Micro no More
Friday, November 4, 2005
The group of 30 women in the dusty square of a poor village outside Hyderabad, their children on their laps, passing tiny deposits and loan payments to a young man in their midst, seem to be engaging in a form of finance quite unlike that practised in the City of London or Wall Street. But is it really that different?
Microfinance offers all the transactions you would expect in any branch of finance: loans, deposits, money transfers, insurance. It is distinct only because it involves amounts of money so small that in the past conventional firms did not think them worthwhile. That is clearly changing.
Many microfinance institutions report better returns on equity than do large banks. Five years ago, providing financial services to people with little money might have been dismissed as a tiny niche business or charity. Now all the participants in the capital markets, from big banks to investors to rating agencies, are beginning to open up to it.
The evolution of microfinance into a serious and viable business has many benefits. It means that in future the bulk of the capital is likely to go to the most efficient institutions with the best growth prospects. They will select their clients on the basis of merit rather than cronyism or bribery, of which state banks (as well as some private banks) in poor countries have often been guilty in the past.
Sound institutions will be able to protect their deposits and attract new ones. In the most optimistic scenario, an open, viable financial sector will create a large body of people with economic stakes in their society who will demand decent public services, which in turn should help to promote growth.
Plenty of obstacles remain. Venezuela, Brazil and Colombia, for example, all impose interest-rate ceilings, and other countries are considering them. These discourage new financial firms from entering the microfinance market and encourage existing participants to evade regulation.
But within a few years, the number of people who have access to financial services may expand from hundreds of millions to several billions. Historical precedent suggests that this could bring huge opportunities. In the past, some financial institutions, notably Bank of America, Merrill Lynch and many large European insurers, did spectacularly well by nurturing clients only slightly too poor to be of interest to the leading firms of the day.
But to reach the vast number of people who currently lack access to the financial markets, microfinance will have to change. Four main areas need particular attention: culture, products, funding and the cost of operations.
The cultural challenge is to transform something that started as charity into a proper business. The pursuit of profit may not come easily, but change is already in the air. ?We are not paternalistic, we do not lend to the poor,? says M?nica Hern?ndez of Banco Solidario, a fast-growing and profitable bank in Ecuador. ?We lend to those who do not have access.?
To reach this new group of customers, however, microfinance providers will have to abandon their old attitudes and vocabulary and join the mainstream of the global financial system. Transmitting funds, insuring risks, extending credit and holding deposits for people with almost no money will turn out to be little different from doing those things for anyone else.
One priority is to expand microfinance beyond credit into all the financial products on offer in more sophisticated markets. Today only a few institutions are seriously offering insurance, even though it is particularly valuable to the poor; yet death and illness, for example, are major risks for banks making small loans, and inevitably they charge for bearing that risk. BASIX, a dynamic microfinance institution in India, provides not only basic life insurance, but other products that are particularly appropriate to its agricultural clients, notably insurance against drought or loss of cattle.
It matters enormously where the money comes from. At present, the main sources are charities, governments and international organisations. But serious interest from large banks and private investors would greatly increase the amount of capital available and bring down the cost of funds. The emergence of credit-rating agencies to provide an independent assessment of institutions will make it easier for the banks to come in. Credit bureaus for rating individuals too are now being established in a handful of countries.
Microfinance institutions may also tap wealthy investors directly. More than a dozen institutions recently raised money from American investors, including a university, in a deal structured by Developing World Markets, a specialised American firm of financial advisers, and Blue Orchard Finance of Geneva, a microfinance fund manager. True syndication of microcredit loan portfolios may not be far away, though governments in many poor countries will have to strengthen ownership rights and reduce barriers to foreign investment before it becomes commonplace.
Crucially, the cost of microfinance will have to come down. At present it is far too manpower-intensive, more like private banking for the wealthy than retail banking for the middle classes. Typically, borrowers receive visits from their bankers, sometimes daily, rather than going to a branch or using an automated teller machine. Credit evaluation relies on character or cashflow valuation rather than the statistical techniques used by credit-card companies in rich countries. This has been made possible by low wages and an abundance of highly talented people willing to work long hours, but it will not be sustainable.
More competition will help to reduce costs, but the biggest hope comes from new technology. For example, the cost of sending money from Hong Kong to the Philippines has declined dramatically because of new methods that transfer funds via mobile phones, says John Owens, of Chemonix International, a consultancy. And that is only one of their uses. Through arrangements with merchants in small towns, mobile phones can also be used to pay loans, make deposits and get cash, saving time and money. Vodafone is testing a similar system in Kenya, and Hewlett-Packard has just finished a pilot project in Uganda using a point-of-sale machine with mobile-phone technology. Such techniques may eventually make branches, cheques and even cash superfluous.
In the past, the two main obstacles to providing financial services to poor people have been lack of information and costs. Those obstacles are now being overcome. Ultimately lower costs and better information are good not just for the poor, but for everyone. Microfinance may have started as a niche business, but the chances are it will soon be micro no more.