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AfricaJuly 3 2005

Microfinanciers overtake their commercial peers

In Africa, the poor are proving to be reliable, stable customers who make microfinance institutions twice as profitable as commercial operations, write Elizabeth Littlefield and Martin Holtmann.
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Think microfinance and you might think of small non-governmental organisations – subsidised, inefficient and anything but profitable. They lend money in picturesque settings to groups of poor women who are probably more in need of social assistance than financial services. And their financial health is only as strong as the donor money poured into them. But you would be wrong.

Microfinance has matured into one of the most successful and fastest-growing industries in the world. In Africa, its growth is probably second only to that of cell phone use.

According to a recent analysis conducted by the Consultative Group to Assist the Poor (CGAP), the compound annual growth rate of the world’s leading microfinance providers over the last five years has been a whopping 15%. Worldwide, these leading microfinance institutions are nearly twice as profitable as the leading commercial banks.

The trend is not new. In fact, in the last decade, microfinance has been a more stable business than commercial banking in emerging markets. During Indonesia’s 1997 financial crisis, for example, commercial bank portfolios imploded, but loan repayment among Bank Rakyat Indonesia’s three million-plus micro-borrowers barely declined at all. During the more recent Bolivian and Colombian banking crises, microfinance portfolios suffered slightly, but remained substantially healthier than commercial bank portfolios, and the microfinance institutions remained more profitable.

It’s not rocket science

But there is no real mystery. Microfinance – financial services for the poor – is just retail banking for low-income people: reliable, smart customers who will pay for the services because they value them. The services are the same – loans, deposit facilities, money transfers. The standards, increasingly, are the same – more than 40 recipients of the CGAP Financial Transparency Award comply with International Financial Reporting Standards (IFRS). So what makes microfinance different?

Besides rollicking growth and consistently high repayment rates, the difference is a huge untapped market of reliable customers. In a world where more than three billion people lack access to financial services, it is the microfinance industry that is shaping the future of retail banking. In Africa, strong microfinance providers – from West African mutuelles and NGOs to co-operatives and regulated institutions – are thriving. Weak ones persist, but the leaders are capturing new markets at an astonishing rate. Equity Bank in Kenya, for example, has been opening 15,000 new savings accounts per month for the past year.

With the rural poor accounting for some 60% of Africa’s population, reaching ‘the last mile’ remains a challenge. But it is being overcome. Many institutions in countries as different as Tanzania and Senegal are pioneering the use of payment cards – some using ‘smart’ technology – and deploying points of service to transform local retail shop cash registers into virtual bank branches. Other institutions in places like Zambia and Kenya are using the explosion in cell phones to offer withdrawal, deposit and money transfer services via text messaging. Microfinance institutions in Africa are linking into national ATM networks or installing low-functionality battery-operated systems to reach rural areas.

With so many new and potential customers and increasingly efficient operations, more and more of these providers are realising the profits – and sustainability – of the more densely populated markets in south Asia, where microfinance was born, and Latin America.

Excellent returns

A recent survey by the Microfinance Information eXchange – the Bloomberg of microfinance – shows that the 163 African microfinance lenders provide loans to 2.5 million customers and deposit services to 6.4 million more. That comes to $713m in deposits and $742m in loans. Remarkably, portfolio-at-risk rates average 4%, on par with microfinance operations worldwide. These levels of portfolio quality are similar from east to west and from post-conflict countries such as Mozambique, the Democratic Republic of Congo and Sierra Leone to the more stable markets.

But that is not all. The average return on assets for African microfinance institutions is 3.9%, against just 2.1% for commercial banks.

How do they do it? Ironically, many microfinance providers trace their success to the lack of integration with the mainstream financial sector and, more specifically, to the lack of government intervention. Where governments may impose interest rate caps on commercial lending, they have in many cases paid little attention to village-level micro-lending operations. These, in turn, have charged rates that help them recover their costs but that are only a fraction of those charged by usurious moneylenders.

Scaling up

The benefits of microfinance for the unbanked poor are unquestionable. Instead, the problem today is one of scale. The thousands of NGOs and more formal financial institutions in Africa – including postal, state, rural and some commercial banks – are only serving a fraction of the estimated 560 million Africans living on less than $2 a day. Moreover, the market is highly concentrated in a small number of leading institutions. In Africa, the top 10 organisations cater to 57% of clients.

The question is no longer whether the poor demand financial services, but how to scale up more institutions. Best practices in core microfinance skills and technology such as cash flow-based loan analysis, unsecured lending and the use of collateral substitutes are now well known. Information sharing in the microfinance sector is now about new technologies and forging partnerships with banks and other formal sector organisations.

CGAP predicts that commercial banks will become the dominant players in microfinance. Around the world, commercial banks are moving down market and into microfinance. This is partly the result of increasing competition in the traditional market segments of corporate customers (of whom there are perhaps 300 in a city like Lomé, Togo) and affluent urban professionals.

Dozens of commercial banks throughout the world, and especially in Africa, are seeking advice from CGAP and other microfinance advisory groups on penetrating these lower income markets. Driven by competition and the quest for market share – and inspired by the stability and profitability of microfinance, as well as the promise of cost-reducing new delivery technologies – they see attractive opportunities to leverage their existing infrastructure to reach new clients.

Partnerships

In some cases, such as the Financial Bank in Benin, banks are forging partnerships with microfinance providers. These partnerships range from sharing branch space, to providing back-office functions and on-lending funds. Some even enter into loan servicing or franchising arrangements. (The North-American NGO Acción International, for example, has partnered with five Nigerian banks.) In this way each organisation can leverage its comparative advantage and maximise market share, while keeping costs low and repayment rates high.

Increasingly, microfinance providers use the opportunities provided by enabling regulatory regimes to convert into licensed financial institutions. In Uganda, for example, non-bank financial institutions are now licensed to take deposits. And in Kenya, K-Rep is now a fully converted commercial bank and among the fastest-growing in the country.

Covering the April opening of one of K-Rep’s newest branches, the East African Standard quoted chairman Bethwel Kiplagat as saying that: “The two sub-sectors of [finance] would in future converge as has been witnessed by the recent movement of big banks into the microfinance business and the entry of microfinance institutions into commercial banking.”

As the first such Kenyan institution to make that entry, K-Rep’s assets have grown from Sh500m ($6.5m) to Sh2.9bn ($37.8m) in less than six years.

Power of profit

The anti-poverty agenda which gave birth to microfinance continues to drive the people and institutions that provide the vast majority of financial services to the poor. Yet they, too, recognise the power of profit – to generate even more enthusiasm, to attract greater investment, and ultimately to fight poverty with greater vigour and reach. For this, they need similar recognition from the mainstream financial sector.

Those in the mainstream must be disabused of the notion that microfinance somehow means lesser finance. If anything, the reverse may be true: poor people need and value financial services even more than the traditionally banked. They value loans, however small, because they help them plot their own entrepreneurial pathways out of poverty or manage in unforeseen circumstances (consider the December tsunami, for example). And they value savings services because they offer security and hope.

The poor have demonstrated that they can and will pay the higher costs of the small transactions they need because the alternatives are more costly and less convenient. But why should commercial banks get involved?

Consider again the remarkable fact that microfinance institutions, across the board, are nearly twice as profitable as the world’s leading commercial banks. That alone should be enough incentive to invest in what is today the future of finance – the billions of unbanked potential customers in Africa and elsewhere.

Elizabeth Littlefield is CEO and Martin Holtmann is a lead financial specialist of CGAP, a multi-donor consortium housed at the World Bank in Washington, DC. CGAP is committed to building financial systems that work for the poor. www.cgap.org

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