Giants and Minnows
Friday, November 4, 2005
One of the most encouraging trends in microfinance is that the world’s largest banks and insurers are becoming interested. At a minimum, they can do something that small local institutions cannot: move money around the world through their own systems, and tap and raise huge pots of capital. They can also reduce the risk and increase the liquidity of small institutions by packaging and reselling their loans, and even provide savings products through tiny institutions.
So-called ?bottom of the pyramid? strategies (named after a bestselling book called ?The Fortune at the Bottom of the Pyramid?, by C.K. Prahalad) are currently in vogue among the world’s leading companies in many industries. The idea is that big business has so far ignored a huge number of people who have very little money but nevertheless represent a potentially lucrative market. The big banks have noticed, but they are moving slowly and with great caution. ICICI Bank of India reckons that providing $1.3m in loans to microfinance clients currently requires 40 times more manpower than a corporate loan of the same size.
Typically, the big global financial institutions are moving into microfinance via their corporate-responsibility or community-development departments, not their core for-profit banking operations. Most of them are pleased to do something that may win them good marks from their usual critics in non-governmental organisations. But they are also worried that if they turn microfinance into a real business, they will be slammed for profiteering from the poor. And there are people working in the big banks who honestly do not believe that microfinance can, or should, be a business.
One exception is Citigroup, which happily proclaims that, leaving aside its philanthropic activities, it is also getting into microfinance for its potential profits. But the foremost example is Bank Rakyat Indonisia (BRI). Founded by the Dutch in 1895 as an institution for the elite, by the 1970s it had become yet another badly run state bank with an impossible mandate. It was supposed to help farmers to increase rice production, but the government reserved the right to approve borrowers and required BRI to pay more for its deposits than it received for its loans. Not surprisingly, the bank did not bother to collect deposits, and many borrowers did not bother to repay their loans. According to a report by Marguerite Robinson of Harvard University, an analysis of BRI’s 3,600 lending units concluded that not a single one of them made money.
Facing disaster, in 1983 the bank embarked on a complete reorganisation in which it reversed every policy. It increased its loan rates by half and shifted its target client group from the well-connected to poor people without any ties to government or financial companies. It actively marketed deposits and abolished minimum limits on account. Success followed rapidly. The BRI formula has since been emulated around the world.
In some ways, a successful financial institution may find it tougher to move into microfinance than an ailing one. Bank Pichincha, the leading bank in Ecuador, has created an entirely separate subsidiary, CREDIFE, to serve poorer customers. Its results have been remarkable: small loans now make up 5% of its assets but 8% of its profits. Unibanco in Brazil and Banco Santander Chile took similar steps to attract the unbanked poor. Such efforts are not always welcomed by existing microfinance providers. In Colombia, for instance, Women’s World Banking complains that mainstream banks are increasingly poaching its best clients.
The power of a balance sheet
After just two years in the field, ICICI, India’s second-largest private bank, now has close to 1.5m customers that qualify as deeply poor, and an associated loan portfolio of $265m. It has achieved this by working through 53 small microfinance banks, which are superb at marketing loans but are constrained by having them sitting on their balance sheet. ICICI lends to the microfinance institutions at 9.5-11%, a bit more than it charges its corporate clients, and the microfinance institutions re-lend the money at 16-30%. The microfinance providers are responsible for the first 5-12% in loan losses to ensure that they proceed with caution. Returns are good and ICICI wants to expand the scheme.
The seeds of a better life
There are ample opportunities. According to some estimates, demand for loans from poor but creditworthy people in India could amount to $40 billion, 40 times the current supply. Nachiket Mor, an executive director at ICICI, says very little of the demand could be met from charitable sources, but billions of dollars could be made available on commercial terms. Lots more could be raised by allowing small institutions to take deposits.
Many of the world’s biggest banks have recently launched interesting pilot projects. ABN Amro owns a microfinance bank in Brazil, Real Microcr?dito, jointly with ACCION, and provides credit to five microfinance institutions in India. Deutsche Bank recently raised a $75m investment fund and syndicated a large loan on behalf of ProCredit in Germany.
The most obvious way for large banks to get into microfinance is through handling remittances, a business that according to the World Bank is worth $225 billion a year and growing strongly. Until now it has been dominated by transfer agents such as Western Union and by informal arrangements, often with high charges or high risks. But money transmission is becoming more competitive, and global banks are well placed because they already have systems that can send large amounts of money around the world cheaply.
In September, Bank of America announced that all its account holders would be able to send remittances to Mexico without charge; the money can be retrieved at other banks and payment agencies. HSBC in May announced a joint-venture with Opportunity International that allows money to be sent to the Philippines via the internet and retrieved from local ATMs. In America, HSBC has just launched a scheme under which anyone with a minimum account balance of $1,500, or willing to pay $8 a month, can transmit money to HSBC’s affiliates abroad without charge. To start with, this may not be profitable for the bank, but HSBC reckons that much of the money could be channeled into savings accounts from which other services might follow.
The most ambitious big bank in this area is Citigroup. It does not deal with individual microfinance customers, but has already established relationships with microfinance institutions in 20 countries and thinks the number could soon grow to 30. Working through its Banamex subsidiary in Mexico, it is providing life-insurance policies sold by microfinance firms and is preparing for various bond offerings, private placements and even the securitisation of a large microfinance institution’s loan portfolio that will be resold to investors. For its wealthy clients, it has created guarantee funds that allow them to put up collateral in America for credit extended in poor countries. The list goes on.
Citi’s biggest contribution, though, is its belief that microfinance can become a valid, profit-making business. If it is right, the other big banks will also pile into the market?and so will investors.