs operating in Brazil, the WorldBank task team decided to pursue a comple-mentary approach focused on developingthe commercial bank model.


The CrediAmigo Program of the Banco do Nordeste , Braz i l

The task team spoke with private andpublic banks operating in the Northeast Re-gion to gauge their interest and capacity.Private banks viewed microfinance as char-ity work rather than as a commercial oppor-tunity. Public banks were more interested,given their social mission, but seemed toprovide a weak basis for a financially sustain-able program. In November 1996, a WorldBank team met with senior management atBN’s headquarters in Fortaleza to discussmicrofinance experience and was impressedwith the commitment shown for obtainingand supporting best-practice microfinanceoperating principles.

At an early stage in the discussions, theWorld Bank sought technical help from ex-perts on the staff of CGAP. In February1997, a joint World Bank-CGAP missionvisited BN to evaluate it as a potential mi-crofinance platform. The team was wellaware that microcredit programs in statebanks seldom succeed. But they found thatBN was unusually business oriented andseemed relatively free from external politi-cal interference. The bank was reorganizingto improve its efficiency through better staffincentives, information systems, client fo-cus, and flexibility—all key elements for suc-cessful microfinance. The mission con-cluded that these factors, along with thestrong commitment of BN senior manage-ment and BN’s already significant outreachin the Northeast Region, outweighed therisk of political interference inherent in apublic bank. Based on the mission’s assess-ment, the World Bank agreed to provideminor funding for a pilot microfinance pro-

gram at BN through an existing loan fortechnical assistance and training.

The World Bank Trains Its Staff

It is clear in retrospect that the effectivenessof the World Bank’s engagement with BNdepended on the development of WorldBank staff skills and the close involvementof successful microfinance practitioners.Once the Bank decided to support the Cre-diAmigo pilot, both the task manager andhis division chief attended the three-weekMicrofinance Training Program in Boulder,Colorado (USA). These officers say that thetraining helped them focus the dialoguewith BN on key elements of success, and tobring to the table specific technical advicefrom successful, experienced practitionersthey contacted through their training inBoulder. A number of these practitionerswere later recruited by the World Bank taskteam and BN.

World Bank Technical Involvement is Limited

During the pilot stage, World Bank andCGAP assistance was limited to helping BNfind high-quality international expertise andlearn from similar experiences in other coun-tries. BN used World Bank funding to sendsenior managers to study successful MFIs inBolivia, Chile, Colombia, and Indonesia.Based on these visits, BN was able to con-sider different technical approaches and de-velop a short list of consultants. BN choseACCIÓN International, a group with strongexperience in solidarity group lending.

With ACCIÓN’s assistance, BN surveyed

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informal enterprises and developed pilotloan products. It also prepared training ma-terials and selection criteria for its microfi-nance loan officers. The bank chose to out-source the microfinance loan-officerfunction because of the inflexible qualifica-tions and salary levels of its unionized work-force. Throughout this process the WorldBank’s role was limited to administrative as-sistance in managing the funds. CGAP’srole was limited to helping identify the re-quirements for program development, or-ganizing study tours, and finding potentialtechnical assistance providers. Ultimately,however, through its periodic presence,CGAP provided a constant reminder to allof the best practice operating principles thatwould ultimately be the key to Credi-Aamigo’s success.

In December 1997, BN initiated Credi-Amigo in five of its branches. The pilot in-corporated lessons from the study tours, amarket study, and technical assistance. Test-ing was restricted to a single loan product:90-day loans to individual clients organizedin “solidarity groups” of about five borrow-ers who cross-guaranteed each others’loans. Payments fell due every 15 days. Theinterest rates were considerably higher thanBN’s rates to its conventional borrowers (ashigh as 6% per month), but far below therates of informal money-lenders. Prompt re-payment was encouraged by offering inter-est rebates and new loans within 24 hoursfor groups that consistently repaid on time.

BN’s cabinet chief was named general co-ordinator of the program, with the freedomto recruit top staff from throughout the

bank. In view of the high quality of the pro-gram’s management and design, the WorldBank decided to arrange a US $900,000Japanese grant to support loan officer train-ing, information system development, andfurther technical assistance, all in preparationfor a possible World Bank loan in support ofCrediAmigo’s later expansion.

Overconfidence Leads to Disaster . . .

The pilot seemed to go well for the first fourmonths. BN’s management was excited bythe program’s potential and the positive re-sponse in high quarters of the government.In their understandable enthusiasm, BN’ssenior managers decided to speed up imple-mentation, expanding CrediAmigo fromfive branches to 50. They announced pub-licly that CrediAmigo would have 100,000clients by the end of its first year of opera-tion. The World Bank, CGAP, and the pro-gram’s own technical assistance advisors allwarned that four months was far too shortto test the repayment performance of thenew loan product, because defaults typicallyrose in later loan cycles. But BN manage-ment felt committed to the expansion in or-der to gain a presence in all regions coveredby its development mandate. The WorldBank then indicated that further support,including the Japanese grant, would be con-tingent on maintaining good portfolio qual-ity, with 30-day portfolio at risk no morethan 5 percent.2

As predicted, the expansion resulted inrapid deterioration of portfolio quality andheavy loan losses. Poorly selected andtrained loan officers were given quantity-



based performance targets, so they rushedto lend without sufficient focus on repay-ment capacity and follow-up. The rapidlymounting loan losses took BN’s managersby surprise.3 After two months of expan-sion, the President of BN told all regionalmanagers to slow or stop new lending andconcentrate almost exclusively on loan re-covery. ACCIÓN worked with BN on loanrecovery strategies, and on retraining loanofficers and branch managers. Despite theseefforts, the episode eventually cost BNmore than US $2 million in loan losses. Ittook another six months before portfolio atrisk fell back within the agreed limits.

. . . But Strong BN Commitment GetsCrediAmigo Back on Track

It would have been easy for the World Bankto walk away at this point——there were nodeep or longstanding commitments. BNhad done precisely what naysayers had pre-dicted at the outset of the project. Few inthe informed microfinance communitythought the relationship was worth contin-uing. But the task manager and key mem-bers of the CGAP team sensed that BNmanagement was still committed to makingCrediAmigo sustainable, so they perseveredwith what from the World Bank’s perspec-tive had become a far riskier proposition.

Indeed, it is not unusual for large banksto underestimate the complexity of consol-idating a microfinance program. BN’s expe-rience shows that the resulting problems donot have to be fatal, if the focus returns tosustainability. The problems and costs oftheir premature expansion convinced BN

managers at all levels that microfinanceportfolio quality was challenging andvolatile, and that they needed to manage itmuch more carefully. Since this initial mis-step, CrediAmigo has focused consistentlyon growth with quality. This commitmenthas been evident in a variety of ways:

■ Growth in the number of branchesand loan officers has been carefullycontrolled.4

■ As a state-owned bank, BN has main-tained a commitment to profitabilityin the design and management of Cre-diAmigo. The program was initiatedwith a 5-percent flat monthly rate,translating to a 6.9-percent effectivemonthly rate after adjusting for infla-tion.5 Since then, the interest rate hasdeclined in proportion to the cost offunds in Brazil, but it has remained atlevels consistent with achieving prof-itability.6

■ Sustainability required a high-produc-tivity model with low costs and an in-stitutional culture that would be diffi-cult in a large public developmentbank. BN created a “bank within abank,” first by outsourcing loan offi-cers, and then by replacing BN staffbranch managers with coordinatorsdrawn from the loan officer pool.

Finally, the World Bank Makes the Big Loan

Because of the World Bank’s historicalknowledge of the CrediAmigo program,and the high quality of CrediAmigo’s infor-

6 Case Studies


mation systems, the Bank needed only a sin-gle preparation/appraisal mission to preparea US $50 million loan to support the pro-gram’s expansion over the next five years.7

The mission agreed with BN managementon performance targets that kept the loanand its disbursement tied to portfolio qual-ity, efficiency, and sustainability. The WorldBank’s involvement with BN had lookedvery risky two years earlier; but by the timethe large loan was prepared, the risk hadlessened dramatically because BN now hada proven microfinance business and haddemonstrated the management commit-ment needed to keep that business sound asit expanded. The World Bank’s Board of Di-rectors approved the loan in May 2000.

Subsequently, BN expanded its outreachby increasing the number of outlets. Cred-itAmigo operates in 165 of 175 branch of-fices and through a number of additionalpoints of service in poor neighborhoods. Ithas negotiated additional funding with for-eign agencies. And BN leads discussions onmicrofinance in many forums throughoutBrazil. Its most enduring problem remainsthe high number of clients that take out oneor two loans and drop out. This situation iscommon across microfinance in many coun-tries and in many institutions, and is a coreissue that needs to be addressed by the in-dustry as a whole.

In recent months, CrediAamigo hasfaced its most difficult challenge to date.The newly installed government of Brazilhas announced a significant number of ini-tiatives designed to broaden the access ofthe working class to financial services. Some

of these, such as sponsoring the develop-ment of point-of-service technologythroughout extensive retail and commercialinfrastructure have the potential to posi-tively transform the entire financial land-scape of the country.

Others, such as the stated, well-meantdesire of the government to reduce what itviews as excessively high prevailing spreadsin the pre-existing community of microcre-dit operators threaten the very survival ofmost of the leading NGO microlenders.The government has decided to impose a 2percent cap on the difference between fundsit makes available to MFIs, and the effectiverate they can charge per month to endclients with small loans. These MFIs exhibita significant dependence on governmentfunds in their liability structure and cur-rently require a far greater spread to covertheir operating costs.

While CrediAmigo does not utilize fundsfrom the government, and therefore is tech-nically exempt from this cap, BN is a publicbank whose president was named by the cur-rent government of Brazil. The bank and itsmicrocredit program CrediAmigo have a veryhigh profile in the microfinance community,but it can not be seen to diverge from thegovernment position on interest rate spreads.If BN accepts those same spread caps for itsCrediAamigo program, the program may not be able to cover its fully allocated costsout of its operating revenue without an inter-est subsidy on its sources of funds, much lessinvest the required resources to take on enduring problems, such as high drop-outrates, or increase market penetration through



technological innovation and product re-engineering. BN had already been steadilyreducing its initial interest rates to microbor-rowers before the government decree,though not to the levels that would be con-sistent with the new cap.

In other countries with relatively morerobust microcredit sectors, interest rateshave steadily fallen as a result of competi-tion, a situation that has not yet arrived inBrazil due to extremely low levels of marketpenetration. Longstanding experience indevelopment financial institutions (DFIs)around the world suggests that, in spite oftheir outreach mission, unprofitable pro-grams end up starved of resources and, ul-timately, fail to serve the poor with highquality financial products. In today’s mod-ern financial sectors, unprofitable DFIs areready targets for closure.

Impact Analysis

Within only three years of operation,CrediAmigo was already among the top mi-crofinance institutions (MFIs) in LatinAmerica, in terms of geographical penetra-tion, numbers of clients, and depth of out-reach. As of November 30, 2000, the pro-gram had over 55,000 active clients in 358municipalities throughout the NortheastRegion of Brazil. Three years later, Credi-Amigo has served close to 300,000 clientswith loans through its 175 branch offices,and ranks first on the continent in numberof active clients.

But most notably, BN has one of thelowest average loan balances of any program

in the world, in relation to GNP per capita.The average outstanding loan balance wasR$541.47 (US $270), less than 6 percent ofBrazil’s per-capita GNP.8 By and large, theclients of CrediAamigo have incomes thatpermit levels of consumption below twodollars a day, while many families are livingon less than one dollar per day. Firm statis-tics are not yet available, although the bankis now commissioning an impact study to becarried out with the support from the WorldBank to understand more fully the nature ofits clients and their household finances.

CrediAmigo’s portfolio quality and staffproductivity are at international best-prac-tice levels. Only 3.5 percent of its loans arelate, using a 90-day portfolio-at-risk meas-ure. Its annualized loan loss rate has beensteadily increasing from its historical level of2.5 percent, after fully provisioning all loanswith any payment 90 days or more overdue,though it is still just within acceptable pa-rameters. Loan officers with nine months ormore of experience are each handling morethan 300 clients, on average.

About 85 percent of CrediAmigo’s 108branches became operationally sustainablewithin three years. The program as a wholereached full financial sustainability in mid-2001.9 By 2002 it had recuperated all of itsaccumulated operating losses. CrediAmigo’sreturns on assets peaked at 4.7 percent for2002, and have steadily fallen ever sincebe-cause it has lowered its interest rates, whilestill operating in positive territory. Thus,CrediAmigo is demonstrating that a “down-market” focus can be consistent with sustain-ability in commercial banking in Brazil.

8 Case Studies


To maintain program sustainability in theface of the mandate to decrease interestrates, CrediAamigo has undertaken to re-duce costs and increase productivity—–twintasks that were desirable under any circum-stances as the program has reached greaterscale. It reduced operating expenses from30 percent of total loans to 20 percent overthe course of the year 2003. This brings theprogram within international best-practiceefficiency ratios. It did so by increasing loanofficer productivity, adjusting the staff in-centives package, and controlling expensesin middle management.

The latest round of interest rate decreases(to 2 percent a month) would make theprogram fall below sustainable levels if com-mercial costs of funds were applied to the li-ability structure of CrediAamigo, even ifsome fees were allowed. At 2 percent amonth maximum interest and a 4 percentup-front fee, the effective interest rate forCrediamigo is 38 percent. With an operat-ing cost of 20 percent, loan losses of 5 per-cent, and a commercial cost of funds ataround 16 percent (1990 CD rate), for a to-tal cost of 41 percent, the program requiresan interest-rate subsidy to break even. Whilethe immediate level of interest-rate subsidyis not great, it does raise a concern aboutwhether cost cutting measures will undulyimpair the operations of the program overthe long term.

Driving Factors

Several factors led to the success of Credi-Amigo. The single most important was thecommitment of the President of BN to

acquiring and implementing best practicemicrocredit principles, regardless of the factthat this was a significant departure fromnormal operating practices in the bank.

■ Above-market interest rates are of-fered to clients, in order to cover therelatively high cost of administeringvery small loans sustainably.

■ Compensation of microcredit staff isbased on the results they achieve (per-sonal accountability).

■ Management information systems givemicrocredit staff immediate access toaccurate transaction history and cur-rent repayment status for all clients.

■ Credit decisions are decentralized andbacked up by ex-post quality controls.

■ The bank is committed to very highlevels of loan recovery.

■ Microcredit lending operations arespecifically separated from BN’s gov-ernment-directed lending programs.

■ The World Bank considered the factthat BN President Queiroz was intend-ing to stay an additional 5 years criticalto the successful launch of the program.

Commitment and Political Economy for Change

In September 1996, BN’s president Costade Queiroz told the World Bank that he wasinterested in developing a world-class mi-crofinance program. Emerging from a ma-jor reform, BN had R$6 billion (US $3 bil-lion) in assets and 176 branches throughout



the Northeast Region. To satisfy BN’s re-gional development mandate, Queiroz waslooking for ways of reaching the poor thatwere more effective than the bank’s directedlines of credit had been. He was particularlyinterested in the informal sector.

Dr. Costa de Queiroz was appointedpresident of BN in March 1995, followinga very successful career as a private business-man in the state of Ceara. Dr. Queiroz im-mediately began a major reform of thebank, with the objective of making it moremodern, efficient, and responsive to the de-velopment needs of the Northeast Region.Loan assets grew from R$2.6 billion tomore than R$6.0 billion; the number ofloans grew from 68,000 to more than404,000.

■ BN’s market share increased from 35percent of all loans granted in theNortheast Region to 78 percent.

■ Administrative expenses as a percent-age of assets were less than half their1995 level (3.4 percent in 2000 versus7.9 percent in 1995).

■ Staff were reduced from 5,468 tofewer than 4,000.

■ Lag time between loan request and ap-proval was reduced from an average of217 days to a mandated limit of 21 to60 days depending on loan size.

■ BN reorganized its structure andprocesses to make the client its centralfocus and reduce barriers to staff inter-action across functional areas.

■ BN invested heavily in staff trainingand information systems.

It was into this environment of far-reach-ing institutional reform that CrediAmigowas placed.

Institutional Innovation

The program was ultimately put under thedirect management of Queiroz’s chief ofstaff, which ensured that it would receivethe unconditional and full support of thePresident as it was deployed throughout thebranch network and operating divisions ofthe bank. CrediAmigo has been managedfrom the start by a small group of fewerthan 25 full-time headquarters staff. Linemanagers were drawn from bank staff inbranches. Banco do Nordeste outsourcedthe contracting of its cadre of loan officersand their immediate supervisors in order tocircumvent restrictions imposed by collec-tive bargaining agreements that would havemade microcredit unprofitable and unsus-tainable within the normal staffing patternsof the bank. These outsourced loan officersand coordinators represent 85 percent oftotal staff of the program.

As the program was developed and im-portant issues arose, CrediAamigo drew onsenior managers from all departments in thebank. This guaranteed a higher level re-sponse when compared to the traditionalbank downscaling approach, which has beento build and staff a separate division withinthe bank wholly dedicated to microfinance.The added advantage of this approach hasbeen the far deeper levels of integration of

10 Case Studies


the program and its culture into the bank. President Quieroz always saw in microfi-

nance an opportunity to reinforce broaderreforms within the bank. This has been ac-complished. BN managers have repeatedlysaid that the example of CrediAmigo is hav-ing a catalytic effect on the rest of the bank.BN is using the experience gained underCrediAmigo in areas such as the use of staffincentives and the development of a low-delinquency loan culture.

Learning and Experimentation

On at least two occasions, Banco doNordeste has attempted to grow tooquickly, which has led to excessive losses andthe need to re-establish core operating pro-cedures and principles. In each case, BN hasbeen able to pull back and consolidate itsoperating procedures and re-establish bestpractice performance. The first occasion was triggered by the need felt by the bankto establish the presence of the programthroughout the Northeast Region, where itoperates and has a development mandate.This decision was costly in terms of extraor-dinary loan losses, but the bank has since recuperated all lost funds through profitsgenerated by the program.

The second occasion was prompted by thedesire to grow the program more quickly, inpart due to the excess liquidity representedby the additional funding negotiated withdevelopment organizations and by the desireof BN to expand its outreach and the impactof the program. This decision also led to asharp increase in loan losses, although not assevere as in the first occasion.

Both occasions reveal the fundamental co-nundrum faced by large, public institutionswhen they confront the undeniable fact thatthey have not been successful in meeting the full demand for high-quality financialservices in their target market. They con-stantly face the trade-off between just push-ing services out and incurring the highercosts that ensue from high loan losses, andtrying to stick with best practice methodolo-gies and incurring the higher costs of stafftraining that are required to keep loan losseslow. Thus far, BN has struggled through thisdilemna ultimately favoring best practice inits decisions, at the clear expense of programgrowth. It has not been easy, and BN is constantly looking for ways to grow morequickly and increase its impact. This is, afterall, its clearly stated mission.

External Catalysts

Successive Brazilian governments havedemonstrated a longstanding interest inpromoting microenterprise credit througha series of public-sector initiatives. Access tomicrocredit has frequently been an impor-tant issue in political campaigns. While thegovernment’s initiatives can typically becharacterized as leaning toward subsidizedand targeted development credit, the Cre-diAmigo program resulted from a fortunatecoincidence between the ongoing reformprocess in BN and the interest and ability ofthe World Bank staff member to pursue aradically different approach. Certainly, BNfelt the mandate from the highest govern-ment authorities to engage in microcredit.This continues to the present day, and the



current administration has launched a num-ber of new initiatives designed to broadenaccess to finance, some of which fall into theclassic subsidized credit paradigm while oth-ers, are quite forward looking.

Lessons Learned The activities most critical to CrediAmigo’sdevelopment into a world-class microfi-nance program included conceptualization,design, piloting, and initial consolidation.The most notable aspect of these activitiesis that they required limited external fund-ing and occurred before any disbursementsfrom the World Bank loan. Although theseprocesses required significant investmentfrom BN over almost three years, externalassistance costs were relatively low.

From 1996 to the loan appraisal in 1999,the World Bank spent about US $150,000of its own budget, including the costs ofparticipating in the initial seminar, the observation missions (usually two-days), theMicrofinance Training Program in Boulder,one identification mission, and the projectappraisal mission. CGAP provided aboutUS $50,000 in technical support, includingstaff time and external consulting. In all,BN received US $1.2 million in external financial assistance (US $300,000 of reprogrammed funds from a prior WorldBank loan and US $900,000 from theJapanese), although it spent less than half of that on technical assistance related toprogram operations.

Other funds were spent on impact evaluation assessments and client training

activities. It spent about US $5 million ofits own funds for the salaries of the BN per-sonnel who designed the program, trainingcosts, full financing of the loan portfolio,and accumulated losses, including the US$2 million write-off of bad loans.10

The BN experience suggests that donorsmay need to be opportunistic rather thandogmatic in their approach to microfinance.At first the World Bank was reluctant tosupport a large state-owned developmentbank, even one that had undertaken signif-icant internal reforms. But the demon-strated strength of the commitment by BNsenior management, along with a pressingneed to develop substantial microfinance re-tail capacity in the Northeast Region, andthe Inter-American Development Bank’s“preemption” of the NGO arena, all com-bined to persuade the World Bank to take arisk and support CrediAmigo. Although theBank was advised to withdraw its support,particularly after the ill-advised expansionsin 1998, the clear commitment of BN’s senior managers to develop a world-classprogram kept the World Bank engaged.

In comparison with other recipients ofdonor support, managers of competentbanks are particularly skeptical of, and resist-ant to, technical advice from donors or fromconsultants selected by donors. Recognizingthis, the World Bank team limited its directrole to providing focus rather than technicaladvice. Nevertheless, it took the unusual stepof investing in a three-week training programfor two of its key staff. In retrospect, the WBteam members felt that this training was critical to the success of the engagement.

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Recruiting outside experts is important butcannot substitute for the role of donor staffas the authoritative interlocutors for their in-stitution. Donor staff who lackbasic techni-cal literacy in microfinance will not usuallybe able to identify good consultants or usethem well, and may not have the credibilitythat is essential for an effective dialogue withthe implementing institution.

The most important contribution ofWorld Bank management was its patience inallowing development to proceed at its ownpace. The process of developing, piloting,and consolidating the CrediAmigo pro-gram, particularly with the need to recoverfrom the early rapid expansion, took threeyears before a loan was appraised. This re-quired exceptional patience from the WorldBank’s country management in Brazil,which was under pressure from varioussources to move more quickly with the loan.Although there was some consideration ofmoving more quickly with a smaller loan,management continued to support the taskteam’s assessment of the program’s readi-ness for a major World Bank loan.

As a result of this patient approach, alarger loan was provided with less risk of undermining the program’s focus on sustainability. The initial developmentprocess allowed BN to develop its expertiseand confidence in managing a large micro-finance program. Even the early missteps,based completely on BN decisions with consequences financed by BN resources,were an important element in establishingthe program’s low arrears culture in a public bank environment. BN’s success in

resolving its early problems and developinga sense of how to manage the trade-off between growth and portfolio quality with-out the pressure of disbursing a World Bankloan has brought the program to a levelwhere neither BN nor the World Bank seethe US $50 million loan as an incentive to“supply-led growth.”

In recent years, BN management has negotiated further lines of financing from theInteramerican Development Bank and the“Germans.” These funds raise the total fi-nancing available for CrediAmigo to close to US $100 million, and seem to have provided some of the impetus for themid-2003 push to grow the loan portfolio.As with the initial push in 1999, this push ledto a deterioration in the quality of the loanportfolio, resulting in a spike in non-recov-erable loans, a decrease in loan-officer pro-ductivity, and a drop in overall profitabilityfor the year. Profits for 2003 were consider-ably down from their high in 2002. WhileBN management has not allowed this degraded portfolio quality to persist, thisepisode reveals how the constant pressureapplied by the donor community to supportsuccessful programming, combined with the temptation on the part of governmentagencies to grow the same, can combine toblow up initiatives that, left on their own,would prosper at a more natural pace.

The CrediAmigo experience suggeststhat the World Bank and other multilateraldonors can play a catalytic role in microfi-nance development if they:

■ Pursue the best available opportunitiesin a country rather than impose a



universal model. (All capacity-buildingapproaches involve substantial risks.)

■ Allow programs to develop their ca-pacity to manage growth with portfo-lio quality before providing significantfunding for program expansion, evenwhen this may delay lending targets.(The biggest constraint to the spreadof microfinance services is a shortage,not of funding, but rather of compe-tent retail capacity.)

■ Encourage donors to take advantageof their technical role to set bench-marks consistent with internationalbest practice and put institutions incontact with top microfinance practi-tioners, which can be the critical ingre-dients that keep a DFI on track.

■ Ensure that donor staff working withMFIs are grounded in the basic ele-ments of sustainable microfinance,preferably through training or, at least,close work with high-quality specialists.

1 For background on Brazil’s microenterprises, finan-cial sector, and microfinance industry, see StevenSchonberger, Microfinance Prospects in Brazil, LatinAmerica and the Caribbean Region and Economic andSocially Sustainable Development Unit (Washington,D.C.: World Bank, 2000).

2 “Portfolio at risk” is a measure that divides theremaining balance of loans that are late by the remain-ing balance of the whole loan portfolio.

3 Because microcredit is unsecured, repayment disci-pline can collapse very rapidly. When micro-borrowerssees many of their peers defaulting on their loans, moti-vation to repay plummets. The main reason borrowersrepay their loans is the expectation of future services.They know that once people stop repaying, the servicewill not be available very long, and they do not want tobe the last one aboard the sinking ship.

4 To increase its geographic outreach cost-effectively,CrediAmigo began establishing “individual branches”consisting of a single loan officer. These branchesaccount for most of the growth in branch numbers sinceAugust 1999.

5 In comparison with normal loans, microloans are tiny,yet staff intensive. Thus, administrative costs are highwhen measured as a percentage of the loan amounts. Ittakes a very high interest rate to recoup these costs,especially if management is committed to breaking evenat an early stage. Experience has shown that clientsvalue the loans so highly that they are willing to pay ele-vated interest rates; in fact, many of them have beenpaying much higher rates to informal money-lenders.

6 When BN transfers funds to a CrediAmigo branch, itcharges an internal transfer price equal to the prevailingrate on Interbank Certificates of Deposit.

7 In fact, BN could have funded the five-year expan-sion from its own resources. The World Bank loan wasstill attractive to the Brazilian government because itbrought in needed foreign exchange.

8 At the end of 2000, BancoSol in Bolivia had 61,000loan clients, after 13 years of operation. Compartamosin Mexico had 64,000 clients, after about 10 years. Themedian outstanding loan balance for Latin AmericanMFIs was 45 percent of per-capita GNP, according tothe April 2001 issue of MicroBanking Bulletin. InBangladesh, Grameen Bank’s average outstanding loanis US $140, or about 40 percent of per-capita GDP.

9 “Operational sustainability” is the ability to pay alloperating costs except the cost of funds from interestincome on loans. “Financial sustainability” is the abilityto pay all costs, including financial costs, from interestincome.

10One can argue that BN did not need to spend thisamount of money, that it could have achieved the sameresults with a third of the up-front investment. But per-haps these types of “mistakes” are normal for workingthrough very large institutions. The alternative mighthave been heavy handed (and expensive) technicalassistance, which the Brazilians would not have accept-ed. There is evidence of banks that have spent far less,such as the Banco del Estado in Chile, which made vir-tually no mistakes after spending a few years looking forthe right model, and banks that have spent far more,such as Bank Rakyat Indonesia, which had to turnaround the performance of 3,500 branches.

End Notes

■ ■ ■

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This Case Study was prepared by Robert Peck Christenbased on an earlier publication, A Multilateral DonorTriumphs over Disbursement Pressure: The Story ofMicrofinance at Banco do Nordeste in Brazil, CGAPFocus Note No. 23 (Washington, D.C.: CGAP, December2001), http://www.cgap.org/docs/FocusNote_23.pdf,written with Steven Schonberger and RichardRosenberg. Mr. Schonberger is Senior OperationsOfficer working in the World Bank’s Cambodia CountryOffice. He previously worked on rural development andmicro and rural finance issues as part of theEnvironmental and Socially Sustainable DevelopmentDepartment in the Latin America and Caribbean Regionof the World Bank, based in Washington D.C. Mr.Rosenberg is a Senior Advisor at CGAP. Althoughreordered, most sections are taken verbatim from thatearlier CGAP publication. Other more recent referencesinclude:

Brusky, Bonnie. “From Skepticism to Success: TheWorld Bank and Banco do Nordeste.” CGAP CaseStudies in Donor Good Practices, No. 3, Washington,D.C., April 2003. http://www.cgap.org/direct/docs/case_studies/BancoDoNordeste.pdf

Goldmark, Lara, Steve Pockross, and Daniele Vechina.“A situação das microfinanças no Brasil.” Rio deJaneiro, Brazil: Banco Nacional de DesenvolvimentoEconômico e Social, Programa de DesenvolvimentoInstitucional, 2000.

http://www.bndes.gov.br/conhecimento/microfin/02goldm.pdf

Kumar, Anjali. Brazil: Access to Financial Services.Washington, D.C.: World Bank, forthcoming July 2004.

Nichter, Simeon, Lara Goldmark, and Anita Fiori.“Understanding Microfinance in the Brazilian Context.”Rio de Janeiro, Brazil: Banco Nacional deDesenvolvimento Econômico e Social, Programa deDesenvolvimento Institucional, July 2002.http://www.bndes.gov.br/english/studies/03livreto_eng-lish.pdf.

Parente, Silvana. “Microcredit Policy as a FinancialMarket Mechanism to Reduce Poverty: The Experienceof the Banco do Nordeste in Brazil.” Photocopy, BancoNacional de Desenvolvimento Econômico e Social, Riode Janeiro, Brazil. Unpublished paper prepared for theSpecial Program for Urban and Regional Studies ofDeveloping Areas, Department of Urban Studies andPlanning, Massachusetts Institute of Technology, June2002.

Sanchez, Susana M., Sophie Sirtaine, and Rita Valente.“Bringing Microfinance Services to the Poor:CrediAmigo in Brazil.” World Bank En Breve 7 (August2002). http://inweb18.worldbank.org/External/lac/lac.nsf/0/1FE8954E8345086D85256C08004FEA3E?OpenDocument.

Bibliography


Executive SummaryEquity Building Society (Equity) is a homegrown success story that has only recently attractedinternational attention. Equity’s beginning, 20 years ago, was inspired by an entrepreneurialvision of a potential demand for financial services in the underserved, low-income populationof Kenya. Despite high hopes for serving this market, the first 10 years were characterized bya difficult environment, fierce competition, and a lack of institutional knowledge of how tooperate a profitable financial institution. On the verge of collapse in 1993, Equity broughtin outside experts and committed to radical steps to turn the institution around. This commitment led to improved financial performance and increased outreach.

Since 1993, Equity has grown from 12,000 depositors to more than 250,000 depositors(as of December 2003), making Equity Building Society home for more than 13 percentof all bank accounts in Kenya. This growth can be attributed to committed staff and lead-ership, high-quality customer service, effective marketing, low barriers to access (especiallycompared to traditional commercial banks), appropriate product design, an acceptable en-abling environment, and more recently to external support from donors. Equity also offersa wide range of loan products and other financial services, such as money transfers, banker’schecks, and bid bonds.

In the last few years, Equity has gained recognition within Kenya, and throughout Africaand the world, for its dramatic growth and professional operations. Of course, success bringsits own challenges. In the coming years, Equity will need to manage the sustainability of thisimpressive growth by incorporating new staff, supervising the expanding branch network,maintaining the quality of customer care, and strengthening the quality of its loan portfolio.

Implementation ProcessEquity Building Society opened its doors in 1984 to bring financial services to ordinaryKenyans, especially to those who had no access to the formal banking sector. The foundershailed from senior positions in government and business, and shaped the institution basedon their indepth understanding of the socio-political circumstances, their commitment to the

Equity Building Society:A Domestic Financial Institution Scales up MicrofinanceBY TAMARA COOK, CGAP

Chapter 2

16 Case Studies

A Domest ic F inanc ia l Inst i tut ion Sca les Up Microf inance

government’s rural development policy, andtheir ability to turn a commercial profit in Kenya. Taking advantage of new rules that enabled Kenyans to open formal, licensed financial institutions, Equity wasregistered as a building society, which was anaffordable option in terms of license fees and capitalization. The building society legislation influenced Equity to offer savingsservices and mortgage loans. Equity realized,however, that it was servicing a microfinancemarket for low minimum-balance depositsand loans that were rarely used for housing.

In its early years, Equity faced fierce competition from a multitude of locally-owned financial institutions, which also wereset up during this time. Equity resisted thetemptation to attract deposits from govern-ment and parastatal organizations in contrastto other financial institutions. Instead, Equity mobilized individual customers byone-on-one marketing, entrenching a culture of service excellence from the start.For its first decade of operations, Equitystruggled to maintain clients and cover costs,while other small institutions closed and confidence in the sector eroded.

Despite Equity’s dedicated efforts in adifficult environment, a report issued by theCentral Bank of Kenya in 1993 confirmedthat the institution was technically insolventand had poor board supervision and inade-quate management. Non-performing loanswere 54 percent of the portfolio, and accumulated losses totaled KSh 33 millionagainst a paid-up capital of KSsh 3 million.At this stage, deposits were being used tomeet operating expenses. Its liquidity ratio

stood at 5.8 percent, far below the required20 percent. However, the Central Bank of Kenya did not request closure of Equity, and the Society was given thechance to turn around for the sake of its existing clients who were still committed to the institution.

Realizing the need for a radically new andprofessional approach to retail banking, theEquity Building Society board recruitedtwo experts, a promising banker (who later became the finance director) and anexperienced trainer, to help staff meet thechallenges of the new environment, expandits marketing, and on the whole enhance itsefforts. With the help of the new manage-ment team, Equity focused on staff trainingand marketing. The original culture of goodclient service and teamwork was revived,and the number of depositors grew.

The efforts to turn Equity around werealso assisted by the new political atmospherethat took hold in the early 1990s. The country was moving away from a one-partypolitical system, and more freedom was evi-dent. Equity succeeded in mobilizing depositsfrom churches, and the government allowedemployees to bank at financial institutions notunder government control. Many foreignbanks converted from retail to corporatebanks, leaving a vacuum in the retail sector. Atthe same time, banks were closing their ruralbranches and rationalizing urban branches, attracting a flood of new deposits.

Equity also formalized its commitmentto smaller clients in a new mission statementwhich recognized how financial servicescontribute to the welfare of clients as well as


Equity Bui ld ing Soc iety, Kenya

the national economy. Deposit mobilizationincreased by 40–60 percent per year, andprofits grew. More recently, a special marketing and public relations campaign inAugust 2003 celebrated Equity’s 20th anniversary of “Providing Financial Solutions to Kenyans,” which yielded spectacular increases in the number of newsavings accounts.

During its first 15 years, Equity reliedentirely on its own resources and had neither solicited nor been offered assistancefrom international partners. This began tochange in 1999, when Equity undertooktwo small projects with EU-MESP andUNDP-MicroStart. Deeper partnershipswere developed with Swisscontact and MicroSave-Africa. Both relationships havefocused on providing local and regionaltechnical expertise and on jointly develop-ing new products and services. MicroSave-Africa, in particular, brought a focus onservices and product design based on clientdemand. This led Equity to redesign itsproducts, reflecting its change to focusingon clients. The marketing department wasrestructured, and eventually included agreat deal more time on market research.

DFID’s Financial Deepening ChallengeFund supported the launch of Equity’s mobile banking program. DFID currentlyprovides technical assistance for specific targets, and Equity also receives more general technical assistance from Africap.

The UNDP-MicroStart program alsoplayed a role in upgrading and computerizingthe management information system, whichhas had a tremendous impact on Equity’s

turnover and portfolio growth. In 2003, Africap, a regional microfinance investmentfund of international financial institutions,chose Equity for its first African investment ofUS $1.54 million, accompanied by technicalassistance of US $244,000.

A fitting illustration of the turnaround of Equity is the improved ratings by theCentral Bank of Kenya. The overall rating(shortly after the 1993 rating) rose to marginal, then to fair, and in 2002 to satisfactory. The Equity board and manage-ment were deemed proficient to govern andmanage a financial institution. Capital adequacy and asset quality were satisfactory.Management, earnings, and liquidity wererated as strong.

The 2003 report from the Central Bankhas just been finalized, and its overall finan-cial condition has been rated as satisfactoryagain. Capital adequacy, earnings, and liquidity were all rated as strong. However,asset quality dropped to marginal (19.2 percent portfolio at risk) and managementwas rated as satisfactory. The senior management team has taken this report veryseriously and is revamping the credit operations and methodologies to improvecredit risk management and administration.The report also noted deficiencies in the management information system and improvements are already underway.

The profile of Equity, as of March 2004,shows an institution that is consistently prof-itable, operates through 15 branches and 25mobile units, has 297,000 depositors with deposits of KSh 3.8 billion (US $50 million),and a loan portfolio of KSh 2.1 billion (US

18 Case Studies


$28 million). It is fully computerized and has 384 staff members, 8 directors, and 2,470 shareholders.

Impact AnalysisFinancial services help poor and low-income households increase their incomesand build the assets that allow them to mitigate risk, plan for the future, increasefood consumption, and invest in education,health, housing, water, and sanitation. Equity made a deliberate decision to focuson poor and low-income clients to helpthem improve their lives. Although Equityreaches a wide range of clients, the major-ity of its clients are small-holder farmers,low-end salaried workers, and micro and small businesses. Figure 1 shows thebreakdown of loans according to these categories1 as well as a summary of depositsby account type.

Although it is not a perfect indicator forpoverty level of clients, average account

sizes can point to income and accumulatedwealth of the type of clients being reached.As of December 2003, 73 percent of Equity’s savings account balances were lessthan US $70, not including the 50,000 newaccounts that have not yet received theirfirst deposit.2 Although most of Equity’ssavings accounts have very low balances, 63percent of Equity’s total deposit volume ismade up of corporate savings accounts andfixed deposits over US $1,000 (see Figure2). Given the volume of clients with smallaccounts, Equity staff spend most of theirtime handling small depositors. However,this does not preclude the relatively largedeposits that help provide stability and of-ten longer-term funding to the institution.

On the credit side, about 80 percent ofoutstanding loans have outstanding balancesof less than US $400, although they only account for about 18 percent of the totaloutstanding loan balance. (See Figure 3showing average outstanding balances on Equity’s loan categories.) On average,

Figure 1: Distribution of Clients

81%

9%

1%

5%4%

29%16%

3%

3%

49%

Types of Depositors OrdinaryBusinessFixed DepMobileOther

FarmersSalariedSmall/MicroDevelopmentCorporate

Types of Borrowers

Sources: EBS data, own calculations



small-scale farmers take out the smallestloans (US $132), which are usually evaluatedon the basis of predicted remittances fromthe Kenya Tea Development Authority orother farm produce marketing agencies.Farm input loans are also provided for dairy,coffee, and other crops on a smaller-scale.

Salary-based loans (including educationand medical loans) have slightly higher

average outstanding balances (US $201).Loan repayments are deducted automaticallyfrom salaries that are directly deposited into clients’ savings account at Equity. Equity’s Corporate Branch in Nairobi catersto a higher-end market, where business loansaverage US $9,500. However, in otherbranches, loans to smaller businesses averageUS $1,300. Equity’s business loans have

Figure 3: Average Loan Sizes (US$)

Figure 2: Distribution of Deposit Size

Balance of Deposits

18%

11%20%

32%

1% 2%16%

$1-30$30-70$70-270$270-$1000$1000-2700$2700-13,300Over 13,300

Numbers of Depositersu

64%9%

11%

9%7%

$1-30

$30-70

$70-270

$270-$1000

Over $1,000

Sources: EBS data, own calculations*Overdrafts and new accounts with 0 balances have been excluded

$132$201

$922

0

200

400

600

800

1,000

1,200

1,400 1,279

Farmers Salaried Small/Micro Development**Corporate loans for medium businesses average $9,500

20 Case Studies


been based on revenues demonstrated byturnover in savings accounts and secured withcollateral such as land and vehicles. A new microcredit product targeting even smallerentrepreneurs is slated for pilot testing in2004. It will require reorientation of creditmethodology (including more flexible security requirements with a strict emphasison the analysis of regular cash flows) and substantial training for credit officers.

In mid-2003, a qualitative impact assess-ment3 was conducted in conjunction with Equity’s market research team (using MicroSave-Africa tools), and examined thenature, scope, and depth of client impact atthe individual, household and enterprise level.The research team? conducted 23 focus groupdiscussions from eight rural and urbanbranches. The findings provided insight intohow clients use Equity’s services to managerisk and meet household and business cashflow demands. Equity’s clients report usingsavings and loans to invest in business activi-ties (inventory, salaries); save for the future(education, medical costs); manage householdcash flow needs (rent); invest in assets (land,housing, appliances); and cope with crises orlife events (illness, marriages, funerals). In thefocus group discussions, clients reportedgrowth in their incomes and assets over thepast ten years, and Equity appears to be an important part of that growth.

Equity’s commitment to increasing edu-cational opportunities and addressinghealthcare needs for Kenyans permeates theinstitution. Education and medical loans areoffered at lower rates if the funds are paiddirectly to the educational institution or

medical provider. Equity encourages savingfor education through its “Super Junior”account for children that includes freebanker’s checks for school fees—a uniqueservice in the Kenyan market. It also offersfavorable pricing on issuing banker’scheques required for the payment of schoolfees each term. The Jijenge savings account,a monthly contractual savings product,helps clients develop the discipline to save regularly for education and medical expenses (among other reasons) and also allows clients to borrow against their savingsat a favorable rate.

Equity’s impact can also be viewedthrough the lens of its financial return. Bythe beginning of 1994, Equity had accumu-lated losses of KSh 33 million (US$440,000). Given that it held only KSh 31 million in deposits, this represented a serious problem. After the dramatic shift inits operations in 1994, Equity reported itsfirst profitable year, and by 1997 Equityhad accumulated a profit of US $80,000,which grew to US $5.2 million by the endof 2003 (see Figure 4). In the 1980s and1990s, Equity’s growth was financed entirely by mobilized savings (domestic)and the personal investment of the foundersand shareholders. Survival meant they hadto use their resources efficiently, especiallyto dig themselves out from the crisis in1993. The recent technical assistance and financial investments in Equity are beginning to reap results, but it is too earlyto measure the full impact.



Driving Factors

Equity’s success can be attributed to thededication of its management and staff, aswell as to Equity’s ability to innovate andmaintain extremely high customer service.Equity’s success attracted limited externalsupport in 1999, and more substantial support after 2002, but support followedand reinforced the “homegrown” successrather than creating it.


Internal and external commitment tochange pushed Equity in the right direction.Internally, Equity’s management and boardgoverned the institution effectively duringa period of generally weak governance inKenya. The deliberate decision to concen-trate on the smaller end of the marketshielded the organization from political influence. In addition, Equity’s leadershipfocused operations in one single region(Central region) to provide the best services

to the target market. This helped developinstitutional capacities without overstretch-ing management, operations, and internalcontrols. Equity’s recent growth is built onthe foundation of high quality services andstrong institutional capacities.

