Reaching out to the financially excluded
Silvia Pavoni
Financial exclusion is seen as a purely developing world problem. It
is not. In some developing countries, almost three-quarters of the
population are unbanked and access to financial services is confined to
the urban middle classes.
But the number of people in mature economies who remain outside of
the financial system is also shocking.
In the US, 7.8 percent of the adult population (17 million) do not
have a bank account. In the UK, this applies to 4 percent of the
population (1.75 million adults). Other developed economies boast
similarly ignominious statistics.
Should banks care? The smart banks have realised that reaching out to
the marginalised can be profitable, and helps to nurture a client base
for the future.
In addition, it can also go a long way to improving a public image
badly in need of repair for some banks in the wake of the financial
crisis.
This potential is not lost on banks and many are now targeting the
low-income sector, often as part of a broader corporate and social
responsibility (CSR) programme. In April, for example, JPMorgan invested
$10m in the LeapFrog micro-insurance fund.
In May, Citi provided $1m in grants to three local microfinance
institutions (MFIs) in Haiti, and Wells Fargo made a $1m
equity-equivalent investment in non-profit microfinance organisation,
Grameen America.
It seems that the time is ripe for more of the world’s banks to take
up the challenge to bank the poor.
Developing need
In the developing world, the need is dramatic. A recent survey by
CGAP, the independent policy and research organisation that aims to
improve financial access to the world’s poor, indicates that about 70
percent of adults in developing countries are excluded from the
regulated financial system, despite years of growth in the financial
sector and multiple programmes championed by the World Bank and regional
development banks.
The banking system’s failure to enfranchise the low waged begins in
the remittance sector.
The World Bank estimates that remittances totalled $443bn in 2008, of
which $338bn were sent to developing countries, involving about 192
million migrants that make up a staggering 3 percent of the world’s
population.
According to remittance experts, as much as 40 percent of this
traffic bypasses the regulated banking sector’s remittance operations.
Many are critical about the failure of the banking world to capture a
greater percentage of the remittance market, as well as the failure to
convert those remittance customers who do use banks into account
holders.
If up to 60 percent of remittances are being sent through banks,
credit unions or other types of deposit institutions, this means that
every month, millions of recipients collect their money at bank branches
with little effort being made to retain their services by offering even
the most basic of financial services.
According to the Inter-American Development Bank (IDB), in the
majority of transactions where banks do distribute remittances in Latin
America, they serve only as a licensed distribution agent for a money
transfer organisation.
Remittance operations are largely kept separate from other bank
operations - sometimes even physically separate from the teller queues
available to account holders.
The banks are missing a trick, because where serious efforts have
been made to turn remittance customers into deposit holders, programmes
report a 30 percent conversion rate. Implemented region-wide in Latin
America, this could easily result in more than 3 million new clients and
$1bn in deposits year after year, says the IDB.
Stepping stone
Banks do seem to be finally waking up to the potential of remittances
as the first step in establishing a banking relationship.
The key issue, say bankers, is to understand how to tailor products
and services to an entirely new customer group. “Banks traditionally
have not handled the majority of remittances in the US,” says Bob
Annibale, global director of Citi Microfinance.
“We need to understand what will make a product appropriate for a
customer segment that we’ve never reached before.”
But Citi hopes to change this dynamic. By developing a better
understanding of remittance traffic through partnerships with local and
regional banks, Citi is opening up significant opportunities to
enfranchise family members at both ends of the remittance chain.
Citi knows which of its remittance customers in the US are unbanked,
and through partnerships such as the one it holds with Ecuador’s Banco
Solidario to serve New York’s large Ecuadorian population, it has been
able to analyse transaction data to find out which recipients have no
bank accounts in their home country either.
“By refining a partnership, we often realise that we’re working with
two ends of an unbanked family,” says Annibale.
And this provides an opportunity to turn these family members into a
savings customer. “Someone who does a remittance is someone who saves,”
Annibale said.
The failure to bank the poor has historically been driven by the
perceived lack of profitability in this client segment. But evidence
from the UK proves that this need not be the case.
According to data from Spanish bank Santander, a growing force in UK
retail banking, reaching out to the low-waged community is as much about
creating the customers of the future as it is about social
responsibility.
Santander offers a basic bank account to the low waged, and such
accounts currently represent about 6 percent of its total UK accounts.
Analysis of account data reveals a promising trend: the swift migration
of customers from these so-called entry accounts to intermediate
products.
The bank says that over the past two years, 40 percent of basic bank
account customers have moved to accounts with some access to credit and
other services. This is vital proof that a basic banking product can
quickly become a stepping stone into more sophisticated - and more
profitable - financial service
Government support
Antonio Horta-Osorio, chief executive of Santander UK, underlines the
importance of government and regulatory efforts to encourage banks and
ensure that those which increase financial inclusion do not end up
paying a disproportionate cost.
“There has been significant progress made in the past few years, but
further progress has to be made together with the government, banks and
[non-governmental organisations]. Financial inclusion efforts have to be
coordinated because otherwise this may create an asymmetry in the
market,” he says.
