Mainstreaming the Microfinance Mainstreaming the Microfinance PracticePractice

Challenges & Opportunities for Commercial Banks as Lenders to

Micro-enterprises

Finance Forum 2002June 19, 2002

Characteristics of Micro-enterprises

Micro-enterprises are very small and mostly in the informal sector, semi-legal, often low-productivity, frequently family-based, lack transparency

Micro-enterprises are much more vulnerable to the vagaries of economic cycles

Little is known of the micro-enterprises/entrepreneurs, their markets, and their business dealings

Mostly cash-based markets

Informal contracts/agreements – not recorded, not legally enforceable

Property rights are weak or non-existent

Rural-based businesses are dispersed over large geographical areas

High cost to formalize micro-businesses (registrations, taxes, labor regulations, payroll charges)

Informal businesses maintain a low profile in order to avoid high cost of formalization and enforcement of regulations by authorities

Implications for Commercial Banks

Micro-enterprises:Micro-enterprises:

Very small transaction sizes (credit, savings, payments) --- Very high transaction costs

No formal status – can’t transact

Lack of formal properties – no collaterals

Little prospects for growth fearing formalization

“Fearful” of banks and don’t trust them

Banks:Banks:

Lack experience of transacting with the poor, have a negative pre-disposition, don’t trust micro-entrepreneurs

Lack knowledge and understanding of markets of micro-enterprises

Lack credit information, unable to assess credit risk and thus perceive micro-enterprises as high risk

Distrust NGOs that provide financial services to the poor

Globalization of the Financial Services Industry

Globalization and technology are fundamentally changing the financial services industry worldwide

Competition has accelerated and is fierce for “best credits”/corporates in most countries

New competitors have entered the market

Margins and fees are narrowing significantly

Development of securities markets is providing additional competition for banks

What are the Opportunities for Banks?

Right pre-conditions to develop a microfinance business line?

Large underserved market estimated by some at 500 million micro-entrepreneurs in emerging and transition economies

Banks are increasingly facing stiff competition in their traditional businesses (e.g. large corporates & trade finance) and are starting to pursue other market segments including SMEs and consumers in order to achieve growth and profitability

Microfinance as well as SME finance are prospects to consider but how to target these markets profitably?

Financial and information technologies can be leveraged to reduce transaction costs and improve portfolio risk management

What are the pre-requisites for Banks to enter the microfinance market? Sound macro-economic policies and appropriate regulatory and

prudential framework

Improved legal framework and effective public institutions to enhance business viability (e.g. property registries, contract and collateral enforcement, security of land tenure for low income populations, simplified processes for licenses, customs, tax, labor) eliminate corruption, to reduce constraint on micro-enterprises to formalize and grow

Reliable credit information on micro-entrepreneurs Information on past payment history, level of indebtedness Default information

Understanding the markets of the micro-enterprises primary & secondary market research to better understand the

businesses

Segmentation (size & industries)

Are these pre-requisites enough to interest banks?

The Theoretical Framework:Shifting the Productivity Frontier

Lower unit costs per

transaction or service

Broader service offerings & higher asset quality

Productivity FrontierProductivity Frontier(Future state of Best Practice)

Limitedservices tolimited numberof customersUnprofitable

How?New financial,information &

communication technologies

Better credit risk decisions &

efficient distribution channels

Sustained profitability

What are FIs trying to do?

Reaching Sustained Profitability

in Microfinance

Growth

Operating Efficiency

Asset Quality

Value Creation & Sustained

Profitability

Marketing Strategy

Technological Innovation

RiskManagement

Small & Mid Banks

MicrofinanceInstitutions

What do Banks need to do?

Better understand client needs

Develop appropriate products and services

Develop effective and efficient distribution channels

Implement new risk management technologies, decisioning techniques and appropriate credit allocation processes

Adopt global technologies to local markets

Examples

Bolivian MFIs becoming competitive banks e.g. BancoSol ProFund in Latin America actively building and seeking

linkages with commercial banks – (e.g. BancaSol merging with NGO Genesis in Guatemala, Sogesol – microfinance subsidiary of Sogebank in Haiti, Mibanco in Peru)

AfriCap in Africa driving its investment strategy on integrating microfinance in commercial banks

Accion has been an active player in building strong MFIs that are converting to commercial banks – assisting banks create and manage microfinance subsidiaries

Internationale Projekt Consult (IPC) and its investment vehicle IMI – 17 microfinance banks

Few commercial banks in Asia see microfinance as a profitable core business e.g. BRI in Indonesia, Hatton National Bank in Sri Lanka

The Future? Will banks move down-market?Will banks move down-market?

First to the SME market Then to the micro-enterprise segment

How?How? Establish separate subsidiaries? Acquire existing MFIs and keep them as separate

businesses? Integrate more fully into regular bank operations?

When?When? As macro-environment improves, risk profile of micro-

enterprises will improve When banks see that it can be profitable to lend to micro-

entrepreneurs (demonstration effect) As competition increases, pace of change will speed up

What are the Developmental Goals to pursue?

Increase the number of MFIs that are part of the formal financial sector, able to offer a comprehensive set of products and services to micro-enterprises

Establish linkages between MFIs and the formal financial sector and capital markets

Support banks moving into the microfinance market – demonstration effect

Identify and develop financial technologies that improve risk management and profitability and increase efficiency