Equity’s founding and turn-around benefited from external reforms catalyzed bykey decision makers who shared Equity’s vision. Equity was established under newrules in 1980s to create locally-owned formal financial institutions with the hopethat such institutions would serve the unbanked populations neglected by thecommercial banks. In the early 1990s, when Equity was finding its footing again,multi-party democracy and financial andmarket liberalization helped Equity attractnew clients, such as government employeeswho were (finally) allowed to direct deposittheir salaries in non-government controlled financial institutions. Influenced by World Bank/IMF financial sector reform requirements and lobbying by building

Figure 4: Accumulated Profit/Loss (US $ in thousands)

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000

93 94 95 96 97 98 99 2000 2001 2002 2003

22 Case Studies


societies (especially Equity), Parliament revised the Building Societies Act to widenthe scope of activities almost in line with theBanking Act. For example, the 1999 revisionregularized deposit taking. And last, but notleast, regulators who were sympathetic toEquity’s mission granted it one last chanceto shape up after it was rated “technicallyinsolvent” in 1993 by the Central Bank of

Kenya rather than shut it down.


Arguably, Equity’s most essential institutionalinnovation is motivating and sensitizing itsstaff to embody the company pledge: “…takepride in the noble responsibility of offering financial services and solutions, to empowerour customers to face the future with dignityand realize our full potential.” Equity has atradition of recruiting young people at entrypoints, who are well educated but have littleor no experience. The emphasis in Equity ison instilling the corporate culture. In a way,

the selection of staff is not so much to bringskills into the institution as to mold inexperi-enced graduates to its operational norms andcustomer-service philosophy. This has workedexceptionally well and is reflected in the workethic and culture emanating from the activi-ties of the entire staff complement. Staff areencouraged to see their work as a “calling,”not just a job. This view unifies staff aroundEquity’s vision and has the added benefit ofinducing staff to work long hours to achievethis vision when needed.

Equity is committed to bringing financialservices to rural clients, which make up 68percent of Equity’s clients but only 28 percent of total deposit volume, given therelatively lower average savings account sizeof rural clients (see Figure 5). Building onits existing branches in small towns in Central Province, in 2002 Equity launchedmobile banking (with support from DFID)to deliver services deeper into rural areas.The mobile units are designed as stand-

Figure 5: Distribution of Deposit Size

58%

5%

37%

2%

2%

26%

Distribution of deposits(Ksh)

Rural-branchRural-mobileUrban

Distribution of depositaccounts (#)



alone mini-branches, wholly contained in afortified sport utility vehicle with satelliteconnection to the branch, solar power, anda fold-down teller window. The mobilemini-branch drives up near factories, for example, when salaries are disbursed andserves clients directly from the vehicle.

More often, however, the vehicles areused to transport 2–3 staff over rough ruralroads to rented offices where Equity openstemporary mobile branches at least one daya week. These minimally- equipped rentedlocations generally have a counter for staffand an area for clients to wait for service. Themobile branch downloads the informationfor their clients from the branch onto a laptop (but also brings a hardcopy of thedata in case there is a shortage of electricityor they lose the satellite connection with thebranch). All transactions by the mobile officeare uploaded at the branch before runningthe close-of-day report. The mobile branchesare a cost-effective way to provide better access to rural clients without the significantinvestment needed to open a full-scalebranch. As of December 2003, Equity had25 mobile units serving 12,161 clients (5 percent of existing clients) with an average deposit size of about US $100, (a significantly lower average than for othersavings products). The mobile units earn aprofit, in part by charging a small fee toclients, which is less cost than transportationto the nearest branch.

Innovations in information technologycan dramatically affect an institution’s abil-ity to serve its clients well. For over 16years, Equity survived despite the growing

difficulties of a manual information system,which were amplified at every level ofgrowth. Both customers and staff membersfelt the strain of the manual system as thevolume of Equity’s business expanded overthe years. Equity launched its computerizedmanagement information system in June2000 (with support from UNDP-MicroStart), completing the installation ina record four months. Equity’s efficiency incollecting and reporting data and itsservice delivery to customers improved

greatly thereafter. With the new system, Equity managed to improve its customer turnaround time from 30–40 minutes toabout five minutes at the counter.

Although Equity’s growth is partly at-tributed to its marketing and customer-fo-cused efforts, it is clear from its high growthspurt in 2001 that the new computerizedsystem has been a major factor. This, ofcourse, demonstrates the importance oftechnology to banking in general and tohigh volume, low-value microfinance in particular. Currently, Equity is investing additional resources in a wide area networkto connect all the branches on a real-timebasis, in data warehousing to enable betterreporting and to prepare for potential credit scoring, and in upgrades to its information system to gain more function-ality and reliability.


Since its inception, Equity has been relentless in its constant focus on clients. Of late, Equity has marketed itself as “thelistening, caring financial partner” in an

24 Case Studies


aggressive marketing campaign includingradio, newspaper, and television, not tomention the often more important role of informal marketing by key members of society. Far from just a marketing cam-paign, the slogan represents how Equityruns its business.

Learning and experimentation play keyroles in Equity’s ability to attract and retainclients. Equity “listens” to its clients throughvarious mechanisms for their suggestionsabout current products, needs for new serv-ices, and perceptions of Equity. Focus groupdiscussions have been an effective methodfor listening to clients, and have resulted inimproved service as well as demonstratedEquity’s “caring” to clients in a tangible way.Equity’s bright and energetic marketingteam received training from MicroSave ondesigning and conducting these discussionsfor maximum impact. (MicroSave has alsoconducted “mystery shopping,” after thelaunch of new products to determine howwell staff know and deliver the products, asa valuable feedback loop.) Equity managershave an open-door policy at the branchesand head office, and welcome hearing aboutclients’ experiences with Equity—anotherway of listening to clients.

Equity’s approach to learning fromclients contributed to the successful launchof the Jijenge savings account, a contractualsavings product to help clients “realize theirdreams.” It was designed to meet the needsof lower-end clients seeking discipline to save for needs, such as school fees, weddings, and household items. Jijengeclients can also access cheaper loans of up to

90 percent of their accumulated savings account for urgent needs. The product wasdesigned using client input, pilot-tested, re-fined through discussions between head of-fice and branch management, and success-fully rolled out with support from themarketing team.

External Catalysts

Since 1999, Equity has selectively accessedexternal resources that propel it towards itsmission. Key medium- to long-term donorsand investors formed a steering committeeto provide more coordinated support andguidance to Equity. This harmonized approach encourages complementary inputsby donors and investors and lessens thetransaction costs for Equity in managing relationships with external supporters. Equity has received technical support andfunding from Africap, British Departmentfor International Development, EuropeanUnion, MicroSave, SwissContact, andUNDP-MicroStart.

Lessons LearnedEquity’s 20-plus years of ups and downs of-fer lessons for institutions, donors, and gov-ernments committed to scaling up financialservices to the poor in other countries.

Lessons for Financial Institutions

• Understanding poor and low-incomeclients is essential for identifying “niche”markets, designing appropriate productsand services, and developing and maintaining client loyalty.

• Appropriate technology can increase



efficiency (i.e., computerizing informa-tion systems) and outreach (mobile bank-ing for better penetration and delivery in rural areas.)

• Investing in staff training and developingmeaningful incentives helps staff to inter-nalize and be motivated by the vision of the institution, which in turn leads totangible results.

• Visionary leadership and top management,while vital to the success of an institution,must be supported by strong and techni-cally competent middle management.

Lessons for Donor Aagencies andService Providers

• Donors should seek a consortium approachto funding with a medium- to long-termcommitment and emphasize results.

• Donors can help institutions managegrowth by offering targeted and timelytechnical assistance that is consistent withthe institution’s own vision and objec-tives. Donors should focus on strategicsupport for optimal impact.

• Domestic financial institutions, even non-banks, exhibit great potential as a mecha-nism for massive outreach. Donors shouldexplore relationships with local partnerswho have demonstrated capacity to growthrough visionary leadership, existing in-frastructure and client base, and brandrecognition in local markets.

Lessons for Governments and Policy Makers

• Government can create enabling environ-ments for the creation, proper regulation,

and expansion of indigenous financial in-stitutions with the potential to reach scale.

• Non-bank financial institutions can playan important role in reaching unbankedclients with appropriate services. InKenya, building societies were given amandate to operate like banks. But inother countries in Africa, building soci-eties have been limited in their ability toscale up.

Equity’s Future: Managing theSustainability of Scaling UpAt the end of Equity’s first decade of oper-ations, it was a defunct building society.During its second decade, Equity emergedas an organization with great potential. Asit enters its third decade, Equity will need to transform into a high-performanceinstitution. The main challenges will be managing growth, transforming the institutional culture of what was a family-like business, and balancing the enormoussuccess in mobilizing deposits by expandingand improving the quality of its lending operations. The continuing growth and expansion will require significant enhance-ments of Equity’s organizational architec-ture, especially at the governance level (e.g.,advancing the executive oversight functionof the board of directors). Planned upgrades to the lending methodology willneed to be rolled out including a more serious emphasis on recovery and portfolioquality. Internal controls need to bestrengthened and an effective asset liabilitymanagement system developed. One of the essential ingredients in sustaining the

26 Case Studies


institutional growth is building up the ade-quate internal capacity of appropriatestaffing and middle management capacity.Equity has demonstrated that it is capable

of managing these challenges and shouldcontinue to scale-up its success in the yearsto come.

Figure 6: Number of Deposit Accounts (in thousands)

End Notes

1 Development loans are for longer-term constructionand land development provided to all three categoriesof clients.

2 Equity reduces its barriers to entry by allowing clientsto open accounts without a minimum deposit.

3 UNCDF Impact Assessment report.

Bibliography

Coetzee, Gerhard, Kamau Kabbucho, and AndrewMnjama. Understanding the Rebirth of Equity BuildingSociety in Kenya. Nairobi, Kenya: MicroSave-Africa,August 2002.

Craig, Kim, and Ruth Goodwin-Groen. “Donors asSilent Partners in MFI Product Development:MicroSave-Africa and the Equity Building Society inKenya.” CGAP Case Studies in Donor Good Practices,No. 8. July 2003, http://www.cgap.org/direct/resources/case_studies.html

Equity Building Society. Annual Report and Accounts,1999, 2000, 2001, 2002, and draft 2003. Internally gen-

erated reports from Banker’s Realm, marketing materi-als, and other Equity documents. Nairobi, Kenya.

Negre, Alice, and Josephat Mboya. PlaNet Rating:Equity Building Society, Nairobi, Kenya. Paris, France:PlaNet Rating, June 2001.

Wright, Graham A.N. and James Mwangi. EquityBuilding Society’s Market-Led Approach toMicrofinance. Nairobi, Kenya: Forthcoming, 2004.

United Nations Development Program. Client ImpactAssessment Report. New York: 2003.

■ ■ ■

■ ■ ■

0

50

100

150

200

250

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94 95 96 97 98 99 2000 2001 2002 2003 Mar-04


Executive SummaryThe Agricultural Bank of Mongolia (Ag Bank or XAAH) is the main provider of financialservices in the rural areas of Mongolia. It has the largest branch network in the country,with 379 locations (93 percent in rural areas), and provides deposit and loan products ateach point of service. Although it was in receivership in 1999 and faced possible liquida-tion, this former state bank has been completely turned around and was privatized throughinternational tender to a major Japanese company in March 2003.

Turnaround efforts have resulted in Ag Bank disbursing 878,000 loans between late 2000and February 2004, while maintaining an arrears rate consistently below 2 percent and becoming the most profitable bank in Mongolia, with a return on equity of 44.19 percentin 2003. As of February 2004, 128,227 loans were outstanding for a portfolio of almostUS $50 million with US $75.5 million in 377,424 deposit accounts. The 15,433 domestic transfers totaled US $260,000 for the month. The average outstanding loan balance is US $382, deposit accounts average US $200, transfers US $17, and half of Mongolia’s households do business with Ag Bank. This turnaround identified and mobilized the strengths of an existing institution to rapidly disseminate desperately neededfinancial services to the rural areas and protect access to the few existing financial servicesupon which many rural Mongolians rely.

After many years of operating deficits, loan losses, and a failed attempt at privatization,Ag Bank was placed in receivership in 1999, and many in the international community felt that it could never operate sustainably and should be closed. However, the importanceof Ag Bank to Mongolia’s rural sector can not be overstated. Although one of the smallerfinancial institutions in the country, it was the only bank with branches throughout Mongolia’s vast territory through which to transfer money, make government pension andsalary payments, and accept deposits. Closing it would have had a devastating impact onthe rural economy.

The World Bank made reforming Ag Bank a condition of its Financial Sector AdjustmentCredit Program for Mongolia, and the US Agency for International Development (USAID)

The Agricultural Bank of Mongolia

BY JAY DYER, J. PETER MORROW, AND ROBIN YOUNG

Chapter 3

28 Case Studies

The Agr icu l tura l Bank of Mongol ia

agreed to provide funds for an outside management contract. The Government of Mongolia agreed to provide this outsidemanager with full authority to manage the institution, free from political or otherinterference.

A contract was signed with DevelopmentAlternatives, Inc., (DAI) of Bethesda, Mary-land, USA, to manage the bank. In July2000, a team led by Chief Executive OfficerJ. Peter Morrow arrived in Mongolia. DAI staff and advisors provided technicalsupport as the team set the agenda for theturnaround and transformed Ag Bank. Byagreement among all parties, the mission ofthe turnaround was to: (1) restore financialsoundness to the bank; (2) bring financialservices to the country’s rural population;and (3) prepare Ag Bank to operate independently and be privatized.

The management team developed a newlending program, converted payment servicesinto deposits, created an extensive marketingprogram to improve the bank’s image and attract clients, implemented strong controlsthrough new policies and procedures, estab-lished a more effective management structure,and significantly increased training activities.

In January 2003, the Government ofMongolia received three viable bids for AgBank, all from strong and fully qualified pri-vate sector buyers. H.S. Securities of Japanwas the highest bidder, and at US $6.85million became the successful purchaser ofAg Bank. The sale closed on March 25,2003. The new owners have hired DAI tocontinue managing Ag Bank, a contract thatis fully paid for out of the bank’s income.

The rural areas of Mongolia have been thebank’s main focus, and its successes there havelaid the foundation for substantial growth andnew services for all Mongolians. Ag Bank’scurrent mission statement is “to be the prin-cipal nationwide financial services company inMongolia by delivering first-class productswith the highest level of customer service.”Key to the turnaround of the institution wasdeveloping and implementing productsthroughout the country profitably. Ag Bankhas shown that financial products can be created and delivered gainfully in even scarcelypopulated and poor areas if they truly meetthe needs of customers. The institution hasproven that it can sustain itself and, in fact,contribute significantly to Mongolia’s overalleconomic development. Aside from the largeimpact of its loan and deposit activity, theopening of 110 new branches and creation ofmore than 1,000 good paying jobs boostedthe economies of many communities. In addition, Ag Bank is now one of the largesttaxpayers in Mongolia where before it was acash drain on the government.

Implementation ProcessFollowing almost a decade of political interfer-ence and mismanagement that led to losses and insolvency, a new governance struc-ture combined with an independent and professional management team turned AgBank into a profitable and rapidly growing private bank. Following is a timeline of the keyevents in Ag Bank’s history:

■ 1991. The bank was founded as theAgricultural Cooperative Bank. Thegovernment arranged for agricultural



cooperatives, herders, and farmers tocapitalize this new bank, which tookover 326 rural branches and settlementcenters. It had 2,600 employees, held aportfolio of approximately US $2 mil-lion mostly in non-performing loansand deposits whose interest rates wereset by the Central Bank, and assumed the activities of the formermonopoly State Bank.

■ 1992. The deterioration of Ag Bank’sbusiness and the movement toward amarket economy in Mongolia forced areorganization of the institution. Thebank expanded its lending to larger loansbecause of government interference.

■ 1996. The Ag Bank’s liquidity and finan-cial position deteriorated to a level wherethe Central Bank appointed a receiver.

■ 1999. Existing shareholders’ interestswere eliminated, and the Central Bankput together a restructuring plan. Thegovernment became the new sole ownerthrough a capital infusion from govern-ment restructuring bonds, convertingdebt to equity, and injections of cash.

■ 1999. The World Bank made reformingthe Ag Bank a condition of its Financial Sector Adjustment CreditProgram for Mongolia, and USAIDagreed to provide funds for an outsidemanagement contract. The govern-ment of Mongolia agreed to providethis outside manager with full author-ity to manage the institution, free frompolitical or other interference.

■ 2000. Development Alternatives, Inc.,of Bethesda, Maryland, USA, won aninternational competition to managethe Ag Bank. After the contract wassigned in July 2000, a team led byChief Executive Officer J. Peter Mor-row and Chief Operating Officer De-bra Boyer arrived in Mongolia to man-age the Ag Bank. A new operatingstrategy was implemented and prof-itability achieved in 2001. By agree-ment among all parties, the mission ofthe turnaround was to:

- Restore financial soundness tothe bank

- Bring financial services to thecountry’s rural population

- Prepare the bank to operate inde-pendently and be privatized

■ 2003. H.S. Securities was selected in aninternational bid as the buyer of AgBank and retained DAI on a manage-ment contract. Growth and profitabilitycontinue to increase.

Objectives: Sustainability andPrivatization

At the beginning of the management contract, the team knew it would be crucial to(1) develop internal staff capacities, (2) develop proven products for the market, and(3) find a successful resolution to the politicalinfluence that dominated Ag Bank for years.The initial project goal was privatization. By stabilizing the institution and creatingtransparency, a buyer would clearly understandwhat was being bought. By developing and

30 Case Studies


expanding the product and service offerings inthe market, the Ag Bank would have the prof-itability to sustain itself. As a measure of suc-cess, the bank was privatized in March 2003.

H.S. Securities, the buyer of Ag Bank,has stated that it wants to continue to expand based on the bank’s target markets. It will be investing millions of dollars more into the bank to continue the outreach and market penetration. Since privatization, Ag Bank has continuedto grow rapidly, practically doubling the loan portfolio from US $24.7 to US $49 million during the first year. This was supported by a 110 percent capital increase, from MNT 3.9 billion to MNT 8.2 billion (US $3.32–$6.98 million at actual exchange rates), throughreinvesting all earnings plus a fresh capitalinjection from H.S. Securities of US $2 million. This commitment and financial capacity is the best assurance that access tothese financial services throughout thecountry will continue.

Political Issues

Before the intervention of outside manage-ment, Ag Bank had never escaped the closesupervision of political authorities, particu-larly at the local level. Throughout the1990s, soum (county) and aimag(province) governors continued to appointthe bank’s local managers and consideredthem part of the local municipal manage-ment team. Loans were directed or heavilyinfluenced by local political needs. Thehead office had relatively little control overAg Bank’s offices and their operations.

Thus, a critical part of the restructuringplan was to insulate the bank from this political interference. The agreements between the government of Mongolia, Central Bank, World Bank, and USAID required the government not to interfere in any Ag Bank operations. Other than continuing Central Bank supervision andmonitoring, no governmental entity couldtake any steps to influence Ag Bank.

In effect, normal corporate governancewas suspended for the remediation period.An independent Board of Directors (madeup of two members from the government ofMongolia, two nominated by USAID, andan unaffiliated professional Chairman) wasappointed to monitor the remediationprocess and ensure the government did notinterfere. The Board, a semi-annual meet-ing between the management team anddonors, an annual independent audit, andCentral Bank supervision formed the ad

hoc corporate governance structure for therestructuring period. This arrangement wasessential to break the pattern of interferencethat had contributed significantly to thebank’s demise.

Shortly after the project started in July2000, there was a complete change in gov-ernment from the Democratic Party back tothe former Communist Party. Although ini-tially suspicious of the agreements made forAg Bank’s remediation, the new govern-ment eventually supported it fully.

Credit Culture

No bank in Mongolia had previously attempted to develop and implement a fully



transparent lending program available to allwho qualify. Some donors suggested thatMongolia’s loan history was so bad that Ag Bank should be remediated withoutlending. However, the team felt that it was critical to make loans, otherwise, thebank would not recover financially or restore services to the public. Through the appropriate design of financial productsand the right staff motivation, a new creditculture was developed.

Previously, most people in Mongolia hadto rely on pawnbrokers and family membersfor loans. Thus, Ag Bank’s new lendingproducts were truly welcome as they gavepeople access to larger sums of money at a lower cost. In the past, loans that were secured through banks were associated withthe government. Hence, institutional pres-sure to repay on time was often lax, and theculture of timely repayment among poten-tial borrowers was weak or nonexistent.

For successful growth and profitability,this culture had to change, from the level ofthe branch manager to the customers. Thefirst step in meeting this challenge was to hold the branch managers completely accountable for the decisions they made. Ab-solute zero tolerance was given to politicianslocally or nationally who tried to influencethe lending. Because an outside managementteam was running Ag Bank, it was easier tobuild and sustain this firewall.

Staff Culture

Some felt Ag Bank had too much of a“state sector” mentality and that the staffwould not be able to accept the changes nec-

essary to turn the bank around to a positionof growth, efficiency, and profitability. Al-though the employees were well educatedand adept at performing most day–to–daybanking tasks, it was clear that a new organi-zational culture would not developovernight and would be an ongoing process.The key was to harness the capabilities of thestaff right away and then expand on theirskills. Management wrote new policies andprocedures for all areas of the bank and developed a training program. Given the regional and branch operating structure ofAg Bank, training-of-trainers programs wereused. The program focused on training atthe aimag level, which served as provincial orregional hubs, and then the aimag staffwould train the rural locations that reportedinto that hub. Thus, a fast and efficient wayof disseminating new products and othercommunication was developed. Because ofthe “state culture” to follow the rules, people caught on quickly and responded tothe changes.

In addition, each aimag center branchmanager comes to the head office in Ulaan-baatar once a quarter and is given substantialone-on-one time with the senior managementof the bank. Targets for lending and depositgeneration are set quarterly. Administrative issues also are handled at this time. Thus, thetargets are set mutually by the regionalbranches and the home office so they are realistic yet meet the bank’s overall strategyand objectives.

Achievement of targets is reinforcedthrough the incentive system that has become a critical part of the success of the

32 Case Studies


institution. Every employee receives incen-tive compensation on a quarterly basis that isa significant percentage of his or her salary.

Fully changing the culture from one fo-cused on tasks to one where priorities arecustomers and revenues still is evolving, butis clearly much improved.

Brand and Image of the Ag Bank

A major obstacle was changing the public’sperception of Ag Bank. Although the insti-tution had many advantages, the bank stillsuffered from its reputation as a politicallydriven, untrustworthy, and insolvent organ-ization. The first approach to change thepublic’s perception was to provide valuableproducts and services to customers as soonas possible. The one-percent withdrawal fee was immediately dropped (which hadbeen a major impediment to mobilizingbank deposits), and rates on time depositswere raised to the top of the market, quicklygiving Ag Bank the liquidity it needed.

The management team brought in external marketing expertise and launcheda major public relations campaign to an-nounce throughout Mongolia that Ag Bankwas serious about business and was open toall. Likewise, the bank rebranded itself by switching its name to an acronym,“XAAH.” This translates to khan or king, aname with strong local appeal because of Genghis Khan. Television and radio campaigns soon followed.

Product Strategy

The strategy has been to develop productsthat meet the needs of a large segment of the

market, ensuring diversification in productand geographic area. The idea, from the beginning, was to pilot test products quicklyand then to expand delivery rapidly via loca-tions countrywide, while always maintaininga focus on quality lending. This is differentfrom the strategy of a slower national rolloutand a focus on quick saturation at eachbranch. All Ag Bank products were designedto be integrated into the branches by existingstaff who are responsible for delivering a widearray of these products. Combined with setting quarterly goals mentioned above, thisstrategy ensures that appropriate product offerings and combinations are tailored toeach market.

Loans Ag Bank continues to identify market op-portunities for new loan products. Startingwith working capital loans for micro andsmall businesses just four months after themanagement team took over, they have ex-panded to loans for medium enterprises,pensioners, and herders, plus payroll deduc-tion loans and agricultural loans. Currently,the bank is piloting mortgage loans. Although most of the loans are in local currency, some new loans are available inUS dollars. Prudent credit policies ensurethat lending decisions are based primarilyon a client’s cash flow followed by collateralto ensure low default rates. Following aredescriptions of key loan products.

Micro and small business loans. Thisproduct is the mainstay of the lending program in all markets. The original prod-uct, launched in November 2000, was the



“small trader loan,” which evolved into the“small business loan” as the market for theproduct was widened to include small serv-ice, production, and mixed purpose busi-nesses—essentially any kind of micro orsmall business. Although initially only forshort-term working capital, qualified andexperienced borrowers can now access termloans. Current interest rates are 2.2–4.0percent per month and are decreasing be-cause of competition and efficiency gains inunderwriting from growing economies ofscale. With micro and small business loansstarting at US $80, the average outstandingloan size for this product is US $1,419.

Small and medium-size enterprise (SME) loans. This product was developedfor medium-size production companies. Be-cause these loans are larger in size and term,they are inherently more risky. They are be-ing made on a limited basis now while thelending team for SME loans is trained andthe products are tested in the market. Thecollateral on some of these larger andlonger-term business loans consists of per-sonal residences or business assets. A signif-icant expansion of this product is expected in 2004. The average outstanding smallbusiness loan is US $5,011.

Herder loans. These loans were specificallydesigned to meet some of the unique needs ofnomadic Mongolian herders, while takingtheir cultural and business differences intoconsideration. Available on terms of up to oneyear, they help cover the gap between livingand operating expenses in the months whenherders are not generating income or wish topurchase herd-related goods. Because herders

have substantial cash at certain times of theyear, penetration of the herder market with comprehensive training and banking servicesis a priority. The average outstanding herderloan is US $722.

Agricultural production loans. Intro-duced in May 2002, these loans have garnered interest primarily from vegetablegrowers, small private wheat farmers, andhay producers. The average outstandingagricultural production loan is US $604.

Payroll loans. Borrowers can borrow up to seven times their monthly salary for avariety of purposes for a term up to oneyear. Loan payments are made directlythrough a deduction from their regularsalary. These loans provide significant cross-marketing opportunities for Ag Bank.Employers realize that the bank can handletheir entire payroll under a mutually beneficial agreement: employers save onadministrative costs and bring employer de-posits and fees to the bank. The averageoutstanding payroll loan is US $218.

Pensioner loans. Pensioners were cominginto Ag Bank branches monthly to with-draw their payments, an indication that thismarket was underserved for loans. Therewere also enormous transaction costs forpaying so many small pensions per month.As part of the pension disbursement reformeffort in 2001, a loan product was devel-oped for this market. These small loans,which can be up to six times the value of amonthly pension, are repayable by assign-ment and automatic deduction from futurepension payments. These loans empowerpensioners to control their cash flow, enable

34 Case Studies


them to borrow money to help their familymembers venture into microbusinesses, andare an alternative to the traditional practiceof borrowing from pawnshops and the informal sector. The average outstandingpensioner loan is US $69.

Deposits The deposit strategy since DAI took overmanagement of Ag Bank in 2000 has beenthreefold: (1) to increase the deposit base tofund the bank’s growth; (2) to attract alarge and diverse number of customers(business and consumer) to solidify thebank’s franchise and strengthen the net-work; and (3) to lessen the dependence ongovernment sources of funds.

By creating products that meet the needsof the market, dropping withdrawal fees, and providing good customer service,Ag Bank has been able to increase its deposit base 740 percent since July 2000.This growth has in turn propelled the bank’s expansion. The dependence ongovernment deposits has dropped from 52 percent of all deposits at the end of December 2000 to 6.7 percent at the endof January 2004.

All deposit products are offered in the local currency, tugrug, or US dollars. Following is a summary of deposit products:

■ Personal or business current accounts.These accounts are designed for thosewho are making regular financial transac-tions and who need regular statements.

■ Savings accounts. Depositors may addand withdraw money at any time with-

out fees. The account pays interest.

■ Time deposits. This product pays ahigher interest rate than a savings account. Deposits are encouraged to beheld for at least three months, and incentives are given to savers to add totheir deposits over the term.

■ Pension direct deposit. This program wascontractually agreed to with the SocialInsurance Fund in early 2001. Thismeant opening accounts for each pen-sioner, which provided them with an additional service and raised the depositbase of Ag Bank by opening hundreds ofthousands of new accounts.

■ Payroll direct deposit. Similar to thepension direct deposit, this product ismarketed to large employers that wantto eliminate the administrative expenseof paying employees in cash. In addi-tion to increased fee income for thebank, the bank also benefits from themany new individual deposit accountsand cross-selling opportunities.

Money Transfer Products All transfer products are available to anyone,but Ag Bank customers receive reducedfees. Following is a summary of the bank’stransfer products:

■ Quick Pay This franchise, which hasbeen developed throughout Mongolia,has been key to the success of Ag Bank. This product guarantees fast de-livery (in three hours or less) of cashtransfers between offices in the capital,



Ulaanbaatar, and any one of the 77 on-line locations throughout the country.

■ Money transfer. Money can be trans-ferred from one Ag Bank location toany other Ag Bank location in thecountry. A transfer is delivered the nextday to a regional center and withinthree days to a rural center.

■ Western Union. Money transferredthrough Western Union can be receivedat any Ag Bank in Mongolia, and sent tomore than 180 countries worldwide.

Impact Analysis

Ag Bank operates a network with 379points of service throughout Mongolia,much greater than any of the other 16banks operating in the country. With 354 ofits offices in the countryside, the bankreaches 98 percent of the rural communitiesin Mongolia.

The results from the new products intro-duced and other restructuring initiativeshave been impressive. Below are some ofthe remarkable statistics for the period July2000–February 2004:

■ Bank offices grew from 269 to 379points of service.

■ The number of employees increasedfrom 803 to 1,833.

■ One of every two Mongolian house-holds uses Ag Bank.

■ Almost 900,000 loans were made witharrears consistently under 2 percent.(Portfolio at risk over one day was 1.83percent as of December 31, 2003.)

■ The total portfolio outstanding is US$49 million.

■ The average loan size is US $382. ■ Ninety percent of all lending is made in

rural areas, across different populationsectors.

■ Deposits grew 740 percent from aboutUS $9 million to US $75.5 million; the 377,424 deposits have average balances of US $200.

■ There were 15,433 monthly domestictransfers, totaling US $259,796, andthe average transfer was US $16.83.

■ Monthly pre-tax profits grew from aloss to a current average of US$300,000, with a return on assets of2.96 percent, and a return on equity of44.19 percent in 2003.

■ Ag Bank paid US $2.9 million (at current exchange rates) in income taxesin 2001, 2002, and 2003 combined.

The management team developed a newlending program, converted payment serv-ices into deposits, inaugurated an extensivemarketing program to increase deposits, established strong controls through newpolicies and procedures, structured manage-ment more effectively, and significantly increased training activities. Products includeloans, deposits, domestic and internationaltransfer instruments, and government pay-ment services. Clients are micro and smallbusinesses, herders and farmers, consumers,and government organizations.

Ag Bank has designed and offered mi-croenterprise loans, SME loans, crop andherder credits, and pension and salaried-

36 Case Studies


based loans (see Table 1). Individuals whodo not qualify for the bank’s small businessloans often use a consumer loan to getstarted in a new venture. Ag Bank has created a new class of bank borrowers. Byrecognizing the informal lending sector as areal competitor, Ag Bank has developed aservice that encourages many borrowers tosuccessfully move into the formal financialsystem. Ag Bank’s branches are quickly re-placing pawnshops, store owners, and rela-tives for business and consumer borrowers.As a result, families and businesses are ableto borrow more money at better terms andlower costs. As of February 2004, 878,976loans had been disbursed and 128,227 were outstanding.

Another example of an important changehas been the conversion of 200,000 govern-ment social security and salary payments into

deposit accounts. Experience at Ag Bankshows that one-third of all government payments made through a deposit accountstay in the account for an extended period.This conversion brought more deposits tothe bank and helped build relationships withnew customers who could then take advan-tage of other financial services and loans.

Money also has moved from under mat-tresses to the bank, witnessed by the growthof individual deposits from just over US $2million to US $54 million between Decem-ber 2000 and February 2004. The averagedeposit account at Ag Bank is US$168. Mostof the new depositors are people who previ-ously did not have accounts in banks.(SeeTables 2 and 3 for a breakdown in the distri-bution and evolution of deposits.)

Ag Bank’s aggressive growth of depositsand loans, and the subsequent expansion of

Loan ProductDate

ProductLaunched

TotalNumber of

LoansDisbursed

Total Valueof Loans

Disbursed(US $000s)*

TotalNumber of

LoansOutstanding

Total Valueof Loans

Outstanding(US $000s)*

AverageLoan

Oustanding(US$)

Micro and Small Nov 2000 80,835 98,780 13,485 19,135 1,419

Small & Medium May 2001 3,300 15,555 1,633 8,184 5,011

Pensioners May 2001 628,431 36,912 72,277 5,003 69

Herders Aug 2001 31,373 20,753 9,449 6,819 722

Payroll Based Oct 2001 132,784 34,177 30,539 6,654 218

Crop May 2002 1,483 746 148 89 604

Mortgage Apr 2003 770 3,752 696 3,144 4,518

Loan Product 878,976 210,674 128,227 49,028 382

Table 1: Ag Bank Loan Porfolio (as of February 2004)



other banks’ operations throughout Mongo-lia, have had an impact on the intermediationof Mongolia’s money supply. In 2000, morethan half the country’s money supply was incurrency held outside of banks; today, lessthan one-third is held as currency. The long-term benefit of this intermediation forMongolia’s development is considerable as

it provides internal resources for increasedinvestment.

Another measure of Ag Bank’s impact isthe growth of the small businesses thatdominate rural Mongolia. Average smallbusiness loan sizes have increased steadilyover the past three years as increased inven-tory levels have translated into increased

*Note: Most loans and deposits are in the local currency, tugrug, and have been converted here to US dollars at the current exchange rate of 1,174

DepositCategory

OutstandingBalance

(US $000s)

% of TotalOutstanding

Blanace

Number ofDepositers

% of TotalDepositers

AverageAccoundBalance (US$)

Organizations 15,849 20.99 14,354 3.8 1,104

Current 12,024 15.92 14,318 3.79 840

Time 2,823 3.74 22 0.01 128,347

Demand 1,001 1.33 14 0.00 71,471

Individuals 59,667 79.01 363,070 96.20 164

Current 2,044 2.71 266,875 70.71 8

Time 47, 265 62.59 39,971 10.59 1,182

Demand 10,358 13.72 56,224 14.90 184

TOTAL 75,515 100.0 377,424 100.0 200

Table 2: Ag Bank Deposit Porfolio (as of February 2004)

Business 9,730 13.2% 9,798 22% 8,117 33% 3,663 28%

Government 4,293 6.7% 8,207 18% 8,570 35% 6,712 52%

Individuals 50,225 80.1% 27,028 60% 7,752 32% 2,520 20%

Total 64,248 100% 45,034 100% 24,439 100% 12,896 100%

Table 3: Ag Bank Deposit Evolution (in US $000s)*

DepositCategory 31 Dec 2003 31 Dec 2002 31 Dec 2001 31 Dec 2000

38 Case Studies


sales. Today, with loans to micro, small, andmedium enterprises, Ag Bank’s average out-standing business loan is US $1,807.

From a cost recovery perspective of theoriginal work that began in July 2000, thevalue of Ag Bank has increased so muchover the period that it could have easily paidfor the cost of the turnaround by the valuethat was created—witness the bank’s saleprice and the ongoing management con-tract between HS Securities and DAI. Theearnings in 2003 were close to the entirecost of the three-year, donor-financed turn-around. Today, Ag Bank is the second mostprofitable bank in Mongolia, with averagemonthly net income of US $300,000 (including the cost of the DAI managementcontract that is paid out of earnings). In2003, Ag Bank ranked number one of allMongolian banks in terms of return on assets (2.96 percent) and return on equity(44.19 percent).

Driving Factors

The government of Mongolia’s commitmentto change Ag Bank, as part of its overall privatization and economic modernizationprogram, was key to success. Its strategy of hiring international consultants and priva-tizing the bank was the right recipe. The experienced management team, coupledwith the commitment of the local staff andstrong business strategy, provided the skillsto achieve the projected outcomes. Finally,the support and pressure from externalforces encouraged political fortitude andkept the project on track.


Management’s Independence.A critical part of the turnaround was gettingassurances from the government that the newmanagement team could operate free frompolitical influence. The new managementteam was given the authority over personnelissues, credit policies, and expendituresthrough a memorandum of understanding. Italso was given capital forbearance (that is, nor-mal minimum capital and capital adequacystandards were suspended) for the period ofthe restructuring agreements.

Central Bank Guidelines Early on, the turnaround team reachedagreement with the Central Bank as to whenAg Bank’s financial ratios would comply withprudential standards, and a conservativetimetable was put in place. Management metall Central Bank guidelines a full year beforethe end of remediation and has continued toexceed all requirements.

Privatization Although the outside management had theauthority and responsibility to run Ag Bank,the concern was that problems could arisewhen they left, when the “firewall” camedown. This is why it was so critical that one of the pre-conditions previously dis-cussed—government commitment to priva-tization of the bank—was held to. The gov-ernment of Mongolia agreed to turn theinstitution over to private investors foraccountability, and the initial managementcontract ran until the bank was privatized.



The government of Mongolia carried out itsprivatization agreement by organizing aninternational competitive tender, on the ad-vice of KPMG Barents (now BearingPoint),another USAID contractor. Most observersfound the process fully transparent and successful.

Local StaffTaking control of the decision process didnot end with ministry and senior management. Previously, local branchesfunctioned as part of the province or countyadministration. Branch managers were appointed in most cases by the local gover-nors of the ruling parties. Appointment as abranch manager was a source of jobs andloans for people who desperately neededthem. Based on the culture, they were morelikely to first accommodate the need than tounderstand the implications from a businessperspective. Managers at Ag Bank branchesnow understand the importance that the institution be strong, which will increaseoutreach to even more viable clients and,thus, stimulate the overall economy. Theyalso know that the senior management teamholds them accountable for their actions,but that if they perform well, they will becompensated fairly and receive proper incentives and bonuses for performance.

The foreign managers also recognizedthat the national staff needed insulationfrom local pressures, as they would becomethe next logical targets. The key to over-coming these obstacles and temptations hasbeen: (1) clear policies that require trans-parency; (2) personnel who will speak up

when they are asked to circumvent policy;and (3) staff ’s willingness to use the foreignmanagers as a way not to comply with inap-propriate requests. The first encounter withan official who wants his way and cannot getit may be difficult, but when people learnthat the new management operates trans-parently, they usually will not ask for favorsor bribes.


An experienced management team using a sound business strategy, upgraded and retailored those products, services, and operations that took advantage of the vastbranch network.

Managerial Leadership. The skill sets and competency of the seniormanagement were critical. The teambrought together experiences, knowledge,and management skills gained from workingin countries with similar economic situations,as well as indepth knowledge and experienceof US banking. In addition, some of the most experienced Mongolians were recruited for the executive team, who pro-vided critical technical and cultural knowl-edge for the transformation of the bank. Themanagement team set the tone and led theorganization to develop a culture based onoperating discipline and service innovation.

Management featuring clear lines of authority was the joint effort of expatriateand local professionals. The starting point ofAg Bank’s turnaround was precarious. Deci-sions had to be reached and implementedquickly, and it was critical to deploy individ-

40 Case Studies


uals with relevant outside experience whowere not beholden to domestic political interests. Local departmental managers hired or promoted to the executive levelwere highly valued for their institutionalmemories as well as their keen understand-ing of the domestic market and culture. The project could not have been successfulwithout this synergy between outside and inside management.

Products and ServicesBefore restructuring a bank and introducingnew financial services, it must be confirmedthat an underserved market exists with untapped demand sufficient to support the re-structured bank. If the prospective market isbeing adequately served by others, the costand effort of a turnaround are probably notjustified and could crowd out existing finan-cial institutions. In Mongolia, studies wereconducted to understand the general marketpotential before the turnaround contract began. The fact that a strong, informal market offered loan rates of 12–15 percent amonth revealed a demand that banks were notserving. Every project needs a golden goose,a competitive advantage. In the case of Ag Bank, a real need for sustainable financialservices existed in the rural areas of the country. The bank was able to leverage exist-ing branches and staff to deliver servicesquickly and efficiently.

DiversificationIn addition to offering new products, one im-portant shift in the product and client mix wasdiversification away from government reliance.

At the beginning, more than 50 percent of deposits were from the government. This re-liance put Ag Bank’s liquidity at potential riskshould the government withdraw significantfunds. The bank sought and attracted depositsfrom private businesses and individuals. Theresult has been a shift from 52 percent govern-ment deposits to the current 6.7 percent. The private sector deposits are made up ofhundreds of thousands of individual deposi-tors, which created greater diversification.

Operational EfficiencyIf faced with challenging financial targets, thefirst reaction of many new managers is to startcutting costs. A common problem at state-owned banks, however, is that not enough isspent to generate required revenues. Thereare costs associated with delivering productsand offering an acceptable level of customerservice that are critical in a competitive market. It was found that small additional ex-penditures (primarily staff training and minorimprovements to the banks themselves, suchas roofs and purchases of furniture and com-puters), combined with prudent lending atthe initial 269 Ag Bank points of service,could lead to exponential growth in revenues.With only US $300 profit from each smallpoint of service and the contributions fromlarger regional centers, it was not long before US $300,000 was earned each month.These numbers were substantial for a bankwithout capital and with initial assets of only US $10 million. Nonetheless, withclient-focused services, prudent lending, andprofessional management, the results werequite achievable.



To generate profitability, however, the in-crease in revenues needed to be met by cut-ting unnecessary expenses. For example, al-though new staff were hired to improve theservices or technical aspects of the bank,other staff had to be cut because they wereless competent or were redundant. In thecase of Ag Bank, most of these cuts tookplace while it was under Central Bank re-ceivership. One of the first steps new man-agement took was cutting the right costs.


The most important change for the new organization was focusing on client serviceand a healthy bottom line. This meant allstaff had to learn new ways of doing busi-ness, and the organization had to experi-ment with products and systems thatmatched the institution with its market.

Staff TrainingOne of the clear advantages at Ag Bank wasa well-trained and disciplined staff. Al-though they were not used to thinkingstrategically, they quickly grasped new products and marketing approaches and im-plemented them. In the countryside, staffand their families are imbedded in the localcommunities, and they know who, where,and how to find people to borrow moneywho would pay it back.

State-owned banks often have negativepublic images. It is important to capitalize onthe existing positive aspects of the brand, butthe institution also needs to be seen as “newand improved” from both a customer and anemployee perspective. Ag Bank had a partic-

ularly unsavory reputation in the eyes of thepublic, but it was trusted because of its im-plicit government backing. Through effortsto develop brand identities, better customerservice, and overall public confidence, AgBank now commands much more favorableopinions. Staff buy-in is critical to the successof an institution. Within the bank, motivatingthe staff with training, fair and performance-based compensation, and recognition forgood work has created better and more efficient working environments.

In the two and half years of the USAID-funded remediation, training was an integralpart of reform for staff at all levels. Thetraining program focused on the practicalskills and information that employeesneeded to deliver bank products and per-form their jobs. Because of the importancetraining played in the turnaround of AgBank, Deutsche Gesellschaft für TechnischeZusammenarbeit GmbH (GTZ) providedassistance to establish a professional trainingdepartment at the bank and significantly up-grade the skills of trainers.

