Wednesday, March 15, 2006
While the value of poverty-reduction strategies designed to help the poor help themselves is now well-known, private sector investment in microfinance is still low.
Microfinance – or the provision of credit to entrepreneurs too poor to qualify for traditional bank loans – has been a tool for poverty-reduction now for three decades.
But just 5% of microcredit demand is currently fulfilled. Moreover, 95% of people in developing countries lack access to financial services, compared with between 3% and 5% in the UK.
This is a prime example of the lack of opportunities for those at the so-called “bottom of the pyramid” – the nearly three billion people in the world living on less than $2 a day, according to the World Bank.
Not a panacea
Arun Kashyap, public private partnerships adviser at the United Nations Development Programme (UNDP), says that microfinance is yet to fulfil its potential. A loan is not a panacea for poverty, although it does represent a “good initial step”, he says.
Small loans work as “liquidity tools”, kick-starting the process of connecting people with capital and injecting cash into local economies. But there is still “a huge need to take microfinance to scale”, says Kashyap. The value of microfinance will be realised if investment is sustained – if one loan leads to another.
Kashyap says there are three potential sources of microfinance funding that are currently untapped.
Firstly, there are the opportunities for microfinance institutions to grow and diversify into other financial services, such as savings and insurance.
A second under-used resource is remittances, or the money sent back home from family members working abroad, most of which now goes directly to households. The Inter-American Development Bank estimates that just 10% of remittances coming into Latin America go through the formal financial system. Thus there is a significant source of funds that could be used to provide credit that the banking sector is missing out on.
And finally, says Kashyap, there is “the need to bring in private sector equity to microfinance”.
There are signs, though, that large commercial banks are starting to take an interest. ABN AMRO, for instance, has lent to 1,000 micro-entrepreneurs in Brazil, through its partnership with Accion, the leading microfinance non-governmental organisation in Latin America.
Since 2003, the Dutch bank has also extended its small loans and advisory services to groups of women in India.
Other good examples include Citigroup, which in February announced a donation of $250,000 to the Grameen Bank in Bangladesh, and Barclays’ new “micro-banking” initiative in Ghana (see box). The Deutsche Bank microcredit development fund, launched in December 2005 also provides microfinance institutions with low-cost loans at interest rates of as little as 1%.
Martin Hancock is chairman of the finance initiative at the United Nations Environment Programme and chief operating officer at the Australian bank Westpac. He says that demand for seed capital in developing countries presents an opportunity for the financial services sector to “kill two birds with one stone”.
Commercial banks stand to achieve a decent return on their microfinance investments, he says, in some cases between 10% and 20%, whilst demonstrating their credentials as good corporate citizens. Hancock thinks that financial institutions have a unique position: “They can use their banking experience and promote sustainability to help the poorest out of the poverty trap.”
A decent return
The credit risk associated with microfinance projects is minimal. According to Deutsche Bank, micro credit institutions typically achieve repayment rates exceeding 97%. As other small lenders have found, borrowers will work hard to protect their access to a source of credit.
The prerequisite for investment, however, is the existence of economically sustainable microfinance institutions. Kashyap says the perceived cost of working through small, and often inefficient, partners has been the major barrier to private sector entry into the microfinance market.
William Derban, manager of financial inclusion at Barclays, and the brains behind the bank’s first international microfinance project, stresses the importance of finding “indigenous models” that are suited to the local context.
In Ghana, Barclays has chosen to work with local Susu collectors, who have been providing financial services there for over three hundred years. Derban, a Ghanaian, says he chose the Susu collection model because it is the “most traditional and the most popular”(see box). Its other strengths are the collectors’ local market intelligence and their proximity to their customers, whom they visit daily.
For Derban, microfinance is defined by a tension between the social agenda and the commercial agenda. In the short-term, he says, the emphasis for Barclays and other banks falls on the social side of microfinance.
Banks can use micro-lending to reach beyond their traditional customer base and become drivers of development. But in the long-term, microfinance projects are a bridge to future commercial success.
Aside from contributing to poverty-reduction, Derban sees Barclays’ investment in its micro-banking project in Ghana as “creating an avenue into a new market”. He hopes that in 10 or 20 years time, as the nation’s economy grows, the people who benefit from micro-loans will themselves be opening bank accounts – presumably with Barclays.
The very poor struggle to get access to financial services. A solution is microfinance where credit is provided, by a number of methods, to those who would not otherwise qualify for bank loans. Some international financial institutions are now taking up microfinance schemes, including ABN AMRO, Deutsche Bank and Barclays.
Barclays in Ghana
In December 2005, Barclays launched a “micro-banking” project in the west African country of Ghana. The project, which is currently at the pilot stage, aims to extend savings and credit services to small-traders and micro-entrepreneurs, whose collective income amounts to around ?75 million. These people are currently excluded from mainstream financial services.
Opening an account with Barclays Ghana requires a deposit of 150,000 cedi or ?100 – just ?10 more than the average government employee earns in a month. Barclays will work in partnership with Ghana Co-operative Susu Collectors Association (GCSCA). Susu collectors have been providing financial services to people in Ghana for three hundred years. For a small fee, they collect money daily from their customers, usually market traders, which they return at the end of each month.
The Susu also lend small amounts of money and make monthly payments, for example for school fees, on behalf of their clients.The project has three strands:
– a specialised bank account for Susu collectors, including the provision of capital for on-lending to their clients;
– training programmes for Susu collectors; and
– financial literacy and education programmes for Susu clients.To qualify for the loan facility, Susu collectors must be a member of the national association, be recommended by the association, and have been making deposits into a Barclays account for two to three months.
Barclays will measure the success of the pilot project in terms of the rate of repayments, and the number of deposits left in Barclays’ accounts. The latter will be a measure of whether the financial literacy programmes are actually encouraging people to save. Most people who deposit money with Susu collectors currently tend to withdraw it all at the end of 31 days, regardless of their expenses.
The Grameen Bank
The classic microfinance model is the Grameen Bank, an institution established in Bangladesh in the 1970s. The bank makes small loans – perhaps as little as $5 – to a small group whose members then all share responsibility for repayment.
Like many microfinance institutions, the model capitalises on strong social ties existing within the communities that it serves. In the absence of land or other assets, it is the shared responsibility of the borrowers themselves that serves as collateral on the loan. The Grameen Bank has been a huge success. It now lends to 3.7 million borrowers, 96% of whom are women, and covers more than two-thirds of the total villages in Bangladesh.
The Microfinance Information Exchange (www.mixmarket.org), lists more than 600 microfinance institutions and 74 funds. Returns vary greatly and institutions with large amounts tend to be offered better rates.