Evidence is accumulating to show that microcredit can be a profitable business for commercial banks. Stephen Timewell reports on progress in the International Year of Microfinance.
For the 2.5 billion people from low-income countries and many of the 2.7 billion from middle-income countries, traditional banking services are largely unavailable. But while many people are not served by established banks, many low-income consumers are both willing and able to pay for services. And many financial institutions, ranging from small microfinance institutions (MFIs) to global giants such as Citigroup and ABN Amro, are now realising that small customers are not only a large market but also a profitable one that can be financially sustainable.
Proving that the poor are bankable is no easy task but in the past 20 years or so pioneers, such as Professor Muhammad Yunnus with Bangladesh’s Grameen Bank, have helped to break down preconceptions concerning the viability of what is now known as microfinance. And in their latest book, Small Customers, Big Market: Commercial Banks in Microfinance, Professor Malcolm Harper and Sukhwinder Singh Arora provide 18 case studies from 15 countries that show how commercial banks have successfully engaged in the provision of financial services to poorer people.
Hard-nosed approach
Taking a different perspective from some non-government organisations (NGOs) that focus on softer social development issues, the book takes a more hard-nosed financial approach and focuses on what MFIs and a few others have achieved so far and, in this Year of Microfinance (see Viewpoint p12), what could be achieved if more commercial banks got more deeply involved.
Messrs Harper and Arora conclude that “poverty and a predominantly rural population is no bar to commercial banks’ entry to microfinance” and plenty of examples are provided. The world’s largest MFI is the microbanking division of Bank Rakyat Indonesia (BRI), which today serves almost 30 million savers and three million borrowers through 4185 outlets. Provision for the $3bn in savings funds comes from the $1.7bn loan portfolio and the average loan is $541. In the 1998-2002 period, the unit made consistent profits of $139m annually, translating into an annual return on assets of 5.8%. “BRI has proven that institutional viability, sustainability and outreach to low-income people are compatible,” they write.
Viable business
In Kenya, the Equity Building Society has built a viable business serving small customers since it started in 1984. Equity now serves 252,000 depositors and 66,000 borrowers (the average loan is $360) from five branches and 24 other outlets. It has made growing profits since 1994 and in 2003 delivered a return on equity of 30% and return on assets of 3.6%.
In the vast spaces of Mongolia, microfinance’s low non-performing loan rates (NPL) have also proved successful at AgBank. “The bank has disbursed 878,000 loans (the average loan is $382) between late 2000 and February 2004, while maintaining an arrears rate consistently below 2% and becoming the most profitable bank in Mongolia, with return on equity of 44% in 2003,” say Messrs Harper and Arora.
Bigger banks in poorer countries – such as India’s State Bank of India and ICICI Bank, the country’s two largest – are realising there is potential in microfinance. “ICICI Bank only entered the market in 2001, by offering wholesale finance to other institutions, as well as direct service delivery. In two years, its microfinance portfolio grew from $16m to $63m (the average loan is $223) and the bank envisages a potential portfolio of $4bn from this market,” says the book.
“State Bank of India now allows informal self help groups (SHGs) of 10-20 women to open bank accounts and borrow from the bank (average loan is $53). SBI was lending to 174,666 such SHGs in March 2004, against only 12,200 SHGs four years earlier, and the bank aims to be doing business with one million SHGs, with approximately 15 million mainly women members, by 2008,” it says.
The size of the under-banked and unbanked markets around the world is enormous. For example, Banque du Caire estimates that only 7% of the 2.4 million small entrepreneurs in Egypt have access to microfinance. But, although the aspects of unsecured lending into very different delivery channels may seem daunting to many, microfinance’s excellent repayment record (NPLs of 2% or better) now enables the sector to be seen as a profitable long-term business opportunity and not as an act of social responsibility for public relations’ purposes.