Product DevelopmentIn addition to staff training, product devel-opment and rollout was based on a rapid butintegral learning and experimentationprocess. As described above, products wereidentified by managers at various levels.Once standard policies were drafted and approved, the products were pilot tested, refined, and then rolled out nationally. Training for product rollout went from thenational to the regional and branch levels,and decisions on how much to focus on a

42 Case Studies


particular product were decided jointly at thelocal and national levels. In this way, staff wasable to experiment and learn which productswere most appropriate in each market.

Management Information Systems One common reason why a business fails isuncontrolled growth. In a state-owned bankturnaround, it is imperative that revenuegrowth be balanced by a quality portfolio and by systems and procedures to detect andcorrect problems. Systems to monitor portfo-lio performance and to detect fraud are bothcrucially important. These systems do nothave to be complex—at remote branches,they need not always be computerized—butthey must be timely and complete. At AgBank, the lack of computers and networkedcommunication systems was not a hindranceto timely and accurate reporting. Managersdeveloped simple paper reporting systemsthrough which local, regional, and nationaldata were tracked and used for ongoing analy-sis and decision making. The data are criticalto the learning and experimentation processas they provide the evidence of which innova-tions work and which require refinement.

External Catalysts

The support and pressure provided by external agents—including donors and private firms—were key to securing initialand ongoing commitment for change andachieving sustaining results at Ag Bank.

Donor Agencies Although a turnaround is conceptually feasible without international support, the

turnaround in Mongolia would not have occurred without participation by the WorldBank and USAID. Other bilateral and multilateral entities also made significant contributions. International donors helpedensure the decision-making authority of theturnaround teams and provided criticallyneeded funds for capital improvements and technical assistance. The World Bank was instrumental in reaching consensus with the Mongolian government, while USAID funded the DAI team that led AgBank’s turnaround.

Consultants and Managers. As an expa-triate on a management team, operating under a clear sense of corporate governanceand of protecting Ag Bank's assets, theCEO and his team had clear power and theauthority to say “no.” Foreign managersworking on the bank’s turnaround did not have the societal imperatives that would create expectations and temptationscontrary to the turnaround efforts. There-fore, it was critical that the new senior managers come from outside of Mongoliafor the rapid turnaround. Likewise, the external consultants were important for managing a transparent valuation, bid, andselection process.

Private InvestorsThe private investors that purchased the bankwere the final link in ensuring the turnaroundefforts created economic value and that thebank would continue to offer services to ru-ral Mongolians in a sustainable manner. Theirinternational links have brought new ideasand resources to the institution.



Lessons LearnedIt is challenging to turn around a largestate-owned bank. Success rests on a conflu-ence of political and financial circumstances,both internal and external. The driving factors summarized above should be consid-ered as requirements for any successful turn-around effort. The most critical lessonslearned are summarized below.

Management must be politically independent and qualified

Management was able to pursue successfulturnaround strategies at Ag Bank because ofthe unique design of the remediation andthe support of the bank’s stakeholders. Asthe historically state--owned bank in thecountryside, Ag Bank was under very strongpressure to serve the government’s politicalneeds. Because the USAID-funded projectteam was given full authority for the bank,a unique approach for USAID, a new creditand operating culture could develop thathas resulted in a very profitable and highquality credit portfolio. The carefully struc-tured independence, buttressed with donorconditions, was essential to rebuilding asound bank.

The starting balance sheet must be clear

Before beginning an assignment, the turn-around team must understand the true po-sition of the bank’s balance sheet and nego-tiate accordingly with the government. Allearnings and fixed assets must be properlyevaluated, and any needed capital must beput into the institution to raise the capitalbase to no less than zero. Capital can be

injected as cash or as development bonds,depending on the institution’s liquidity position. If bonds, the interest should bepaid in cash to provide adequate cash flow.There should be adequate funds to coverinitial operating costs and to purchase immediately required fixed assets. A long-term cash flow stream needs to be identifiedto support the ongoing operations.

Staff requires training, incentives andprotection from political pressures

Staff requires ongoing training in skills, policies, products, and systems, especially dur-ing a time of significant organizationalchange. Transparent and performance-basedincentive systems help ensure that prioritiesand behavior are aligned with the institution’sbest interests. When staff is threatened orpressured by political forces, senior manage-ment should provide protection in the formof being used as an “excuse” for not giving in.

Marketing is essential

A key lesson learned by Ag Bank is the impor-tance of marketing- focused research, strongbrand promotion, and products responsive tocustomer demand to provide an incomestream to sustain the organization. Ag Bank’smanagers used a combination of local knowledge from their branch managers, formal market surveys, and experience fromworking in other developing countries.

Financial intermediaries can profitablyservice low-income markets

Some doubt whether low-income popula-tions can or will pay for the financial

44 Case Studies


products and services they need. The expe-rience in Mongolia proved different—thatwhere per capita incomes are low, there is alarge market for the right kind of depositand credit products, even if the interestrates and fees are relatively high. Low-in-come market segments will pay for the rightproducts and good service.

Meeting client’s financial services needshas a positive economic impact.

Often, small businesses will borrow loweramounts of money than they need, whichcan be valuable in building a credit history.However, if the lending products do not adequately meet the needs of the businessowners, and match their ability to servicecertain levels of debt, a large dropout ratewill occur. Thus, the products (includingthe delivery and services attached to them)must grow and develop to reflect accuratelythe needs of the market. The most expensive part of a borrower relationship isacquisition—bringing the borrower into theinstitution for the first time. Profitabilityand sustainability will come from loanrenewals and cross-selling other products.

Penny wise may be pound foolish when itcomes to operating efficiency.

Although competitive and profitable banksmust operate efficiently, the focus should notbe exclusively on cutting costs. Rather thanclosing branches, the focus should be on rev-enue-generating services that take advantageof the network. Incremental revenue can add

up to significant net income. Nonetheless,operating costs should remain under control.State-owned banks can usually meet theneeds of their market segment with relativelylow-cost operations. The intent is not tocompete with international banks going after high-end customers, but to appropri-ately serve rural and low-income market seg-ments. Money should be spent to make thebranches adequate and comfortable, but theydo not have to be the best in town. Occasion-ally, only two people are needed in a location,and hand ledgers and a calculator may be ad-equate technology.

State-owned banks can be turned around.

With a low operating costs and good returns from lending, Ag Bank was able togenerate the profits to reinvest in physicaland human infrastructure and make thebank sustainable, while providing theneeded services to the underserved market.The process evolved into a “virtuous cycle”driven by the strong demand, as well as unmet need, for the new services. The AgBank experience stands in contrast to thecommonly held view that state-owned “dinosaur” banks cannot be turned aroundand successfully privatized. There may beother cases where, despite a poor historyand state sector culture, latent but strongfranchise value in a branch network or customer flow can be capitalized into profits and sustainability.



Loan, deposit, and profitability data were provided byAg Bank CEO Peter Morrow. Other information on AgBank can be found on its website, www.agbank.mn.

Boyer, Debra, and Jay Dyer. “The Agricultural Bank ofMongolia: From Insolvent State Bank to Thriving PrivateBank.” Paper prepared for “Paving the Way Forward forRural Finance: An International Conference on BestPractices,” Washington, D.C., June 2003.http://www.basis.wisc.edu/live/rfc/cs_12a.pdf

Dressen, Robert, Jay Dyer, and Zan Northrip. “TurningAround State-Owned Banks in Underserved Markets.”Small Enterprise Development 13, no. 4 (December2002).

Morrow, J. Peter. “Marketing for Profit in the Land of theKhans.” DAI Developments, Spring 2002.

Bibliography

46 Case Studies


Executive SummaryIt is truly remarkable that the microfinance industry in Bangladesh has been able to provide access to credit to around 13 million poor households. There are hundreds of organizations offering microcredit, although the bulk of the clients borrow from a handfulof large organizations—Grameen Bank, BRAC, ASA, and Proshika.

This growth in access took place during several distinct phases over the last three decades.The origins of the current microcredit model can be traced back to action research in the late1970s, carried out by academics as well as practioners in organizations that were created todeal with the relief and rehabilitation needs of post-independence Bangladesh. The 1980switnessed a growing number of non-governmental organizations (NGOs) experimenting withdifferent modalities of delivering credit to the poor. The various models converged aroundthe beginning of the 1990s toward a fairly uniform “Grameen-model” of delivering microcredit. This last decade, especially, saw a sharp increase in access to microcredit. And inrecent years, the standard Grameen-model has undergone greater refinement in order to caterto different niche markets as well as to different life-cycle circumstances.

Looking at the Bangladesh experience in perspective, one can argue that the current, remarkable scale of access is attributable to specific factors. First is visionary leadershipwithin the pioneering microfinance organizations. The founders and leaders of GrameenBank and BRAC, in particular, created decentralized structures with appropriate incentivesthat encouraged high staff performance, which in turn underpinned rational expansionbased on existing capacity and client demand. Second, the government of Bangladesh cre-ated a conducive macro-environment and implemented a “hands-off” regulatory policy.Third, donors played a constructive role by providing resources at the appropriate time.This included funding the initial expansion phase of several microfinance institutions andthen building the institutional capacity and systems needed to ensure sustainability. Fourth,high population density and relative ethnic, social, and cultural homogeneity made “fran-chising” the microcredit model less difficult, and significantly propelled its expansion. Fifth, the public-private microcredit “wholesaler,” PKSF, was far-seeing enough to take

Microfinance in Bangladesh:Growth, Achievements, and LessonsBY HASSAN ZAMAN

Chapter 4

48 Case Studies

Growth, Achievements , and Lessons

advantage of already-established retail ca-pacity to scale up the microcredit industry,as well as demand professional standardsand a focus on sustainability.

The consensus in the literature holds thataccess to these micro-loans has considerablyreduced the vulnerability of poor householdsin Bangladesh. Poor households are able tosmooth their consumption more depend-ably, thereby limiting the hardships arisingfrom seasonal shortfalls of income. Unantic-ipated shocks such as natural disasters can be better absorbed by building up assets. Female borrowers are less vulnerable andmore empowered within their householdsand the wider community.

The availability of microcredit has indirectlyaffected social conditions—for instance, chil-dren of borrowers are more likely to go toschool, have better sanitation facilities, andbetter nutrition. These impacts are due to the“increased income effect” of microcredit as well as the “social mobilization effect” ofborrower group meetings.

This paper proposes five lessons fromBangladesh that are relevant to microfi-nance growth and impact in other countries. First, an “enabling environment”for microfinance is critical, especially main-taining a stable macro-environment whereboth interest rates and inflation are kept atreasonable levels. Government regulationsand policies are needed to create an appropriate environment for the growth ofthe sector, where regulatory policies strikea balance among protecting the interests of depositors, supervising microfinance institutions that collect savings, and not

excessively regulating the sector with un-necessary red tape.

A second lesson is that microcredit may bea more effective remedy against poverty andvulnerability if it is complemented by other in-terventions. These interventions may be espe-cially important for the poorest households,which face the greatest risk of income fluctu-ations and have the greatest need for a rangeof financial and non-financial services.

Third, there is a role for donor financialassistance in expanding the capital base ofemerging microfinance institutions, as wellas developing the technical capacity neces-sary for organizational sustainability.Hence, subsidies can be justified to supportmicrofinance institutions in their earlieststages, as long as there is a viable route toinstitutional sustainability.

A fourth lesson is that, while visionaryleadership cannot simply be “franchised,”the systems and formal rules that governthe successful microfinance industry inBangladesh can to an extent be replicated.These may vary according to the size of theorganization, but by and large, the success-ful organizations delegated significant decision-making authority away from head-offices, monitored individual staffperformance, and linked staff incentives toprogram targets. Client feedback and program monitoring are also crucial. As organizations grow, the willingness tochange products based on client need anddemand and to create products tailored toniche markets is crucial for success.

Fifth, one of the lessons unique to theBangladesh experience was the critical role


Microf inance in Bangladesh

played by a microfinance wholesaler, in expanding access and developing profes-sional standards. However, apex bodies arenot a panacea, and a rigorous analysis of theunderlying retail capacity and demand forfunds must be carried out before they are established.

Introduction

The fact that the microfinance industry has been able to provide access to credit,currently, to nearly thirteen million poorhouseholds in Bangladesh is truly remark-able. There are around twelve hundred microfinance institutions (MFIs) operatingin Bangladesh,1 but the industry is dominated by by four large MFIs—BRAC,Grameen, ASA (Association for Social Advancement), and Proshika—that servearound 11.5 million, or 90 percent of allMFI clients.2 After the “big four,” the nextlargest NGO, Swarnivar Bangladesh, has 0.7 million clients, and then there areprobably only ten NGOs that have morethan 100,000 borrowers. The bottom lineis that the majority of the MFIs are small(less than 5,000 borrowers), and that thebulk of the access to microcredit is suppliedby four MFIs. As such, the experiences ofscaling up discussed here draw primarilyupon these large MFIs.

The Evolution of the MicrofinanceIndustry in Bangladesh The growth in the poor’s access to credittook place in several distinct phases over thelast three decades. The origins of the cur-

rent microcredit model can be traced backto action-research in the late 1970s, carriedout by academics as well as practioners inorganizations that were created to deal with the relief and rehabilitation needs ofpost-independence Bangladesh. The 1980switnessed a growing number of non-governmental organizations (NGOs) whichexperimented with different modalities ofdelivering credit to the poor. The variousmodels converged in the beginning of the 1990s toward a fairly uniform“Grameen-model” of delivering microcre-dit. It sparked a sharp growth of access tomicrocredit during this decade. In recentyears, the standard Grameen-model has undergone more refinements in order tocater to different niche markets as well as todifferent life-cycle circumstances.

The 1970s

Experimentation in providing credit tohouseholds considered “unbankable” bythe formal financial system originated a fewyears after Bangladesh’s war for independ-ence in 1971. The independence move-ment gave rise to a new generation ofyoung activists who were keen on contributing to the reconstruction of thiswar-ravaged country. The new governmentand a myriad of aid agencies that arrived onthe scene were unable to cope with the scaleof destitution, and non-governmental organizations emerged to meet the challenges. The early years of the NGOmovement in Bangladesh focused on reliefand rehabilitation with an emphasis oncommunity development. However, by the

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mid-1970s, two of the NGOs that wouldsubsequently expand in scale, BRAC andProshika, found that “elite capture” was aserious impediment to their developmentobjectives. As a result, a separate focus on the poor through a “target-group” approach was introduced. Moreover, anideological debate within both these organ-izations began to brew, between those whofavoured economic tools (credit, savings,etc.) to support poverty reduction andthose who believed that social mobilizationagainst existing injustices would suffice andfinancial services were unnecessary.

Around the same time, a team of researchers at Chittagong University, led byProfessor Yunus, began an action-researchprogram that provided loans to poor households in a few villages. Borrowerswere mobilized in “peer groups” composedof four to five individuals who were jointlyresponsible for each others repayment. Sev-eral of these small “peer monitoringgroups” would be organized together intoa larger unit which would meet weekly withthe primary purpose of repaying loan install-ments. The process of trial and error initiallycombined males and females in the samecredit group, but then changed to separategender groups. It also included “occupa-tional groups,” but this was dropped in favor of village-based groups. The demandfor loans grew rapidly and Professor Yunusenlisted the support of the Bangladesh Bankand other commercial banks to provide the Grameen Project—as it was thencalled—with resources. The success of this experiment paved the way for the

establishment of the Grameen Bank undera special ordinance in 1983.

The 1980s

In the early 1980s, several NGOs experi-mented with different ways of deliveringcredit. One important mode tested was the efficacy of providing loans for groupprojects compared to offering loans to individuals with peer monitoring. Thebroad lesson was that the latter was moreeffective because of the incentives and itlacked the “free-rider” problems seen inlending to a group. Hence, by the late1980s, the predominant model becameproviding individual loans to a target groupof poor households, with peer monitoringand strong MFI staff follow-up.

The Association for Social Advancement(ASA) is a classic example of this shift. Itsinitial emphasis was on forming “peoples’organizations,” mobilized for social actionagainst oppression. It changed to targetgroups and then to provision of financialservices in the late 1980s. Now ASA is thefourth largest MFI in Bangladesh in num-ber of clients, and its unique low-cost creditdelivery mechanism is being replicated inseveral other countries. ASA keeps paper-work requirements to a minimum, has de-centralized most decision making to thefield, and overall has a very lean operation.3

The 1980s and early 1990s were also important to the development of manage-ment capacity within several of the largeMFIs, which allowed them to expand theirmicrocredit programs. What is particularlyinteresting is that the development of the



know-how and confidence to implementlarge programs arose, in some cases, fromthe experience of scaling up programs notrelated to microcredit. For instance, in thecase of BRAC, its first major experiencewith a nationwide program came when itimplemented an oral rehydration programto combat diarrheal disease. Thirteen mil-lion women were trained to use a simple buteffective rehydration solution, and BRACstaff were paid based on how many of theirtrainees used and retained this knowledge.4

Early to Mid-1990s

The early 1990s was the period of rapid ex-pansion of the Grameen-style microcreditapproach.5 The growth was fueled largelyby “franchising,” whereby new branchesreplicated the procedures and norms thatprevailed in existing branches. It was clearlyaided by the high population density and relative ethnic, social, and cultural homogeneity in Bangladesh. A notable shiftoccurred during this expansion phase toplacing a greater emphasis on individualborrower accountability for loan repaymentand less reliance on peer monitoring. Staff follow-up of loans became more rigorous and professional with the use ofcomputerized management information systems.Donor funds helped in varying degrees to expand the revolving loan fundsfor MFIs, particularly during expansionphases of the various institutions. Moreover,PKSF emerged during this period as awholesale financing institution. Followingthis expansion, a geographical mapping ofmicrofinance suggests that all districts in

Bangladesh now have microcredit services,although there are many smaller pocketswith little or no coverage (e.g., ChittagongHill Tracts). A closer look shows that thereis somewhat greater coverage of poorhouseholds in the central and western dis-tricts. The southeast and pockets of thenortheast still have room for expansion ofcoverage.6

Mid-1990s Onward

Feedback from the field, academic research,and international experience contributed toan increasing emphasis on providing diversified financial services for differentgroups of households from the mid-1990sonwards. The benefits of a narrow focus onmicrocredit during the expansion phase wasthat it kept costs low, operations transpar-ent, and management oversight relativelystraightforward. However, it became clear that the standard Grameen model ofproviding microcredit with fixed repaymentschedules, and standard floors and ceilingson loans sizes, was not sufficient to meet theneeds of the extreme poor or the vulnerablenon-poor.

Moreover, existing microcredit borrow-ers also required complementary financialand non-financial services. The standardpractice for MFIs until the late 1990s was to collect compulsory weekly savingsfrom their clients, holding the money as a de facto lump sum “pension,” whichwas returned when a client left the organi-zation. Access to these deposits was otherwise limited, which curtailed a potentially important source for smoothing

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consumption. Recognizing these limitations, an in-

creasing number of MFIs in Bangladeshhave offered savings accounts that clientscan withdraw from more freely, in additionto the fixed deposit scheme. Moreover,many MFIs have life insurance products,whereby outstanding microcredit debts arewritten off and other benefits are paid following the death of a borrower. Non-credit services can also take the form of input supply, skills training, and marketingsupport for micro-enterpreneurs.7 A com-plementary package to microcredit can alsotake the form of providing education forthe children of borrowers. Grameen Bank,for instance, has a scholarship program for secondary education for girls, and a student loan program for tertiary education. Similarly many MFIs have community health programs, legal literacytraining, and information on how to access local resources.

MFIs began to experiment with newniche markets as the traditional microcreditbusiness became standardized (and horizon-tal expansion slowed) and required less attention. For instance, several NGOs beganproviding larger loans to “graduate” micro-credit borrowers, and in some cases tohouseholds which were not part of the microcredit system but which wanted a micro-enterprise loan. These loans typicallyrange from 20000 taka (around US $320) to 200,000 taka (US $3,200). Innovative solutions are also emerging to address theproblem of access for the small enterprisesector. For instance, BRAC has established a

separate financial institution, BRAC Bank,that focuses on lending to the “smaller end”of the small enterprise sector, with loans av-eraging 400,000 taka.

Moreover, evaluation studies pointed out that extremely poor households werestruggling to benefit from the standard mi-crocredit model, even if they joined the programs. There were a number of factorsthat kept the extreme poor from borrowingor from benefiting from loans if they obtained them. Minimum loan floors for afirst loan sometimes exceeded what clientsperceived they needed. Fixed weekly loanrepayments could be difficult to commit toin light of seasonal income. Other membersof peer-monitored groups sometimes donot wish to guarantee loans for extremepoor households. Residing in remote or depressed areas can also complicate access.

Programs have been developed to makethese constraints more manageable. ASA’sFlexible Loan Program introduced more flex-ible repayment schedules. Mimimum loanfloors for first loans were lowered so thatamounts as small as 500 taka ($9) could beborrowed. Grameen’s program offers zero interest loans to beggars. The Resource Inte-gration Center’s program specializes in offer-ing loans specifically to the elderly poor, anunserved vulnerable group. Various programsalso combine food aid with microcredit andtraining, like BRAC’s IGVGD program. ASAhas targeted remote areas, offering servicesthrough its cost-effective mini-branch system,and Integrated Development Foundationswork in the Chittagong Hill Tracts.



Factors That Led to the Scaling Up

Institution Building—Leadership, StaffIncentives, and Learning by Doing

It is unquestionable that the vision and per-sistence of the leaders of the NGO/MFImovement are key factors behind the success of the microfinance industry inBangladesh. Leadership skills were instru-mental at initial stages in persuading a skeptical public that providing credit to the poor could become a viable andreplicable proposition. These skills wereequally important during the process ofscaling up—skills such as being able to recruit and motivate staff, decentralizing authority away from the center, buildingmanagement information systems and internal controls, as well as having the humility to learn from mistakes.

Staff recruitment, motivation, and reten-tion are particularly important for large organizations. BRAC, for instance, employsaround 28,000 staff in its various programs;Grameen has around 12,000 in its microcre-dit program; and ASA’s microcredit programemploys around 8,000 staff. A critical elementin this process is an objective performanceevaluation system for staff that is linked to career mobility and other incentives for staffto perform well both individually and inteams. Grameen Bank, for example, has introduced a system for rating branch officeson the achievement of specific targets, whichnot only include standard loan recovery butalso factor in social indicators, such as the proportion of children of Grameen clients going to school.

Staff motivation is also enhanced by de-centralizing significant responsibility to thelower tiers of the administrative structure.ASA is the best example of a lean credit de-livery structure with high levels of decision-making authority given to field offices, fromloan sanctioning decisions to staff humanresource issues. Moreover, the structurewithin field offices is relatively horizontalwith a branch manager who works with in-dividuals fieldworkers to resolve problemsand typically shares living quarters withother field staff.8

Effective internal controls are also impor-tant in ensuring effective staff performance.The fact that financial transactions are han-dled openly, in the weekly meetings and inthe branch offices, is a major deterrent toany form of discretionary behavior by fieldworkers. Many NGOs, particularly the onesthat have successfully expanded in scale,have developed measures that include frequently rotating staff within and betweenbranches, scheduling regular field visits bysenior management, developing a strong internal audit team, and contracting annualexternal audits.

A fundamental part of the scaling up ofBangladesh’s NGOs, and more specificallythe microfinance movement, has been theability to learn from experiences and adaptprograms accordingly. This learning processtakes place both through informal feedbackby field staff during regular interactionswith management, as well as through a formal monitoring and evaluation process.BRAC’s Research and Evaluation Divisionhas around 20 professionals whose key

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function is to evaluate BRAC’s multi-di-mensional programs and give timely feed-back to program staff and management.This feedback process occurs in longer termresearch as well as assessments with quickturnaround. The shift to more flexible fi-nancial services, that took place in recentyears, was largely based on client feedbackand analysis of the limitations of a uniformmicrocredit model.

A Constructive Donor-Client Relationship

External resources played an important partin the experimentation, subsequent growthin outreach, and institutional strengtheningof the microfinance industry. At the sametime, the large microfinance institutionshave been successful in “managing donors.”

International NGOs, such as the FordFoundation, Oxfam, and the Aga KhanFoundation, played an important role in theinitial stages of the NGO-MFI industry inBangladesh. The subsequent expansion andconsolidation was funded largely by officialbilateral agencies, and later by multilateralagencies, when international NGOs couldnot match the growing resource require-ments of the larger MFIs. The 1990s haveseen dependence on donor resources progressively decline for the large MFIs.Grameen Bank, ASA, and BRAC do not receive any grant financing for their micro-credit operations. Moreover, out of BRAC’stotal $160 million expenditure on develop-ment programs in 2002, more than 80 percent was financed from its own resources,through the interest income on microcreditas well as surplus from its commercial

enterprises. Two facets of these trends areworth highlighting.

First, the decisions to subsidize these operations were not free from controversy.Advocates for funding these loan funds had to argue their case with officials within their own agencies who believed thatthe capital base for loan operations oughtto be enhanced only by savings mobiliza-tion or borrowing from commercialsources. In retrospect, these decisions to contribute to MFI loan funds were byand large correct, as almost all of the MFIsthat received this support have either attained financial self-sufficiency or are wellon their way to doing so. Donors also invested in organizational systems and MFI staff training in order to strengthenthe capacity to administer these growingprograms.

Second, large NGOs in particular havebeen reasonably successful in managingdonors. BRAC, with its large multi-facetedprograms, has a long history of workingwith donors, and the evolution of this relationship is worth highlighting. Donors,who have their own incentives to commitresources and demonstrate results on the ground, have been eager to provide resources to organizations with proven trackrecords. Hence, the likes of BRAC have hadto deal with multiple donors who eachwanted to fund specific projects. These uncoordinated donor missions and disparatedisbursement and reporting arrangementstaxed BRAC’s internal capacity and led toits management proposing changes for howdonors ought to operate.



In the early 1990s, donors shifted theirapproach from financing specific BRACprojects to financing BRAC programs.Donors also formed a “consortium” thatpooled funds, negotiated jointly withBRAC, and agreed to common reportingrequirements. An important part of theconsortium funding arrangement and themove toward program funding has been an improvement in the predictability of resource flows. For instance, BRAC securedfinancing for its Rural Development Pro-gram for a five-year period from the donorconsortium. Moreover, the establishment ofa donor liason office for BRAC also acts asa buffer between BRAC staff and the various visitors, consultants, and evaluators.

A Progressive Government Stance

The appropriate “enabling environment”that existed in Bangladesh greatly aided theearly experimentation and later scaling-up ofthe microfinance industry. The macro-econ-omy of Bangladesh has, by and large, beensoundly managed, and the significance ofthis should not be underestimated. The rateof inflation has been kept to single digits,and economic growth over the past decadehas averaged around 5 percent per annum,thereby creating economic opportunities formicrocredit-financed investments.

It is also significant that the governmentof Bangladesh has thus far maintained a balanced approach towards regulating andsupervising the activities of the NGO sec-tor. This has been critical in ensuring theoperational flexibility that is the cornerstoneof service delivery by NGOs. While this

long relationship has not been free fromtensions on both sides, the government ofBangladesh has thus far been able to placethe interests of the poor foremost whendealing with NGO issues. A recent exampleis the decision to release donor funds ear-marked for Proshika, even though it was being investigated for alleged irregularitiesin the use of its funds.

Ultimately, though, the relationship between the government and the NGOs depends on individual personalities and social ties9 as there have always been widelyvarying individual views regarding NGOswithin the civil service and the Cabinet. Individuals in key positions within the government have time and again been in-strumental in facilitating the growth of themicrocredit sector. The early developmentof the Grameen project, its registration as abank, and the decision to grant it manage-rial autonomy are clear examples,10 as wasthe establishment of PKSF with a strong autonomous board. However, the prevail-ing consensus is supportive of NGOs, although accusations of involvement inparty politics by a handful of NGOs havestrained the overall government-NGO relationship of late.

Looking forward, it is clear that the reg-ulatory framework for microfinance needsto be strengthened, particularly in light ofthe large amounts of deposits mobilized forthe poor. The Central Bank, PKSF, and rep-resentatives of MFIs are currently workingto produce a set of guidelines and standardsto strengthen the regulatory framework.

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A Professional Apex Body forMicrofinance

The Palli Karma Sahayak Foundation(PKSF) was created in 1990, and is gov-erned by a board composed of both publicand private sector representatives. It is apublic-private apex body that channelsfunds for microfinance to MFIs, and hasbeen critical to the expansion and improvedprofessionalism of the microcredit industryin Bangladesh. PKSF’s core functions include (i) lending money to MFIs, whichmeet certain eligibility criteria, to expandtheir microfinance operations; (ii) buildingcapacity and giving hands-on assistance tostrengthen MFIs and move them towards financial sustainability; (iii) advocating microfinance issues and helping develop an appropriate regulatory framework for the industry.

PKSF played an instrumental role in contributing to the sharp increase of accessto microcredit that took place in the 1990sby expanding the capital base for MFIs toonlend to the poor. For instance, as of December 2003, PKSF loans constitutearound 30 percent of ASA’s current revolv-ing loan fund. PKSF is also widely creditedfor sharpening the focus of many MFIs on financial sustainability and in setting appropriate standards to pave the way to a strengthened regulatory structure for microfinance.

There is a growing experience with setting up apex institutions worldwide, e.g.,PPAF in Pakistan, RMDC in Nepal, FONCAP in Argentina, LID in Bosnia-Herzogovina, and MISFA in Afghanistan.

One of the fundamental factors behind thesuccess or failure of an apex is the underly-ing retail capacity in a particular country.The overall strength of the MFIs inBangladesh has been key to PKSF’s success.Overestimating the capacity to absorb fundsby the MFIs on the ground can lead anapex body to fail. However, if a realistic as-sessment of the underlying retail capacity ismade, then apexes offer many benefits, suchas the ability to screen MFIs on standardcriteria and creating a “level playing field.”

The Impact of Microfinance inBangladeshThe evidence of the impact of microcredit canbe assessed from two interrelated angles. First,who does credit reach, and second, how doesit affect the welfare of different groups of individuals and households?

Land ownership, occupational criteria,and asset valuations are standard targetingtools used by microcredit providers inBangladesh in order to direct resources tothe rural poor. These indicators have beenshown to be relatively accurate correlates ofpoverty by program administrators who donot have the time, resources, or expertise to carry out more sophisticated calculationsof poverty for each household in their targeted area.

In practice, the land criterion is the onethat is more closely adhered to in the field.Several studies show that between 15–30percent of members of microcredit pro-grams are from “non-target” households asmeasured in terms of land.11 However, theytypically are marginal farmers and can still



be considered part of the vulnerable non-poor, prone to transient bouts of poverty.12

On the other hand, there is also evidencethat a large proportion of extremely poorhouseholds join microcredit programs.13

For instance in Khandker’s sample, 65 percent of BRAC households had no agricultural land, compared to 55 percentfor Grameen members, and 58 percent for a comparable government-run microcre-dit program.

Not only do the poorest join BRAC’scredit program, but their borrowing pat-tern is similar to better-off members.14 Inother words, the presence of wealthierhouseholds does not appear to affect thecredit supply to poor households; however,there is evidence to suggest that poorerhouseholds use a larger share of their loansfor consumption purposes, compared tobetter-off households.15 Noting that thepoorest join BRAC’s credit program andthat they also actively borrow after theyjoin, it must also be mentioned that there isevidence which suggests that householdswho join microcredit programs a few yearsafter the village group has been establishedtend to be less poor, compared to the members who join at the start of the program.16 This feature of better-offhouseholds joining over time has also beennoted as a general rule of thumb in many targeted anti-poverty programsworldwide.17 The bottom line is that the literature on targeting suggests that microfinance programs are reasonably suc-cessful at reaching the poor, and that thosehouseholds who fall above the stipulated

landholding criterion tend to be marginallyabove the poverty line and are susceptibleto transient poverty in certain years.

The literature broadly supports the hypothesis that access to microcredit contributes to poverty reduction inBangladesh, although the evidence is notentirely clear-cut.18 For instance, data collected by the World Bank in 1992 havebeen used to show widely varying resultsdepending on the methodology chosen toassess impact. Khandker estimates that forevery 100 taka lent to a woman, householdconsumption increases by 18 taka; interest-ingly, the figure is 11 taka if the sameamount was lent to a man.19 Moderatepoverty falls by around 15 percent, and ultra-poverty by 25 percent, for householdswho have been BRAC members for up to three years (controlling for other factors), according to the author. Similar results are found for Grameen Bank andBangladesh Rural Development Board(BRDB) members.

On the other hand, using the same dataand a different way of correcting for selec-tivity bias, Morduch finds that microcreditdoes not have a significant impact on con-sumption levels and therefore on incomepoverty.20 Consumption data from 1,072households in one district of Bangladesh isused to show that the largest effect onpoverty occurs when a moderate-poorBRAC client borrows more than 10,000taka ($200) in cumulative loans.21 In otherwords, there may be a threshold level ofcredit above which a household gains mostin terms of increases in income. The

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Bangladesh Institute of Development Studies (BIDS) carried out an extensivestudy of the impact of PKSF PO’s microcre-dit program using longitudinal data of3,000 households between 1997–2000.One of the key findings was that “microcre-dit has a positive and significant effect on poverty status of the program households.…”22 The study also finds thatmembers of microcredit programsare less vulnerable when faced with crises.Moreover, improvements in other social indicators (child immunization, use of san-itary latrines, prevalence of contraception)are also more noticeable for microcreditprogram members compared to non-members.

The literature also suggests that moder-ately poor microcredit borrowers benefitmore than extremely poor borrowers, interms of reduction in income (consumption)poverty. The basic premise is that the poorest have a number of constraints (fewerincome sources, worse health and educa-

tion, etc.) which prevent them from invest-ing the loan in a high-return activity. Thiscould be due to the higher risk associatedwith a high-return activity or because of along gestation period for the returns to accrue.23 This is borne out by detailed case-study evidence24 and by comparing participants of credit programs who cater todifferent socio-economic groups.25

There is strong evidence that microcreditcontributes to reducing household vulnera-bility. Morduch shows that consumptionvariability is 47 percent lower for eligible26

Grameen households, 54 percent lower for

eligible BRAC households, and 51 percentlower for eligible BRDB households, com-pared to a control group.27 This consump-tion smoothing is driven by incomesmoothing as evidenced by the significantlylower labor supply variability experienced bymicrocredit members compared to the control group.28 The importance of this result cannot be over-emphasized, given the fact that seasonal deficits play a key partin the poverty process in Bangladesh.29 Es-sentially, Morduch’s results indicate thatprogram participants do not benefit interms of greater consumption levels, butthey participate because they benefit fromrisk reduction.

Asset creation is important to reducehousehold vulnerability to various liveli-hood risks. The findings of an impact assess-ment of ASA borrowers, conducted in2003, suggests that the average value ofphysical assets increased by 127 percent inrural areas, and grew by about 150 percentin urban areas over a five-year period. Moreover, the average increase in cash sav-ings rose by 133 percent and 111 percent inrural and urban areas, respectively, over thissame five-year period. Similar evidence isfound in studies of BRAC, Grameen, andPKSF’s partner organizations.

Another pathway by which microfinanceappears to reduce vulnerability is throughthe emergency assistance provided by manymicrofinance organizations during acutenatural disasters, such as the recent floodsin Bangladesh. The fact that these organiza-tions turn into de facto relief agencies is crucial to sustaining these households in the



immediate aftermath of a natural disaster.Moreover, post-disaster rehabilitation assistance, in terms of both financial andother services, is also highly valued by microcredit clients.

The pathways by which microcredit re-duces vulnerability, that have been discussedhere, relate to income and consumptionsmoothing and asset building. However, theimpact of credit on women’s empower-ment, or reducing female vulnerability, hasalso received considerable attention. Empowerment of women in Bangladesh canbe viewed against the backdrop of patriarchy, defined by Cain et al as a “set ofsocial relations with a material base that enables men to dominate women.”30

Hence, it can be thought of as an improve-ment in intra-household gender relations.31

Moreover, given the institution of purdah(loosely translated as ”veil”), a pervasive social construct which restricts the female sphere within a typical Bangladeshi household, empowerment can also beviewed in terms of a woman’s interactionsoutside the homestead and the acquisitionof skills, knowledge, and confidence thatsuch interactions can bring.32

The work by Amin et al in 36 villages in Bangladesh showed that membership inmicrocredit programs positively affected awoman’s decision-making role, her maritalstability, her control over resources, and hermobility, but had less impact on her attituderegarding marriage and education of daughters.33 Naved finds that the womenparticipants in credit programs, in her sample, felt their status had improved due

to the fact that they were seen as incomeearners for the family because of their accessto credit.34

Hashemi et al developed an “empower-ment index” based on eight empowermentindicators. Their analysis establishes thatcontributing to her household's income is asignificant factor contributing to a woman’sown empowerment. However, Hashemi etal also show that credit programs can em-power women independently of whetherthey contribute to family income or not, after controlling for other factors.35

Those who are skeptical about the em-powering effect of microcredit have focusedon the issue of women’s control over loans.Goetz et al used a sample of 253 femaleborrowers from four rural credit providersin Bangladesh. Their investigation of loanhistories led the authors to conclude that“about 63 percent of the cases fall into thethree categories of partial, very limited, orno control, indicating a fairly significant pat-tern of loss of direct control over credit.”The authors disaggregated their data interms of loan activity and concluded that investing in traditional women's work in-creased their chances of being able to con-trol the loan.36 Montgomery et al also havereservations about the empowering effect ofmicrocredit. Their argument is based largelyon secondary sources and a small field survey focusing on the issue of control overloans.37 While the authors admit that theirsample is small, they on balance supportGoetz et al that microcredit reinforces existing gender patterns and inequalities bypromoting traditional income generation

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activities,38 which they believe do little toalter the social status quo.

On the whole, the evidence presented bythose who argue that microcredit improvesthe status of females within a household appears more convincing that that arguedby the skeptics’ camp. There are two mainreasons for this contention. First, the under-lying thread of the argument, that access toan important household resource (credit)enhances a female’s status within the house-hold, is both intuitively appealing and resonates with the theoretical literature onbargaining models of the household.39

Second, the focus on female control overloans, as a key component of the skeptics’argument, fails to recognize that credit enters the overall household income pooland that household members jointly partic-ipate in the loan investment.

Lessons Learned

The importance of an enabling environment for microfinance cannot be underestimated.

A critical part is maintaining a stable macro-economic environment with both interestrates and inflation kept at reasonable levels.The lack of macro-stability has seriouslyconstrained the growth of microfinance inseveral countries, e.g., Malawi. Governmentregulations and policies are also crucial increating the appropriate environment forthe growth of the sector. These policiesneed to strike a balance between protectingthe interests of depositors, in microfinanceinstitutions that collect savings, and not

regulating the sector excessively (i.e., stran-gling it with unnecessary red tape).

Microcredit may be a more effective remedy against poverty and vulnerability ifit is complemented with other interventions.These interventions may be particularly ap-propriate for the poorest households, whichface the greatest risk of income fluctuationsand have the greatest need for a range of fi-nancial and non-financial services. More-over, while the provision of microcredit canenhance a woman’s status in the eyes ofother household members, social mobiliza-tion and legal education interventions inconjunction with credit are likely to have amore significant effect than credit alone.However, this does not imply that microfi-nance institutions ought to provide theseservices. In many cases, organizations mayprefer to specialize in providing microfi-nance and facilitate linkages to providers ofother non-credit interventions.

There is a role for donor financial assis-tance in expanding the capital base inemerging microfinance institutions, aswell as in developing technical capacitythat leads to organizational sustainability.

Hence, subsidies can be justified to support“infant” microfinance institutions, as longas there is a viable route to institutional sus-tainability. The duration of these subsidieswould vary according to local conditionsand level of poverty of the clients.



The systems and formal rules that governthe successful microfinance industry inBangladesh can, to an extent, be replicated.

These vary according to the size of the or-ganization, but by and large, these organi-zations delegate significant decision-makingauthority away from head offices, are ableto monitor individual staff performance,and have linked staff incentives with program targets. Client feedback and program monitoring are also crucial. As organizations grow, the willingness tochange products based on this feedback and

to tailor or create products for niche mar-kets is critical for success.

The creation of a microfinance whole-saler, like PKSF in Bangladesh, has thepotential to play an important role inexpanding access and developing profes-sional standards.

However, apex bodies are not a panacea,and a rigorous analysis of the underlying re-tail capacity and demand for funds needs tobe carried out before they are established.

End Notes

1 Credit and Development Forum, “CDF MicrofinanceStatistics,” (Dhaka: CDF, 2002).

2 The latest figures indicate that BRAC has 3.5 millionborrowers, Grameen Bank has 3.1 million clients,Proshika 2.9 million, and ASA 2.1 million clients.

3 S.H Choudhury, “Financing the Poor: ASAExperience,” The Daily Star (Dhaka), March 13, 2003.

4 In addition to this innovative staff incentive system, adetailed evaluation of the oral rehydration experiencealso points to a number of other success factors: sys-tematic recruitment and training of staff, an effectivefeedback loop, the willingness of senior management tolearn from the lessons from the field, and support fromthe government, donors, and professional experts. SeeM. Chowdhury and R. Cash, A Simple Solution:Teaching Millions to Treat Diarrhoea at Home (Dhaka:UPL, 1996).

5 S. Ahmed, “Microcredit and Poverty: New Realitiesand Strategic Issues,” in Attacking Poverty with Micro-credit, (Dhaka: UPL, 2003).

6 PKSF, “Maps on Microcredit: Coverage inBangladesh,” (Dhaka: PKSF, 2003).

7 For instance, to support sericulture, BRAC trains theentrepreneur in silkworm farming, supplies the silkwormeggs, plants the mulberry trees, arranges for extensionservices by a BRAC specialist, purchases the cocoonsfrom the farmers at their homesteads, and suppliescocoons to a BRAC-run silk-reeling center.

8 P. Jain, and M. Moore, “What Makes MicrocreditProgrammes Effective? Fashionable Fallacies andWorkable Realities,” IDS Working Paper 177, Universityof Sussex, 2003.

9 N. Hossain, “Elites and Poverty in Bangladesh,” DPhilthesis, University of Sussex, 2003.

10 M. Yunus, Banker to the Poor (Dhaka: UPL, 1998).

11 It is interesting to compare this figure withCopestake’s (1992) evaluation of India’s IntegratedRural Development Project, where the proportion ofnon-poor households ranged upto 36 percent. See S.Mustafa, et al, “Beacon of Hope: An ImpactAssessment Study of BRAC’s RDP,” Research andEvaluation Division, BRAC, Dhaka, 1996; R.Montgomery et al, “Credit for the Poor in Bangladesh:The BRAC Rural Development Programme and theGovernment Thana Resource Development andEmployment Programme,” in Finance against Poverty,ed. D. Hulme and P. Mosely, vol. 2 (London: Routledge,1996); H. Zaman, “Assessing the Poverty andVulnerability Impact of Microcredit in Bangladesh: ACase Study of BRAC,” Policy Reseach Working PaperSeries 2145, World Bank, 1999; and S. Khandker,Fighting Poverty with Microcredit, (Oxford: OxfordUniversity Press, 1998).