The importance of legislative support has been clearly demonstrated
in Kuwait, where a local law has forced employers to use bank accounts
to distribute payroll to all employees, including low-income
expatriates.
As a result, Commercial Bank of Kuwait (CBK) has been able to
introduce a low-cost labour account dedicated to the low-income segment,
which was previously ignored by the country’s banks.
The average holder of the new accounts earns less than $100 per
month, and typically has never had a bank account before, even in their
home country. Because of this initiative, CBK has more than doubled the
number of its accounts over a four-year period.
Push on microfinance
In broader terms, the push to bank the unbanked also includes the
world of microfinance, where small loans are extended to borrowers
without bank accounts or credit history.
Having achieved widespread recognition as a development tool,
microfinance has been promoted by many national governments and
multilateral agencies eager to bridge the financial inclusion gap.
According to data from the Microfinance Information Exchange (MIX),
between 2004 and 2008 the microfinance sector experienced average annual
asset growth of 39 percent, accumulating total assets of more than $60bn
and gross loan portfolios of more than $44bn by the end of 2008, the
latest full-year figures available.
The sector’s impressive performance means that it has moved beyond an
early reliance on philanthropic donations, and has widespread support
from commercial banks and growing access to the capital markets.
Compartamos Banco is a prime example of the sector’s success.
Established in 1990 to work in rural areas of Mexico, Compartamos - the
largest MFI in the western hemisphere - listed on the Mexican stock
exchange in 2007. The initial public offering (IPO) of 30 percent of
Compartamos’ equity was 13 times oversubscribed and the share price
surged by 22 percent in the first day of trading.
The IPO raised $458m for its original investors, including
not-for-profit entities such as the International Finance Corporation,
although one-third of investors were private.
This represented a return on the original investment (which was about
$6m) of 100 percent a year compounded over an eight-year investment
period, and was seen as a clear indicator to private capital of the
money that could be made by lending to the poor.
Success with a price
The reason for Compartamos’s robust equity market valuation is to be
found in its staggering returns on equity, averaging more than 50
percent a year.
And the reason for such startling returns leads to the controversy
which increasingly surrounds the microfinance sector: Compartamos
generates those returns by charging annual interest rates of about 72
percent.
Compartamos is not the most expensive lender. Another Mexican MFI, Te
Creemos, has annual interest rates of 125 percent, which many suggest is
one of the highest in the mainstream MFI industry. Neither compare well
to the industry average.
Based on the 1084 MFIs reporting to the MIX, the median interest rate
was 31 percent (the average interest rate was 38 percent), with
one-quarter of MFIs charging rates of less than 22 percent, and
three-quarters of MFIs charging rates of less than 44 percent. By
comparison, the average interest rate on a UK credit card is between 16
percent and 19 percent.
Many feel uncomfortable about such large returns being made on the
back of loans to the very poor. Muhammad Yunus, who earned a Nobel Prize
through his work pioneering microfinance with Bangladesh-based Grameen
Bank, voiced his criticism of MFI interest rates earlier this year to a
gathering of financial officials at the UN.
“We created microcredit to fight the loan sharks; we didn’t create
microcredit to encourage new loan sharks,” Yunus told his audience.
“Microcredit should be seen as an opportunity to help people get out
of poverty in a business way, not to make money out of poor people.”
Yunus has advocated rates of no more than 10 percent to 15 percent
above the cost of borrowing, saying that higher rates are akin to loan
sharking.
Yet by this calculation, more than three-quarters of the MFIs
reporting to the MIX would fail Yunus’s test.
High touch, high cost
According to the MIX’s research, the bulk of the money from interest
rates is used to cover operating expenses in what is a high-touch
business, where the cost of reaching the most inaccessible poor is high.
In addition, it costs much more to manage multiple small loans than a
single big loan, and many industry practitioners argue that reducing
costs, rather than attacking profit, is the best way to lower interest
rates.
Carlos Danel, executive vice-president of Compartamos Banco, defends
its rates, saying that customers make good returns and therefore are in
a position to pay the interest rates it charges.
“Our clients have on average a monthly return on equity of 50
percent, which means that they are able to repay the interest rates
without a problem,” he says.
“There was a time when interest rates were above 100 percent, when we
were smaller. Going public has allowed us to grow more, to drive cost
down.”
Danel also says that Compartamentos does not set rates as high as it
could, and neither do its investors encourage it to do so. “I have had
many investors come to me asking: ‘How are we going to lower cost and
become more competitive?’ The right kind of investor raises the bar for
institutions to improve their performance and better service their
clients.”
He argues that the peculiarities of each market dictate what
operating costs and business models are workable.
“The only way to reduce the interest rates faster is to grow the loan
amount; and if we do that, we would need to move away from our target:
the lower income client. Or we would have to push money onto [our
clients]; so if they need $300 we would try to give them $1000. We don’t
want to do this either.
Mutually exclusive operations?
The difference between a good loan and a bad loan is that a good loan
is one you can repay; a bad loan is one you can’t repay. We don’t want
to over-leverage the client,” Danel says.