Big banks get involved
The world’s largest bank, Citigroup, has realised the huge opportunities that are available through microfinance by reaching deeper and providing services for a new group of customers that can have an enviable credit record and can prove profitable. Clearly, the challenge of scale is critical for institutions like Citigroup, and finding the right structures to enable such a giant to give a wider range of people financial access and choice is essential. A key aspect of this challenge is where the microfinance unit is situated in the structure of the bank. At Citigroup, global director of microfinance Robert Annibale, an international banker with more than 20 years of experience, reports directly to the head of global consumer banking, not to a charity subsidiary. The business linkage is critical.
Citigroup is interested in developing scale and building partnerships with MFIs and the investment community. Last August, through its Mexican subsidiary Banamex, the bank did a landmark 500m peso ($44m) bond issue for Financiera Compartamos, the largest microfinance lender in the Americas.
Explaining the issue to The Banker, Mr Annibale notes: “Compartamos is providing access and opportunity to financial services for 300,000 principally rural women. The Citigroup/Banamex led bond, which achieved investment grade rating in Mexico, raised enough capital to allow the equivalent of over 400,000 microloans, giving access to not only new entrepreneurs but also including local financial players from domestic mutual and pension funds to capital markets.”
The World Bank’s private sector arm, the International Finance Corporation, had provided the five-year bonds with a 34% loan guarantee, thereby helping the issue to achieve an AA rating by the local affiliates of Standard & Poor’s and Fitch Ratings. The deal highlights not only the role of guarantees in terms of credit enhancement but also how large institutions can help MFIs to access local markets to leverage their funds. It is also part of the trend for MFIs to reach out to more commercial sources of funding and away from donor funds.
Joint ventures
Other big international banks, such as the Netherlands’ ABN AMRO, are strengthening their involvement in microfinance through a combination of equity, guarantees and debt as well as technical assistance to local microfinance partners. In Brazil, ABN has formed a joint venture, Real Microcredito, with international specialist ACCION to focus on Sao Paulo’s favelas (shantytowns). With ABN providing 80% of the capital, almost 2000 loans have been made (the average loan is €370) at monthly interest rates of 2%-3.5%, which is the market rate for microcredit in Brazil.
In India, ABN has formed relationships with eight local MFIs and last September the microfinance business had reached break-even; its goal is to reach one million poor women within five years in a commercial, profitable and sustainable way.
ABN emphasises that microfinance is not separated but is integrated into its regular banking business and that a reasonable return has to be made. “Microfinance activities are an integral part of ABN AMRO’s sustainability strategy,” says senior vice-president Paul Mudde. “One of the most important themes of sustainable development is to integrate the concept of triple P (people, planet and profit) in the business of the bank.”
ABN, through its US subsidiary LaSalle ABN AMRO in Chicago, also has a $1m equity stake in ShoreBank, the leading US community development and environmental banking corporation. Shorebank has worked in the microfinance area in 30 countries for more than 15 years and in 2003 established a London-based subsidiary ShoreCap International to make equity investments in MFIs in Africa, Asia and eastern Europe.
Momentum builds
ShoreBank and the Consultative Group to Assist the Poor (CGAP), a consortium of 28 multilateral development agencies and foundations housed in the World Bank, are two key institutions that have helped to build momentum in microfinance and strengthen its commercial foundations. CGAP chief executive Elizabeth Littlefield, a former managing director at JPMorgan, stresses the variety of engagements that banks can have with MFIs, from the back office to lending and to taking equity investments. “There is a dawning understanding that developing countries’ financial systems need to be more accessible to poor people and that there are practical ways to make this happen,” she says.
She also notes the possibilities of reaching poorer people profitably, whether it is through the network of lottery agents in Brazil, using shops or kiosks for basic financial transactions with card technology or the post office networks, among other means.
MFIs face a multitude of challenges but many have proved, through their good credit performances, that they can be profitable and commercial banks and are becoming aware of where that can lead. The Compartamos bond issue demonstrates that there can be a genuine link between the poor and the capital markets where all can be winners. Banks can do much more but financing the billions of unbanked poor people around the world is slowly becoming a viable reality.