12 Zaman, “Assessing the Poverty and VulnerabilityImpact,” 1999.

13 Khandker, Fighting Poverty with Microcredit; andZaman, “Assessing the Poverty and VulnerabilityImpact.”

14 Zaman, “Assessing the Poverty and VulnerabilityImpact”; and S. Halder and A.M. Husain, “Indentificationof the Poorest and the Impact of Credit on Them: TheCase of BRAC,” mimeo, BRAC Research and EvaluationDivision, Dhaka, 1999.

15 Halder and Husain,“Indentification of the Poorest.”

■ ■ ■

62 Case Studies


16 I. Matin, “Mis-targeting by the Grameen Bank: APossible Explanation,” IDS Bulletin 29, no. 4 (1998).

17 Lipton, M. “Successes in Anti-poverty.” Issues inDevelopment Discussion Paper, No. 8, InternationalLabour Office, Geneva, 1996.

18 The methodological problems associated withassessing the impact of microcredit are complex. Theliterature typically uses “control groups,” usually “eligi-ble non-members,” or “recently joined members” inorder to address the problem of the counter-factual.There have been attempts to account for selectivity biaswith varying degrees of success.

19 Khandker, Fighting Poverty with Microcredit.

20 J. Morduch, “Does Microfinance Really Help thePoor: New Evidence from Flagship Programs inBangladesh,” Department of Economics and HIID,Harvard University, and Hoover Institution, StanfordUniversity, 1998.

21 Zaman, “Assessing the Poverty and VulnerabilityImpact.”

22 BIDS, “Monitoring and Evlauation of MicrofinanceInstitutions,” Bangladesh Institute of DevelopmentStudies, Dhaka, 2001.

23 G. Wood and I. Sharif, eds., Who Needs Credit?Poverty and Finance in Bangladesh ( London: ZedBooks, 1997).

24 F. Farashuddin and N. Amin, Poverty Alleviation andEmpowerment: An Impact Assessment Study of BRAC’sRDP—Ten Qualitative Case Studies, mimeo, BRACResearch and Evaluation Division, 1998.

25 R. Montgomery, D. Bhattacharya, and D. Hulme,“Credit for the Poor in Bangladesh: The BRAC RuralDevelopment Programme and the Government ThanaResource Development and Employment Programme,”in Finance against Poverty, vol. 2, ed. D. Hulme and P.Mosely (London: Routledge, 1996). Montgomery et alcompare the performance of BRAC borrowers with theborrowers from a government-run microcredit scheme,the Thana Resource Development and EmploymentProgramme (TRDEP). The initial endowment conditionsof TRDEP’s borrowers are higher than BRAC’s (averagepre-loan landholding is 46 and 30 decimals* for TRDEPand BRAC members, respectively, and the percentageof income derived from daily labour is 5 percent and 32percent, respectively), while the credit-delivery mecha-nism and average loan size are, broadly speaking, verysimilar. The typical TRDEP borrower’s increase in assetsand income during the course of the most recent loan ishigher than for BRAC clients, giving rise to the author’scontention that better-off borrowers benefit more thanpoorer borrowers. (*Note: A decimal is 1/100 of an acre.)

26 Morduch only includes households who fulfill the tar-geting criteria of the three organizations and labels them“eligible households.”

27 These results are statistically significant at the 95percent level.

28 Morduch’s estimates of labor supply variability is 39,which is 46 percent lower for microcredit memberscompared to a control group.

29 H. Rahman, “Mora Kartik: Seasonal Deficits and theVulnerability of the Rural Poor,” in Rethinking RuralPoverty: Bangladesh as a Case Study, ed. H. Rahmanand M. Hossain (Dhaka: UPL, 1995).

30 M. Cain, S.R. Khanum, and S. Nahar, “Class,Patriarchy and Women’s Work in Bangladesh,”Population and Development Review 5, no. 3 (1979):405-38.

31 R. Naved, “Empowerment of Women: Listening tothe Voices of Women,” Special Issue on Women,Development, and Change, Bangladesh DevelopmentStudies 22 (2 & 3): 155-79; N. Kabeer, ReversedRealities: Gender Hierarchies in Development Thought(Dhaka: UPL, 1994); S. Hashemi, S. Schuler, and I.Riley, “Rural Credit Programs and Women’sEmpowerment in Bangladesh,” World Development 24,no. 4 (1996):635-53.

32 S. Amin and A. Pebley, “Gender Inequality withinHouseholds: The Impact of a Women’s DevelopmentProgramme in 36 Bangladeshi Villages,” Special Issueon Women, Development, and Change, BangladeshDevelopment Studies 22 (2 & 3): 121-54; S.C. White,Arguing with the Crocodile: Gender and Class inBangladesh (London: Zed Books, 1992); and S.Mahmud, “From Women’s Status to Empowerment:The Shift in the Population Policy Debate,” BangladeshDevelopment Studies 22, no. 4 (1994): 77-99.

33 Amin and Pebley, “Gender Inequality withinHouseholds.”

34 Naved, “Empowerment of Women.” Naved usesParticipatory Rural Appraisal (PRA) techniques to iden-tify the effect of participation in Save The Children’s sav-ings and credit program in Manikanj.

35 Hashemi et al, “Rural Credit Programs and Women’sEmpowerment.”

36 A. Goetz, and R. Sen Gupta, “Who Takes the Credit?Gender, Power, and Control over Loan Use in RuralCredit Programmes in Bangladesh.” WorldDevelopment 24, no. 1 (1996): 49.

37 Montgomery et al, “Credit for the Poor inBangladesh.”

38 Goetz, “Who Takes the Credit?”

39 S. Lundberg and R. Pollak, “Separate SpheresBargaining and the Marriage Market,” Journal ofPolitical Economy 101, no. 6 (1993): 988-1010.



Ahmed, S. “Microcredit and Poverty: New Realities andStrategic Issues.” In Attacking Poverty with Micro-cred-it. Dhaka: UPL, 2003.

Amin, S., and A. Pebley. “Gender Inequality withinHouseholds: The Impact of a Women’s DevelopmentProgramme in 36 Bangladeshi Villages.” Special issueon Women, Development, and Change, BangladeshDevelopment Studies 22 (2 & 3): 121-54.

Bangladesh Institute of Development Studies.“Monitoring and Evlauation of MicrofinanceInstitutions.” BIDS, Dhaka, 2001.

Cain, M., S.R. Khanum, and S. Nahar. “Class, Patriarchyand Women’s Work in Bangladesh.” Population andDevelopment Review 5, no. 3 (1979): 405-38.

Choudhury, S.H. “Financing the Poor: ASAExperience.” The Daily Star (Dhaka), March 13, 2003.

Chowdhury, M., and R. Cash. A Simple Solution:Teaching Millions to Treat Diarrhoea at Home. Dhaka:UPL, 1996.

Credit and Development Forum. “CDF MicrofinanceStatistics.” Dhaka: CDF, 2002.

Farashuddin, F., and N. Amin. Poverty Alleviation andEmpowerment: An Impact Assessment Study of BRAC’sRDP—Ten Qualitative Case Studies. Mimeo, BRACResearch and Evaluation Division,1998.

Goetz, A., and R. Sen Gupta. “Who Takes the Credit?Gender, Power, and Control over Loan Use in RuralCredit Programmes in Bangladesh.” WorldDevelopment 24, no. 1 (1996): 45-63.

Halder, S., and Husain A.M. “Indentification of thePoorest and the Impact of Credit on Them: The Case ofBRAC.” Mimeo, BRAC Research and EvaluationDivision, Dhaka, 1999.

Hashemi, S., S. Schuler, and I. Riley. “Rural CreditPrograms and Women’s Empowerment in Bangladesh.”World Development 24, no. 4 (1996):635-53.

Hossain, N. “Elites and Poverty in Bangladesh.” DPhilthesis, University of Sussex, 2003.

Jain, P., and M. Moore. “What Makes MicrocreditProgrammes Effective? Fashionable Fallacies andWorkable Realities.” IDS Working Paper 177, Universityof Sussex, 2003.

Kabeer N. Reversed Realities: Gender Hierarchies inDevelopment Thought. Dhaka: UPL, 1994.

Khandker. Fighting Poverty with Microcredit. Oxford:Oxford University Press,1998.

Lipton, M. “Successes in Anti-poverty.” Issues inDevelopment Discussion Paper, No. 8, InternationalLabour Office, Geneva, 1996.

Lundberg, S., and R. Pollak. “Separate SpheresBargaining and the Marriage Market.” Journal ofPolitical Economy 101, no. 6 (1993):988-1010.

Mahmud, S. “From Women’s Status to Empowerment:The Shift in the Population Policy Debate.” BangladeshDevelopment Studies 22, no. 4 (1994): 77-99.

Matin, I. “Mis-targeting by the Grameen Bank: APossible Explanation.” IDS Bulletin 29, no. 4 (1998).

Montgomery, R., D. Bhattacharya, and D. Hulme.“Credit for the Poor in Bangladesh: The BRAC RuralDevelopment Programme and the Government ThanaResource Development and Employment Programme.”In Finance against Poverty, edited by D. Hulme and P.Mosely. Vol. 2. London: Routledge, 1996.

Morduch, J. “Does Microfinance Really Help the Poor:New Evidence from Flagship Programs in Bangladesh.”Department of Economics and HIID, Harvard University,and Hoover Institution, Stanford University, 1998.

Mustafa, S., I. Ara, D. Banu, A. Kabir, M. Mohsin, A.Yusuf, and S. Jahan. “Beacon of Hope: An ImpactAssessment Study of BRAC’s RDP.” Research andEvaluation Division, BRAC, Dhaka, 1996.

Naved, R. (1994) “Empowerment of Women: Listeningto the Voices of Women.” Special issue on Women,Development, and Change, Bangladesh DevelopmentStudies 22 (2 & 3): 155-79.

PKSF. “Maps on Microcredit: Coverage in Bangladesh.”Dhaka: PKSF, 2003.

Rahman, H. “Mora Kartik: Seasonal Deficits and theVulnerability of the Rural Poor.” In Rethinking RuralPoverty: Bangladesh as a Case Study, edited by H.Rahman and M. Hossain. Dhaka: UPL, 1995.

White, S.C. Arguing with the Crocodile: Gender andClass in Bangladesh. London: Zed Books, 1992.

Wood, G., and I. Sharif, eds. Who Needs Credit?Poverty and Finance in Bangladesh. London: ZedBooks, 1997.

Yunus, M. Banker to the Poor. Dhaka: UPL, 1998.

Zaman, H. “Assessing the Poverty and VulnerabilityImpact of Microcredit in Bangladesh: A Case Study ofBRAC.” Policy Reseach Working Paper Series 2145,World Bank, 1999.

Bibliography

64 Case Studies


Executive SummaryThe network of Savings and Loan Associations (SLA), known as the TIAVO network, be-gan as a pilot program in rural microfinance in 1996, serving Fianarantsoa, the poorestprovince in Madagascar. The TIAVO network has impressively expanded its services to thepoor, especially to the very poor, by integrating the SLA and Credit with Education programs. It achieved these gains despite political turmoil in Madagascar in 2002 and othersevere constraints. Fianarantsoa—like all of Madagascar—faces inherent disadvantages in providing financial services for the poor: it has a low per-capita income, the populationis dispersed, and communications are inadequate, in part because of the country’s ruggedtopography.

The expansion of the TIAVO network is part of a nation-wide program supported by thegovernment of Madagascar with donor financing. It aims to assist local groups to developself-sustaining financial institutions, in four of Madagascar’s six provinces (initially), to ad-dress the virtual lack of financial services for the poorest of the population. Proponents ofthe program recognized at the outset that the microfinance institutions created or expandedunder this microfinance program might not reach the very poor without specific efforts.Consequently, they tested and implemented special programs for socially excluded groups—typically women and the poor living in isolated areas.

The Credit with Education (CWE) program was introduced in the TIAVO network in1999, using Freedom from Hunger’s methodology and financed through MicroStart(United Nations Development Programme). Under CWE, poor women are encouraged toform groups, or credit associations (CAs), that join the SLA and thus gain access to creditfrom the TIAVO network. The TIAVO SLAs are member-owned microfinance institutionsthat serve low-income members. Members must have savings and provide physical guaran-tees in order to get access to credit—requirements that individual women could not meet,but now can through CWE and the CAs.

CWE program loans are small and are guaranteed by the CA members; repayments areweekly or biweekly. Loan recipients are selected by local women’s committees. The CWE

Madagascar : Credit with Education Programin the TIAVO Savings and Loan Associations NetworkBY HERMINIA MARTINEZ

Chapter 5

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TIAVO Sav ings and Loan Assoc ia t ions Network

program integrates training with the creditprogram. Promoters (field agents) visit the CAs in their communities every week.During these visits, they also provide train-ing on family health, child nutrition, andbusiness practices; and disburse loans andcollect repayments.

From 2000–03, loans outstanding in theTIAVO network increased more than sev-enfold, to around US $850,200, and mem-bership more than tripled to 14,000. In thethree and one-half years since the CWEprogram started, 129 CAs were established,with close to 2000 women members. CAmembers received a total of 11,000 loansby the end of 2003. Initially an independ-ent program within the TIAVO network,CWE is now being integrated into the net-work operations.

The experience of the program offers onemore example of how successfully microfi-nance institutions can target programs tothe very poor, and more evidence that theseprograms do increase the depth of outreachto the very poor.


Background and Rationale

In Madagascar, providing services to thepoor, particularly financial services, is diffi-cult and costly. The country is one of thepoorest in Africa (per capita income was US $240 in 20021), it is very large (582thousand square kilometers), and the population is dispersed. The country has inadequate transportation links associated

with its rugged topography. The TIAVOnetwork in Fianarantsoa, the poorestprovince in Madagascar (83 percent of itspopulation is poor), was chosen for the casestudy because both the network and a tar-geted program for the very poor have madeimpressive progress over the past four years,despite the odds against. In addition, theprogram targeted at the poor integratedtwo other initiatives, from which there arelessons to be learned.

Objectives and Features

The TIAVO network is one of four net-works supported under the 15-year Micro-finance Program which is financed by thegovernment and donors, including theWorld Bank through its Adaptable ProgramCredit. The program aims to encourage thedevelopment of sustainable microfinance institutions, primarily savings and loan associations (SLAs), by providing technicalsupport to local groups in the fourprovinces where most of the populationlives.2 The program also will begin puttinga legal framework for microfinance intoplace. Microfinance networks supported bythe government program expanded from9,500 members in 1999, to close to100,000 members at the end of 2003.

The Microfinance Program includes aspecific initiative—the Credit with Educa-tion program—to provide services to thevery poor (the socially excluded) in each ofthe networks. The architects of the programrecognized that large segments of the pop-ulation, who were not already clients of theparticipating institutions, would initially be


Credi t wi th Educat ion Program, Madagascar

missed. The special initiative actively soughtout this target population and enlistedknowledgeable network field staff (or agentsfrom a private agency contracted on a feebasis) to educate them about the advantageof the services offered. Performance of theprogram for the socially excluded is meas-ured by how efficiently and how many beneficiaries are served.

A specialized institution within the Microfinance Program provides support tothe SLA network on technical aspects, in-cluding the program for the socially excluded groups, which will decline overtime. Contracts with the specialized institu-tions providing technical assistance3 include performance benchmarks that are moni-tored. The participating SLA networks arerequired to comply with prudential normsset by the Madagascar Banking Commissionand to meet performance targets associatedwith the technical support they receive.

The TIAVO savings and loan associationsare member-owned microfinance institu-tions serving low-income clients. The SLAsencourage member savings, which is a pre-requisite to credit. Under the Credit withEducation program (CWE), poor womenare helped by promotersof the program, orfield agents, to organize into credit associa-tions (CAs). The women choose the mem-bers of their CA, and the CA becomes amember of an SLA. Women are eligible forloans from the network without meetingsavings or physical guarantee requirements.The loans are small and guaranteed by theCA members, and repayments are weekly orbiweekly. Loan recipients are selected by

local women’s committees based on theirpersonal knowledge of applicants.

The program integrates training with thecredit program. The promoters visit the CAgroups in their communities every week andgive training on family health, child nutri-tion, and business practices. Instruction isalso offered on financial matters, such as managing the family budget, saving,making deposits, and requesting loans. Thepromoters disburse loans and collect repay-ments during their weekly visit to each CA.CWE managers approve the loans, whichare made by the TIAVO network with fundsobtained for this purpose from UNDP andWorld Bank, and are disbursed through thelocal SLA. Since 2002, some SLAs havebeen dealing directly with the groups, approving the loans that they disburse.

Features of the savings and loan transac-tions in the TIAVO SLAs and CAs are summarized in Table 1.

Political and Regional Context

Madagascar today is a democracy with agenerally liberal economic system. Thecountry has undergone a process of politi-cal and economic liberalization since thelate 1980s, which has entailed periods ofcivil unrest. Regionalism is strong, althoughuntil the late 1990s when reforms began,the government was highly centralized. Fianarantsoa, located in central Madagascar,has traditionally carried considerable politi-cal weight. The population in the provinceis dispersed and lives in two distinct regions—the highlands (cattle grazing andsubsistence farming) and the coastal plain

68 Case Studies


(historically coffee exports, but increasinglysubsistence agriculture). Communicationsbetween the two regions are weak, whichmakes reaching the poor difficult. In the1970s and 1980s, Fianarantsoa benefitedfrom a large number of government-fundedprograms, including credit programs. Thelatter contributed to a tradition of non-re-payment of loans in Fianarantsoa, a problemthe TIAVO network has had to address.

The Microfinance Program was devel-oped by the government, in the second halfof the 1990s, to bring about economicgrowth and poverty reduction through am-bitious policy reform program. An elementof the reforms was government divestiturefrom ownership of two banks. The statebanks were bankrupt and had abandonedtheir mandate of financing small and poorer

clients through their large branch network.The Microfinance Program was intended topartially address the vacuum created by theprivatization of the state banks. The pro-gram is aligned with the objectives of thegovernment’s Interim Poverty ReductionStrategy of December 2000 and the PovertyReduction Strategy of July 2003.

Initial commitment to the MicrofinanceProgram by the government and other stake-holders was strong. The TIAVO networkleadership was interested in the program because it could increase its membership and influence in the region. A number of non-governmental organizations, includingFreedom from Hunger, had discussed credit programs with local leaders in Fianarantsoa,where the main bank, the Agricultural Bankof Madagascar, was reducing its branches in

Table 1: Features of Savings and Credit Transactions

Sources: Assouline. 2003, TIAVO 2003 Annual Report.

Feature TIAVO SLA TIAVO MEMBER CA

Members

Membership fees

Credit eligibility

Loan size

Interest Rate

Maturity of loans

Repayment Arrangements

Persons/groups in the municipality of the SLA

Contribution to SLA capital:US$1.7; fee: US$0.8

SLA member; savings deposit inSLA, 10-30% of credit; physicalguarantees, 100-150% of credit

Varies: Average loan for low-income members, US$50; rural,US$473; urban, US$1,097

Equivalent of 3% per month foramounts due

Depends on type of loan

Depends on client

Low-income women in the municipalityof the SLA; members of a credit group

Fee: US $0.50–US $0.80

Member of a credit group

Loan maximum: US$23 (first loan);US$152 (last loan)

Equivalent of 4.5% per month foramounts due

Initial loans 4 months; subsequent loans5 months

Weekly or semi-monthly, incorporatingmember training



preparation for privatization. The governmentsaw support for the microfinance program,and the programs for the most disadvantaged,as an action that could help alleviate the pervasive lack of financial services for the poor, which had been aggravated by the statebank failures.

The TIAVO network is the principal in-stitution in the microfinance program. TheCWE component of the network wasfunded for the first three years by theUNDP as part of its MicroStart program us-ing the methodology of Freedom FromHunger. Initially, implementation of CWEwas assigned to the Agency for the Execu-tion of the Microfinance Project(AGEPMF), which was specifically createdin 1999 and charged with the coordinationand follow-up of the 15-year MicrofinanceProgram.4 The CWE program was latermoved to TIAVO to pre-empt a similar(and redundant) pilot program thatTIAVO intended to initiate.

Preliminary Results and Comparison withOriginal Objectives

The TIAVO network began in 1996 as a pi-lot rural microfinance program, then in 2000significantly expanded and strengthened itssystems. Over the past three years, its operations have increased substantially, withmembership more than tripling to 14,000.Loans outstanding increased more thanseven-fold during the three-year period, to US $850,200 by the end of 2003, partlyreflecting pent-up demand after the politicaldifficulties in 2002 (see Table 2). Arrears,which were a serious problem in the network, have been declining for the pastthree years, from 16 percent (arrears of morethan thee months) in 2001 to a more accept-able 3 percent in 2001.

The network surpassed its self-financingobjectives, covering about 77 percent of allcosts (except depreciation). The govern-ment finances TIAVO operations on a declining basis under the Microfinance Program. At the end of 2003, 36 of the 130

Table 2: Evolution of TIAVO Network

Sources: AGEPMF database.* Figure at end of September of each year.** Operational Self-sufficiency covers all costs except depreciation.

Indicators 1999 2000 2001 2002 2003

No. of Members 4452 4820 6223 8408 14000

No. of SLAs 29 24 23 27 36

Total Number of Active Loans 1078 1898 897 1302 2834

Loans Outstanding (US $000) 112.0 157.2 133.8 257.3 850.2

CWE/Total Loans Outstanding (%) 14.1 13.4 31.6 18.6 9.1

Arrears (more than 30 days) * N.A. 12 16 6 3

Operational Self-Sufficiency ** N.A. 50 54 64 77

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savings-based SLAs in the country weremembers of the TIAVO network.

The CWE program, started in 1999, wasinitially a separate activity within theTIAVO network with its own accounts andindependent management. The CWE program was gradually integrated into theTIAVO network as the latter was expanded,beginning in 2000 with the transfer ofCWE accounts from the TIAVO head officeto the individual SLAs.5 (The transfershould be completed in 2005.) Over thepast three years, CWE activities have beenconsolidated, including transferring CA su-pervision to TIAVO, and incorporatingCWE operations into the regular TIAVOaccounting system. CWE increased its efficiency by raising the ceiling for loans inurban areas and introducing incentive pay-ments for promoters. (The incentives arelinked to the quality of the portfolio andnumber of members served.) TIAVO alsotightened control of CWE operations to

make it more reliable and began rotatingthe promoters.

The CWE program exceeded the origi-nally planned objectives in terms of mem-bers and loans approved (see Table 3). Thecosts of the program (US $450,000) were higher than estimated at the start ofthe Microfinance Program. These highercosts can be attributed to the fact that theprogram is larger (more members, moreloans, more promoters) than anticipated,and because it was set up as a stand-aloneprogram rather than integrated into the network, which would have reduced costs.

Impact AnalysisThe impact of the program on benefici-

aries, the network, and the region cannotyet be quantified because base line data wasnot gathered as planned, and the results ofan impact study are not yet available. Theaverage loan to the members of the CAs is US $37, while the averge loan size of

Table 3: Actual and Projected Development of Credit Associations in TIAVO Network

Sources: Background documents for World bank Appraisal of Microfinance Project, 1999. ABEPM andTIAVO databases

Indicators 1999 2000 2001 2002 2003 Projected

No. of Members 634 1189 1610 1746 1922 960

No. of Savings Groups 26 61 105 105 129 160

Avg. Size of Group 15 6

No. of Promoters 6 4

No. of Active Loans 581 1015 1409 1443 1657 960

Loans Outstanding (US $ 000) 16 21 42 48 78



members of the TIAVO SLAs is US $222(see Table 4). It seems the program is reach-ing the poor, even those who live in remoteareas. About half of the CAs are on thecoast, a region which is particularly isolatedand where there are few financial interme-diaries. Figures for another network in the Microfinance Program, which is locatedin a more urban area, show that close to 50 percent of the members of the groupsin the socially excluded program (the CWEprogram of TIAVO) are among the verypoor (the poorest one third among the poor).6

The impact on the development of theTIAVO network itself will also be signifi-cant. At the end of 2003, loans outstandingunder CWE program accounted for some 9percent of total loans outstanding in thenetwork, and 40 percent of all TIAVO SLAshad CWE programs. The importance of theCWE program in the individual SLAs variesconsiderably: CWE program loans out-standing range from 2–65 percent of totalloans outstanding in the SLAs where theprogram operates.

It is expected that the CWE program willincrease the impact of the TIAVO network,

particularly along the coast. Analysis showsthat the focus on lower income clients has had an impact on the operations of thenetwork.7 Visits by CA members to the SLAshas increased the familiarity of the womenwith the activities of a savings and loan association, and has helped the SLA leadershipunderstand issues and needs of this clientele.As a response to the program, the TIAVOnetwork is planning to develop new creditproducts geared to the CA members. To haveaccess to credit, the CA women will need tojoin the SLA as individuals, pointing to the in-terest that SLAs have in this potential market.

Cost and Efficiency in the Use ofResources

The US $450,000-grant from MicroStartcovered the operating costs of the program—salaries of promoters and relatedexpenses such as transportation, equipment,specialized training, and administration expenses. Equipment and administration costswere high in part because the program was setup as an independent activity and did not ben-efit from the TIAVO systems. Costs were alsoaffected by the turnover of promoters at thebeginning of the program. This partly reflects

Table 4: Comparison of TIAVO and CA Indicators 12/31/03

Sources: TIAVO 2003 Annual Report, AGEPMF Database. Assouline, 2003. *Including 129 CAs.

Indicator TIAVO CAsNo. of Members 1385* 1922No. of SLAs/CAs 36 129Loans Outstanding (US$ ‘000) 850 78Average Loan Size (US$) 222 37Deposits/Member (US$) 429 0.1

72 Case Studies


the very difficult environment in Fianarantsoa(extreme poverty, poor transportation) whichmakes the task of promoters unusually diffi-cult. (The TIAVO network also suffered fromthe new system of personnel rotation).

The costs of operating the program were inline with what had been anticipated. By 2002,income from operations covered some 70 percent of direct operating costs of the CWEprogram (excluding indirect costs such as theTIAVO supervision and general TIAVO expenses). Efficiency indicators, such as thenumber of beneficiaries served by each promoter, are consistent with those estimatedat the beginning of the Microfinance Program.An analysis by IRAM has estimated that in order to cover costs, the number of CAsserved by each promoter will have to increasefrom an average of 15 (in 2003) to an averageof 20.8 Efficiency of promoters should increaseas administrative functions are transferred tothe network. However, as measures to increaseCWE efficiency are introduced, it is criticalthat the training aspects of the program not besacrificed. In fact, there is a concern over an ex-cessive preoccupation with ensuring quickprofitability of this type of program. The pushtoward early profitability could lead to shifting the program towards higher incomebeneficiaries who can absorb larger loans at thesame cost to the CA or SLA.

Driving Factors


Madagascar’s political liberalization ofthe early 1990s saw the government lift

restrictions on a number of activities, including the creation of cooperatives. Successive governments have recognizedthe need to improve the conditions of thepoor, particularly in the rural areas, andsupported programs, including microfi-nance, designed to assist them. Programs toaddress poverty directly were emphasized in the late 1990s when macroeconomic reforms were advanced. The governmentprepared an interim poverty reduction strategy in 2000, followed by a full strategyin 2003, which focuses on governance, inclusive growth, and service delivery forhuman and material security.

Microfinance initiatives supported bythe government, international (official andprivate), and bilateral organizations beganin the early 1990s, in response to thechronic shortage of financial services in ru-ral areas. The design of the MicrofinanceProgram involved extensive consultationswith stakeholders, and particularly amongorganizations in this field working inMadagascar. The Microfinance Program, ofwhich the TIAVO network is part, focusedon providing technical support to localgroups, and its costs were small comparedto other government programs which involve large transfers. Even though thegovernment obtained financing for thetechnical assistance being provided to thefour networks, it has not, on the whole,been involved in their operations.


The CWE program in the TIAVO net-work confirms the view that microfinance



institutions can provide financial servicesand training for the very poor. The programalso confirms the importance of including astrong training component in programsaiming at increasing availability of financialservices to the very poor.


Testing new approaches was the objectiveof the CWE program for the socially excluded by the Microfinance Program. Inaddition, the integration of the CWE program into the SLA network came aboutgradually, and involved testing different approaches in four SLAs and replicating thesuccessful ones. Increasing the role of theSLAs in CWE collections and loan approval(after the fourth loan to a CA member), andincluding CA members in the SLA creditcommittees were both tests. The expandedSLA functions has contributed to the sense ofownership of the program among CA andSLA members. It has helped improve collec-tions under the CWE program, as CA mem-bers do not want to to be in arrears with theSLA. CA member participation in the SLAcommittees (an ad hoc arrangement not pro-vided for under the SLA regulations) did notprove particularly useful because the CAmembers were not able to represent theirgroups effectively. However, other forms ofCA participation in the SLAs will be tested.Promoter performance improved when incentive payments were introduced. Also, itis expected that individual SLAs will play amore active role in the CWE program as theircompensation is increased from 2–10 percent of the credit. Program remuneration

favored the TIAVO head office initially, andnow will fall from 13–5 percent of the credit.

Lessons Learned

Programs targeted to the very poor canbenefit both microfinance institutions and clients.

The experience in Fianarantsoa points tothe benefits of introducing programs for thevery poor in microfinance institutions. Theapproach is beneficial both to the institutionand to the client: it generates new clients,especially women, for the microfinance in-stitutions, it helps microfinance institutionsunderstand the problems of the lower endof the market, and thus develop appropriateproducts for this market, and it educates thevery poor in the use of a financial institu-tion. Direct involvement of the SLAs in theCWE program, which requires the membersof the CAs to visit the SLAs, has contributed to the sense of appropriation ofthe program by the SLAs and the CAs; andhas improved loan recovery in the CWEprogram, as women want to establish agood record with the SLAs. Creating a pro-gram parallel to the microfinance institutionincreases inefficiencies through increasedcosts, and may also lead to competitionamong programs, which in this case is notdesirable as the programs in support of thepoor are subsidized.

Microfinance institutions require financialand technical support to establish pro-grams for the very poor.It cannot be expected that microfinance in-stitutions will be able to finance targeted

74 Case Studies


programs from their own resources. Thecriteria for assessing the program should beefficiency in service delivery and not short-term sustainability, although sustainabilityshould be a medium-term objective. Exces-sive emphasis on profitability may have theeffect of changing the type of client served.

Programs that reach the poor need timeto yield results.

Microfinance programs in general take timeto yield results because they entail changesin behavior. This is particularly true of pro-grams aimed at the very poor; such pro-grams should have strong training compo-nents such as that included in the TIAVOprogram. The time it takes for programs toyield results should be taken into accountwhen the programs are designed.

Staff incentives work.

The experience with the CWE programconfirms what is generally known of othermicrofinance programs: incentives, particu-larly for staff, matter. Performance of pro-moters in the CWE program improved af-ter incentive payments were introduced (itwas also true of the TIAVO staff). Similarly,it is expected that the SLAs will play a moreactive role in the program as they are betterremunerated for the work involved.

Monitoring impact on poverty is difficult.

It is critical to have good base line indicators to measure progress and to beable to design improvements in programs.However, the time it takes to design and,more importantly, put in place, monitoringtools should not be underestimated. For instance, despite considerable work at thetime the Microfinance Program was designed, the base year data to measure theimpact of the program was not gathered intime. A qualified agency could provide support in the introduction of an appropri-ate impact assessment methodology in programs that require it.

Government has a role in supervising theperformance of microfinance institutions.

The government has a role to play in super-vising the performance of microfinance institutions, as it safeguards the financialsystem and depositors in a manner akin tothe role it performs in supervising the bank-ing sector. However, governments can betempted to interfere with the operations ofmicrofinance institutions, which is not useful, when it obtains financing for them.The program in Madagascar has generallyhad little government interference over theyears, which has contributed to its progress,even in the midst of a very difficult politicalperiod.



End Notes

1 Gross National Income per capita, World Bank AtlasMethodology.

2 The process of integration of the CWE program in theTIAVO network is summarized in Nathalie Assouline,“Processus d’intégration de l’Activité Crédit avecEducation au Sein du Réseau TIAVO,” prepared forAGEPMF, IRAM, August 2003.

3 The specialist institution providing technical supportto the TIAVO network is Institut de Recherche etD’Application de Méthodes de Développement (IRAM).

4 AGEPMF continues to monitor the performance con-tracts with the specialized agencies providing technicalsupport to the networks.

5 The process of integration of the CWE program in theTIAVO network is summarized in Assouline, “Processusd’intégration.”

6 Anton Simanowitz, “Appraising the Poverty Outreachof Microfinance: A Review of the CGAP PovertyAssessment Tool,” Imp-Act Occasional Paper 1,(Brighton, U.K.: Imp-Act, Institute of DevelopmentStudies, University of Sussex, 2003).

7 Assouline, “Processus d’intégration.”

8 Assouline, “Processus d’intégration.”

Bibliography

AGEPMF [Agency for the Execution of the MicrofinanceProject]. Rapport d’Activités. 2001, 2002.

AGEPMF. Rapport D’évaluation a Mi-Parcours de laPremière Phase du Programme Microfinance. February2002.

Assouline, Nathalie. Processus d’intégration del’Activité Crédit avec Education au Sein du RéseauTIAVO. IRAM report prepared for AGEPMF. August2003.

Simanowitz, Anton. Appraising the Poverty Outreach ofMicrofinance. A Review of the CGAP PovertyAssessment Tool. Impact Occasional Paper 1. Brighton,U.K.: Imp-Act, Institute of Development Studies,University of Sussex, 2003

Morin, Gilles, Faisabilité du Projet Microfinance dans laRégion de Fianarantsoa. Report prepared for AGEPMF.June 1998.

Réseau TIAVO. Rapport de Présentation de la Situationa la Fin 2003 (2003 Annual Report). January 2004.

World Bank. Memorandum and Recommendation of thePresident for a Rural Finance Technical AssistanceProject (Report No. P-5807-MAG), January 1993.

World Bank. Project Appraisal Document on a pro-posed Adaptable Program Credit to the Republic ofMadagascar for a Microfinance Project. (Report No.18959-MAG) April 1999.

World Bank. Madagascar – Poverty Reduction StrategyPaper and Joint Assessment. (Report No. 27335-MAG),November 2003.

■ ■ ■

76 Case Studies


Executive Summary BRAC approaches microfinance as a key instrument to build ladders of opportunity for thepoorest people, who tend to be left out. BRAC’s main point of departure from conventionalthinking is that, although the poorest do need subsidy-based programs to supply their imme-diate food needs, microfinance can play a fundamental role in constructing a long-term, sustainable foundation for improving food security and livelihoods. However, this is unlikelyto happen automatically. BRAC’s experiences suggest that creating a strategic linkage betweengrant-based and market-based microfinance programs requires careful planning, and solidand committed management. Scaling up this approach to reach significant numbers of thepoorest requires constant learning and innovation, and ongoing negotiation with partnersbased on practical field experience. In particular, it requires an appetite for tackling the largerchallenge of developing markets that can open up new opportunities for the very poor.

Most important of all, it requires vision and commitment to include the poorest. BRAC’sexperiences suggest that carefully designed strategic linkages, which include grants with acentral role for microfinance, can work for the poorest. There certainly will be many differ-ent models and approaches for including the poorest, which will vary according to countrycontexts. However, the starting point has to be reversing the trend of apathy—which eitherexcludes the poorest or treats them as “relief cases” to be dealt with by “others.” BRACbelieves that the poorest are, can, and must be central to the vision and commitment of mi-crofinance institutions. Only then will the search for possibilities and opportunities to in-clude the poorest begin and develop.


BRAC’s Microfinance Canvas

BRAC was originally set up as a relief and rehabilitation committee in 1971 to address theimmediate needs of the refugees returning home after the nine-month war for independence.

Managing Scaling Up Challenges of a Program forthe Poorest: Case Study of BRAC�s IGVGD ProgramBY IMRAN MATIN

Chapter 6

Figure 1: BRAC’s Microfinance Canvas

78 Case Studies

Managing Sca l ing-Up Chal lenges of a Program for the Poorest

Today it is today one of the largest microfinance NGOs in the world, providing financial services to over 3.5 million poor women throughout Bangladesh. Thedistinctive feature of BRAC’s microfinance isa perspective on the poor as a diverse groupwith diverse livelihoods, needs, and poten-tial, which change over time in response tolife events, new opportunities, and externalshocks. This diversity and dynamism of poorpeoples’ lives is the canvas on which BRACconceptualizes and designs its repertoire ofdevelopment programs, where microfinanceis a core element. If one maps the variouscategories of poverty, described in theBangladesh literature that profiles poverty,

onto BRAC’s different microfinance pro-grams, one gets a picture like Figure 1.

There are two principles of BRAC’s con-cept of microfinance worth highlighting. Oneis the belief that microfinance can work for adiverse group of the poor, and two is the importance of creating deliberate linkages tosupport continuous progression in the liveli-hoods of the poor, including the poorest.

BRAC’s microfinance programs are thusabout building ladders of opportunity for theextreme poor—those who tend to be left outof conventional microfinance programs. Theidea is to design subsidies in ways thatstrengthen the initiatives for the extremepoor, so that they, too, over a time can build

Sources: Background documents for World bank Appraisal of Microfinance Project, 1999. ABEPM andTIAVO databases

Target group Urban (20%) Rural (80%)

Better-off (27%)

Vulnerablenon-poor (20%)

Moderate Poor(17%)

Extreme Poor (31%)

Destitute (5%)

MELA

EDP

Microfinance

IGVGD

CFPRP/TUP


Case Study of BRAC’s IGVGD Program, Bangladesh

the capacities to benefit from microfinanceand other mainstream development pro-grams. The Income Generation for Vulnera-ble Group Development (IGVGD) and thenew BRAC program for the ultra poor,“Challenging the Frontiers of Poverty Reduc-tion/Targeting the Ultra Poor” (CFPR/TUP), are examples of this approach.

It is also about combining microfinancestrategically with other interventions to cre-ate new livelihoods for people facing suddenvulnerabilities. Recently BRAC began pilottesting a microfinance program that offeredtraining in new skills, for retrenched workersfrom the ready-made garments factories andstate-owned enterprises, and counseling.

Finally, BRAC’s microfinance vision supports growth by using the knowledgeembodied in its institutional networks toprovide financial services to new marketsegments. The Microenterprise LendingProgram (MELA) and the Enterprise Development Program (EDP) both servegrowth segments of the market with finan-cial services. (See Table 1 for key informa-tion on BRAC’s microfinance programs.)

The main idea behind BRAC’s microfi-nance programs for the poorest combinesbasic social service interventions (such asfood aid),which are based on grants, withpromotional ones (uch as training, savings,and credit). IGVGD, which hs been in op-eration since 1985, is a good example ofsuch an approach. Even more interesting, itis a partnership between a donor (WorldFood Program), the government ofBangladesh, and an NGO (BRAC). Thispaper highlights the main challenges that

IGVDG faced in scaling up, what it learnedfrom the dealing with those challenges, andthe steps taken to address them. One of theprimary outcomes gained from the IGVGDexperience has been the design of a newBRAC program for the poorest, “Challeng-ing the Frontiers of Poverty Reduction—Targeting the Ultra Poor” (CFPR/TUP),which is also discussed in brief.

IGVGD Program and Ladders ofOpportunity for the Poorest

In 1985 BRAC approached the World FoodProgram (WFP), which was providing time-limited food assistance to the extreme poorthrough its Vulnerable Group Feeding(VGF) initiative, to pilot a new programand model. The results were impressive. ABRAC study found that the income ofwomen who participated in the pilot increased significantly, and that their addi-tional income was more than the wheat donations from the VGF program. Around80 percent of the women had also enteredBRAC’s Rural Development Program andgained access to its microcredit and socialdevelopment services. A separate assessmentof the VGF, by contrast, found that many ofits participants were no better off when theyleft the VGF than when they joined.

Impact Analysis

Targeting the Poorest

Reviews of the IGVGD have been favor-able and a study commissioned by the WFPfound evidence that the program reached

80 Case Studies


the very poor, that the economic position ofIGVGD recipient households improved,and that access to NGO microfinance serv-ices was greatly enhanced. Hashemi’s com-parison1 of the 1994 WFP baseline survey

with key poverty indicators for ruralBangladesh (see Figure 2) found thatIGVGD attracted members who had signif-icantly higher levels of absolute landlessness,were functionally landlessness (owned less

Table 1: BRAC’s Microfinace Programs

Program Target Group Term and Conditions Product Details

MELA Larger loans provided toBRAC and non-BRACmicroentrepreneurs toscale up their enterprises

• Must have good entrepre-neurial skills

• Must not have any outstand-ing loans from BRAC orother microfinance institutions

• Must open a bank accountto receive loan

• Loan size range US$400–$4,000

• 15 % flat interest rate• 12-, 18-, and 24-

month loan productsrepayable in monthlyinstallments

Microfinance • Less than 50 deci-mals* of land owned,live in slums, and earna living by manuallabor

• Households headed bywomen and vulnerablepoor households (tar-geted specificallythrough IGVGD)

• Must be a member ofBRAC VO

• Must save• Must not have a loan with

other NGOs

• Loan size range US$50–$350

• 15 % flat interest rate • Loans repayable in

weekly installmentsover a year

IGVGD • Households headed bywomen, who own nomore than 10 decimalsof land.

• Women divorced,separ-ated, or have adisabled husband.

• To be eligible for loans:• Must be a VO member• Must save

• Initial loan size aboutUS $50

• Other conditions similar toMicrofinance

CFPR/TUP • No more than 10 dec-imals of land

• No adult earningmember

• No productive assets• School-age children

working Adult womenin manual labor

• Must not be members ofany government or NGOdevelopment program

• Must have at least oneadult woman who is physi-cally able

• Distribution of incomeearning assets

• Subsistence allowancefor a specified period

• Employment andenterprise develop-ment training andtechnical support

• Essential health caresupport

* A decimal is 1/100 of an acre.



than a half acre of land), owned two sareesor less, and lacked winter clothing, than theextremely poor identified by Rahman andHossain.2 While 8 percent of rural house-holds and around 10 percent of extremelypoor households overall were headed bywidowed, divorced, or abandoned women,approximately 44 percent of households en-tering the IGVGD program in 1994 werefrom this social category. This indicates thatthe program reached a substantial numberof the population for whom poverty is likelyto be persistent.

Impacts and Graduation

In terms of economic indicators, the1994 WFP survey found that, on average,incomes of IGVGD clients rose signifi-cantly, material assets (ownership of home-stead plots, land, beds, and blankets) increased, and the percentage of households

engaged in begging dropped dramatically(see Table 2).

A cross-sectional study that comparedIGVGD participants at the various stages ofthe program cycle found significant positiveimpacts over a range of social and economicdimensions as the participants progressthrough the IGVGD cycle.3 [Inst. Tb 2-3]

Another performance indicator, whichexamined how successful the IGVGD pro-gram is at “graduating” very poor house-holds to regular microfinance programs,provided evidence of improvement. At thebeginning of the program, only 15 percentof the IGVGD participants were MFIclients. By the program end in 1996, thishad increased to 28 percent, and by 2000had reached 66 percent. Although access tomicrofinance increased across Bangladeshduring the late 1990s, a 440 percent in-crease in MFI membership for such a cohort

Figure 2: Targeting Performance in IGVGD

widowed,divorced,

abandoned

landless functionallylandless

no sandals 2 sanees or less

no winter clothing

80%

40%

0%

IGVGD clients Hard-core Poor Rural Bangladesh

Key Poverty Indicators

82 Case Studies


of very low-income, very low-asset peoplerepresents massive improvement in thenumbers of the poor gaining access to fi-nancial services.