Compartamos has serious growth plans, however, to be funded by an
expansion into retail deposits in Mexico and an ambitious capital
markets issuance strategy.
Its recent bond issues suggest there is growing appetite for MFI
paper among investors, despite a difficult macroeconomic backdrop and
the struggle by many MFIs to refinance existing loan portfolios.
It began a 6bn pesos ($486m), five-year funding strategy with a 500m
pesos bond issue in July last year, followed by a 1bn pesos bond in
November, one of the largest MFI bond issues ever.
Commercial banks have taken to microfinance with increasing
enthusiasm. But many argue that running microcredit alongside
conventional banking is an uneasy relationship. Culturally, they are
worlds apart, not least in the dramatic differences in levels of
customer sophistication and the very different skill sets required.
Conventional mechanisms, such as the use of collateral in traditional
lending, become unworkable concepts when applied to microfinance.
“I don’t like the idea of having microfinance in a commercial banking
business, because the way you conduct the two is very different,” says
Manuel Mondez del Rio Piovich, president of the BBVA Foundation, the
banking group’s CSR concern.
“Traditional commercial banks have gained high efficiency by using
collateral guarantees; their activities are based on [their] use, this
is something poor people don’t have.”
Operational cost and intensity are other big differences. Mondez del
Ro Piovich likens microfinance to project finance due to the level of
due diligence required. “The amounts we’re talking about are $300, $500,
but the analysis you need to do [on every project] is the same that you
would do on a large project, such as financing a highway,” he says.
Similarly, recruiting people with the right skill set is a huge
challenge for any microfinance operation. Analysing the ability of a
client to repay a microloan is often based purely on ‘soft’ factors; for
new customers there is rarely a credit history to refer to.
Additionally, for microfinance to reach out to the rural poor, staff
must be prepared to travel to often remote and difficult regions,
carrying cash and relying on simple printed spreadsheets for loan
calculations.
“A loan officer in microfinance has to be out seeing customers, out
in the sun and the rain, visiting villages, [meeting] in markets,” says
Kurt Koenigsfest, CEO of BancoSol, Bolivia’s leading microfinance bank.
But Koenigsfest argues that microlending and conventional banking
work happily together at BancoSol. And having a large microfinance
business has certainly not discouraged other depositors, he says.
“[Many of] our depositors have $300 in their savings account, so
they’re the same [microborrowers] that we lend to,” Koenigsfest says.
“But we also attract deposits from larger companies, such as insurance
and pension funds, [which see ours as] safe deposit accounts.”
Partnership model
Other banks have built microlending on partnerships within the local
business infrastructure. This provides greater familiarity for borrowers
and reduces risk for the bank, says Coenraad Jonker, head of Standard
Bank’s community banking unit.
Standard Bank has focused on creating partnerships with local
retailers, which handle cash for clients on behalf of the bank. In a
community of 500,000, say, the bank would typically have partnerships
with 100 retailers, which bring the net cash positions of clients to the
bank on a daily or monthly basis; others manage the entire position
locally.
“This shifts the risk of handling and transporting cash from within
the bank to the community - where people know each other - while dealing
with a bank means dealing with people they don’t know,” Jonker says.
“In such a community, the bank would have six or seven ATMs, while
with 100 retailers, acting as points of business, the risk per
transaction is much lower.”
To ensure that policies on interest rates and other areas are
respected, retailers sign an ethical code stating that they cannot
independently change interest rates. If the terms are not met, the
partnership is terminated.
Technological challenge
One of the biggest hurdles for microfinance is the technological
demands of gathering and maintaining management information, reconciling
data on a timely basis, and giving customers access to bank accounts or
an MFI branch in remote areas.
In more developed markets, the provision of mobile
telecommunications-based microfinance demands secure and reliable
telecoms networks.
Many technology vendors are working on solutions that can potentially
revolutionise microfinance business models. IBM is working on a solution
that promises to dramatically reduce costs, something that may help MFIs
to address criticism over high interest charges.
“We saw that MFIs operating costs were 20 percent of overall loan
value, while in traditional banks it would be 3 percent,” Ian Watson
says, director of microfinance at IBM. “Our solution will lower costs by
five or 10 times.”
Watson says that IBM is focusing on a centralised back office for
MFIs, which will go live in the fourth quarter of this year for Prisma,
a microfinance institution based in Peru.
IBM has already teamed up with the Grameen Foundation in India to
develop Mifos, a scalable, centralised, open-source banking platform
designed to help Grameen gain better control of transaction and
accounting information, in order to generate growth and obtain new
funding.
In areas where there is a reliable telecoms network, microfinance
representatives visiting rural villages can enter transaction data into
the Mifos system on the spot, accessing a centralised web-base
repository holding transaction data from 46 bank branches.
Information that once took weeks to compile is now available in real
time, so that Grameen can more easily shift resources to where they are
needed. It allows MFIs to accurately predict cash requirements, freeing
up capital to support greater lending activity.
And it provides timely, accurate information to help raise new
capital from global financial institutions.
The banker |