Cost Effectiveness

There are no comprehensive cost-effective-ness or cost-benefit analyses of the IGVGDavailable, but Hashemi estimates that the

Monthly income (Taka)Percentage of households earning more than

TK300 per monthPercentage of households with homstead landPercentageof funtionally landless householdsPercentage of households with bedsPercentage of households with blanketsPercentage of households begging

75 717 4157 64 31

73 87 na94 72 na58 60 6414 na na18 2 0

Variables Time

1994 1996 1999(pre-program) (end of program) (3 years after program)

Source: Adapted from Hashemi et al. (2001, p. 9)

Food Aid +Savings

Food Aid + Savings+ Training

First Loan

% Attending most VO1 meetings 2 19 83

% Attending Gram Shobha meetings2 2 17 40

% Reporting positive difference due tomeeting participation

38 55 83

% Reporting that they wanted to startan IGA after training

42 53 82

% Reporting greater levels of confidence

62 78 91

% Reporting that they aspired to be aVO leader

6 16 25

% Reporting that life now is better 24 32 54

Table 2: IGVGD Economic Impacts

Table 3: IGVGD Social Impacts

1 The Village Organization (VO) is the gateway of BRAC’s development programs. About 30 BRAC mem-bers from a village form a VO.2 The Gram Shobhas are monthly meetings on specific issues, where both the women members and theirspouses attend. These provide a fairly regular forum in which VO members are exposed to and discussvarious social and economic problems, and potential solutions.



amount of subsidy per household was US$135 per cycle for the year 2000, which heargues was a reasonable cost for the im-provements that have been recorded.4 Thisevidence, plus other reviews, has certainlyconvinced aid agencies that IGVGD cansuccessfully reduce poverty for sections ofthe population that few other programs canreach. Over the last few years, donors andMFIs have been keen to build on theIGVGD experience and expand programsfor “those left behind.”

Driving Factors

The IGVGD program is a partnership be-tween a donor (World Food Program), the

government of Bangladesh (specifically theMinistry of Women’s and Children’s Affairs,Directorate of Relief and Rehabilitation,and local government representatives), anda development organization (BRAC). Themain role of the various important actors inthe IGVGD program is shown in Table 4.


BRAC’s commitment to bring the mostvulnerable into its development program inways that are cost effective and sustainable inthe long run has been the main driver for theIGVGD program. Concerns over food secu-rity, safety nets, and improved nutrition for

Partners Main role

Ministry of Women and Children Affairs - IGVGD household selection- Arrange funds for training- Extend administrative support

Monitoring programme progress

Directorate of Relief and Rahabilitation - Allocating and distributing food aid- Extending administrative support

World Food Programme - Provide food aid- Arrange funds for training- Monitoring the programme progress- Reseach and Evaluation- Coordinate with GoB and BRAC

PKSF and other banking institutions - Provide credit funds to IGVGD programme

BRAC - Development and implementation of theprogramme which includes:

- Arrange income generating activities(IGA) and social awarness training

- Provide credit and other sector support- Savings managment- Follow, supervision and monitoring- Mobilize donor funds for training- Research and Evaluation

Table 4 Major Actors and Their Role in the IGVGD Program

84 Case Studies


the most vulnerable women attracted thegovernment of Bangladesh to the Vulnera-ble Group Feeding (VGF) program. Although these needs are central to the livesof the extreme poor, BRAC felt that withouta more strategic approach, that linked thesevulnerable women to development activities,the food aid-based program on its ownwould not be able to create sustainable, positive change in the lives of these women.The IGVGD approach, therefore, grew outof BRAC’s determination to leverage the ex-isting commitment of the government ofBangladesh towards the most vulnerablewomen of rural Bangladesh.


In 1987, the government of Bangladeshand WFP transformed the VGF programinto the Vulnerable Group Development, or

VGD, program. They also reached an agree-ment with BRAC to expand the pilotscheme into the IGVGD program. Becausethe architects of this expansion did notgrow complacent, the IGVGD continued toevolve.5 For example, in 1989, field staffpointed out that even though they weremembers of IGVGD, many women couldonly buy and raise a single chicken at a timebecause of lack of capital. Why not provideloans to program recipients as soon as theycompleted their training? This led to the addition of a third element to theIGVGD––microcredit––with the aim ofspeeding up client adoption of more pro-ductive livelihoods and graduation toBRAC’s programs for the moderate poor.This three-pronged approach (food grant,skills training, and microcredit) has been thebasis of IGVGD throughout the 1990s.

[Insert Figure 3]

Figure 3: The Idea Behind the Strategic Linkage Approach

Householdincome/

consumption

Upper PovertyLine

(Moderate Poor)

Lower PovertyLine

(Hardcore Poor)

Food AidTime

Skills-training Microcredit

Join BRAC VO




Challenges Faced in Scaling Up IGVGD. During the scaling-up phase, the programexpanded into areas with poor infrastruc-ture and weak communications. The newfocal ministry did not have offices in all thethanas where BRAC had expanded itsIGVGD program.6 Accordingly, per theagreement with the government ofBangladesh, in thanas where the new focalministry did not have presence, the previousministry responsible for the program wouldcontinue to fill in the gap. This was a com-plex and challenging arrangement becauseit required coordination between the oldand new VGD focal ministries—a far fromeasy task.

Scaling up the IGVGD program, whichwas based on BRAC’s existing area officeinfrastructure, also posed challenges forBRAC’s microfinance program. The maincomponent of the IGVGD program was ul-timately to incorporate the VGD benefici-aries into BRAC’s mainstream developmentprograms that operated through VillageOrganizations (VOs)—the gateway ofBRAC’s development programs. However,once BRAC agreed to implement theIGVGD program in a thana, all of the existing VGD beneficiaries in the thana hadto be covered.

It was not easy to provide the develop-ment package to VGD beneficiaries wholived in areas where BRAC had not extendedits microfinance infrastructure. Setting upnew VOs was not always feasible either, ifthere were too few VGD beneficiaries in the

areas. These areas generally had weak infra-structure and poor communication with thetown in the thana where the AOs were typically located. This made organizing train-ing, providing credit, and managing savingsfor VGD women difficult at best. Follow upand monitoring was also less than optimal,which led to repayment irregularities andeventual dropout of VGD members.

The current VGD cycle had been reducedto 18 months, from the 2-year cycle in 1996.The logic behind shortening the time framewas that more VGD beneficiaries could behelped with the resources at hand. The reduced cycle hampered the effectiveness ofthe overall objective, which was further affected by administrative delays in the beginning of the program.

The life of the program lost 3–4 monthsto finalizing the VGD beneficiaries and getting the contract between the govern-ment of Bangladesh and BRAC signed. Almost another two months passed beforethe government circular to the local officialswas issued—without which BRAC could notstart its work on the development package.This in effect meant that BRAC had only a year to implement the activities of the development package, which was exacer-bated by the difficulties of the poor cover-age, mentioned above. BRAC was alsoacutely aware that the period when VGDbeneficiaries could benefit the most from aloan was when they had the food security offered by the VGD card. Their experiencesuggested that the VGD beneficiaries, whotook out a loan early and completed the loancycle while they had food assistance, would

86 Case Studies


be much more likely to stay in the microfi-nance program, compared to those who gotloans late in the cycle and had to repay theloan after VGD support ended.

A lack of understanding about the mainpurpose of the IGVGD program betweenthe various partners was a major challenge.The IGVGD program has a strong develop-mental focus in contrast to the earlier VGF program, which principally focused onrelief. What this fundamental change infocus meant in terms of program design

and approach was not adequately discussedwith the most important partners—the local government officials. This gap led to major difficulties for BRAC as the imple-menter of the developmental component of the program.

One area which best captures this chal-lenge is the issue of returning savings. Sav-ings is not only a financial product, it is animportant part of the process for VGDmembers who are moving from livinghand-to-mouth to planning for the future.For development staff, too, the act of saving regularly by the VGD members isimportant. On one hand, it challenges theimage of the members as beneficiaries andrelief recipients. On the other hand, it provides a space for engagement. This is why savings constitutes such an impor-tant place in development programs. Abedaptly captured the whole idea behind savings as a developmental concept whenhe said: “In Bangla, we have a very apt word for planning, porikolpona, mean-ing “arranging imagination.” Regular sav-ings, however meager, is a very powerful

mechanism that gets the poor to arrangetheir imaginations for tomorrow and be-yond. It also is important for building relationship between the savings institutionand the people it serves.”7

However, the other partners of IGVGDdid not (and do not) readily understand the larger role of savings in development.This lack of conceptual congruence oversavings becomes most evident when thefood aid ends and there is pressure fromother partners in IGVGD to return the savings to the VGD members. Returningtheir savings, for BRAC, signals the end of the relationship with the VGD members.This is inconsistent with the central logic of the IGVGD program—that of creatingstrategic linkages between a relief and a development program to include thepoorest.

Another area of contest among the partners is targeting. The development focus of IGVGD targets the poorest womenwho are physically and mentally able to ben-efit from the income generating trainingand who can manage an income-generatingproject with microcredit. This condition ex-cludes certain categories of the extremepoor for whom the IGVGD approach is notthe most appropriate.8 Yet, because theVGD food aid is one of the scarce resourcesthat the local government representativescan allocate among the poorest, they face alot of pressure to include different categories of the poorest, including the oldand the disabled. This compromises the ideabehind the IGVGD program.



Managing the Challenges

The main challenge to scaling up theIGVGD program was providing effectivecoverage to areas that were outside the op-erating area of an Area Office—the lowestunit of BRAC management. Branch Officeswere set up to provide better follow up andmonitoring to members residing in areasbeyond the operating area of an Area Of-fice. The expansion of the Branch Officenetwork is shown in Figure 4 below.

The density of VGD card holders in athana is an important operational variablefor the IGVGD program. If the density istoo low, organizing the VGD women be-comes difficult, and the whole purpose ofthe program suffers. Figure 4 also shows theaverage number of VGD cards per thana forthe VGD cycles in which BRAC’s IGVGDprogram was in operation. The average den-sity of VGD cardholders decreased sharplyduring the time that the IGVGD program

was scaling up. From the 1999 cycle, den-sity gradually increased, related to a delib-erate BRAC policy to focus on thanas withgood VGD-card density.

Several steps were also taken to stream-line the internal management system of theIGVGD program. First, in managementmeetings at all levels, separate sessions onthe IGVGD program were held as a matterof routine. This had not been done system-atically before. Second, the monitoringfunction was separated from management;it had been combined earlier. Separate mon-itors for IGVGD were hired, who regularlymonitor the program on specific issues.Third, a more intensive follow-up systemwas put in place by deploying staff at the re-gional (roughly district) rather than the di-visional level. (Table 5 summarizes some ofthe steps that BRAC took in response to thechallenges faced in scaling up the IGVGDprogram.) [Insert Figure 4]

Figure 4: IGVGD Over Time

3000

2500

2000

1500

1000

500

0

1994-961997

1998-991999-00

2001-02

800

700

600

500

400

300

200

100

01990 1992 1994 1996 1998 2000 2002

88 Case Studies


As the biggest implementing partner of aflagship program for the poorest, BRACalso had an important voice and role. BRACrepeatedly highlighted the importance ofthe government of Bangladesh and its localrepresentatives to this program, especiallythe need to have a common understandingof the objectives and program activities. Tosupport this, BRAC initiated regular work-shops in the thanas for local governmentrepresentatives. Coordination with localgovernment representatives was the weak-est in thanas where the focal ministry didnot have any offices or presence. Repeatedly

emphasizing this as an important constraintfor the program gradually led the focal min-istry to take more initiative, such as promot-ing attendance at the BRAC workshops, ex-panding their infrastructure in the thanas,and strengthening their monitoring of theprogram. [Insert Table 5]

External Catalysts

The IGVGD idea and the subsequentprogram has largely been driven by BRAC,especially during the scaling up phase of theprogram. However, during the initial pilot-ing of the idea, WFP played a pivotal role.

Table 5 Key Challenges, Consequences, and Steps Taken

Challenges Consequences Steps Taken

Inadequate Area Office coverage

• Poor follow up• Training program hampered• Credit disbursement

hampered

• Branch offices set up tocover areas far from the AreaOffice

• Separate sessions dedicatedto IGVGD issues in allBRAC management meet-ings

• IGVGD monitors deployed• Workshops held in the

thanas to coordinate and getbetter support from localgovernment

• Infrastructure of focalMinistry increased in thanas

Time for ImplementingDevelopment Package Limitedby Procedural Matters

• Credit not be given to allduring the food aid cycle

• Adequate time not availableto provide technical supportand supervision for sustain-able graduation

• From the 2003 cycle, theVGD cycle increased to 24months.

Lack of CommonUnderstanding

• Pressure for savings return• Poor motivation• Drop out

• Workshops in thanas withlocal government officials

• Closer dialogues among thepartners

• Field level exposure



As a matter of fact, when WFP decided totransform its Vulnerable Group Feedingprogram into the Vulnerable Group Devel-opment program, the government was running the program and was expected toimplement this new approach. In practice,however, the change of the program namefrom “Feeding” to “Development” was inname only. Skeptics called it a “poverty con-tainment program” rather than a “povertyalleviating” one.

In 1985, the founder of BRAC, F.H.Abed, had a meeting with the deputy executive director of WFP who told himthat that the government of Bangladesh wasrunning the VGD program just like VGF,and that if it continued as such, it would be difficult to maintain support for the pro-gram. In terms of outreach, VGD was thelargest safety net program in Bangladesh,and its withdrawal or contraction would bedisastrous for the extremely poor. The mat-ter was extensively discussed within BRACto assess the pros and cons of BRAC partic-ipating in the program as a developmentpartner along with the government.

BRAC asked WFP to allocate 700 VGDration cards especially to test the VGD ideain one sub-district of Manikgonj whereBRAC had significant presence. However,there was a hiccup during this pilot phase,which turned out to be a blessing in disguise. An influential national daily ran a story on the pilot, accusing BRAC of “taking 25 taka every month” and “makingthe VGD women work” for the “free card.”Yet the VGD guidelines, under whichBRAC was operating, clearly mentioned

“savings” and “training” as the develop-ment components of the program. The government of Bangladesh, also withoutconsulting the VGD guidelines, carried outan investigation into the matter and foundBRAC “guilty.” In response, the WFP conducted its own investigation and foundthat BRAC was very effectively followingthe guidelines. This brought the matter outinto the open, and the relevant governmentministry started discussing the VGD approach more closely with BRAC. It was aturning point for BRAC as a major, credi-ble actor in developing the IGVGD idea.

Lessons Learned

The Complexity of Including the Poorest:Poultry Sector Development and IGVGD

The story of scaling up IGVGD is closelylinked to BRAC’s entry and its poultry pro-gram. BRAC wanted to find appropriateproducts for the VGD women, that hadlarge-scale potential; were relatively easy tomarket with existing skills; were homebased, and could generate quick cash flow.BRAC also had to be able to provide or facilitate provision of the required supportservices. Poultry seemed to satisfy all ofthese conditions.

The human and physical infrastructureneeded to support the development andscaling up of a poultry sector had to becreated incrementally. This process needselaboration to show that developing pro-grams useful to the extreme poor is a com-plex undertaking that requires coordinatedaction at various levels.

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BRAC observed that the various linkagesthat made the poultry sector viable was absent, especially for the poor living in ruralareas. Poultry raising was not considered abusiness for the poor. BRAC realized thatthe crucial challenge for success would becontrolling poultry mortality. Poultry exten-sion services were non-existent, and therewere many bottlenecks in the supply chainfor poultry vaccination. The other big chal-lenge was to improve the quality of the breedto increase yield. A local bird lays only 60eggs a year. The government had a HYV(high yield variety) poultry setup, but because of the severe supply and supportbottlenecks, effective demand was low. Thegovernment was very supportive whenBRAC began to work on relieving these bottlenecks, because demand would increaseall over Bangladesh.

BRAC used its local presence and grass-roots knowledge to create a cadre of poul-try workers from the VGD women. Theywere trained in basic poultry diseases andprovided medicine and vaccination servicesfor a modest charge. BRAC facilitated thenetworking of these poultry workers withthe government’s local poultry and livestockinfrastructure. Today BRAC has more than40,000 such poultry workers workingthroughout rural Bangladesh.

BRAC started by buying day-old chickfrom government-run poultry farms, butthere were several problems. The largestunit was in Dhaka and transporting largenumbers of day-old chicks to rural areas was both expensive and hard on the chicks.The quality of the day-old chicks was not

satisfactory, and supply could not be deliv-ered on time or in the right quantity. In1996, BRAC modernized its small poultryfarm. Today, BRAC has six such poultryfarms which supply over 1 million day-oldchicks every month.

Ensuring quality feed was another chal-lenge that that had to be addressed. Hybridmaize, the main ingredient of poultry feed,was not produced in Bangladesh, so BRACimported five tons of hybrid maize seeds. To attract farmers to cultivate hybrid maize, a guaranteed floor price was set. In 1999, BRAC set up a poultry feed mill toguarantee a supply of high quality and timelyfeed for the expanding poultry sector. Recognizing that importing enough hybridseed would be expensive and would translateinto higher feed prices, BRAC entered into a joint venture with an Australian seedcompany. Today, BRAC’s Maize Seed Production Program produces 400 tons ofhybrid maize seeds, which in turn producesan annual maize crop of 100,000 tons.

Taking the Challenge Further: BRAC’sNew Program for the Ultra Poor

BRAC’s IGVGD experiences demonstratedthe possibility that opportunities could be created from safety nets for those who are left behind by conventional micro-finance. This made BRAC experiment even more boldly with the concept ofstrategic linkages.

BRAC noticed that for a great majorityof the poorest, the IGVGD increased theirability to benefit from regular microfinanceprograms, but for a significant minority, this



did not happen. It was more worrisome thatthose who failed to make it were among thepoorest and most vulnerable. There wereseveral reasons for this.

BRAC was at times dissatisfied with thetargeting that local government representa-tives carried out, which was sometimes basedon political and other motives. More impor-tantly, the women often failed to get the fullbenefits of the VGD food aid. Often, oneVGD card was unofficially shared betweentwo or more women. Sometimes, womenhad to “buy” the VGD cards by bribing thegovernment official. The destitute womenwould borrow the money for the card fromwheat dealers, who would repay themselvesby charging the women more than marketrates for wheat bought with the VGD card.BRAC wanted a program where it had morecontrol over the processes, and which wasspecifically designed to build a solid founda-tion from which the extreme poor couldmove forward.

In January 2002, BRAC started a new ex-perimental program with these challenges inmind, called “Challenging the Frontiers ofPoverty Reduction: Targeting the UltraPoor,”or TUP, for short. The program wasdesigned to address the various interlockingconstraints affecting rural women who live insevere poverty. The strategy is to help the ultra poor build a solid physical and socio-political asset base. The first two years of theprogram were the pilot phase, during which5,000 ultra-poor households were selectedeach year. In 2004, the program will be scaledup, and 10,000 more ultra poor will partici-pate. In the remaining two years (2005 and

2006) of this experimental program, 25,000ultra-poor women will be targeted.

Program components for the ultra poorare selected by using a careful targetingmethodology, that combines participatoryapproaches with a simple survey-based tool.The program also includes a special invest-ment program that grants assets and astipend, an enterprise specific skills develop-ment training program, a program of essen-tial healthcare, and a social developmentprogram. The program aims to cover70,000 ultra poor from 2002–2006.

The whole idea behind TUP is to enablethe ultra poor develop new and better op-tions for sustainable livelihoods. This re-quires a combination of approaches, somepromotional, such as asset grants and skillstraining; and some protective, such asstipends and healthcare services. It also re-quires addressing constraints at various lev-els, household and the wider environmentsof institutions, structures, and policies.

The results from the pilot phase suggestthat the targeting of the TUP has been suc-cessful. Comparison with the generalIGVGD membership profile suggests thatTUP is targeting people more poor thanVGD members. [Insert Table 6]

The changes that are taking place in thelives of the ultra poor targeted by the pro-gram also show promising results. The program, according to a recently conductedmid-term review, has produced noticeablegains in social and human capital. A consolidated view of the profiles indicates amajority have escaped their ultra-poor statusand acquired a poor but improved standard

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of living. About 40 percent are moving toward the standards of households targetedby microfinance institutions. Although predictions are premature, about 75 percenthave some prospect for sustaining these improvements into the future.

At $291 per member, financial allocationfor a 18-month cycle of the TUP programis more expensive than IGVGD, which hasa financial allocation of $225. However, thetwo programs target different groups of theextreme poor. TUP focuses on those whofail to benefit from the VGD card or do notget or it. The TUP approach is different andrequires a more comprehensive, and moreexpensive, set of instruments for the typesof ultra poor the program targets. The mainquestion is the extent to which the benefitsprovided by the program are sustainable.

It may be too early to assess sustainabil-ity, but the mid-term review found that the mean increased net income for TUPmembers is actually significantly higher thanthat of IGVGD members (CFPR Donor

Consortium, 2004). This very early resultsuggest that the TUP model may actually bequite cost effective.

In the long run, the most important variable will be the proportion of the ultrapoor who manage to build sustainable livelihoods. Joining mainstream microfi-nance programs, especially being able toparticipate over a long time, can be an important marker. This has been widelyused to assess graduation in IGVGD. Although this will certainly be an importantindicator for monitoring graduation, it maynot be the only one, and the challenge willbe to find more appropriate ones for the ultra poor targeted by the TUP program.

Bringing in the Poorest

BRAC’s conviction, underlying its micro-finance programs for the poorest, has been simple yet unconventional—that thepoorest can and should be included. Thestrategy for BRAC was not to force the existing model of microfinance, as it was

Variables TUP VGD

Average owning land 2.13 4.72% of households owning no cultivable land 93 87

% of households not owning theland they live on 54 43

% of households reporting out-standing loan from any source 2.13 36

% of households reporting theyeat at least two meals a day 2.13 61

% of households reporting deterioring economic condi-tions over the last year

44 35

Table 6 Key Differences between VGD and TUP Members



clear that the model itself was part of theproblem. BRAC knew from experiencesthat the interlocking constraints and depri-vations, within which extreme poverty ex-ists, are too complex to tackled by microfi-nance alone as a strategic intervention.

The IGVGD program used the period ofsecurity provided by the food aid to developthe skills and confidence of the poorest, andfinally provide them with credit to build on.The TUP program was based on the expe-rience of IGVGD—that there are peopletoo poor to benefit from IGVGD, who stillshould not be ignored as an eventual targetgroup for microfinance.

The idea of building inclusive marketsand systems, especially focusing on thosewho tend to be left out, has been central tothe microfinance movement. Yet, ironically,mainstream microfinance models have not

only bypassed the poorest, but mainstreammicrofinance discourse did not considerthem to be an area of concern or relevancefor microfinance.

BRAC’s experiences suggest that carefully designed strategic linkages thatcombine grants with a central role for microfinance can work for the poorest.There will surely be many different modelsand approaches for including the poorest,which will vary according to country con-texts. However, the starting point will haveto be reversing the trend of apathy, that either excludes the poorest or treats them as“relief cases” to be dealt by “others.” Thepoorest are, can, and must be central to the vision and commitment of microfinance institutions. Only then will the search forpossibilities and opportunities to includethe poorest begin and develop.

End Notes

1 S. Hashemi, Including the Poorest: LinkingMicrofinance and Safety Net Programs. CGAP FocusNote No. 20, (Washington, D.C.: CGAP, 2001).

2 H. Rahman and M. Hossain, eds., Rethinking RuralPoverty: Bangladesh as a Case Study, (Dhaka: UPL,1995).

3 P. Webb, et al, “Expectations of Success andConstraints among IGVGD Women,” report prepared forWorld Food Program, Bangladesh, 2001.

4 Hashemi, Including the Poorest, p. 11.

5 Imran Matin and D. Hulme. “Programs for the Poorest:Learning from the IGVGD Program in Bangladesh,”World Development 31, no. 3 (2003): 647-65.

6 In 1998, the focal ministry for the VGD program waschanged from Ministry of Relief and Rehabilitation to theMinistry of Women’s and Children’s Affairs.

7 F.H. Abed, “Programs for the Extreme Poor: BRACExperiences So Far,” paper presented at the interna-tional conference, “Staying Poor: Chronic Poverty andDevelopment Policy,” Chronic Poverty Research Centre,IDPM, University of Manchester, UK, April 7-9, 2003.

8 Matin and Hulme, “Programs for the Poorest.”

■ ■ ■

Bibliography

Abed, F.H. “Programs for the Extreme Poor: BRACExperiences So Far.” Paper presented at the interna-tional conference, “Staying Poor: Chronic Poverty andDevelopment Policy,” Chronic Poverty Research Centre,IDPM, University of Manchester, UK, April 7–9, 2003.

CFPR Donor Consortium. “Review of the CFPR/TUPSpecially-Targeted Ultra Poor (STUP) Program.” MissionReport, 2004.

■ ■ ■

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Hashemi, S. “Those Left Behind: A Note on Targetingthe Hardcore Poor.” In Who Needs Credit? Poverty andFinance in Development, ed. G. Wood and I. Sharif.Dhaka. Bangladesh: UPL, 1997.

Hashemi, S. Including the Poorest: Linking Microfinanceand Safety Net Programs. CGAP Focus Note No. 20.Washington, D.C.: CGAP, 2001.

Matin, I., and D. Hulme. Programs for the Poorest:Learning from the IGVGD Program in Bangladesh.World Development 31, no. 3 (2003): 647-65.

Rahman, H., and M. Hossain, eds. Rethinking RuralPoverty: Bangladesh as a Case Study. Dhaka: UPL,1995.

Sattar, M.G., N.S. Chowdhury, and M. Hossain. “FoodAid and Sustainable Livelihoods: BRAC’s Innovationsagainst Hunger. Research and Evaluation Division.”Report prepared for BRAC, July 1999.

Webb, P., et al. “Expectations of Success andConstraints among IGVGD Women.” Report preparedfor World Food Program, Bangladesh, 2001.


Executive SummaryEstablished 20 years ago, the Unit system of Bank Rakyat Indonesia (BRI) today is thelargest and one of the most successful microfinance institutions in the world. The 3,855Units—small outlets mostly in rural areas with around six staff members each—are scat-tered all over Indonesia and provide services to almost 30 million small savers (the averageaccount is US $108) and 3.1 million small borrowers (average loan outstanding is US$540). The BRI Units have followed a profitable, sustainable approach to microfinance ona large scale, based on locally-mobilized savings without subsidies and funds from govern-ment or donors. The commercially-based provision of credit and savings services has had apowerful positive impact on the lives of millions of poor and low-income households.

Several factors have driven the reform and implementation of the BRI Unit system. Effective leadership, strong commitment, and political support were crucial at the initial reform stage but also throughout the development process. The institutional design of theBRI Unit as the nucleus of the entire system combined standardization and flexibility in aunique way. The BRI experience drew extensively on the lessons and experimentation ofother initiatives and from BRI’s own trials and pilots.

External factors gave the impetus for the initial reform. Later on, stable macroeconomicconditions and a series of financial sector reforms provided a conducive environment in which the new Unit system could develop and prosper. When the Indonesian bankingsystem collapsed in 1998, BRI’s Unit system remained profitable, loan repayment rate stayedhigh, and the deposit volume more than doubled. The BRI Units emerged from the crisisstronger and even more robust than before.


Origins of the BRI Units

Bank Rakyat Indonesia (BRI) is a state-owned commercial bank that has historically concen-trated on providing banking services to the agricultural sector and rural areas of Indonesia. BRI

Bank Rakyat Indonesia (BRI):Twenty Years of Large-Scale MicrofinanceBY KLAUS MAURER

Chapter 7

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Twenty Years of Large-Sca le Microf inance

established 3,600 village units in the early1970s as conduits for channeling subsidizedcredit to farmers under the BIMAS program.When the government decided to terminatethe BIMAS program, and with it the massivesubsidies to unit operations, BRI was facedwith a difficult choice: either introduce dras-tic measures to make the village units viable,or close them down. With the encouragementof the Ministry of Finance, BRI decided to convert the units into a rural banking network that would meet a wide range of financial needs of rural households in a sus-tainable manner.

The timing and conditions for a “big-bang reform” of the BRI Unit systemwere favorable as the collapse of BIMAS coincided with important events: the collapse of oil prices and the sharp declinein oil revenues which put heavy strains onthe government budget, a new cabinet andkey personnel changes in the government(finance minister), and the launching offundamental economic reforms. A major financial sector deregulation package wasannounced in June 1983 allowing banks toset their own interest rates; this created opportunities and the enabling environ-ment for a viable rural banking operation.1

Establishment of the New Unit System(1984–86)

Viability guided the transformation of theUnits from conduits for BIMAS (which wasnot profitable) to full-service rural bankingunits. A massive restructuring took place.One of the first steps taken was reorganizingthe Units into profit centers and the creating

separate balance sheets and profit and lossstatements for each Unit. Almost one thirdof the Units was identified as having low po-tential and were downsized to village serviceposts. Many Units were physically relocatedfrom out-of-town field sites to central loca-tions close to the markets.

New products were introduced. A pair of products, KUPEDES (for credit) andSIMPEDES (for savings), have become thebackbone and trademark of the new Unitsystem. KUPEDES is a single loan productfor general rural credit. It is non-targetedand is available to any creditworthy cus-tomer for any kind of productive enterprise.KUPEDES interest rates were set at 1.5percent flat per month (an annual effectiverate of 33 percent). KUPEDES borrowersmust provide sufficient collateral to coverthe value of the loan, usually in the form ofland titles, but also can pledge buildings,motorcycles or other property. KUPEDESalso has a timely repayment incentive,equivalent to a refund of 25 percent of theinterest paid on the loan.

SIMPEDES is a simple passbook savingsproduct that was introduced after pilot-test-ing and experimentation. Savings have beenan integral part of the Unit banking philos-ophy and strategy from the outset. Becausemore people in rural areas tend to be saversthan borrowers at any one time, providingbetter savings services was seen to be moreeffective in achieving an equitable distribu-tion of banking services than providingcheap credit. In addition to SIMPEDES, themain product, the BRI Units offer demandand time deposits, as well as another savings


Bank Rakyat Indones ia

product called TABANAS, which is mainlytargeted at school children and students.

KUPEDES and SIMPEDES had a suc-cessful start, and after three years it becameclear that the BRI Unit system could be fi-nancially viable. In 1984, only 14 percent ofthe Units were profitable. Two years later,this had increased to 72 percent. The BRIUnit system as a whole achieved profitabil-ity in 1986, the third year of operations.

Expansion and Scaling Up (1987–97)

The initial phase of transformation and es-tablishment of the new BRI Unit systemwas followed by a decade of rapid expansionand scaling up. The expansion was fueled bycontinued deregulation and reforms of thefinancial sector and by macroeconomicgrowth and stability. Every year, the BRIUnit system added an average of 100,000borrowers and 1.5 million depositors.

In the sixth year of operation in 1989,the BRI Unit system achieved self-sufficiency in funding when the volume ofdeposits was equal to the loan amount outstanding. Since then, deposits continuedto outstrip loans both in terms of numberof accounts and volume. In terms of volume, the deposit-to-loan ratio has beenabout 2:1, with the result that only half of the funds mobilized by the Units wererecycled as KUPEDES loans, and the otherhalf were transferred to the branch system.For the Units, the fund transfer was attrac-tive because they were paid an interestrate—the so-called transfer price—whichwas normally set slightly above the interestrate paid on time deposits. The branches

easily absorbed the Units’ excess liquidityand channeled the funds into large corpo-rate loans that were rapidly expanded dur-ing the 1990s.

In 1997, the Unit Banking Systemrecorded more than 18 million savers and2.6 million borrowers (see Table 1). Thisdimension of outreach clearly establishedthe BRI Unit system as the major institutionin rural finance in Indonesia.

Financial and Economic Crisis (1998–99)

In late 1997, Indonesia was hit by a severefinancial and economic crisis. Within a fewmonths, the country's currency—the rupiah—experienced a dramatic 80 percentplunge in its value against the US dollar, followed by sharp increases in inflation (77percent in 1998) and interest rates. The ensuing political crisis mounted in May1998 with the downfall of PresidentSuharto. The banking system was on thebrink of collapse, forcing the government tostep in and provide a blanket guaranteecover for all bank deposits. Many privatebanks were closed down, major state banksmerged, and non-performing assets trans-ferred to the newly-created IndonesianBank Restructuring Agency (IBRA).

The BRI Units weathered the crisis pe-riod remarkably well. On the one hand, theBRI Unit system experienced an enormousinflux of deposits because it benefited fromits status as a state-owned bank and safehaven for depositors. In 1998 alone, morethan three million new deposit accountswere opened, and the volume of deposits inRupiah doubled. On the other hand, the

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number of KUPEDES loans stagnated dur-ing the two years of crisis, and the portfoliolevel declined in real terms.

Most surprisingly, however, loan repay-ment suffered only marginally. Contrary tothe massive defaults of large and corporatecustomers in the Indonesian banking sector,the KUPEDES borrowers maintained astrong repayment discipline and continued

to honor their obligations despite the economic hardships they faced. Microenter-prises primarily employed family labor andtheir own capital, and were able to adjustmore flexibly to the external shock. Further-more, the impact of the crisis on the poorwas generally more severe in urban areasthan in the countryside.2 A key factor wasalso the long-term banking relationship that

DEPOSITS LOANS OUTSTANDING

YearEnd

Number Amount Amount(in thousands) (Rupiah billion) (US$ million)

Number Amount Amount(in thousands) (Rupiah billion) (US$ million)

1984 0.003 42 39 641 111 103

1985 0.04 85 76 1,035 229 204

1986 419 176 107 1,232 334 204

1987 4,184 288 174 1,315 430 260

1988 4,184 288 174 1,386 542 313

1989 6,262 959 533 1,644 847 471

1990 7,263 1,695 892 1,893 1,382 727

1991 8,588 2,541 1,276 1,838 1,456 731

1992 9,953 3,399 1,644 1,832 1,649 798

1993 11,431 4,325 2,058 1,896 1,957 931

1994 13,067 5,232 2,379 2,054 2,458 1,118

1995 14,483 6,016 2,631 2,264 3,191 1,395

1996 16,147 7,092 3,026 2,488 4,076 1,739

1997 18,143 8,837 2,424 2,616 4,685 1,285

1998 21,699 16,146 2,044 2,458 4,697 595

1999 24,236 17,061 2,419 2,474 5,957 845

2000 25,823 19,115 1,986 2,716 7,827 813

2001 27,045 21,991 2,105 2,790 9,873 945

2002 28,262 23,480 2,627 3,056 12,011 1,344

2003 29,869 27,429 3,240 3,100 14,183 1,675

Table 1: Deposits and Loans in BRI Units 1984-2003



had developed between the Units and theircustomers.3 Amid a general credit crunch inthe banking sector, KUPEDES loans werecontinuously available to existing customersduring the crisis years, although Unit man-agers did not seek out new clients duringthat period. Borrowers were particularlyanxious to continue having access to BRI’scredit facilities because such credit availabil-ity represented a form of insurance for dealing with external shocks. Hence, theystrived to keep their borrowing historygood and placed a high priority on repayingtheir loans to BRI.

The impact of the crisis on the viability ofBRI Unit operations was thus only mar-ginal. The BRI Units were able to maintaintheir profitability, albeit at slightly lower lev-els. The BRI Units came out of the crisisstable and robust, contrary to the rest ofBRI. Due to heavy loan losses in the corpo-rate business unit, BRI almost collapsed andwas recapitalized by the government.

Post-crisis Period (2000–Present)

In the four years since the crisis, the BRIUnit system continued to expand in scale.At the end of 2003, the Units recorded 30 million deposits and a volume of US$3.1 billion. The number of borrowers increased to 3.1 million, with a total loanamount outstanding of close to US $1.7billion. With less than five percent of theportfolio at risk, the quality of loans remained excellent.

The crisis had brought a considerable risein poverty. In 1998, over 24 percent of Indonesia’s population, or almost 50

million people, had fallen below the povertyline, from around 15 percent before the crisis. The Poverty Alleviation Committee,established in 2001, has launched a ten-yearprogram of poverty alleviation until 2010and has set an intermediate target to reducepoverty to 14 percent of the population, or26.8 million people, by the end of 2004.The Committee has realized the importantrole of the banking sector and has obtainedthe commitment of major banks, includingBRI, to expand their lending to micro andsmall enterprises.

In an attempt to provide access to com-mercial credit for the enterprising poor in In-donesia on a massive scale, in January 2000BRI introduced a small-scale KUPEDESproduct with simplified administrative proce-dures and flexible collateral requirements forloans under Rp 1 million (US $120). Although BRI has developed a significantportfolio of small-scale loans, it has not ex-panded to full capacity in the small-scalecredit market, and there remains considerablescope for financing a significant portion of mi-cro-entrepreneurs below the poverty line. Butthere are also limits to the provision of verysmall loans in a financially sustainable way. Despite the simplified administrative require-ments, the break-even point for small-scalelending is Rp 1.2 million (US $143) when ac-counting for the full cost of lending.4

The latest development has been the privatization of BRI. The sale of 41 percent of BRI shares to the public throughan IPO was completed in November 2003. The IPO was successful and drewstrong interest from investors—its shares

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oversubscribed by 16 times. The IPO wasthe largest equity deal since the financial cri-sis. Total proceeds from the IPO amountedto Rp 4.1 trillion (US $486 million), ofwhich around Rp 2.5 trillion (US $297 million) is to be transferred to the statebudget and the remaining is to increaseBRI’s capital.5 What impact this partial pri-vatization will have on the microbankingbusiness and the Unit system is yet to beseen. However, with the BRI IPO, microfi-nance has made a successful entry into private equity markets, and this will send apowerful message to policy makers andbankers in Asia and the developing world.

Impact Analysis

Looking back on 20 years of implementa-tion, the BRI Unit system has had a strongimpact on rural microfinance in Indonesiaand beyond. The immediate impact was feltby millions of microenterprises and poorhouseholds who benefited as savers and/orborrowers from the financial services offeredby the BRI Units. Moreover, the BRI expe-rience was a powerful demonstration to policy makers and other financial institutionsin Indonesia and in many other countries. Itsimpact can be measured in terms of effi-ciency, effectiveness, and poverty outreach.

Efficiency in the Use of Resources

Efficiency and productivity have been keyoperating principles in the BRI Unit system. The Unit system functions as an independent profit center within BRI, andeach small BRI Unit is a profit center

within the system. This has formed the basis for transparency, accountability, andefficiency in the use of resources. BRI hasset clear benchmarks for staff productivity:one credit officer for every 400 borrowers,one teller for every 200 daily cash transac-tions, and one bookkeeper for 150 dailytransactions. Nowadays, a credit officer isresponsible for more than 500 borrowersand a teller handles an average of 6,000deposit accounts. The computerization ofthe BRI Units in the course of the 1990shas significantly contributed to the gains instaff productivity. As a result, cost efficiencyof the Unit system has increased consider-ably over the years. In 2000, administrativecosts as a percentage of the average loanportfolio came down to about 8 percent,which is very efficient by microfinancestandards.

Effectiveness Judging from the BRI Units’ success inbuilding and maintaining a large, stable, andgrowing customer base, it is clear that BRIhas been highly effective in meeting therural population’s demand for savings and

credit services at a reasonable cost. Beyondthese direct effects, the performance of theBRI Units had a significant impact on finan-cial sector policy in Indonesia. The designof the 1988 decree (so-called PAKTO) forsetting up private rural banks was stronglyinfluenced by the initial success of BRI’scommercial approach to rural microfinance.The BRI Unit system has emerged as theleading institution in rural areas and has setthe benchmark for rural microfinance in



Indonesia. Moreover, BRI has gained inter-national recognition as the most prominentshowcase of large-scale microfinance andhas become a learning ground for policymakers and practitioners from many coun-tries. The BRI experience served as a modelfor institutional design in Cambodia, forsavings product development in Thailand,and as input for microfinance legislation inTanzania, to name a few examples.

Poverty OutreachOver the past 20 years, the BRI Units haveprovided financial services to millions of microenterprises and rural households,most low-income in the general populationand many among the poorer of the ruralpopulation. BRI’s KUPEDES lending program does not specifically target the verypoor below the poverty line but rather theworking poor who have viable economic activities and sufficient repayment capacity.Poverty data for BRI Unit borrowers arenot available, but proxy indicators (such as the number of small KUPEDES loans)provide an indication of depth of outreach.

Presently, the average outstanding loansare US $540, which is about half of the percapita income in Indonesia. In 2001, 60percent of KUPEDES loans were below US$300.6 However, KUPEDES lending hasnot reached much of the population belowthe poverty line or the very poor, but ratherthose near the poverty line. A recent impactevaluation found that regular BRI Unit borrowers are relatively better off thanother respondents, including BRI saversonly and non-customers, whether measured

in terms of income or wealth.7 It remains tobe seen whether the small-scale KUPEDESproduct introduced in 2000 can addressthese issues and successfully expand lendingto poorer segments of the population.

Much of the debate on poverty outreach ofthe BRI Unit system (and of other microfi-nance institutions) has focused on loans andon the poor as potential borrowers. One mayargue, however, that poor people are morelikely to be found among the BRI Units’ 30million savers (average deposit US $108) thanamong the three million borrowers.

Savings are a cushion against emergenciesfor poor households. They help reduce theirvulnerability and provide them with a toolfor managing uncertainty and risks. Formany poor people, credit may not be appro-priate as it may not lower but rather increasetheir risk. Findings of the recent impactevaluation seem to confirm this hypothesisfor rural Indonesia. When potential borrow-ers with viable enterprises were asked whythey didn’t borrow from formal financial in-stitutions, two thirds said they did not wantto be indebted.8 It would be worthwhile tostudy the characteristics of BRI Units’ smallsavers in more detail, as well as the impor-tance of savings services for the poor, andthe impact of savings services in terms ofpoverty reduction.

Driving Factors


Effective leadership, strong commitment,and political support were crucial factors

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not only at the initial reform stage but alsothroughout the development process of theBRI Unit system. In 1983, several eventsconverged, to create the political economyand climate for change. The governmentlaunched overall economic and financial reforms, which prepared the groundworkfor a radical reform of the BRI Units. Theblueprint for the new BRI Unit system wasperfectly in line with the financial sector reforms announced in June 1983, thus winning the support of the architects of thereform in the Ministry of Finance and theCentral Bank.

Commitment and leadership within BRIhave been essential. BRI’s president director from 1983 to 1992 took personalinitiative and responsibility for the develop-ment of the Unit banking system. Jointlywith the other members of the Board, heprotected the Units from interference andled the development of what they calledBRI’s new institutional culture and Indone-sia’s new rural banking. system.9 The changein culture was associated with the shift fromsubsidized farm credit to commercial microbanking. Starting from the top man-agement, it triggered a major transformationof the entire institution by changing themindset of its 14,000 employees.

Despite being part of a government-owned bank, the BRI Units were able tomaintain their operational autonomy and tostay free from interventions, such as credittargeting, interest rate restrictions, provi-sion of cheap funds, or from interference inlending decisions. However, as the desig-nated bank for the rural and agricultural

sectors, BRI continued to implement subsi-dized credit programs for priority sectorsand specific target groups. These programswere shifted to the BRI branches at the dis-trict level, strictly separate from Unit oper-ations. This way, BRI was able to accommo-date specific requests and special programsfrom the government and from donors,without disturbing the development of theUnit system.


The BRI Unit—as the nucleus of the entiresystem—is itself an institutional innovation.Much of its success may be attributed to theorganizational set-up of the single BRI Unitas a highly decentralized and semi-au-tonomous financial entity. The BRI Unit iscommonly found in a central location of thesub-district town, often near the marketplace. It typically rents a one-room office, inorder to keep overhead costs low. A Unitcovers about 16–18 villages at the sub-dis-trict, and nowadays serves an average of10,000 savers and a little over 1,000 borrowers. The individual Unit was pur-posely kept small, by limiting the number ofstaff and focusing its operations. The fourstaff—a manager, a loan officer, a teller, anda desk officer—have clear job descriptionsand division of responsibilities. Personnel responsibilities and performance-based standards are harmonized across the Unitsystem. As volume of operations increase, upto 11 additional staff are posted to a Unit. Ifthe business of a Unit expands beyond themaximum staff limit, the Unit is split to keepthe operation small and focused.



The accounting system allowed eachUnit’s performance to be evaluated as profitcenter. Unit managers and staff are account-able, which has instilled a high degree of responsibility among them. A standardizedmanagement information system (MIS),centered on a few key performance indica-tors, provided timely information to managers and supervisors at all levels. Onthis foundation the staff incentive systemwas built.

Overall, the Unit as the institutional nu-cleus combines standardization and flexibil-ity; it can be easily replicated and easilyadapted to the scale of operations in a par-ticular area, providing an ideal institutionalsolution for expansion and scaling up.


The BRI experience is based on extensivelearning and experimentation. Learningfrom others dominated the period before implementation while learning by doing(including pilot testing) were the main features during implementation.

BRI did not invent all the features thatcharacterize the Unit system. It pointedlystudied the experiences of others before setting up its own system, such as, Bank Dagang Bali, a private bank founded in1969; the Badan Kredit Kecamatan(BKK), a community-based institution inCentral Java; and informal moneylenders,specifically that they collected valuable insider information on prospective borrow-ers from input suppliers and buyers. BRIhad experimented with the Kredit Mini andKredit Midi products for several years and

learned how to analyze the viability of informal microenterprises. The design ofthe KUPEDES product, the analysis of borrowers’ repayment capacity, and the system of monitoring and collection wereall built on this early experience.

Pilot testing became standard for BRI.Until 1983, BRI had virtually no experiencewith rural savings mobilization. Followingan initial demand study, a first version of SIMPEDES was introduced as a pilotproject in November 1984, and quicklyshowed evidence of massive demand for aliquid, convenient, and safe deposit facility.After some modifications and refinements,the facility was expanded to all Units bySeptember 1986.

The BRI Units also learned from mis-takes. For example, continuous access tocredit is an important incentive for borrow-ers to repay their loans. When tight mone-tary policy caused a liquidity shortage inBRI and the management imposed a halt inlending in 1991–92, loan repayment dete-riorated because borrowers perceived theavailability of future loans to be at stake.During the recent financial and economiccrisis (AUTHOR: which crisis, or when?),the KUPEDES lending window remainedopen to credit-worthy borrowers.

External Catalysts

External factors played an important rolefor the initial reform. The oil price collapsein 1983 and the decline in oil revenuesforced the government to impose austerityon budgetary expenses and subsidies. Economic pressures made politicians adopt

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a commercial approach to rural microfi-nance. During the scaling-up period, stablemacroeconomic conditions and a series offinancial sector reforms provided a conducive environment in which the newUnit system could develop and prosper. Adecade later, the BRI Unit system was stable and robust enough to weather the severe economic crisis.

External assistance was crucial, especiallyin the early years. Technical assistance wasprovided by the Harvard Advisory Group,partially funded by the World Bank and USAID. Together with local bankers, theexperts developed the initial design andprinciples of the new BRI Unit system. Financial resources were only required inthe very beginning. With the know-howand the systems in place, the BRI Unitswere soon able to generate their own re-sources locally. A World Bank loan of US$97 million for KUPEDES onlending wasdisbursed in 1990, at a time when, strictlyspeaking, the BRI Unit system no longerneeded outside funds.

Lessons Learned

Many lessons can be learned from the BRIexperience. Some of its key principles havebeen replicated and adopted by the interna-tional microfinance industry as best prac-tices. Some of the features are unique to thespecific context of rural Indonesia and/orto BRI as an institution, but others can begeneralized and applied in other countries.The BRI experience has become a learningground for policy makers and microfinance

practitioners from all over the world. BRIhas established an International VisitorsProgram (IVP) to facilitate international exchange and learning, and every year,about 20 international delegations visit andstudy the BRI Unit system.

Reforming a state-owned bank and utiliz-ing existing infrastructure is possiblewithin a short period of time.For scaling up poverty reduction, the majorlesson to be learned is perhaps that reform-ing a state-owned bank, and utilizing theexisting infrastructure and human resourcesto implement a sustainable approach oflarge-scale microfinance, is possible withina short period of time. Commercially-basedprovision of credit and savings services hashad a powerful positive impact on the livesof millions of poor and low-income house-holds, based on locally-mobilized savingswithout subsidies and funds from govern-ment or donors. This required a change ofculture: treating the poor no longer as beneficiaries but as customers who can save,who are able and willing to pay marketprices for good services, and who honortheir obligations and repay their loans despite economic hardships.

Expand microbanking services to ensuresustainability.

Some challenges remain and actions shouldbe taken to ensure the sustainability of pres-ent achievements. First, lending should befurther expanded. Even though the BRIUnits have done a remarkable job in extend-ing savings and credit services throughout



Indonesia, there is considerable scope forexpanding these microbanking services, especially to poorer segments of the ruralpopulation. Most Indonesians still do notmake use of formal banking services, so thechallenge for BRI is to address the needs ofthis “unbanked majority.”10 However, anexpansion of borrower outreach can only beachieved with additional staff, especiallyloan officers who serve more than 500 borrowers on average. Management mustensure that the increase in staff—and thuscost—is balanced by an increase in incomefrom lending to additional borrowers, in or-der to maintain the profitability and sustain-ability of Unit operations.

Re-invest profits to ensure sustainability.

BRI should not use the Units’ profits tocross-subsidize the non-profitable parts of BRI as has been done. Profits shouldrather be re-invested in the Unit infrastruc-

ture in order to improve the services to those who enabled the profits, Unit borrowers and savers.

Microfinance providers need competition.

BRI Units need competition, which theyhave not had, and they hold a quasi-mo-nopolistic position in the rural areas of Indonesia with market shares of 74 percent(deposits) and 39 percent (loans). Policymakers should create a conducive policy environment, and donors should providesupport to other microfinance operators(for example, private rural banks) to encourage healthy competition. Competi-tion is the driving force behind innovations,expanding outreach, and improving servicesto the poor. All these efforts are necessaryto maximize the impact of large-scale microfinance on the reduction of povertyand on the achievement of the MillenniumDevelopment Goals.

End Notes

1 K. Maurer and H.D. Seibel, Agricultural DevelopmentBank Reform: The Case of Unit Banking System of BankRakyat Indonesia (BRI), Rural Finance Working Paper,No. B5 (Rome: International Fund for AgriculturalDevelopment [IFAD], 2001).

2 M.S. Robinson, The Microfinance Revolution, Volume2: Lessons from Indonesia (Washington D.C.: WorldBank, 2001).

3 R.H. Patten, J.K. Rosengard, and D. Johnston, Jr.,“Microfinance Success amidst Macroeconomic Failure:The Experience of Bank Rakyat Indonesia during theEast Asian Crisis,” World Development 29, no. 6 (June2001): 1957–69.

4 J. Marquez and J. Seward, Bank Rakyat Indonesia:Financially Sustainable Lending to the Enterprising Poor(Cambridge, Mass.: Harvard University, John F. KennedySchool of Government, 2002)

5 World Bank, Financial Sector Monthly Report—October 2003, internal document, World Bank,Washington, D.C., 2003.

6 The MIXMarket. 2004. http://www.mixmarket.org

7 Bank Rakyat Indonesia (BRI), BRI MicrobankingServices: Development Impact and Future GrowthPotential (Jakarta: BRI; and Cambridge, Mass.:Harvard University, Center for Business andGovernment, John F. Kennedy School of Government,2001).

8 BRI Microbanking Services: Development Impact andFuture Growth.

9 M.S. Robinson, “Savings Mobilization andMicroenterprise Finance: The Indonesian Experience,”in The New World of Microenterprise Finance, ed. M.Otero and E. Rhyne (West Hartford, Conn.: KumarianPress, 1994).

■ ■ ■

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Bibliography

■ ■ ■

Afwan, I., and S. Charitonenko. Commercialization ofMicrofinance: Indonesia. Manila: Asian DevelopmentBank, 2003.

Asian Development Bank. Technical Assistance No.3810—Indonesia: Rural Microfinance. Frankfurt:Bankakademie International, 2003.

Bank Rakyat Indonesia (BRI). Introduction to BRI’s UnitBanking System. Jakarta: BRI, 1997.

Bank Rakyat Indonesia (BRI). BRI MicrobankingServices: Development Impact and Future GrowthPotential. Jakarta: BRI; and Cambridge, Mass.:Harvard University, Center for Business andGovernment, John F Kennedy School of Government,2001

Charitonenko, S., R.H. Patten, and J. Yaron.. Indonesia:Bank Rakyat Indonesia—Unit Desa 1970–1996.Sustainable Banking with the Poor, Case Studies inMicrofinance. Washington, D.C.: World Bank, 1998.

Hieman, W. Case Study: Bank Rakyat Indonesia. In TheChallenge of Sustainable Outreach: How Can PublicBanks Contribute to Outreach in Asia? Five CaseStudies from Asia, ed. D. Steinwand and M. Wiedmaier-Pfister. Eschborn, Germany: German Agency forTechnical Cooperation (GTZ), 2003.

Holloh, D. ProFi Microfinance Institutions Study.Denpasar, Indonesia: Bank Indonesia and GermanAgency for Technical Cooperation (GTZ), 2001.

Marquez, J., and J. Seward. Bank Rakyat Indonesia:Financially Sustainable Lending to the Enterprising Poor.Cambridge, Mass.: Harvard University, John F. KennedySchool of Government, 2002.

Maurer, K. Bank Rakyat Indonesia (BRI): Indonesia. Casestudy for CGAP Working Group on Savings Mobilization.Washington, D.C.: CGAP, 1999.

Maurer, K., and H.D. Seibel. Agricultural DevelopmentBank Reform: The Case of Unit Banking System of BankRakyat Indonesia (BRI). Rural Finance Working PaperNo. B5. Rome: International Fund for AgriculturalDevelopment (IFAD), 2001.

The MIXMarket. 2004. http://www.mixmarket.org

Robinson, M.S. “Savings Mobilization andMicroenterprise Finance: The Indonesian Experience.”In The New World of Microenterprise Finance, ed. M.Otero and E. Rhyne. West Hartford, Conn: KumarianPress, 1994.

Robinson, M.S. 2001. The Microfinance Revolution. Vol.2, Lessons from Indonesia. Washington D.C.: WorldBank.

Patten, R.H., and J.K. Rosengard. 1991. Progress withProfits: The Development of Rural Banking in Indonesia.San Francisco: International Center for EconomicGrowth.

Patten, R.H., J.K. Rosengard, and D. Johnston, Jr.“Microfinance Success amidst Macroeconomic Failure:The Experience of Bank Rakyat Indonesia during theEast Asian Crisis.” World Development. 29, no.6 (June2001): 1957–69.

World Bank. KUPEDES: Indonesia's Model Small CreditProgram. Operations Evaluation Department, OEDPrécis, No.104. Washington, D.C.: World Bank, 1996.

World Bank. Financial Sector Monthly Report–October2003. Internal document, World Bank, Washington,D.C., 2003.

Yaron, J. Successful Rural Financial Institutions. WorldBank Discussion Paper 150. Washington, D.C.: WorldBank, 1992.

Endnotes Continued

10 BRI Microbanking Services: Development Impactand Future Growth.


Executive Summary

With the passage of the Popular Savings and Credit Act in 2001 and the subsequent launch-ing of a US $150 million program to strengthen savings and credit institutions and expandtheir outreach in marginal rural areas, the Mexican government embarked on a pioneeringeffort to alleviate poverty and increase income-generating potential by massively scaling-upaccess to safe and efficient financial services for the poor.

The Savings and Credit Sector Strengthening Program, BANSEFI

The Savings and Credit Sector Strengthening Program, implemented by the National Sav-ings and Financial Services Bank (BANSEFI), is building the capacity of more than 400“popular savings and credit institutions” (or EACPs by their Spanish acronym) to meet newlegal and regulatory standards and offer safer, more efficient financial services. The EACPstarget almost 3 million users who are generally among the poor and lower-income groups.These clients typically have no access to the commercial banking sector, which currentlyreaches only about 25 percent of the adult population in Mexico’s urban areas and has amuch smaller presence in the rural sector.

BANSEFI wants to ensure that the clients of every savings and credit institution gain access to safe and efficient financial services via its outreach expansion programs. Hence,BANSEFI is developing an information system to link EACPs (those that elect to participate)to its network federations and confederations, the banking supervisor, and BANSEFI itself.This shared technological platform will offer retail financial service advanced software andservices—such as treasury management, funds compensation, and portfolio risk analysis—atlower costs available to a network of financial institutions than to individual institutions.

With this technological platform (currently in its pilot stage), BANSEFI also spearheadedthe development of a voluntary internet-based network of savings and credit institutions

Integrating the Poor into the Mainstream FinancialSystem: The BANSEFI and SAGARPA Programs inMexicoBY LISA TABER, WITH CARLOS CUEVAS

AND INPUTS FROM JUAN NAVARRETE AND GABRIELA ZAPATA

Chapter 8

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Integrat ing the Poor into the Mainst ream Financ ia l Sys tem

called “L@Red de la Gente,” or “the Peo-ple’s Network.” L@Red links BANSEFI’s551 branches to more than 180 offices of19 participating institutions, and creates anexpansive network of more than 730branches. As of 2005, clients of any partic-ipating branch or institution will be able tomake transactions on their accounts, formost of the products offered, from anyother network participant.1

More importantly, these individual insti-tutions and branches have been incorpo-rated as nodes in the network of the national payments system. As a result, emigrants and public institutions can sendcash transfers securely and cost-effectivelyto recipients in some of Mexico’s poorestand most remote locations. Federal programs providing payments to targetedgroups for health, education, and agricul-tural production are already tapping the potential of L@Red, which will expand toinclude approximately 2,000 branches whenthe Savings and Credit Sector Strengthen-ing program is completed in 2008. by to. Asof December 31, 2003, L@Red de la Gentehad distributed payments from these programs to more than 1.5 beneficiaries,and this number is expected to grow to 3.3million by the end of 2004.

Among these programs, Oportunidades(a program that provides cash subsidies for health and education expenses to thepoorest of Mexican families) is worth noting. This is one of the most successfulanti-poverty programs in Mexico. Approx-imately 750,000 savings accounts have been opened as a new way to transfer

government subsidies through L@Red de laGente. This has not only made Oportu-nidades more transparent, but has had the effect of coaxed the poorest Mexicanfamilies into using financial products. Asthese poor families earn interest on theirnew accounts, they learn how savings canopen access to other types of financial serv-ices. This is the major permanent impact ofthe program. As of December 2003, for example, 78 percent of the 633,974 peoplewho received transfers through L@Redfrom Oportunidades had savings accountswith positive balances in branches ofL@Red. This suggests that this strategy isintroducing savings services into the welfaredynamics of poor families, which can be thebasis of future asset accumulation.

In addition to the transfers from govern-ment programs, the network also channeledmore than US $53.6 million in remittancepayments, sent from abroad to friends andfamily members. It is worth noting thatL@Red de la Gente offers accounts that linkdifferent savings and investment products(standard savings accounts, housing-savingsaccounts, etc.). This feature is particularlyuseful for remittances, since emigrants can chose the proportions of the moneysent to be cashed or invested in different financial products.

Reaching the Rural Marginal Areas,SAGARPA

As part of the same government strategy,the Secretariat of Agriculture, Livestock,Rural Development, Fisheries, and Nutri-tion (SAGARPA) is now working in 13


The BANSEFI and SAGARPA Programs in Mexico

states to set up new savings and credit insti-tutions, build the capacity of existingEACPs. SAGARPA aims to bridge the gaps in knowledge, understanding, and interaction between these financial serviceproviders and the communities of poor andmostly indigenous people living in the areasthey serve.

A survey of Mexico’s marginal rural areasin 2000 showed that just 2.5 percent ofhouseholds had access to credit from a financial institution, and less than 6 percentused formal financial savings instruments.Poor households in marginalized rural areasstand to gain the most from increased accessto financial institutions and services—wherethey can safely build up liquid savings—be-cause currently they rely on informal savingsmechanisms and physical assets, like smalllivestock, that have low yields and high lossrates. They generally pay high transactioncosts and commissions to receive remittancepayments, and are typically charged about120 percent2 per year in interest if they borrow money.

To combat these trends, SAGARPA be-gan to implement the Rural MicrofinanceTechnical Assistance Project (or PATMIRin Spanish) in 2001 to expand the networkof EACPs into Mexico’s poor and isolatedrural communities. PATMIR providesEACPs with technical assistance and limitedstart-up funding to develop the outreachcapacity of their existing institutions, including opening new branches or savingsand credit institutions. In each case, technical assistance providers also ensurethat participating institutions comply with

the new law requiring minimum perform-ance standards.

As of January 2004, PATMIR hadstrengthened and increased the outreach ca-pacity of 41 EACPs in Chiapas, Huasteca,Guerrero, and Veracruz, improving the fi-nancial institutions upon which nearly24,000 people rely. In addition, more than10,000 clients gained access to financial serv-ices at new branches or institutions.Clientshave more secure savings and can cashchecks at savings-driven institutions that follow sound and prudent financial practices.These institutions also offer other services,such as credit funded by member savings andaccess to the payments system to receive remittances and government transfers (viaL@Red de la Gente).

The program has now expanded to threemore regions of the country and is expectedto sustainably integrate more than 80,000people from Mexico’s poorest, most mar-ginalized groups into the financial systembefore its completion in 2007. To achievethis goal, PATMIR works extensively with individuals and groups in these ruralcommunities to educate them about thebenefits of formal savings, how to use savings and other financial services to their advantage, and the rights and respon-sibilities of membership in a cooperative financial institution. Rather than quicklyadding names to a membership roster, theprogram focuses on cultivating conciencia,confianza y compromiso—awareness, trust,and commitment—between the new mem-bers (who are typically from indigenousgroups and include everyone (women,

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youth, and the aged, as well) and their financial institutions, so that each under-stands its investment in the other.

In addition, PATMIR helps the EACPsto incorporate new ways of attracting andresponding to marginalized clients. Theycan hire multi-lingual staff to promote theirservices and introduce personal digital assis-tants and mobile banking to make savingsmore convenient and attractive.

In 2003, more than 4.2 million familiesreceived transfers through one federal safetynet program alone, and US$13.2 billion inremittances flowed into the country fromMexicans living and working abroad. Mostof these funds went to the marginal areaswhere PATMIR is working. By incorporat-ing poor and marginalized households intothe financial system and providing themwith safe savings facilities, families an develop the capacity to better manage thefunds received and capitalize on these fundsto generate more on their own.

Main LessonsBringing the poor into the financial system, especially those at the margins of society in geographically isolated regions,teaching them to better manage the cash resources they have, and giving them accessto new sources of finance at lower costs isthe root objective of the massive and ambi-tious programs undertaken since 2001 by BANSEFI and SAGARPA. While it ispremature to assess the programs’ overallimpact, results to date indicate that they arelikely to have far-reaching effects on thescope and direction of sustainable financial

services in the future to alleviate povertyand stimulate equity-enhancing growth.The main lessons the BANSEFI andSAGARPA programs have revealed so far in-clude the following:

■ Government intervention can effectivelyincrease access to financial services forlow income households and businessesthrough getting the regulatory frame-work right, building the institutional capacity of financial institutions, andsubsidizing the deployment of moderntechnology to increase the efficiency ofservice providers.

■ Packaging the development of ade-quate regulations and supervision, institutional capacity-building, andtechnological infrastructure is morelikely to yield sustainable results andcost less over time than traditional interventions which focus on increasingcredit flows.

■ Outreach expansion efforts among thepoor in marginalized rural areas havemuch better long-term prospects ifthey focus on building the stake thatthese clients have in their savings andcredit institutions, as savers, rather thanbuilding financial relationships basedon the expectation of getting a loan.


Context

In 2000, Mexico was in the midst of a remarkable economic comeback and



profound political transformation. After tenyears of gains in poverty reduction were undone by the severe macroeconomic andfinancial crisis of 1994–95, the financial system had stabilized, credit to the privatesector was growing, and the economy wasexpanding at a rate of nearly 7 percent perannum. President Vicente Fox's electoralvictory in July ended 71 years of domina-tion by a single political party. It broughtenergy and hope into the policy-making andlegislative processes with the widespread expectation of more open, participatory,and transparent government.

Yet about 58 million Mexican people—50percent of the total population—still lived inpoverty in 2000. While the commercial bank-ing sector had recovered from the collapse of1994–95, about three-quarters of all adults inmetropolitan areas—and 85 percent of indi-vidual entrepreneurs—had no access to thesefinancial outlets. Bank density ratios were low,with a country-wide average of one branchper 12,000 people. In the southern states ofOaxaca, Chiapas, and Guerrero, bank branchdensities ranged from one for every 25,000 to30,000 people. In rural areas, where abouthalf the population live in extreme poverty,participation in the formal financial systemwas predictably low. A survey of rural areas inthe Oaxaca and Huasteca regions in 2000showed that just 2.5 percent of householdshad access to credit from a financial institu-tion, and less than 6 percent used formal financial savings instruments.

About 3 million people countrywide, orapproximately 7 percent of the economi-cally active population, relied on loosely or

completely unregulated financial institu-tions to safeguard their savings or provideloans, including a variety of savings andcredit associations, cooperatives, creditunions and NGOs. While some of these instituciones de ahorro y crédito popular, orpopular savings and credit institutions,3 hadbuilt a tradition of solid financial intermedi-ation over more than 50 years, the lack ofeffective regulation and supervision of the sector as a whole put millions of peopleat risk of losing hard-wrought savings andinvestments in poorly or unscrupulouslymanaged institutions. These risks becamemore apparent with the failure of numerousinstitutions due to fraudulent activities in 1998–2000. The vast majority of theseinstitutions were small, community-basedorganizations, moreover, with no links tothe national payment system, limited prod-uct offerings, and low levels of technologyand efficiency.

Despite these weaknesses, in the late1990s policy-makers began to perceive that popular savings and credit institutionscould potentially play a key role in alleviating poverty and stimulating inclusive economic growth. In 1999, theSecretariat of Finance and Public Credit(SHCP), the National Banking and Securi-ties Commission (CNBV), the CentralBank of Mexico (BANXICO), and the National Savings Bank (PAHNAL) initiateda process of consultation with legislators,sector institutions, and the World Bank onthe development of a new legal and regula-tory framework for popular savings andcredit institutions.

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Both the outgoing and incoming administrations employed a two-pronged development strategy to combat poverty:efficient and well-targeted public spendingcombined with sound macroeconomic management. Clearly the lack of access tosafe, efficient financial services was affectingthe ability of poorer Mexicans to get out ofpoverty through their own savings, the helpof emigrant family members, or productiveinvestment in their own enterprises. The ac-cess problem was particularly acute in ruralparts of the country, where the governmenthad recently put forward major initiatives—such as dissolving the state grain purchasinginstitution—to curtail market distortionsand encourage the pursuit of new businessopportunities in the NAFTA environment.

Agricultural growth picked up after 1998and aggregate poverty trends declined, butproductivity gains were still low and one ofevery two Mexicans living in rural areas wasextremely poor. Maintaining a stable macro-economic environment, funding socialsafety net programs, and investing in criti-cal infrastructure were key elements of theFox administration’s poverty alleviationstrategy. In addition, the new governmentfocused on enhancing competitiveness, par-ticularly of small-scale enterprises, by betterintegrating markets and targeting capitaliza-tion programs, especially at poorer groupsin the rural sector.

Overhauling the Legal, Regulatory, andInstitutional Framework

The potential to provide millions of peoplewith efficient and competitive financial

services through savings and loans, creditunions, cooperatives and savings associa-tions, which were operating about 1800 offices—including in some of the most remote corners of the country—became atop public policy priority for Fox’s adminis-tration in 2000. The Consejo Mexicano deAhorro y Crédito Popular (COMACREP),a council representing at least 80 percent ofthe sector, was formed to participate in thedialogue with government officials, thusgiving about 1.5 million clients or membersfrom communities throughout Mexico avoice in the future of their organizations.After more than 16 months of analysis andnegotiations, the Popular Savings andCredit Act was passed in April 2001.

The law, which became effective on June4, 2001, provides for the gradual incorpo-ration of all non-bank savings and credit in-stitutions into a new legal and regulatoryframework over a four-year period, andforms the basis of what is perhaps the mostambitious effort to massively scale-up accessto financial services for poor and marginal-ized people in the world. Under the newlaw, two types of popular savings and creditinstitutions (referred to in Spanish as Enti-dades de Ahorro y Crédito Popular, orEACPs), will be authorized by the CNBVto collect deposits from the public and con-duct a range of intermediation activities.The scope of intermediation activities andprudential standards to which institutionsare held depends on the size, geographiccoverage, and demonstrated operational capacity of each entity, as distinguished byfour distinct categories of operations.



The CNBV is also in charge of licensingfederations (voluntary groupings of retailEACPs) and confederations (voluntarygroups of federations), which play pivotalroles in the new regulatory system. To belicensed by the CNBV, an institution must

first receive a favorable rating from the Supervision Committee of its federation,which evaluates candidates and subse-quently supervises its licensed members—inan “auxiliary” capacity—according to standards established by the banking au-thority.4 The decisions of the supervisioncommittees with respect to the entrance orcontinued operation of a member EACPcan be overruled by the CNBV, however,which maintains ultimate responsibility for the prudential oversight of the individ-ual retail institutions.

A complementary law, enacted on June 1,2001 transformed PAHNAL into the National Savings and Financial Services Bank(Banco del Ahorro Nacional y Servicios Financieros), or BANSEFI. PAHNAL had a50-year history and network of 590 branchesfocused exclusively on capturing deposits,mainly among small-scale clients, investingtheir funds primarily in government debt securities, and proving nodes in the paymentsystem often used to distribute payments bythe federal government. Under the new in-stitutional framework, BANSEFI retainedPAHNAL’s role of promoting savings habits,and gained an important new set of man-dates as a bank for the popular savings andcredit institutions and the coordinator of an ambitious one-time program of publicsupport to the sector.

The Scope of the Initiative

The US$150 million program, whichBANSEFI initiated in 2002 in coordinationwith other public sector agencies, includingthe CNBV and the Secretariat of Agricul-ture, Livestock, Rural Development, Fish-eries and Food (SAGARPA), encompassesthe following :

■ Consolidating and strengthening ap-proximately 400 popular savings andcredit institutions to bring them intoline with new regulatory standards andimprove their efficiency and outreachcapacity

■ Strengthening EACP federations andconfederations

■ Developing an information technologysystem linking EACPs, federations, con-federations, regulators, and BANSEFI,which will help the retail outlets reduceoperating costs, improve the efficiencyof their administrative processes, and facilitate regulatory compliance throughautomated reporting

■ Developing the capacity of BANSEFIto provide second-tier central bankingservices to the sector, such as back-of-fice functions, accounting, reportingand financial management, and liquid-ity brokerage

■ Strengthening the CNBV’s capacity toadequately supervise hundreds of small,dispersed financial intermediaries, themajority of which are engaged in microfinance activities, through theauxiliary supervision structure

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■ Evaluating the social and economic im-pact of the program and the sector onan on-going basis, to gauge its successand allow for adjustments as needed tomeet poverty-alleviation objectives

Most importantly, the program will incorporate millions of new clients into theformal financial intermediation system. Retaining recipients of government transferpayments as new account holders in aprocess called bancarization is already rapidly integrating previously unserved segments of the population into the economy through their access to financialservices.

BANSEFI and SAGARPA are also coor-dinating efforts through an innovative part-ner project (implemented by SAGARPA) toexpand the outreach of popular savings andcredit institutions particularly amongwomen and indigenous groups, in marginalrural areas of Chiapas, Hidalgo, San LuisPotosí, Veracruz, Oaxaca, Guerrero, More-los, Michoacán, the State of Mexico,Puebla, and Tlaxcala.

The Rural Microfinance Technical Assis-tance Project, or PATMIR, provides train-ing in basic principles of household financeand participation in financial institutions forgroups and individuals in marginal ruralcommunities. It also assists savings andcredit institutions in increasing their outreach to these clients by tailoring products, promotional materials, and outreach methods to the needs of commu-nity members. In marginal areas where nointermediaries exist, PATMIR providesprofessional technical assistance and limited

start-up funding to develop new savings andcredit institutions, or for existing institu-tions to open new branches. In each case,technical assistance providers also assist participating institutions in complying withthe new legal and regulatory standards.

Implementing BANSEFI and Progress to Date

The government faced formidable challengesin developing and implementing the programto transform the savings and credit sector, asapproximately 90 percent of the existing insti-tutions lacked the experience and capacityneeded to meet the standards of sound regu-lation and supervision. The great majority ofinstitutions, moreover, are very small, withsingle branches located in dispersed commu-nities throughout the country.

A census of institutions was initiated in September of 2001 to determine moreprecisely the number and size of entities operating in the sector, their locations, andaffiliations with other such organizations, ifany. A more in-depth evaluation of a subsetof those institutions provided more infor-mation on the financial health and techno-logical capacity of popular savings and creditinstitutions, as well as their operational,management and governance capacity. This information was used to help gaugethe extent—and cost—of the program oftechnical assistance needed to strengthenthe intermediaries.

Technical assistance and training are being provided to Supervision Committeesand EACPs countrywide, so they can evaluateevery savings and credit institution which opts



to participate, and strengthen or restructur-ing those institutions which do not yet meetthe operational or solvency standards of thenew legal and regulatory framework.

To meet these objectives, BANSEFI has recruited international organizationsspecialized in providing technical assistanceto savings and credit institutions and theirsector organizations through a competitivebidding process that began in 2001. Actionplans have now been formalized for 381 institutions, of a total of 400 that are expected to participate in the program.Those remaining have either chosen to stopmobilizing deposits or will be merged, acquired, or dissolved.

In addition to their individual actionplans, popular savings and credit institutionshave the opportunity to attend training sessions organized by BANSEFI. So far,courses on risk management, credit analysis,accounting, and governance have been attended by 2,900 people from about 400institutions. Training for federations andconfederations has emphasized the prepara-tion of supervision committee members. Asof November 30, 2003, seven auxiliary su-pervision committees had received intensivetraining in the law and applications of the norms and guidelines developed forevaluating and classifying institutions, andhave been certified by the CNBV.

The CNBV now has 27 people to provide oversight for the sector through aspecialized unit, the General Directorate forthe Supervision of Popular Savings andCredit Institutions (or DGSEACP, by itsSpanish acronym). Each of these staff have

benefited from on-site training with expertconsultants and participated in seminars andstudy tours to improve their capacity to ef-fectively supervise the savings and creditsector through the auxiliary mechanism.The CNBV has also developed a number oftools, including the Supervision Guidelinesfor the federations’ supervision committees,the Integrated Supervision Manual for in-ternal use, and a specialized financial analy-sis system.

BANSEFI has undertaken initiatives todisseminate the requirements of the newlaw, and accompanying supervision and reg-ulatory framework. Seven workshops havebeen conducted jointly with the CNBV,each in a different region of the country, toexplain the changes, encourage institutionsto participate in the sector consolidationand strengthening program.

Key to BANSEFI’s role, however, arethe actions it has taken with respect to developing a technological platform whichsector institutions can use to access back-office or liquidity services, to file mandatedreports to their supervision committee andto the CNBV, and also to network withother institutions. The technology platform is expected to reduce the transac-tion costs and expand the range of servicesprovided by the sector, in addition to facilitating the accreditation of the entitiesby the CNBV.

The organizational basis of the commer-cially-oriented network has already beenformed with the establishment of “L@Redde la Gente” (“The People’s Network”), avoluntary internet-based alliance of popular

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savings and credit institutions and BANSEFI.L@Red has already linked BANSEFI’s 554branches with more than 180 offices of 19participating institutions to provide a geo-graphically expansive network of more than730 branches of coverage.

Implementing SAGARPA and Progress to Date

As of January 2004, PATMIR had so farstrengthened and increased the outreach ca-pacity of 41 savings and credit institutionsand their branches in Chiapas, Huasteca,Guerrero, and Veracruz, providing morethan 10,000 clients with access to financialservices from new branches or institutions,and improving the financial institutionsupon which nearly 24,000 people rely.

The program now has operations in threemore regions of the country and is expectedto sustainably integrate more than 80,000people from Mexico’s poorest, most margin-alized groups into the financial system beforeit finishes in 2007. To achieve this goal,PATMIR works extensively with individualsand groups in these rural communities to ed-ucate them about the benefits of formal sav-ings, how to use savings and other financialservices to their advantage, and the rightsand responsibilities of membership in a cooperative financial institution. Rather thanquickly adding names to a membership roster, the program focuses on cultivatingconciencia, confianza y compromiso—aware-ness, trust, and commitment—between newmembers (who are typically from indigenousgroups and include everyone—women,youth, and the aged, as well) and their

financial institutions, so that each under-stands its investment in the other.

In addition, PATMIR helps the EACPsincorporate new ways of attracting and re-sponding to marginalized clients—by hiringmulti-lingual staff to promote their servicesand introducing personal digital assistantsand mobile banking to make savings moreconvenient and attractive, for instance. In2003, more than 4.2 million families received transfers through one federal safetynet program alone, and US $13.2 billion inremittances flowed into the country fromMexicans living and working abroad. Muchof these funds went to the marginal areaswhere PATMIR is working. By incorporat-ing poor and marginalized households into the financial system and providingthem with safe savings facilities, families aredeveloping the capacity to better manageand capitalize on funds they generate andreceive from multiple sources.

Impact AnalysisThe cost of the popular savings and creditsector strengthening program, including theRural Microfinance Technical AssistanceProject administered by SAGARPA and the comprehensive sector strengthening program underway through BANSEFI, totals about US $150 million. The objectiveof this program is to develop a vibrant and viable savings and credit sector with dramatically increased financial services out-reach, especially to poor and marginalized rural populations. It is premature to assessthe program’s overall impact, given that it is still being implemented and ex-ante



cost-benefit analyses of this type of institu-tion-building initiative are problematic. Thedegree to which program results translateinto poverty reduction will be carefully monitored, however, using panel data from6,000 households that will be surveyed annually over the five-year period beginningin 2004.

Implementation progress and indicatorsof impact, to date, indicate that the pro-gram is likely to achieve its objective of increasing the number of people served byparticipating financial institutions from 2million to 5.5 million by 2008, and showsubstantial progress in poverty alleviation.The benefits to members and clients ofEACPs are reaped directly through lowercosts of credit and payment services, positive yields and increased security on savings deposits, and greater access to an array of government programs, includingsocial insurance.

Benefits for Institutions

When financial institutions become more efficient and financially sound, clients canbenefit from the lower costs and risks asso-ciated with their products and greater accessto services. In addition to the advantages ofadequate supervision and regulation, theeconomic benefits for the institutions participating in the program are clear. Efficiency gains will accrue to the EACPsfrom staff training, upgrading internal controls, and building credit appraisal andrisk management capacity, and through theservices provided by BANSEFI and networkorganizations. One such benefit provided to

EACPs by BANSEFI relates to liquiditymanagement. BANSEFI consolidates theliquidity of EACPs and invests it on theirbehalf in the commercial banking system,thus securing a higher interest rate thanwhat the entities could obtain individually.By late December 2003, a total of 93 EACPs had already invested 626.2 mil-lion Mexican pesos—or US$55.8 million—in BANSEFI.

The technological platform for EACPscurrently being piloted by BANSEFI willcontribute significantly to their operationalefficiency and income-generating potential.Rather than each individual institution acquiring the technology componentsneeded to manipulate, transfer, and storethe information needed to operate andcommunicate with other sector institutions,EACPs can subscribe to these services selectively and share the cost with other participants. The creation of this commontechnology platform will allow for sharedoperating, technological, and marketingprocesses, and a common trademark.

In addition to compatible or shared hard-ware and software, the alliance BANSEFIhas created with sector institutions throughL@Red de la Gente (which currently includes more than 730 participatingbranch locations) is expected to includemore 3,000 points of service by 2008.L@Red aims at breaking a key barrier to developing a viable system of financial serv-ices for the poor: gaining sufficient scaleand scope to cost-effectively process largenumbers of small-volume transactions. An-other important result of this technological

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interlinking is the ability to organize partic-ipating institutions as conduits for govern-mental support programs, which will makeit possible for institutions to increase theirrevenues through fees for the distributionof financial services, and more importantly,by retaining users and increasing their mar-ket penetration.

Benefits for Clients

Providing access to sound, efficient finan-cial services clearly contributes to incomegeneration and poverty alleviation at thehousehold level. This is particularly true for the poorer rural households, which areexpected to gain from access to adequatedeposit instruments and an improved ability to take advantage of productive investment opportunities.

Economic analysis5 has shown that transforming informal, non-earning finan-cial assets, and monetizing even a fractionof the savings held in physical form by ruralhouseholds, would have substantial eco-nomic benefits in terms of safety and return.Informal means of savings that dominatethe households’ portfolios are, in principle,inferior to financial instruments in terms ofsafety and returns. For example, tandas, orrotating savings clubs, report a 6 percentrate of noncompliance (group memberswho cease to contribute once they havetaken a turn); and the most common formsof livestock holding, pigs and chickens, havemortality rates above 40 percent. Sinceholding livestock as savings is more preva-lent in poorer areas and among indigenouspeople than elsewhere, the transformation

of these assets into financial savings wouldbenefit the poorest segments of the popula-tion by increasing returns and providinggreater liquidity.

By providing poor and remotely locatedhouseholds with access to the national pay-ments system through the L@Red de laGente, moreover, they can more securelyand cost-effectively receive remittance payments from family members workingelsewhere in Mexico or abroad, as well as thebenefits of social safety net and developmentprograms. As of December 31, 2003,L@Red de la Gente had distributed paymentsfrom federal health, nutrition, education,and agricultural production programs tomore than 1.5 million beneficiaries, and thenumber is expected to grow to 3.3 millionby the end of 2004. By receiving transferpayments through L@Red, poor beneficiar-ies are introduced to financial institutionsand encouraged to participate as members or clients.

About 750,000 new savings accounts havebeen opened at L@Red institutions throughone such program, Oportunidades, whichprovides targeted cash subsidies for health andeducation. This transfer mechanism hashelped to introduce some of the poorest fam-ilies in Mexico to the financial system. As theseclients earn interest on their new accounts,they learn how savings can open access toother types of financial services. This is themajor permanent impact of the program. Asof December 2003, for example, about 80percent of those beneficiaries of Oportu-nidades who had savings accounts in branchesof L@Red were maintaining a positive account



balance. This suggests that this strategy is introducing savings services into the welfaredynamics of poor families, which can be thebasis of future asset accumulation.

In addition to the transfer of governmentprograms, L@Red had also channeled morethan US $53.6 million in remittance payments to recipients as of December 31,2003. L@Red de la Gente offers accountsthat link different savings and investmentproducts—such as standard savings ac-counts and housing investment funds, forinstance—so that emigrants can chose howto allocate remittances among differenttypes of accounts.

SAGARPA is working to ensure that themost marginalized people living in largelyindigenous rural communities benefit from access to L@Red, as well as the otherfinancial services that savings and credit institutions provide. Through the PATMIRproject, more than 41 savings and credit institutions and branches have received spe-cialized technical assistance to strengthenand increase their outreach capacity amongmarginalized clients, so far improving orgenerating access to financial services formore than 34,000 poor people.

DRIVING FACTORS


The determination to reform and transformthe popular savings and credit sector, as ameans of alleviating poverty and integratingmillions of poor and lower-middle classMexicans into the formal financial system,

was in part the result of a historical evolu-tion in Mexican politics. The election of President Fox in July of 2000 was theculmination of many years of work to createa political system characterized by greaterparticipation, openness, and accountabilityon the part of Mexicans from diverse socialand economic groups and political affilia-tions. These same forces have arguablyhelped foster the political will needed toembark on an ambitious and comprehensiveprogram to integrate into the formal financial system those institutions that servepeople on the margins of society.

The degree of economic stability Mexicoregained over the last decade has also playedan important part in providing the resourcesneeded to reform the EACP sector. The results of increased economic integra-tion with the United States throughNAFTA, sound domestic macroeconomicmanagement, and high oil prices since 1999have all contributed fundamentally to the prosperity and stability that have clearly facilitated the EACP reform.


Prior to directing its attention to the popu-lar savings and credit sector, the government had previously attempted toprovide access to financial services primarilythrough first and second-tier developmentbanks and trusts. This approach generallyrelied on directed credit at subsidized interest rates, subsidized credit guarantees,and debt forgiveness and restructuring.These interventions were unsuccessful inproviding sustained access to financial serv-

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ices for their target populations and re-quired large fiscal outlays, estimated to costapproximately US$28.5 billion over the1983–92 period.

The government began introducing re-forms in rural credit policies in the early1990s, reducing interest rate subsidies,making transfers to development banksmore transparent, and experimenting withalternatives to promote sustainable, com-mercial intermediation. A project waslaunched in 1995 to provide subsidies forcommercial banks to establish services insmall cities and rural towns where there wasno banking presence. Banks were reluctantto participate and retreated from the program and rural areas altogether with theexchange rate crisis and rapid economic decline of 1995–96.

In addition to these policy failures,the lackof an adequate legal and regulatory frame-work for savings and credit institutions com-pleft low-income depositors exposed to therisk of losing their savings and constrainedthe growth of the sector. Numerous savingsand credit institutions were thus supportingthe development of an appropriate legalframework for their activities. At the sametime, the need for institutional change wasreinforced by the detection of fraudulent activities committed by managers of somepopular savings and credit institutions in thelate 1990s. Not only did thousands of low-income depositors lose their savings inthese cases, but some municipal govern-ments that managed their funds through savings and credit institutions lost millions ofdollars in scarce public resources. As a result,

both the government and the sector initiateda dialogue that led to the design and approval of the new law which governs thesector’s activities.

At the same time, international develop-ment agencies were putting increasing focuson the potential of popular savings andcredit institutions as a means for sustainableincreasing broad-based access to financialservices. A substantial number of these typesof institutions had been offering financialservices in Mexico for decades—withoutany regulation or supervision. Low levels of efficiency and a lack of widespread confi-dence on the part of depositors, however,severely limited their outreach capacity.

While it became clear that savings andcredit institutions represented great prom-ise in achieving the outreach and sustain-ability goals that so many public sector in-stitutions and interventions had not, therewere many difficult questions to answerwith regard to regulatory framework andthe nature and scope of public investmentneeded to shore up the sector.

It was clear that the sector, which wasand is dominated by small institutions—only three of which have more than 50branches—would likely take many years toconsolidate and organize on its own.BANSEFI was thus created to accelerateand enhance the process, through the benefits of networking, based on successfulexperiences in other countries. BANSEFI isnot an ordinary development bank, as itsmission and methods exclude lending. Toavoid shifting risk to the public sector,BANSEFI has concentrated on providing



fee-based services without exposing itself tothe credit risk of the EACPs or their clients.The value that BANSEFI provides to theEACP network institutions is likely to betransferred to them in the future when itputs itself up for sale to these clients. Whiledesigned from the experiences of successfulsavings and credit sector institutions world-wide, an institutional transformation of thenature and scope being undertaken byBANSEFI is undoubtedly a first in the annals of development banking.

At the same time, PATMIR was launchedin order to make sure that sound, efficientsavings and credit services are delivered tothe poor in rural areas, which does not normally happen through a "trickle downeffect." Large intermediaries have seldomshown any interest in the marginal rural sector; they tend to focus on an urban andsemi-urban market. PATMIR thereforeprovides technical assistance and small in-kind grants of support to institutions interested in developing tentacles to ruralcommunities and also creates intermediariesadept at responding to the needs of the people in these communities. SAGARPA’sinnovative program is to trying to demon-strate that the provision of financial services—based on a cooperative savings-driven model—can be profitable in marginalrural areas.


The implementation of this ambitious newregulatory and development framework forthe savings and credit sector has been achallenging process for many of the institu-

tions involved. Some institutions have resis-ted the changes, preferring to remain out-side of the new legal and regulatory system.Some of them have tried to influence legis-lators in order to boycott the transition ofcooperatives into either of the two types ofsavings and credit institutions considered inthe Popular Savings and Credit Act.6 Theinclusiveness that characterized the designof the new law7 and its general acceptancehas prevented this resistance from garneringmuch support from legislators or other sector institutions, however. BANSEFI hasalso organized an ongoing campaign to inform and facilitate participation in thenew system through greater understandingof how and what it will require.

BANSEFI has not only emphasized therelevance and practical aspects of imple-menting the new law in its communicationsand outreach, but has had to focus on explaining its own role in the sector as well.Indeed, its traditional mandate of promot-ing popular savings together with its newrole of coordinating public support for the sector seem contradictory to some insti-tutions. A few see BANSEFI more as a competitor rather than as an agent coordi-nating support. As a result, BANSEFI hashad to reiterate its intention to be sold tothe sector and shift its focus to providingsecond-tier central banking services to popular savings and credit institutions.8

In some cases, such as with the transferof government programs through L@ Redde la Gente, branches of the sector havebeen given priority when a branch ofBANSEFI is located in the same commu-

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nity. Communicating its mission has notbeen easy, nor have the effects of BANSEFI’sefforts to demonstrate its role as a partnerto popular savings and credit institutionsbeen immediate. The perceptions of thebank as a “competitor” are diminishing, andparticipation in the services and networks itsupports are increasing.

SAGARPA’s efforts to expand the out-reach of financial institutions in marginal rural areas have met the difficult challenge ofeducating people about the use and benefitsof financial services. New promotional toolsand methods have been developed to explain how financial products work andwhat improvements they offer over tradi-tional savings instruments are. Technical assistance providers work with institutions todevelop products tailored to the particularneeds of different marginalized communitiesin order to attract greater participation.Some of these products include savings plansand accounts tailored to specific groups, including savings plans for children, and accounts set aside for school fees and Christ-mas expenses. Group savings plans have beencreated, called “tandahorro,” which arebased on traditional rotating savings clubs; and specialized credit products, suchas credimujer for women and crediapuros foremergencies, have been designed to intro-duce new users to the formal financial system. Many of these services are provideddirectly at the community level by “promo-tores” or, in the case of a savings and creditinstitutions in Chiapas, via mobile bankingservices which operate on market days on aweekly or fortnightly basis.

External Catalysts

The government’s program of support forthe EACP sector, and for financial educa-tion and the expansion of savings groups inmarginal rural areas, was developed and isbeing implemented with the energetic andproactive participation of numerous development agencies and professional savings and credit institutions networksfrom many countries.

USAID has sponsored US $2 million intechnical assistance work to upgrade the capacity of one of Mexico’s primary savingsand credit networks since 1999. The USAgency for International Development has also been active in helping forge alliances between financial institutions inthe United States and the savings and creditsector in Mexico to help lower the costs toMexican emigrants sending funds back totheir families.

Through its Multi-lateral InvestmentFund, the Inter-American DevelopmentBank (IDB) has provided US $3 million intechnical cooperation for components of BANSEFI’s information system that isbeing upgraded. IDB has also provided support to the CNBV for training in auxil-iary supervision. The German governmenthas also supported the sector with US $ 1.2million for federation restructuring.

The World Bank has been a major spon-sor of the government’s initiative, havingprovided a loan of US $64.6 million in2002 to consolidate and strengthen savingsand credit institutions, build supervision capacity, pilot the technology platform forthe sector, and expand access to financial



services in rural marginal areas. The WorldBank is also preparing a new loan, worth ap-proximately US $70 million, to help thegovernment finance the national roll out ofthe technology platform.

Lessons Learned

Bringing the poor into the financial system,especially those at the margins of society ingeographically isolated regions, teachingthem to better manage the cash resourcesthey have, and providing access to newsources of finance at lower costs is the rootobjective of the massive and ambitious pro-grams undertaken since 2001 by BANSEFIand SAGARPA. While it is premature to as-sess the overall impact of the two programs,results to date indicate that they are likelyto have far-reaching effects on the scope anddirection of sustainable financial services inthe future to alleviate poverty and stimulateequity-enhancing growth. The main lessonsthe BANSEFI and SAGARPA programshave revealed so far include the following:

Government intervention can effectivelyincrease access to financial services for lowincome households and businesses by getting the regulatory framework right,building the institutional capacity of financial institutions, and subsidizing thedeployment of modern technology to increase the efficiency of service providers.

Packaging the development of adequateregulations and supervision, institution capacity building, and technological infrastructure is more likely to yield sus-tainable results and cost less over time than traditional interventions which focus on in-creasing credit flows.

Outreach expansion efforts among thepoor in marginalized rural areas havemuch better long-term prospects if they focuson building the stake that these clients havein their savings and credit institutions assavers, rather than building financial relationships based on the expectation ofgetting a loan.

End Notes

1 L@Red de la Gente represents, for many financialintermediaries, an additional incentive to acceleratetheir formalization process, since complying with estab-lished performance standards is a requisite to join thisstrategic alliance.

2 World Bank, Mexico Rural Finance: SavingsMobilization Potential and Deposit Instruments inMarginal Areas, Report No. 21286-ME, WashingtonD.C., World Bank, 2001.

3 “Popular savings and credit institutions” or “savingsand credit institutions” are used throughout this paperto denote a variety of non-bank financial intermediariesthat serve middle- and low-income segments of thepopulation, such as Sociedades de Ahorro y Préstamo(SAPs), Cooperativas de Ahorro y Préstamo (CAPs),Uniones de Crédito (UC), Cajas Solidarias (CS) or non-

governmental organizations (NGOs). Over 90 percent ofthese intermediaries are CAPs.

4 It is not obligatory for candidates to join a Federation.Nonetheless, they must obtain an opinion from a feder-ation and submit to that federation’s auxiliary supervi-sion. Any institution that does not wish to join a federa-tion may submit its application directly to the CNBV. TheCNBV will then determine which federation will issue theopinion and, if applicable, exercise auxiliary supervisionover the institution, provided that the authorization isgranted. Unaffiliated institutions must apply to a confed-eration to participate in its depositor protection fund,whereupon they would enter into an auxiliary supervi-sion agreement with that body’s member federations.

5 World Bank, Mexico Rural Finance, Report No. 21286-ME.

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6 They have sought immunity from the new law underthe umbrella of the so-called Ley General deSociedades Cooperativas.

7 Most notably, through organizations (like COMACREP)created to represent the sector in the dialogue that wasinitiated to design the new law.

8 The term Caja de Cajas is commonly used to denotethis role.

Bibliography

This case study was prepared by Lisa Taber, based oninternal World Bank, BANSEFI, and SAGARPA reports,and written inputs from Carlos E. Cuevas, LeadFinancial Economist for the Financial Sector Operationsand Policy Department of the World Bank; Juan JoseNavarrete Luna from BANSEFI; and Gabriela Zapata,Director of the PATMIR program in SAGARPA.

World Bank. Savings and Credit Sector Strengtheningand Rural Microfinance Capacity Building ProjectAppraisal Document. Report No. 23868-ME.Washington D.C: World Bank, 2002.

World Bank. Mexico: Country Assistance Strategy,2002. Report No. 23849-ME. Washington D.C: WorldBank, 2002.

World Bank. Mexico: Country Assistance StrategyProgress Report. Report No. 22147-ME. WashingtonD.C: World Bank, 2001.

World Bank. Mexico Rural Finance: Savings MobilizationPotential and Deposit Instruments in Marginal Areas.Report No. 21286-ME. Washington D.C: World Bank,2001.

World Bank. Mexico: Country Assistance Strategy,1996. Report No. 16056-ME. Washington D.C: WorldBank, 1996.

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EXECUTIVE SUMMARYThe Kazakhstan Small Business Programme (KSBP) is the second program to try to “down-scale” commercial banks as a means of delivering micro and small enterprise (MSE) loansin transition countries. Since its beginning in April 1998, KSBP has worked with seven private commercial banks (including the biggest and strongest local banks), and has greatlyoutperformed expectations. It serves as a model for expanding the outreach of commercialbanks to poorer clients.

The Kazakhstan Small Business Programme, supported by EBRD, was established at therequest of the Kazakh government to succeed a failed credit line for small and medium en-terprise loans. KSBP’s principal objectives are “to provide finance to MSEs which currentlyhave insufficient access to the formal sector finance; and to build up the credit capabilitiesof Kazakhstan's financial sector so that local banks are able to provide MSEs with access tofinance on a permanent basis.” KSBP received a sovereign, guaranteed EBRD credit line ofUS $77.6 million as a refinancing facility. Furthermore, considerable funding was also pro-vided by the government of Kazakhstan, EBRD, USAID, and the EU for a technical assis-tance package to support institution building in partner banks.

According to its objectives, KSBP was not designed to fight poverty directly, but to pro-mote financial market development that would have long-term, but indirect, impact onpoverty reduction by creating sustainable access to formal loan financing for micro and smallentrepreneurs. These small businesses are a major and growing source of employment bothin developing and transition countries. Measured against its objectives, KSBP can show im-pressive achievements.

■ Outreach. By February 2004, KSBP was established in all urban centers in Kazakhstan.Partner banks opened MSE departments in 135 branches, with an additional 50 loanoutlets in 39 different cities, some of them as small as 20,000 inhabitants. The out-standing MSE portfolio has grown to over US $162 million, with more than 35,000

The Kazakhstan Small Business Program:Commercial Banks Entering Micro and SmallBusiness Finance

BY EVA TERBERGER AND ANJA LEPP

Chapter 9

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Commerc ia l Banks Enter ing Micro and Smal l Bus iness F inance

loans. The MSE departments employ535 loan officers, who disburse over4,000 micro and small loans everymonth. The program is still showinghigh growth rates.

■ Target group. At least 90 percent ofKSBP clients had never had access toformal bank loans, and 85 percent ofthe outstanding loans are micro-loans.Over 50 percent of the newly disbursedloans are “express micro loans,” anewly developed product for very smallcustomers needing uncollateralizedworking capital loans that are disbursedalmost instantly.

■ Sustainability. Although the programhas been moving far down in the mar-ket to serve the smallest traders, and atthe same time growing very fast, arrearshave stayed extremely low. (Arrears >30 days stood at 0.25% of portfolio vol-ume in February 2004.) Loan-officerefficiency has continuously increased. Anewly developed profit-center account-ing method, currently being tested, isyielding strong evidence that the MSEbusiness has not only passed the profitability threshold, but is just as, oreven more, profitable than the averagealternative business in the Kazakhbanking sector. The partner banks areresponding accordingly. They are usingconsiderable amounts of their ownfunds to expand the business—over 40percent of the portfolio is now being financed with the banks’ own funds—and are continually training new loanofficers and opening MSE departments

and outlets in new locations. MSElending, so it seems, has become a sustainable business which private com-mercial banks will stick with, evenwhen the program staff have gone andKSBP itself has been wound up.

■ Spill over. KSBP has positively affectedthe institutional set up of the partnerbanks and their competitors as well.For example, the program’s trainingand recruitment methods are copied,its incentive-based pay schemes areadapted for use in other departments,and MSE loan officers are frequentlypromoted within the banks to seniorpositions or are hired by competitors.

The KSBP owes its success to sound,professional institution building. As a firststep, a limited number of smoothly-func-tioning, independent MSE departmentswere established within each partner bank.Further expansion—into other regions, intopoorer market segments, and into the orga-nizational structure of the partner banks—was not attempted until the program couldrely on a solid base of successful MSE lending, and human resource capacity hadbeen strengthened by the first generation oflocal consultants trained by the program.

KSBP also had a favorable environment in which to thrive. Kazakhstan’s macroeco-nomic situation was stable, and the govern-ment showed a strong political commitmentto developing the SME sector. It supportedKSBP from the beginning, while at the sametime resisting the temptation to directly intervene in the program. Furthermore, the


The Kazakhstan Smal l Bus iness Program

Kazakh financial market had been liberalized,and was well regulated and supervised.Strong competitive pressure on banks, as the sector consolidated, made even the bigprivate Kazakh banks interested in participat-ing in KSBP and developing the new MSE business.

To replicate KSBP’s downscaling successin other countries, sound institution build-ing needs to be paired with favorable polit-ical and economic conditions. If these occurtogether, downscaling for-profit commercialbanks should be tried first, before any otheralternative for microfinance, in case the fi-nancial services market just needs a jumpstart in order to become a powerful instru-ment in the fight against poverty.


Background and Project Design

The history of the Kazakhstan Small Busi-ness Program, teaches an important lesson:Never underestimate the significance ofprogram design and institution building.

Quite unusually for a project as innova-tive as KSBP, the initial impetus to createthe program did not come from the EBRD,but rather in response to an urgent requestfrom the Kazakh government. It needed areplacement for an underperforming pro-gram (or more precisely, a failure), consist-ing of an SME credit line provided byEBRD and guaranteed by the Kazakh gov-ernment. This SME line, which had beenapproved in 1993, offered partner banks afinancing facility of up to US $122.6 mil-

lion via an apex structure, but less than onethird had been disbursed by 1997. Further-more, portfolio quality was rather poor, andone partner bank had completely failed,forcing the government to honor its guar-antee for a lost portfolio of US $9.5 million.

Confronted with this failure, butnonetheless still convinced that the highestpolitical priority should be the developmentof the SME sector, the Kazakh governmentrequested that the unused funds (US $77.5million)—and the sovereign guarantee—betransferred to a new program modeled onthe Russian Small Business Fund. This re-quest was approved by the EBRD board in1997, and KSBP became operational in latespring of 1998.

Its history as the successor of a failed pro-gram had a positive effect on the KSBP intwo respects. First of all, there could be nodoubt about the strong commitment of theKazakh government to support the SMEsector and the new program. Secondly, thelack of success of the SME line had givenclear hints as to what went wrong. It wasunlikely that lack of demand was the maincause of failure. Even though there hadbeen no reliable numbers on the size of theSME sector in the mid-1990s, there couldbe no doubt that the sector was growingand that it had hardly any access to the for-mal banking sector. Almost certainly thefailure of the first program had been causedby a deficiency on the supply side. Partnerbanks lacked the interest and/or know-howto issue and monitor SME loans. There wasno mechanism in the old program to over-come this deficiency—a structural fault in

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design which the new program had toavoid. The mission of KSBP was not only toprovide funds to onlend, but equally, oreven more importantly, it was to transferknow-how and to create incentives to buildthe capacity of the partner banks to go afterMSE business. Accordingly, the Kazakhgovernment and several donor organiza-tions1 financed a technical cooperationpackage to support institution building.

The Start-Up Phase, 1998-99

KSBP went into operation in May 1998.Five partner banks which met the eligibilitycriteria were selected beforehand (namely, a full banking license, approval by the National Bank of Kazakhstan, an IAS audit,a program-compatible strategy, bank man-agement committed to MSE business, astrategically interesting geographic location,and financial stability as defined by bankregulation standards). Four of these banks,Almaty Merchant Bank (AMB), CenterCredit Bank (CCB), Kazkommertsbank(KKB, the biggest Kazakh bank and one ofthe strongest in Eastern Europe and Cen-tral Asia), and Tsesna Bank (TB) were pri-vately owned. The fifth bank, Halyk SavingsBank (HSB) initially was state-owned, butwas privatized in 2001. Two more privatebanks joined the program later: Bank Turan Alem (BTA) in November 1998, andTemir Bank (TB) in September 1999.

Responsibility for implementing the first steps lay in the hands of eight experi-enced foreign experts.2 They hired new, local staff to be loan officers, and trained them in microfinance (assessment of client’s

payment capacity, close monitoring, gradu-ation principle, etc.). The experts becameacting heads of the new MSE loan depart-ments, which opened their doors in eightbranches of the five banks, in the two mainKazakh cities, Almaty and Astana. They offered micro and small business loans intenge (local currency) and in US dollars astheir basic products.

KSBP concentrated on the organizationalstructure of these new departments, intro-ducing IT-based management informationsystems (MIS), preparing MSE lendingguidelines, and implementing an incentive-based pay scheme for loan officers whichtook into account all aspects of their per-formance, from disbursement level to port-folio quality.

The aim of the first phase was to build upspecialized loan departments as stable andindependent entities within each partnerbank. Once this was achieved, the KSBP extended its activities in two dimensions:

■ Horizontally, by building MSE depart-ments in the new banks joining theprogram and in more large cities. Bythe end of 1999, KSBP had reached sixmore cities—Aktubinsk, Karaganda,Shymkent, Atyrau, Ust-Kamenogorsk,and Pavlodar.

■ Vertically, within the banks by trainingstaff who worked in lending operationsother than the MSE department; andoutside the banks through efforts to in-fluence the regulatory environment.Such activities included discussionswith local authorities to streamline collateral registration procedures and



raise the level of understanding of theKSBP’s undertakings, as well as inter-action with government agencies to re-move legal and administrative obstaclesto MSE development in general, andMSE finance in particular.

Furthermore, KSBP improved its ownorganizational capacity by requiring regularinternal audits of the program’s portfolio inall partner banks and all regions where theprogram was being implemented.

The institution building efforts began toshow results. The loan portfolio grew steadily,and arrears stayed low. Only a few months after its launch, KSBP passed its first test successfully. In April 1999, in the aftermath ofthe Russian financial crisis, the Kazakh gov-ernment stopped supporting the local currency, and the value of the tenge droppedfrom KZT 85 to KZT 120 to the dollar. Yetthis did not undermine the quality of theMSE portfolio, and the portfolio at risk (PAR > 30 days) remained under 4 percent.

By the end of 1999, the first generationof local consultants had joined the projectteam, taking over training and setting uplending operations in new locations. TheKSBP was now ready to tackle the secondphase of implementation.

The Expansion Phase, 2000–02

Being able to rely on a core of smoothlyfunctioning MSE departments and havingtapped local sources to create new consult-ing capacity, KSBP now moved to expand itsoperations without danger of destabilization.Expansion took place in several dimensions.

Regional expansionFrom 2000 on, KSBP attempted to capturethe urban MSE loan market throughoutKazakhstan. MSE departments were set up inbanks in all major cities, and some small cities(of 20,000 inhabitants) were covered by sub-branches. By December 2002, 23 more citieshad been included in the program. The num-ber of lending outlets had risen to 117, andthe number of MSE loan officers to 283.

Product expansion and moving down market The two basic products of the MSE departments were targeted to the needs ofestablished micro and small businesses, butwere not really suitable for market tradersand other potential clients who neededsmall working capital loans that could bedisbursed quickly. To be able to offer reli-able services to this customer group, KSBPdeveloped a new product, the “express mi-cro loan.” In contrast to micro and smallloans, express loans can be secured withmoveable assets as (unregistered) collateral.Disbursement is extremely fast (within 24hours), and all client contact is handled byspecial MSE outlets located at the markets.

Expansion within the partner banksAs the MSE business became increasinglyimportant in every partner bank, the banks’managements realized that it was necessaryto firmly integrate these departments intothe banks’ organizational structure. MSEmanagement positions were created for experienced MSE staff; and a head office

130 Case Studies


department, responsible for coordinatingand monitoring the MSE business, was es-tablished, step by step, in all partner banks.

Expansion of training and monitoring. As training new loan officers became rou-tine, and standardly contracted to localconsultants, KSBP concentrated on furtherdeveloping its training program. Seminarsfor experienced loan officers and back-officepersonnel, as well as advanced trainingcourses for local consultants, were intro-duced. Furthermore, first steps were takento develop performance benchmarks whichwould allow banks to monitor the efficiencyof their MSE operations.

By the end of 2002, another milestonehad been reached: MSE lending was nolonger a new business, but was firmly estab-lished in the market and within programbank. Banks were training loan officers andopening new outlets on their own initiative;they even began using their own funds toexpand the business. The skills acquired bythe MSE personnel were highly appreci-ated. The partner banks—and their competitors—were now eager to hire andpromote KSBP-trained staff to fill seniorpositions in lending departments, in riskmanagement, and even in the managementof the bank itself. They reduced the number of foreign experts working for the KSBP, and those who stayed on concen-trated on the remaining program task—assuring the sustainability the MSE businessand preparing to hand over more and moreresponsibility.

Institutionalization, Preparing for theHand-Over, and New Challenges, 2003–04

To date, KSBP’s lending operations havespread to every city in Kazakhstan with apopulation over 100,000. The lower endof the market has been penetrated to a degree which hardly seemed possible forcommercial banks. In February 2004, express loans accounted for 50 percent ofall loans disbursed. Partner banks financearound 40 percent of the MSE businesswith their own resources. MSE productsare marketed regularly. MSE managers inthe banks are taking increasing responsibil-ity for planning and implementing newlending operations, as well as for budgetcontrol and human resource development.Full responsibility for all basic training activities will be handed over to the part-ner banks in the near future.

Accordingly, KSBP can now concentrateon product development, advanced training(management, personnel development, con-flict resolution, etc.), and audits. It also willstreamline the partner banks’ institutionalprocedures to prepare them to gradually assume more and more responsibility. Handing over audit functions to the partnerbanks is currently being discussed, and the banks have started to adapt their internal structures accordingly. Furthermore, KSBP is actively developing new reporting and monitoring instruments and furtherstandardizing the express loans.

Last but not least, as urban MSE lendingvia commercial banks no longer poses a“real” challenge in Kazakhstan, KSBP islooking for new challenges. The first pilot



projects to test the new “agricultural loan”product have already been set in motion.

Impact Analysis

The Impact of Downscaling in FinancialMarket Development

Establishing MSE lending in (private) com-mercial banks, so-called “downscaling” inmicrofinance, offers clients (especially micro and small entrepreneurs) not servedby the formal financial sector, sustainableaccess to loan financing. Impact assessmentswhich concentrate solely on whether loansactually reach the targeted group of thepoor, and whether their incomes and livingconditions improve, would be misleadingfor a downscaling project because its effecton poverty reduction is indirect. The suc-cess or failure of a downscaling programdoes not hinge on direct poverty reduction.Rather, success is determined by whetherthe program can build and maintain sustain-able institutional structures, after donors’support and monitoring are gone. Privatecommercial banks can only be expected to continue lending to micro and smallbusinesses if it stays profitable.

KSBP’s Outreach and Client Structure

The dynamics of KSBP have been remark-able from the beginning. During the firsteight months of its existence (1998), 14MSE departments were set up in five differ-ent cities, 842 loans totaling almost US $7.7 million were disbursed, and theoutstanding portfolio consisted of 764 loanswith a total volume of US $5.8 million. In

1999, the number of branches doubled, theoutstanding loan portfolio grew almost 100percent in volume and almost 120 percentin number of loans. Since then, the numberof branches has grown steadily but at aslower pace, picking up new momentumwhen smaller outlets were added and whenthe express loan was introduced.

The number of outstanding loans moreor less doubled every year of the program’sexistence, rising to roughly 35,000 MSEloans outstanding in February 2004. Port-folio volume grew at a rate of 170 percentin 2000. It slowed the following two years,to approximately 85 percent in 2001 and 23percent in 2002, only to explode again in2003, with a growth rate of more than 100percent. As of February 2004, the outstand-ing portfolio came to US $162 million.

Growth of KSBP’s portfolio was notbought at the price of moving up-marketand abandoning the original target group ofmicro and small business. On the contrary,average loan amounts (which may serve asan indicator for target group orientation)declined considerably during the first twoyears of the program. After the introductionof the express loan, the average loanamounts stayed relatively stable at about US$5,000 per disbursed loan, US $1,800 foroutstanding micro loans, and US $20,000for outstanding small business loans. Themedian client had an outstanding loan ofaround US $2,000.

Data on KSBP loans confirm that bankshave overcome their former reluctance tocater to micro and small business clients. InFebruary 2004, over 65 percent of all loan

132 Case Studies


clients (more than 50 percent of the out-standing portfolio), were individuals withan unregistered business. Women hold 61percent of all loans (42 percent of the out-standing portfolio), and 65 percent of mi-cro-loans (59 percent of the outstandingmicro portfolio). Working capital loans ac-count for almost 80 percent of all KSBPloans, and 82 percent of micro-loans (65percent and 75 percent, respectively, of theportfolios outstanding).

KSBP’s market penetration is remarkablyadvanced: it is represented in all Kazakhcities with over 100,000 inhabitants, in 64percent of the smaller cities with popula-tions of 50,000–100,000, and in 25 percentof cities even smaller.

KSBP’s performance and outreach to itstarget group has surpassed expectations, andit still shows extremely high growth rates.There were 535 loan officers in the MSE de-partments in February 2004—newly createdjobs in the banking sector. The loans they is-sued have supported or created aroundmore 200,000 jobs for their clients’ busi-nesses in less than 6 years. Tables 1-4

Month

Jun 1998

Dec 2002

Dec 2003

Feb 2004

NumberAnnualgrowthTotalSmallMirco

50 4 54

16,433 978 17, 411 78%

27,724 4,880 32,604 87%

29,814 5,424 35,238

Volume (US$ million)AnnualgrowthTotalSmallMirco

0,424 0,123 0,547

41,778 31,609 73,386 46%

51,507 97,486 148,993 103%

54,907 107,791 162,698

Outstanding Portfolio

Table 1: Portfolio Development

Is Lending to MSEs Sustainable?

Straightforward data about the profitabilityof MSE departments is difficult to obtainbecause their cost and revenue structure isembedded in the financial accounting sys-tem of the whole bank. Only now is a spe-cial reporting system for MSE departmentsas profit centers being developed. Lookingat the main costs associated with the newMSE departments (i.e., loan defaults, ad-ministrative costs, and cost of funds, as wellas the revenues generated by MSE lendingand preliminary profit calculations) allowssome preliminary conclusions about theirprofitability to be drawn.

Credit Risk and Loan Loss Provisions. Like other best practice microfinance proj-ects, KSBP has been extremely successful incontrolling credit risk. Even in 1999, in theaftermath of the Russian financial crisis,portfolio at risk (PAR > 30 days of arrears)never exceeded 4 percent of portfolio volume. During the last 3 years, which werecharacterized by financial stability and abooming economy, PAR always stayed well under 1 percent. Considering that



Loan Amount in US$ Number Percent Volume Percent

< 1000

1001-2000

2001-5000

5001-10000

10001-20000

20001-30000

30001-50000

50001-70000

70001-100000

> 100000

6,904

9,959

9,543

4,346

2,384

933

652

199

194

124

19.59

28.26

27.08

12.33

6.77

2.65

1.85

0.56

0.55

0.35

3,039,038

10,191,287

21,941,387

24,495,695

27,404,825

18,686,632

20,831,178

9,370,367

13,232,331

13,505,302

1.87

6.26

13.49

15.06

16.84

11.49

12.80

5.76

8.13

8.30

Total 35,238 100.00 162,698,041 100.00

Table 2: Distribution of Loans by Loan Amount (February 2004)

Working capitalFixed assetsOthersTotal

24,469 41,167,524 3,443 64,714,7803,746 10,838,584 1,760 37,905,2681,599 2,900,928 221 5,170,955

29,814 54,907,036 5,424 107,791,003

27,912 79.21% 105,882,304 65.08%5,506 15.63% 48,743,852 29.96%1,820 5.16% 8,071,883 4.96%

35,238 100.00% 162,698,039 100.00%

MaleFemaleNot applicableTotal

10,282 21,869,2342, 407 43,779,60419,424 32,588,6102, 202 36,048,176

108 449,194 815 27,963,22229,814 54,907,038 5,424 107,791,002

12,689 36.01% 65,648,838 40.35%21,626 61.37% 68,636,786 42.19%

923 2.62% 28,412,416 17.46%35,238 100.00% 162,698,040 100.00%

TradeProductionServiceAgricultureOthersTotal

25,633 45,021,792 3,709 66,138,744789 1,985,455 502 12,716,110

3,362 7,826,454 1,170 27,877,74816 31,512 13 169,91814 41,824 30 888,484

29,814 54,907,036 5,424 107,791,003

29,342 83.27% 111,160,536 68.32%1,291 3.66% 14,701,565 9.04%4,532 12.86% 35,704,202 21.95%

29 0.08% 201,429 0.12%44 0.12% 930,308 0.57%

35,238 100.00% 162,698,040100.00%

Table 3: Loan and Customer Characteristics - February 2004

TotalNumber % Volume %

Micro SmallNumber Volume Number Volume

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AggregateLoan Portfolioof All Banks

( US$ million)

SmallBusiness Loan

Portfolioof All Banks

( US$ million)

KSBP MSELoan

Portfolio(US$ million)

KSBP LoanPortfolio :AggregatePortfolio

KSBP LoanPortfolio :

SME Portfolioof All Banks

Dec 2000 1,899 510 28 1.46% 5.42%Dec 2001 3,327 828 50 1.51% 6.05%Dec 2002 4,370 952 73 1.68% 7.71%Dec 2003 6,385 1,343 149 2.33% 11.09%

Table 4 Relative Market Share of KSBP Loans

almost 20 percent of all bank loans in Kazakhstan were doubtful at the end of2002 (according to the National Bank ofKazakhstan), the low loan default and write-off rates for MSE loans are remarkable.

[Insert Table 5]

Administrative CostsLending to MSEs is staff intensive and personnel costs account for most of theadministrative costs. MSE lending requiresthorough credit analysis and close monitor-ing of the portfolio to keep arrears

No. of LoanOfficers

Capital at Risk

0.00% 0.00% 0.00% 0.00% 0.0000.46% 0.28% 0.89% 0.64% 0.4690.32% 0.22% 0.32% 0.26% 0.3950.57% 0.25% 0.62% 0.25% 0.410

Arrears >1day (%)

Arrears>30 days

(%)

Arrears >1day (%)

Arrears >30days (%)

Arrears >30day (US$million)

Number VolumeMonth

Jun 1998Dec 2002Dec 2003Feb 2004

31283527535

No. of LoansOutstanding

No. of LoanGranted

Volumes ofLoans Granted

1.29 11,520 1.74 17,6407.28 37,797 61.52 259,3157.80 40,842 61.87 282,7197.77 42,299 65.87 304,108

No. of LoanOfficersMonth

Loan Officer Effciency(each value per loan officer in corresponding month

Volume ofLoans

Outstanding

Jun 1998Dec 2002Dec 2003Feb 2004

31283527535

Table 5: Portfolio at Risk and Loan Officer Efficiency

low. Furthermore, MSE loans are small andhave higher administrative costs per dollar lent. Therefore, loan officer efficiencyis strategically important in managing profitability of the MSE business. In KSBP, loan officer efficiency has increasedcontinually over time; further efficiency improvements and cost reductions can beexpected once all the loan officers hired bythe participating banks have become fully experienced lenders.

Cost of FundsFunding costs vary considerably amongKSBP partner banks. While the formerstate-owned savings bank has access to rel-atively cheap savings as a source of loanablefunds (incurring 5.5% p.a. interest expensesin 2003), other banks had to pay between 9percent and 13.5 percent for their funds,depending on the currency (tenge or US$)and depending on which bank acquired the funds. Drawing on the funding line provided by the EBRD, the interest costswere just under 8.5 percent.

Gross Margin, Net Margin, andProfitabilityThe average gross interest rate earned onthe MSE portfolio is just over 20 percent,giving banks a margin ranging from7.5–14.5 percent, depending on cost offunds. Deducting 1 percent for loan lossprovisions and 2.8 percent for administra-tive costs, a net margin of 3.7–10 percentgoes to bank profits or other overhead ex-penses. Furthermore, the pilot profit-centeraccounting method clearly shows that older



branches usually achieve a much better per-formance than new ones, due to greater ef-ficiency and experience. Compared to theaverage return on assets (RoA) and returnon equity (RoE) in the Kazakh commercialbanking system (reported by National Bankof Kazakhstan for 2002, as 1.8 percent and12.8 percent, respectively), there can be nodoubt that MSE lending is already a prof-itable business which can compete withother businesses of the banks.

Spill-Over Effects of the KSBP

KSBP has undoubtedly had a positive effecton the whole organizational structure of itspartner banks, as well as on their competi-tors and on the financial system in general.Credit assessment and monitoring tech-niques, administrative processes (creditguidelines, auditing procedures), as well asincentive-based pay schemes, were originallyintroduced into the banks by KSBP andhave been adopted in other departments of the banks. KSBP’s methods of human resource development and standard recruit-ment procedures, introduced for MSE staff, are now used by some partner banksthroughout their institutions.

Training courses have become an integralpart of human resource management in allpartner banks. A considerable number of loanofficers trained by KSBP have been promotedwithin their banks or hired by competitors.KSBP has successfully been able to dissemi-nate knowledge and build capacity, therebyhelping develop the financial services market.

KSBP has decisively increased provisionof loan finance to thousands of micro and

136 Case Studies


small entrepreneurs in Kazakhstan who pre-viously had little or no access to financialservices. What is more important, however,is that MSE finance has been well estab-lished as a sustainable and profitable busi-ness for Kazakh commercial banks, whichwill continue without KSBP’s support.

Driving Factors

Commitment to Political and EconomicChange

Without doubt, the political and macro-economic situation in Kazakhstan has to be a critcal factor in KSBP’s developmentand success. Kazakhstan is one of the mostadvanced countries in Central Asia in termsof transition and economic development,mainly because as early as 1993–94 the gov-ernment firmly committed to pursuing apolicy of liberalization, privatization, and structural reform. In the mid-1990s,the reforms began to show measurable effects. As a result, Kazakhstan has had positive growth rates (except in the after-math of the Russian financial crisis), it hasalmost balanced its national budget, and ithas successfully brought down its inflationrate to under 10 percent.

Reform of the financial sector had al-ready reached an advanced stage whenKSBP was launched in 1998. Interest rateceilings had been abandoned, a two-tierbanking system had been established in1993, and the government was pushing forward with privatization. The last state-owned commercial bank, Halyk SavingsBank, was privatized in 2001, leaving one

development bank owned by the govern-ment. Just as important, the government refrained from any directed lending. Thanks to this policy environment, theKazakh government not only was commit-ted to supporting the KSBP, but made a contractual commitment to abstain from interfering in the program.

It was significant, too, that a very efficientbanking supervisory authority had been established at the National Bank of Kaza-khstan. A legal framework in accordancewith international supervisory standards wasenacted as early as 1995, and the NBK putpressure on the banks to fulfill its require-ments. Many of the more than 200 bankswhich sprang up in the early 1990s due tolax licensing were closed down. In 1997 thenumber of banks was reduced to 101, and by2003, just 34 banks were left.

The consolidation of the Kazakh bankingsector is continuing, and competition hasbeen rather fierce in recent years (and remains so). Fighting for market shares,banks were eager to improve their compet-itive position by acquiring knowledge andattracting new business. This was an idealfield in which to downscale banks, and it en-abled KSBP to win the strongest Kazakhcommercial banks as committed partners.


The most important institutional innovationwas the downscaling approach itself. Numer-ous institutional design features were newlyintroduced into the Kazakh financial sector,such as MSE loan technology based on theassessment of cash flow; performance-based



pay schemes; and recruitment and trainingmethods, to name just a few.

Because KSBP had no experience indownscaling, some new institutional com-ponents had to be newly developed. Themost fundamental was a method forsmoothly integrating MSE departmentsinto the banks’ organizational structures.KSBP also implemented a profit-center ac-counting system, specifically to monitor theMSE departments. Last but not least, itventured into pilot testing and launchingnew products (like the express micro loanand the forthcoming agricultural loan) asMSE lending moved further down market.

Another institutional innovation deservesmention. KSBP used the competition between partner banks to spur outreach, andat the same time to impel exemplary coordi-nation, cooperation, and mutual learning viathe structure provided by its program. TheKazakh experience needs to be analyzedmore thoroughly to identify optimal levels ofcompetition and coordination. But regard-less, when prime conditions for downscalingare present, the KSBP model deserves to seriously considered for replication.

Lessons Learned

Intelligent project design is the key to thesuccess of any downscaling project.

Institution building in downscaling projectsshould be undertaken in several steps orphases, which can of course overlap in cer-tain cases. In the initial phase, institutionbuilding should concentrate on selectingpartner banks, training, and creating a small

number of MSE departments within part-ner banks. These departments will be thebase from which to expand. The secondphase should focus on promoting regionalexpansion by opening new branches, mov-ing down-market by offering smaller loans,and firmly integrating the MSE depart-ments into the organizational structures ofthe banks. The third phase should preparethe hand-over of responsibility step by step.

Downscaling private commercial banks toserve MSE loan clients can be successfulif the conditions are favorable.

■ The macro-economy is fairly stable andthe government shows a strong com-mitment to SME development.

■ The financial market is sufficiently lib-eralized (most importantly, there areno interest rate ceilings) and prudentlyregulated, and financial institutions areprivatized.

■ The banking sector is characterized byfairly strong competition, forcing com-mercial banks to look for new business.

■ The market for MSE loans is notswamped by non-profit institutions offering the same product on more attractive terms and conditions thanfor-profit players can afford.

Ideally, a profit center accounting methodshould be deployed right from the start.

Monitor profitability, with profit centeraccounting is a must if MSE lending is to become a sustainable business for thepartner banks.

138 Case Studies


Downscaling should be tried first.

If conditions are favorable, downscalingshould be tried first—before other institu-tion building projects are tested—becausedownscaling private commercial banks isthe touchstone for microfinance as a “win-win” solution. If subsidized institutionbuilding in for-profit partner banks is theonly support necessary to kick-start a com-

mercial microfinance business, the financialservices market can work towardpoverty re-duction. Donors do not need to supportnon-profit institutions to provide micro-loans. Instead, donors can channel theirscarce resources into those projects thatfight poverty, where the market—left to itsown devices—would fail.

End Notes

1 Specifically, EBRD, USAID, and TACIS.

2 The project was, and still is, managed byInternationale Project Consult (IPC) GmbH, Frankfurt,Germany. Today the program is run by 30 local expertsand three foreign experts.

■ ■ ■

Bibliography

Baydas, M.M., D.H. Graham, and L. Valenzuela.Commercial Banks in Microfinance: New Actors in theMicrofinance World. Economics and SociologyOccasional Paper No. 2372. Columbus, Ohio: The OhioState University, 1997.

Krahnen, J.P., and R.H. Schmidt. “Development Financeas Institution Building: A New Approach to Poverty-Oriented Banking.” Journal of Development Economics50:392-95.

Morduch, J. “The Microfinance Promise.” Journal ofEconomic Literature 37 (1999): 1569-1614.

Morduch, J. “The Microfinance Schism.” WorldDevelopment 28, no. 4 (2000): 617-29.

National Bank of Kazakhstan. Current Development ofthe Banking Sector. 2003.

National Bank of Kazakhstan. Annual Report 2002,2001, 2000.

Republic of Kazakhstan National Bank SupervisoryBoard. Regulations on Prudential Standards for Second-tier Banks. Resolution No. 213. June 30, 2002.http://www.nationalbank.kz

Schor, G. “Commercial Financial Institutions as Micro-Lending Partners. Some Lessons of the Micro GlobalProgram in Paraguay.” IPC Working Paper, Frankfurt,Germany, 1997.

Terberger, Eva. “Instituciones de microfinanciación en eldesarrollo de mercados financieros.” Revista de laCEPAL 81 (2003): 195–211. (Unidos Naciones ComisíonEconómica para America Latina y el Caribe).

[“Microfinance Institutions and the Development ofFinancial Markets.” CEPAL Review 81 (2003): 195-21.(UN Economic Commission on Latin America and theCaribbean) ].

Wenner, M. D., and S. Campos. “Lessons inMicrofinance Downscaling: The Case of Banco de laEmpresa, S.A.” IDB Working Paper, Washington, D.C.,1998.

■ ■ ■


Executive Summary

K-Rep was started in 1984 as a USAID project applying an integrated methodology to in-termediate funds for non-governmental organizations (NGOs) that were addressing povertyalleviation in Kenya through microfinance and enterprise assistance. K-Rep has undergonetwo major transformations, the most recent and most significant during 1997-2001, whena commercial bank (K-Rep Bank, Ltd.), a development agency (K-Rep DevelopmentAgency), and a consulting firm (K-Rep Advisory Services [Africa], Ltd.) merged to fulfillthe mission of the K-Rep Group: to empower low-income people, promote their participa-tion in the development process, and enhance their quality of life.

K-Rep’s first transition in the late 1980s was characterized by changing its institutionalstatus from a project to an NGO, and by changing its leadership from international man-agers to indigenous microfinance specialists—thereby establishing a Kenyan NGO. K-Rep’ssecond transition, from an NGO to a commercial microfinance bank, was in the late 1990s,where the main goal continued to be the pursuit of self-sustainability as a basis for long-term scaling up of outreach to the poor. To this end, K-Rep sought sustainable fundingsources from the financial markets and financial independence from donors. K-Rep alsowanted to influence financial sector policy to be more favourable toward microfinance forlow-income people, and to change perceptions of the public, clients, and players in the for-mal financial economy through its acceptance, legitimacy, and recognition as a licensed fi-nancial institution.

K-Rep’s need to find external investors for funding and expertise posed a risk to preserv-ing its core mission. The K-Rep Board of Directors developed guidelines for selecting in-vestment partners with the right combination of desirable characteristics: strong financialand commercial discipline; sufficient resources for additional future investments; sufficientclout to influence Kenyan authorities and to protect K-Rep from political interference; and willingness to divest some of their equity holdings when K-Rep went public. K-Rep’s

The Case of K-Rep�Nairobi, Kenya

BY JOHN NYERERE

WITH INPUT FROM KIMANTHI MUTUA, WILLIAM F. STEELE, ALEKE DONDO,

AND JOHN KASHANGAKI

Chapter 10

140 Case Studies

The Case of K-Rep

leadership also had to lobby and educate theregulators of the industry on the benefits of an NGO transforming into a regulatedmicrofinance commercial bank.

Despite intensive preparations and training, the actual changeover to a commercial bank presented a culturalshock for personnel and, as a result, oper-ating systems. Management had to bringin new staff to cope with regulatory requirements, introduce special training toresolve a culture clash between new and old staff, and restore morale and commitment by creating an employeestock ownership program.

After the expected initial teething prob-lems, transformation yielded very positiveresults. In just four years, the combinedoutreach of K-Rep institutions rose to over90,000 borrowers and savers (including theautonomous financial service associations—FSAs—created and managed by K-Rep Development Agency), from slightly over15,000 before transformation. Most ofthese clients are poor, and new productshave further deepened outreach to provideactive poor with opportunities to improvetheir incomes by maintaining and growingtheir businesses. Although non-poor clients were added in the search for depositmobilization as a base for scaling up, theability to reach the poorest of the poor wasalso enhanced. Out of 45,000 active borrowers and 62,000 active savers of K-Rep Bank in December 2003, approxi-mately 6,000 are considered very poor; and over 70 percent of the 48,000 FSAshareholders are considered poor.

K-Rep’s leadership has remained focusedon the poor while pursuing sustainability by building stakeholders’ confidence that large-scale microfinance business canfocus on the poor and still be profitable.Not to be ignored is the for-profit consult-ing arm of K-Rep, KAS, which has indirectlycontributed to scaling up and transferringknowledge by providing advice and technical assistance in over 15 countriesacross Africa.

Besides the need for a conducive regula-tory environment to successfully scale upand transform, an important lesson fromthe evolution of K-Rep is that leaders have to be ready to continually respond to challenges, to be innovative, and to modify institutional structures in order tosuccessfully adapt to changing environ-ments. In an industry that is still considerednew, emerging, and informal, continuouslearning and experimentation is essential to respond to needs of clients and stakeholders in microfinance. Perhaps themost significant challenge in institutionaltransformation and scaling up is developingthe human capacity and commitment.

K-Rep’s success has provided a platformfor legitimizing microfinance and improv-ing awareness among the public about the immense growth opportunities in the industry in Kenya. As a result of K-Rep’s demonstrated success and its lobbying efforts, a bill institutionalising a microfinance category among financial institutions, licensed by the Central Bank, isawaiting parliamentary discussion.


Nairobi , Kenya

BackgroundThe issue of transformationfrom an NGO,here a donor-funded project, to a licensedand regulated commercial bank is critical inthe microfinance field. There is immenseunmet demand from the poor for access to appropriate financial services, and trans-formation holds promise for institutions toincrease their outreach by tapping into commercial sources of funding. K-Rep isthe only microfinance bank in Kenya and in Africa that has gone through thisprocess, and its success can guide otherAfrican microfinance institutions (MFIs)and regulators.

World Education, Inc., a private Ameri-can- voluntary organization launched theKenya Rural Enterprise Programme (K-Rep) in 1984 as a five-year projectfunded by the United States Agency for In-ternational Development (USAID). Its mis-sion was to wholesale services by providinggrants, training, and technical assistance toaddress the financial, management and technical needs of NGOs involved in microand small enterprise development. An evaluation in 1986 by USAID concludedthat the project had limited developmentimpact, was not cost-effective, and shouldbe terminated at the end of the five years.The report prompted K-Rep founders toquestion the future sustainability of theproject. It also raised issues of reliance on asingle donor, and sub-grantees, for results.

This crisis—deciding to terminate orcontinue dependent on one donor—plantedthe seed for creating a sustainable institu-tion that would focus on long-term

intervention strategies to alleviate povertythrough the delivery of micro credit andother financial services. In 1987, the proj-ect was incorporated as WEREP Ltd., acompany limited by guarantee with no sharecapital, thus assuming the status of anNGO. By 1987, K-Rep started seekingother donors to broaden its funding baseand changed its strategy from being solely aservice provider to other NGOs to also de-veloping its own loan portfolio, assumingdirect lending responsibilities in 1989.

Development of a Modified CreditMethodology: Juhudi and Chikola

After exchange visits with other MFIs inBangladesh and Latin America, K-Rep in-troduced a group-based lending approachamong its partner NGOs and launched itsown lending program in September 1990.The program, known as Juhudi, was mod-elled after the Grameen Bank group-basedlending method and modified to theKenyan environment. Juhudi is based onthe co-guarantees of peer groups of five toseven members (called watanos) withinlarger groups of five to six watanos (knownas a kiwas). These groups receive an initialtwo months of training on group dynamicsand methodology that emphasizes the im-portance of savings, before receiving loans.1

In 1991, in response to demands and inan effort to upscale outreach, K-Rep tar-geted the pre-existing indigenous rotatingsavings and credit schemes primarily locatedin rural areas and created a new productknown as Chikola. Lending to Chikolas wasinitially a highly cost-effective method of in-

142 Case Studies

The Case of K-Rep

creasing outreach since only one check wasissued to each group, which was then responsible for allocation to individualmembers. In 1994–95, however, repaymentrates fell to 90 percent due to a lack ofgroup cohesiveness among the largerChikolas. As a result, K-Rep changed manyfeatures of the scheme and began disburs-ing loans to individual members within thegroup, and moving Chikolas toward smallergroups and weekly repayment in line withthe Juhudi lending approach.

Transformation to NGO

In 1993, K-Rep received its NGO certifi-cate of registration, in compliance with theNGO Co-ordination Act of 1990, as KenyaRural Enterprise Program (K-Rep), Ltd. In1996 and 2000, it became K-Rep Holdings,Ltd., and K-Rep Group, Ltd, respectively,solidifying its move from a project to an institution and self-sufficiency.

Then followed a period of rapid expansionwith larger loans, which unfortunately re-sulted in increased delinquency and in-creased desertion rates because many clientswere uncomfortable co-guaranteeing largeloans. Neither were credit officers able to ef-fectively manage their portfolios and providethe necessary client follow-up in this periodof rapid growth. In 1994, to turn theseproblems around, all wholesale lending toNGOs was stopped, due to their increasingarrears to K-Rep. K-Rep began to focus ondirect lending activities to low-income com-munities and merged the administration ofthe Juhudi and Chikola lending methodolo-gies. K-Rep’s institutional strategic plan

began to address long-term issues of financial sustainability, growth, continueddependence on donors, and appropriatenessof the NGO institutional form.

K-Rep reorganized its operations intotwo divisions: the financial services division oversaw the Juhudi and Chikolagroup credit methodologies, and the non-financial services division handled research and evaluation of K-Rep’s programs and the NGOs it supported. Theresearch helped develop new products, understand the needs of their customers,improve methodologies, and develop new information for the sector. Althoughthe financial services division was designated as the profit center and providedcredit services, the non-financial services division gradually engaged in activities that were not only strategic but also profitable, and helped build outreach capacity through consulting services. K-Rep’s transformation from a project to anNGO with two divisions yielded dividendsin the breadth and depth of outreach,shown in Table 1.

In 1997, K-Rep decided to cut back on lending for three reasons: 1) the loandelinquency was increasing and K-Repfeared that continued rapid growth wouldhide the deteriorating quality of the loanportfolio; 2) it had become difficult to raisefunds for lending; and 3) K-Rep needed toconsolidate its lending activities in prepara-tion for its transformation to a commercialmicrofinance bank. It wrote off some oldNGO loans, and implemented a “Back toBasics” program.


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Under “Back to Basics,” K-Rep retrainedall of its credit officers in its original philoso-phy and the fundamentals of microfinance,and re-emphasized the institution’s commit-ment to the microenterprise sector. Servicedelivery changes were also introduced to helpclients gradually learn the habit of weekly deposits, and collateral requirements were revised.2 The loan portfolio was reduced to US $3.6 million in 1997, then increasedgradually to just under US $4 million in1998. By late 1998, total member savingshad risen to over US $1.37 million, and delinquency rates were drastically reduced,with arrears over one day past due down from20.9 percent in 1997 to 9.7 percent. Thenumber of active borrowers rose from 11,000in 1995, to 13,150 in 1998, while 4,149members held savings but had no loans. It became clear that increasing savings was bothdesirable as a service to clients and necessaryto help finance further scaling up and long-term self-sufficiency of K-Rep itself.

The Process of Transforming to aLicensed Institution

K-Rep’s vision of transformation to a licensedinstitution emerged in 1994 from a staff con-cept paper on possible transformation, and afeasibility study funded by the Ford Founda-tion in 1995. The decision to transform wasbased on mitigating the following challenges:

■ K-Rep’s NGO structure prevented itfrom attracting funds from investors andinhibited potential benefits of privateownership. Accessing additional sourcesof capital, particularly from client sav-ings (by mobilizing deposits3), wouldpermit sustained scaling up of credit tothe target population.

■ Cross-subsidizing the non-financialservices from lending operations wasimpeding the growth its lending activ-ities. In addition, the energy and focusrequired to oversee adequately the micro-lending program was overshad-owing the potential for new product

Year No. of ActiveLoan Clients

OutstandingLoan Portfolio

(US$)

Average LoanSize (US$)

Total Assets(US$ million)

1991 1,253 580,607 463 0.9

1992 2,852 982,991 344 1.2

1993 4,331 1,087,100 251 2.1

1994 5,149 3,514,797 682 5.0

1995 11,137 4,601,441 413 5.0

1996 12,885 4,534,323 351 5.0

1997 10,958 3,622,043 330 5.8

1998 13,150 3,816,639 290 6.3

Table 1 Outreach and Performance, 1991-98

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The Case of K-Rep

development and expansion of thenon-financial activities of the NGO.

■ K-Rep expected that transformation toa regulated financial institution wouldenable it to right the inequity of clientsavings being onlent to wealthierclients of formal banks. K-Rep clientsavings were deposited in these banks,but neither K-Rep nor the clients couldaccess loans from the same banks.

■ Transformation would help ensure in-stitutional permanence of K-Rep’s mi-crocredit program through improvedgovernance and increased profitability.

Initially, some board members had reser-vations about K-Rep’s transformation to acommercial bank. They especially fearedlosing control of K-Rep’s mission to new investors with different views, ideas, andmissions. This challenge of attracting invest-ment partners who shared K-Rep’s twingoals of providing financial services to low-income communities on a commercial basiswhile also pursuing social development objectives was daunting. Once initial reser-vations were overcome, a nine-member advisory team4 was formed to prepare abusiness plan, present it to potential investors and the Central Bank of Kenya,educate Central Bank officials about micro-finance as a commercial proposition, andnegotiate the licensing requirements for theproposed K-Rep Bank.

K-Rep’s New Organizational Structure

The transformation of K-Rep into a

commercial bank required creating three legal entities under the umbrella of K-RepGroup Ltd.,5 which is a holding companywith the largest equity holding in K-RepBank. K-Rep Bank, Ltd., is a private, for-profit company, owned jointly by others,pursuing microfinance. K-Rep AdvisoryServices (Africa), Ltd., or KAS, is a private,for-profit consulting firm, owned 100 percent by the K-Rep Group. K-Rep, theNGO, was not created anew, but was reincarnated as the K-Rep DevelopmentAgency, with substantial changes in its in-ternal operations.

K-Rep Group transferred the financial as-sets, liabilities, and activities of the financialservices division to K-Rep Bank. The assets, li-abilities, and activities of the non-financial serv-ices division remained with KDA, which wasthen divided into microfinance research andinnovations; and microfinance capacity build-ing. In 2001, the microfinance capacity-build-ing division was spun off to K-Rep AdvisoryServices, which was incorporated to providefee-based microfinance consulting services.

The new structure was intended to protectK-Rep’s original vision of providing both fi-nancial and non-financial services to the poor.Each institution provides different serviceswithin the microfinance and micro enterprisesector. The institutions within the K-RepGroup are separate legal identities. Each hasits own board of directors and own mission,vision, core values, and organizational culture.

K-Rep Group, Ltd. K-Rep Group, as the holding company, hasthe largest equity participation in K-Rep


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Bank (28.8 percent), and wholly owns bothsubsidiaries, KDA and KAS. The board ofdirectors of K-Rep Group are the samemembers who oversaw K-Rep’s transforma-tion from an NGO to commercial bank,with the addition of the managing directorof KAS. This board continues to be the mis-sion bearer for the K-Rep Group and en-sures that, although the entities are pursu-ing different strategies in the Africanmicrofinance industry, they remain unitedin their mission.

K-Rep Development Agency. As the research and development arm, KDAfocuses on product research and innova-tion, and dissemination of results to thebroader microfinance industry. KDA’s strategy is to identify, test, and develop newmicrofinance products to help the poor organize their financial lives, as well as to facilitate partnerships with institutions thatcan deliver these products and services topoor clients. Some of these innovations include financial service associations (au-tonomous user-owned, -managed, and self-financed savings and credit schemes),healthcare financing and insurance for thepoor, microloans for smallholder dairyfarms, low-cost housing finance, and ruralsavings mobilization (rural communitiespool savings to access higher returns, forexample, through treasury bills). While K-Rep Bank benefits from the researchfindings, KDA shares its findings with all interested parties, and helps implement newproduct lines within other development organizations. Donors continue to support

KDA with the understanding that its services are valuable resources for microen-terprise development in Africa.

K-Rep Advisory Services (Africa), Ltd.Incorporated in January 2001, KAS is an independent profit center with its ownboard of directors and capital structure. Asthe advisory and consulting arm of the K-Rep Group, it provides a wide range ofservices that include institution capacitybuilding and training, project management,business, and financial and strategic plan-ning for MFIs. It also manages a public relations program, which hosts visitors fromall over the world and introduces them toK-Rep Group activities and other leadingMFIs in Kenya. All KAS services are fee-based. KAS continues the managementand technical support to NGOs that K-Repwas initially formed to provide.

K-Rep Bank, Ltd. K-Rep Bank, Ltd., began operations as afully-fledged commercial bank in December1999, and to date is the only commercialbank catering to low-income communitiesthat is licensed and regulated by the CentralBank. It is also the first microfinance NGOto transform itself into a regulated bankinginstitution in Kenya and, indeed, in Africa.

Issues and Challenges ofTransformationK-Rep’s transformation took four years, re-quiring difficult decisions of institutionaltransformation and persistence in mobiliz-ing the right investment partners who could

146 Case Studies

The Case of K-Rep

assist in overcoming the Central Bank’sconcerns with the proposal. Other issuesarose, including the danger of mission drift, the appropriate institutional form for K-Rep Bank, the Central Bank’s mispercep-tion of microfinance, concern over meetingregulatory requirements, and the search for investment partners were other transfor-mation issues.

Despite extensive staff training and systems development and simulation, nu-merous problems were encountered in datamigration and staff morale. The new requirements exacerbated a culture conflictbetween “old” and “new” staff. The tensionbetween different shareholders was not always creative, which affected the gover-nance of K-Rep Bank. The commitment of management and staff to resolving these challenges of transformation was severely tested over a transition period thatstretched throughout the first year of K-RepBank’s operations.

Internal Issues

The overriding concern of K-Rep’s boardregarding transformation was “missiondrift”—the risk that commercial bankingconsiderations would drive K-Rep Bank upmarket to serve higher-income clients at the expense of scaling up their mission ofserving low-income and poor people. The second was the need for partners thatshared the original vision and objectives. A third concern was the K-Rep’s prepara-tions to comply with rigors of supervisionand prudential guidelines of a regulatoryauthority.

The biggest issue was grappling with theinstitutional options for K-Rep Bank. Thoughthe final decision was a commercial bank,management came to this after considering afinance company (non-banking financial insti-tution), a co-operative society, and a buildingsociety. Staff, board members, and externalstakeholders, such as customers, government,the Central Bank, and other players in the microfinance sector, were canvassed regardingtransformation. Internal operations were assessed to determine if systems were capableof operating as a commercial financial institu-tion and were supported by adequate staff capacity and strong leadership. The financecompany format initially appeared to offer thebest fit, with a lower capital and liquidity re-quirement than a bank. However, this optionwas closed by the Central Bank as it pursueda universal banking policy. The co-operativesociety presented a good option for includingclients in the ownership structure, but had aweak regulatory framework. Hence the finalpreferred option was a commercial bank.

External Issues

Sceptics and doubters were many, the mostcritical being the Central Bank, as the regulators of Kenya’s financial industry. Theydoubted the viability of microfinance, givenits unconventional lending practices and thefact that hitherto it was a donor-funded activ-ity. Whether an NGO could own a bank wasalso as an issue, given that NGOs have no realowners. The Central Bank worried that noone would be responsible if things wentwrong. The situation was exacerbated by thefact that five indigenous banks had recently


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been placed under Central Bank managementdue to lack of liquidity, and in 1998 the Na-tional Bank of Kenya (the fourth largest)nearly collapsed. The Central Bank therefore decided not to license any new banks, and K-Rep’s application was placed on hold. Thereluctance of the Central Bank was finallyovercome only through lengthy lobbying,donor support to help the Central Bank tounderstand how microfinance was regulatedin other countries, investment by internationalfinancial institutions in K-Rep Bank, and therequirement that K-Rep meet a minimumcapital investment6 of KSh 500 million.

Whereas K-Rep had sufficient loans,cash, and other assets to meet the requiredminimum paid-up capital of US $6.3 mil-lion, it needed at least three other investorsto comply with a 25 percent ownershiplimit per single investor. K-Rep restricted itssubscription to US $1.82 million in equityand invested US $2.06 million in incomenotes,7 while US $4.48 million was offeredto other investors. A search for local in-vestors was not successful, as the few thatwere identified sought returns of over 20percent. Donor agencies helped search forforeign investors, which finally bore fruit.After many months of lobbying and net-working by the Advisory Team, six investorswere found that satisfied the desired com-bination of financial expertise and commit-ment to K-Rep Bank’s social mission.

The Challenge of Regulation

K-Rep Bank came from an NGO back-ground with no stringent external regulator.The first inspection by the Central Bank six

months after commencement rated K-RepBank as strong, largely due to its capitalbase, but also cautioned K-Rep Bank aboutits data migration difficulties, high operat-ing costs, slow growth of deposits, and lowearnings. Most surprising, the Central Banktook issue with non-compliance with theregulatory requirement limiting each share-holder to a maximum of 25 percent of totalshares, even though K-Rep Group had negotiated its 28.8 percent shareholdingwith the licensing department of the Central Bank. The Central Bank also ques-tioned K-Rep’s field offices because theywere not licensed as bank branches and didnot meet the minimum requirements in security and infrastructure.

Furthermore, the inspectors advised K-RepBank to book large loans and attract large deposits to increase earning and reduce costs,in contradiction to K-Rep Bank’s fundamen-tal objectives. Clearly, more work needed tobe done to help the Central Bank fully under-stand microfinance. K-Rep Bank’s manage-ment formally applied for a waiver of the 25percent ownership limit; it redefined field offices as “marketing offices” rather than formal branches, and secured approval; lobbied for a Microfinance Regulation Bill(approved by the Cabinet of Ministers in2004); and lobbied for a microfinance unitwithin the supervision department of theCentral Bank (set up in early 2004).

Data Migration and HarmonizingOperations

Staff members were overwhelmed by new products (such as deposits) and

148 Case Studies

The Case of K-Rep

procedures—new savings products doubledtransaction volumes. The accuracy andtimeliness of data were adversely affected bythe centralization of the system. Initially, K-Rep Bank was licensed to operate only onebranch, so the head office bank branch tookover the accounting and record-keepingthat previously had been spread over 17field offices. The distance between manyfield offices and the head office slowed datatransferof the transactions.

Urgent problems like these divertedmanagement’s attention away from businessdevelopment. Management hired consult-ants to address the problem, train staff, andrestructure data migration at extra costwhich had not been anticipated. While theproblems were solved within six months,the higher costs of operation and reducedprofitability below the projections in thebusiness plan and past performance con-cerned the Central Bank and K-Rep Bank’sboard of directors.

The Challenge of Governance

The new regulatory environment was morestringent in matters of governance. Boardmembers represented diverse shareholderinterests, and the individual memberschanged frequently, had limited under-standing of microfinance, and mistook thetransformation difficulties to mean that mi-crofinance was not profitable. They sup-ported the Central Bank’s recommenda-tions for alternative (non-microfinance)products to improve profitability. Someboard members became involved in detailsof management rather than formulating

policy, assisting management, and directingthe institution. The resulting tensions led tomistrust between management and theboard, and diverted energy from productiveactivities; and confidence dropped.

Some changes in the individuals repre-senting investors on the board were made.The board sought individuals who under-stood microfinance, and brought in a hybridof professionals that represented broad in-terests but common objectives. It also ad-dressed tensions at the board level by ensur-ing that other directors were trained andexposed to the dynamics of microfinance.

The Challenges in Human Resources

Difficult decisions were made as to whichboard members and staff members wouldmove to the new K-Rep Bank or continuewith the NGO (K-Rep DevelopmentAgency) after transformation. On one hand,staff who did not move to K-Rep Bank feltinsecure and were not convinced that NGOwould survive. On the other hand, some ofthose who moved to the bank were not con-vinced of its viability and were further un-settled by the difficulties encountered withdata migration and new procedures. At theboard level, only two directors moved to theK-Rep Bank board, and the rest felt left outof an institution that they helped establish.

During the first three months of bankoperations, productivity actually decreased.K-Rep Bank hired traditional bankers to run certain functions (front and back officeoperations, clearing functions, regulatorycompliance, and treasury management), at higher salaries for specific skills and


Nairobi , Kenya

experience not available among existingstaff. The commercial bankers were lesssympathetic to microfinance clients and focused more on conventional bankingpractice and adherence to strict proceduralrules and regulations. In contrast, the NGOstaff was more sympathetic to their poorclients and embraced microfinance bestpractices. The resulting culture conflicts andpersonality clashes slowed operations andpolarized the new bank. The tension, how-ever, presented an excellent opportunity tocreate a new culture that embraced the bestof both values.

K-Rep Bank brought the staff togetherto discuss the issues that affected them. The professional bankers went to the field to learn about microfinance, while former NGO staff members worked in thebanking hall as tellers and clerks to givethem a feel of traditional banking. Trainingactivities were carried out across cadresrather than across disciplines. Any staff (old and new) who could not adjust to the new environment had to be let go or was transferred back to the NGO(KDA). It took time for the two groups to work harmoniously.

To overcome feelings of being left out, staff and board members who did not move to K-Rep Bank were allowed tobuy equity shares through the EmployeeStock Ownership Program (ESOP). Thenew organization structure (K-Rep Group,KDA, and KAS) offered new opportunitiesfor board members who did not move to the K-Rep Bank Board. This, coupledwith a bi-annual get-together of all staff

and board members of the group, hashelped K-Rep remain united with one de-velopment vision, which is pursued throughdifferent objectives and corporate entities.

The Challenge of Mission Drift

To demonstrate its commitment to servingthe poor, K-Rep Bank located its headquarters in one of the largest slums inNairobi, Kawangware. Nonetheless, K-RepBank encountered potential mission drift,as regulators and some board membersurged the bank to move into more prof-itable lending activities (especially after theCentral Bank’s first inspection). Some of the new staff from the banking sectortried hard to instill conventional lending practices that would exclude poor clients. Itwould have been difficult to overcomethese challenges if the board compositionand top management did not include keyproponents of microfinance.

The characteristics of K-Rep Bank’sproduct did not change after transforma-tion, even though new loan and savingsproducts were introduced. The bank continues to target poor and low-incomepeople, as did the NGO. The average loansize is one indicator of the bank’s orienta-tion toward the poor, which has generallyremained at less than US $500 both beforeand after transformation (with the exceptionof 1994 and 2001). The average size of first loans is lower at US $263; the higheraverage loan size is due to larger repeatloans. The average customer deposit size isUS $247.

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The Case of K-Rep

Impact of Transformation on ScalingUP, Services, and Clients

The primary objective of scaling up, to in-crease outreach, was quickly achieved. K-Rep’s initial 1,253 loan clients grew steadilyin 1991 to 11,137 in 1995, but thengrowth slowed considerably, reaching only13,636 by 1999, the year of transformation(see Table 2).

Teething problems limited growth in thefirst two years after transformation. Butfrom 2001 to 2003, loan clients doubledfrom 22,659 to 45,379. The loan portfolioincreased from more than US $4 million in2000 to US$ 20 million in 2003. Althoughsome of this increase came from non-poorclients, a survey of the income status ofclients indicates that the number of poorclients in 2003 is triple the total number ofclients before transformation. Furthermore,the ability to take savings has brought innew clients, many of them poor. The number of customers demanding savingsdeposits has greatly outstripped those demanding loan products, reaching 62,643in 2003.

K-Rep Group’s outreach has also beenenhanced by KDA’s support of developingand spreading the FSA model. By late 2003,67 FSAs had been established (half in aridareas), with some 48,000 shareholders,most of whom use the FSA to save andwithdraw when needed. They have an out-standing loan portfolio of US $0.5 million.Other projects supported by KDA, for example, in HIV/AIDS, agriculture,healthcare, and low-cost housing, reach anadditional 9,000 poor people, largely in rural areas.

Impact on Products and Services

Transformation led to a number of newbanking products. New loan products con-sisted of individual loans, wholesale loans,bank overdrafts, consumer loans, healthloans and others. This has permitted K-RepBank to accommodate more group-basedclients, as well as new small and medium enterprise (SME) clients and others whowere targeted as a source of new deposits.The deposit instruments include passbook

Year No. ofLoans

No. ofSavings

Accounts

LoanPortfolio

(US $ 000)

Avg.Loan Size

(US $)Deposits

Avg.Deposit

Size

TotalAssests

1991 1,253 0 581 463 0 0 0.9

1999 13,636 0 3,228 237 0 0 6.3

2000 17,139 19,863 4,178 275 3,512 177 12.64

2001 22,659 28,584 9,458 417 5,377 188 15.42

2002 38,739 46,969 14,535 375 10,779 230 22.00

2003 45,379 62,643 20,389 449 15,481 247 28.58

As aBank

As anNgo

Table 2 Client Outreach Before and After Transformation 1991-2003


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savings (attractive to the poor) and time deposits (to mobilize savings from SMEsand others).

Loan Products

K-Rep Bank continued traditional group-based lending to individual members for amaximum of 24 months, at an interest ratehigher than standard commercial bank loans,with options for repayment frequency and agraduated loan size. Prior to transformation,K-Rep offered only the group-based loans(the Juhudi and Chikola products had beenmerged). The group loan product did notchange after transformation, although theproportion of the group-based loans was deliberately reduced to diversify risks. Proportionately it has decreased from 81percent to 49 percent of the total portfolio;volume grew from US $3.7 million in 2000to US $10.1 million in 2003.

As a commercial bank, K-Rep has beenable to expand its credit products to caterto both conventional clients and its coreclients who have outgrown the group basedmethod. Individual loans are issued toclients within the group structure, but arenot co-guaranteed by group members aswith group-based loans. K-Rep Bank alsooffers individual loans to clients who havegrown their businesses, have substantial sav-ings, and have a minimum of three yearssuccessful repayment experience with K-RepBank. Previously, such clients would havehad to seek loans from commercial financialinstitutions, with little chance of success.

K-Rep Bank also began traditional collat-eral-based individual lending with new

clients. In 2000, loans and advances increased by 76 percent. K-Rep Bank alsodeveloped a credit product, known as Kati-Kati, for individual entrepreneurs withhigh-potential businesses and credit needsthat exceed US $1,250. Overdraft facilitiesare available for current account holders—a standard banking product positionedcompetitively with other commercial banksand aimed at attracting small business ac-counts as a source of funds. After transfor-mation, the outstanding loan portfolio grewby nearly 200 percent in 2001, from US$4.2 million to US $9.03 million, then in-creased again by over 120 percent in just sixmonths, to US $10.9 million in June 2002,despite a poorly performing economy. Theprimary focus remains on the poor: 80 per-cent of the loan portfolio continues to rep-resent loans advanced to micro-enterprisesthrough the group-based loan products.

Savings Products

One key objective of transformation was themobilization of deposits. In 1996, clientsand non-clients within the target populationwere surveyed to determine the level of interest in opening savings accounts. Themajority of the respondents (91.7 percent ofentrepreneurs and 86.4 percent of non-entrepreneurs) expressed their willingness toopen a savings account. Their interests, in order of importance, were access to credit,low minimum balance, proximity, good cus-tomer relations, fast service, and competitiveinterest rates. Prior to its transformation, K-Rep could only use compulsory savings assecurity for its loans. After its transformation,

152 Case Studies

The Case of K-Rep

K-Rep Bank offers five main kinds of savingsproducts: group savings,8 standard savingsaccounts (voluntary), Msingi children’s accounts,9current/checking accounts; andterm/fixed deposit accounts.

During 2000, the first year after transfor-mation, K-Rep Bank mobilized deposits to-talling US $3.5 million, largely from groupsavings held in other banks. By the end of2003, deposits had grown substantially toUS $15.5 million from a wide spectrum ofclients. Despite this growth, K-Rep Bankhas a funding gap, which it covers with linesof credit. The majority (96 percent) of K-Rep Bank’s depositors are micro-savers,whose savings balances average less than US$650. The total amount of savings for thisgroup accounts for 38 percent of the de-posits. Depositors with large balances ofover US $13,000 contributed 39 percentof the deposits as of the end of 2003.

Other Services

Together with KAS, K-Rep Bank is devel-oping additional structured financing serv-ices. One such initiative helps clients to starta community telephone business. KAS

works in partnership with a communityphone distribution company in structuringthe finance, training and marketing of theproduct, and K-Rep Bank provides loans ofa minimum of US $1000 to a maximum ofUS $1400, repayable in six months. Thisparticular initiative began in earnest in Oc-tober 2003. As at March 2004, 421 unitshave been sold, with K-Rep Bank clientsforming the vast majority of owners.

Interest Rates

In the 1990s, K-Rep Bank was able to offer its group-based loans at an average in-terest rate of 33 percent per annum—com-parable to commercial bank lending rates—despite the relatively high operational costsof microfinance, due to its grant-basedsource of funds. Despite the higher cost ofcommercial sources of funds after transfor-mation, it was able to reduce the interestrate on the same loans to 31 percent in2001 and to 30 percent in 2002 (althoughthis was higher than commercial bank rates,which averaged around 14.5 percent in2004). Before 2001, K-Rep did not offerwholesale or term loans because it did not

US$ No of Clients % of Total Amount(US$ 000) % of Total

< $650 60,267 96% 5,861 38%

$650-$1,300 1,605 3% 1,480 10%

$1,300-$6,500 634 1% 1,601 10%

$6,500-$13,00 58 0% 508 3%

> $13,000 79 0% 6,054 39%

Total 62,643 100% 15,504 100%

Table 3 Average Deposit Sizes for K-Rep Bank Clients (as of December 2003)


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fall under its mandate as an NGO. As acommercial bank, it has been able to offerthese products, with the average interestrate falling from 25 percent in 2000 to 14percent in 2003 (from slightly above tocomparable commercial bank rates).10Thus, the cost of finance to customers hasbeen declining (at least in nominal terms) asaccess to credit has been expanding.

Impact on Clients

K-Rep Bank has been able to maintain its fo-cus on providing financial services to poorclients, especially women, who would notnormally be able to access commercialsourcesof finance. Although non-poor clients wereadded in the search for deposit mobilizationas a base for scaling up, the overwhelming ma-jority still use the group-based products designed for low-income clients. In 2002,11,000 first-time borrowers participated inJuhudi and Chikola groups. Approximately5,000 (over 12 percent) customers surveyedin 2003 were categorized as very poor.Women, who are largely in trading and small-scale manufacturing, account for 52 precentof K-Rep Bank clients. With KDA, over 70precent of the 48,000 FSA shareholders areconsidered poor, 49 percent of them women.Clients have testified not only to the impactof K-Rep Bank’s financial services on theirbusinesses and their lives, but also to the positive results of transformation.

Implementation and Success Factors

K-Rep’s experience in searching for a modelof sustainability while retaining a consistent

focus on the poor provides some lessons re-garding the factors leading to successfulscaling up and implementation of institu-tional change. Transformation that seeks anappropriate business model has been under-taken with the objectives of extending out-reach, in both breadth and depth, andachieving institutional permanence. Eachmajor transformation stage presented im-portant challenges of implementation. Thissection analyzes lessons from how thesechallenges were met and key success factorsfor institutional change, including: institu-tional commitment, political economy forchange, innovation and adaptation, a learn-ing culture, and external catalysts.


Transformation posed risks to K-Rep’spoverty focus by forcing it to deal with ex-ternal investors and the Central Bank, bothwith different objectives than K-Rep, andto hire staff members who came from apurely commercial banking culture. A keysuccess factor was management’s readinessto recognize problems and treat them aschallenges to be overcome, and determina-tion of its leadership to maintain the insti-tution’s original commitment to serving thepoor. This is reflected in the “Back to Basics” program of staff training and thecontinued predominance of women amongK-Rep Bank’s current loan clients (over 60 percent).

External factors helped create a politicaleconomy for change. The government’sgrowing focus on developing a strategy for

154 Case Studies

The Case of K-Rep

poverty reduction helped to raise the recep-tiveness of officials to the role that MFIscould play. International partners played acatalytic role, through donor-supported activities such as sponsored trips to success-ful MFIs in South America and Asia andthrough the willingness of international financial institutions and investors to pro-vide capital and help educate and persuadethe Central Bank. Public and private institutions worked together to hold seminars to try to develop guidelines thatwould enable other MFIs to join the financial sector with less stringent hurdlesthan those that K-Rep had to overcome.

Commitment to poverty focus is furtherdemonstrated by the decision to appoint aseasoned leader from within (rather than anoutside banking professional) to undertakethe launch and management of K-RepBank, in order to ensure consistency andcommitment to the mission. K-Rep Grouphas also demonstrated the commitment ofits leadership to poverty focus through col-laborative efforts of its different subsidiariesto develop and introduce new financialproducts for the poor, piloting financialservice associations in low-income commu-nities, and working with other organizationsoutside as well as inside Kenya to share K-Rep’s experience in poverty alleviation.

Success with the Central Bank

The regulatory environment was a signifi-cant barrier to transformation efforts. The board chairman and the managing director identified and targeted the governor of the Central Bank as a person

critical to the success of transformation.They built a solid working relationship,confidence, and trust with the governor andsimultaneously educated Central Bank offi-cers on microfinance.

Management continued these efforts after transformation to a bank to help regulators better understand the mechanicsof microfinance. They successfully responded to issues raised by Central Bankregulators without requesting special ex-emptions, thus instilling the credibility ofmicrofinance. The result has been not onlythe establishment of a microfinance unit inCentral Bank, but also the development oflegislation that will make it easier for futureNGO MFIs to transform and for CBK toregulate the industry more appropriately.Besides contributing to preparation of thenew bill, other MFIs are also developing aninstitutional framework for self-regulationthrough which they can ensure that non-genuine players do not bring the indus-try into disrepute.


K-Rep’s innovativeness has positioned it asa market leader and created an environmentthat has helped other MFIs and encouragedother stakeholders to support the industry.From the beginning, K-Rep established atradition of experimenting with creditmethodologies, such as Juhudi and Chikola,to adapt international best practices to theKenyan context.

K-Rep’s second transformation was farmore complex in externalising differentfunctions into separate but inter-related


Nairobi , Kenya

organizations. The holding company orga-nizational design not only provided legalownership, it was crafted to create distinctstructures (KDA, KAS, and K-Rep bank)with sufficient synergies to depend on eachother in pursuit of common objectives. Thestructure of three separate institutions wasan innovative approach to resolving the potentially divergent objectives (profit vs.social) by allowing each to specialize withinthe overall K-Rep Group mission of servingthe poor.

Governance of the new organizationalstructure was complicated by having tobring in external investors to meet regula-tory requirements. An important successfactor was the establishment of guidelinesby board and management for selection ofsuitable partners. Further efforts wereneeded to ensure that the individuals repre-senting these partners on the board had theright skills and understanding of microfi-nance to help the new institution fulfill itsdual mission of financial sustainability andoutreach to the poor.

Institutional change such as K-Rep wentthrough can be devastating to staff morale.Management’s humility and readiness totake corrective action were critical with respect to new staff. First, they recognizedthe need to recruit seasoned bankers in order to quickly meet Central Bank requirements. Second, they recognized theconflict of cultures and brought staff face toface to discuss it. Third, they recognized the need for special training to educate newstaff in microfinance methodologies and mission, and to train “old” staff in

traditional banking techniques. Fourth,they included K-Rep pioneers and existingstaff in the shareholding of the new venturethrough an employee stock ownership pro-gram which helped reinforce their commit-ment. The result was a blended workforcethat enables K-Rep Bank to straddle themiddle way of serving low-income commu-nities in a profitable, commercialized way.

Conclusions and lessons

K-Rep has been modelled as a “learning or-ganization.” It learned very quickly that itsinitial integrated model of packaging non-financial services with finance might not at-tain the objectives of outreach and sustain-ability, and shifted to a minimalist modelfocusing on developing financial productsappropriate for its target population of thepoor. It then experimented with new prod-ucts, such as the Juhudi credit scheme (anadaptation of Grameen Bank methodol-ogy), which had greater impact on low-in-come customers by tapping on their groupstrengths and focusing on unity, commit-ment and trust by members.

The results of a study in K-Rep’s initialphase as a service wholesaler indicated thatthe objectives of the MFIs it assisted werenot in concert with its objectives of outreach(both in breadth and depth) and sustainabil-ity. It then embarked on direct financial service provision to the poor to improve onoutreach, efficiency, and effectiveness.

Observing that donor interest and funding were waning, K-Rep embarked onfurther transformation. It had learned from

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The Case of K-Rep

experience that microfinance was not only viable, but also sustainable if the right models were implemented. It soughtto combine the drive for profit as a com-mercial bank with its mission to serve the poor is its latest venture in learning and experimentation.

Learning was institutionalised by the creation of a research and development department, which could test products andadapt them to customer requirements. Several products adapted from various geographical locations have been incorpo-rated into the K-Rep portfolio of products,e.g., Kati-Kati, Juhudi, Chikola, and FSA.This department laid the foundation for the eventual emergence of KDA, whosemandate largely continues to be experimen-tation, leaving K-Rep Bank to focus on making profits while the other subsidiariesundertake the risks of experimentation andpass on the benefits. This model has facili-tated outreach in terms of learning: the advisory and consulting services provided by KAS have enabled the K-Rep Group toextend their experience to over 15 countriesin Africa.

A key lesson is the need for an institutionto continually remain dynamic and relevantto the environment in which it operates. K-Rep was initially one entity, but when thetime was right, the Board made the some-what painful decision to spin off the financial services division into what is nowK-Rep Bank. A second decision was madeto spin off the microfinance capacity-building division into what is now K-RepAdvisory Services. K-Rep’s leadership was

bold enough and dynamic enough to let goof projects that are now incubated in the K-Rep Development Agency. KDA has anumber of projects that it is piloting, withits biggest and most promising being the financial services associations. KAS is incu-bating a community phone project. K-Rep’sstructure is designed in such a way thatwhen the board feels that the time is right,financial services associations or the com-munity phone project, for example, couldbe institutionalised and hived off to becomeK-Rep entities in their own right.

Implications for Replication in Other Settings

The leadership of institutions seeking to scaleup and transform need first to understandand foresee the implications that scaling-upmay have, particularly with respect to thestructures needed to maintain their core mission and objectives. In Kenya, the Co-operative Bank is scaling up its microfinanceactivities successfully as a result of betterawareness and a regulatory climate moreconducive to microfinance, as championedby K-Rep and its partners. K-Rep benefittedfrom establishing a research and develop-ment department that would keep it informed of trends in the industry and exper-iment. The importance of testing newmethodologies locally and adapting them tosuit the circumstances requires the creationof an organization capable of learning bothinternally and externally.

Government support is critical in estab-lishing a regulatory climate that will allowsustainable microfinance institutions to


Nairobi , Kenya

service poor clients. Donors should be un-derstanding, flexible and accommodative ofthe unique situations institutions operate in,providing opportunities that seek to empower the leadership and linkages to international networks to expose managersto best practices and nurture leadership capabilities. Donors also could in the initial

stages support institutions by assuming therisks in investments for social reasons, so asto build confidence with other partners. Finally, leaders must continuously transforminstitutions and develop their human resource capacities in response to client demands and to the changing environment.

Overall Financial Performance

Adjusted Return to Assets (AROA)Adjusted Return to Equity (AROE)Operational Self Suffciency (OSS)Financial Self Suffciency (FSS)Productivity

Borrowers Per Staff MembersRisk And Liqudity

Portfolio At Risk >30 Days

Table 4 Select K-Rep Bank Performance Indicators

K-Rep Bank(2003)

2.3%6.9%

132.0%126.0%

172

6.7%

K-Rep Bank(2002)

2.5%6.1%

133%127%

199

2.3%

Average forAfrican MFIs

3.7%14.1%148%133%

138

2.1%

Average forall MFIs

0.1%2.3%

115%104%

121

2.8%

End Notes

1 Savings are collected and loans are disbursed atweekly meetings with two members of each watanoseligible for loans in the first month, two more in the sec-ond month, and the rest in the following month. Thisloan disbursement pattern may vary depending on otherfactors. Each member pays a membership fee and buysa passbook for $3.70 combined. Each borrower pays1.5 percent of the loan amount to cover the applicationfee (1 percent) and insurance (0.5 percent). All membersavings are compiled in a group savings account at aformal (commercial) bank with a credit officer and twomembers as co-signatories. Client savings serve as anadditional guarantee against loan default, but are with-drawn only as a last resort.

2 In the past, K-Rep required collateral security in theform of savings equivalent to 10 percent of each Chikolaloan and 20 percent of each Juhudi loan. In January1998, K-Rep changed this loan guarantee amount fornew clients to 5 percent of the loan amount, incremen-tally increasing to 20 percent for loans of US$ 862 andhigher.

3 In Kenya, only financial institutions licensed by theCentral Bank of Kenya (CBK) can mobilize deposits fromthe public. The “forced savings” that K-Rep held for itsclients as a guarantee for loans was not considereddeposit taking from the public as understood by theCBK; it was considered part of the credit methodologyand not for onlending.

4 The chairman of the board, managing director, andanother board member were included as three memberson the advisory team.

5 By law, K-Rep the NGO was not permitted to own allor part of a commercial bank.

6 The minimum capital requirement at that time was US$2.5 million, but there was a proposal to increase this toUS $6.3 million over the next two years.

7 A convertible debt redeemable after five years.

8 Each individual in a group has their own account withall the group member accounts electronically linked toeach other to cover group guarantees.

■ ■ ■

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9 This account encourages parents and guardians tostart a savings account for their children under 18 yearsof age. A minimum balance of US $6 is required to openthe account and the account earns interest at a mini-mum balance of US $60.

10 Both inflation and treasury bill rates fluctuated duringthe early 2000s, but on an overall declining trend, with90-day treasury bills falling from 13% in 1999 to 1.6% in2003.

End Notes continued

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