Microfinance, the provision of loans and other financial services involving minute transaction amounts and mainly poor clientele, is making inroads into commercial banking. Long considered one of the most promising methods to break the poverty cycle by the international development community, vast sums of money and technical assistance from major donors like the U.S.
Agency for International Development (USAID), Canadian International Development Agency (CIDA) and Egypt’s Social Fund for Development (SFD) have been pumped into the mainly Non-Governmental Organization (NGO) dominated sector – until recently, that is.
In a development applauded by microfinance advocates, commercial banks in Egypt and throughout the region are beginning to take microfinance seriously; either “downsizing their operations or creating independent microfinance units in an attempt to reach the immense and untapped low-income client segment.
Commercial banks less suited for the demanding business of delivering microfinance products are finding indirect – but no less vital – ways to engage in the sector, such as providing refinancing services or loan capital to retail microfinance institutions. Egypt, a pioneer in non-profit microfinance initiatives in the Middle East since the early 90s, is also at the forefront of the challenging and problematic process of incorporating microfinance into the formal financial sector.
What has changed? Microfinance advocates are finally talking a language that the financial industry understands, profit. The formidable task of convincing banks that the economically active poor are not only bankable, but represent a low risk, high growth investment, has been bolstered by data supporting just that. Not only do micro-borrowers (whose loans average LE 1,235) have excellent rates of repayment, according to independent financial rating agency Planet Rating, microfinance portfolios, with an average APR of 23 percent, have a higher return on investment than some other banking services.
Mansour Kelada, head of new Egyptian microfinance consulting firm, Quality Finance International (QFI), posits that microfinance is as sound, if not a more sound investment with lower risk than other options for banks’ surplus liquidity like investment funds, larger commercial and individual loans and credit cards.Technology, such as ATMs and even mobile phones (Vodaphone is currently test marketing a loan repayment service on its networks in the South African and Kenyan markets), lower high transaction costs normally associated with high volumes of small transactions.
Another quantifiable benefit for banks is new clients. According to Kelada,10 percent of microcredit clients eventually become regular bank clients using a range of banking services; a highly salient point in an increasingly competitive market where operators all vie for the limited and saturated middle and upper-income market segments. Moreover, microfinance does more than simply introduce new clients to banks – it also serves as a training ground for consumers who previously felt so alienated from the formal banking sector that they would rather pay 100 percent interest to a local loan shark than step foot in a branch office.
Central to this outcome is the user friendly approach adopted by microfinance programs that has evolved alongside a sophisticated understanding of the unique needs and attitudes of its clients¯the economically active poor and owners of micro, small and medium-sized enterprises. Microcredit programs place a strong emphasis on outreach; improving the poors’ access to financial services by going to them where they live and work and follows a set of guidelines designed to assure the borrowers success.
Potential clients’ first contact with the bank is in the form of the friendly face of a local loan officer who often lives in the same community. Loan officers walk clients through the loan application process, helping them discern the appropriate loan amount and fill out forms; some even provide business support services, such as planning and product marketing, among others. For many micro-clients, this approach serves to increase their comfort level with, and understanding of, the formal banking sector and the rights and responsibilities of the bank/client relationship in small and achievable steps. Successful applicants with good repayment histories are offered successively larger loans and a solid long-term relationship is created.
Although it would be hard to conceive of a better marketing strategy for banks wishing to reach the low-income market, as the above illustrates, microfinance represents a radical departure from traditional bank operations. According to Kelada “there is a totally different approach in microfinance than in regular banking. It is a very specialized set of skills and procedures and set of operating policies that have to come into place that the banks are not accustomed to.
And, for many banks, it is simply too much to consider – even for a shot at the estimated 1.3 million strong potential microcredit market. Banks with extensive branch networks, for example, are better suited for the outreach that micofinance requires. Banque du Caire, with its 250 strong branch network, was one of the first to enter the microfinance market in 2001. Another bank with a large branch network, Bank Misr, began microlending in 2003.
For other banks however, according to Ahmed El Ashmawi, director of the Sanabel Microfinance Network in the Arab Countries headquartered in Cairo, there are other ways to engage in the microfinance sector. At issue is an estimated LE 155 billion in unutilized capital held by Egypt’s banks. A portion of which, it is argued, could be used to sustainably finance microcredit programs,weaning them off their unhealthy and growth-limiting reliance on donors for on-lending funds.
Ashmawi emphasizes partnerships between commercial banks and NGO Microfinance Intermediaries (NGO MFIs), which can range in engagement- level from sharing office space to wholesale lending to equity investments in MFIs, are win-win scenarios. Egypt has its own homegrown examples of where these types of partnerships are working. The National Bank for Development (NBD) has been providing working capital to microfinance institutions since the late 1980s. Commercial International Bank (CIB), the only private sector bank engaged in microfinance, manages a microcredit fund that is disbursed by the NBD.
In an interesting twist stemming from the charitable origins of microfinance, international and local NGOs, and a few private sector players such as QFI, are the repository of microfinance market and product information, not the commercial banking sector. For more than 20 years, NGO MFIs, the main providers of microfinance products and services, have been a critical developing and testing ground. What has emerged is a set of policies and operational modalities know in the industry as “best practice. This had led to impressive levels of collaboration and cooperation between NGOs, international donors and the commercial banking sector where microfinance is concerned.
Large international donors’ heavily involved in microfinance such as USAID, provide funding for technical training in microfinance best practices for commercial banks with start-up microfinance operations; effectively convincing banks that their adaptation is the key to success.
Still more banks in Egypt and throughout the region remain uncomfortable with a financial product with essentially non-commercial origins. For most banking professionals, skepticism prevails, as does the perception that microfinance is a high risk, costly and charitable activity best left to the NGOs. For the lowest end of the microlending spectrum at least (loans can be as small as LE 500), their arguments may have salience.Apparently,there will always be a role for NGO MFIs because, as Ashmawi points out, “It is unclear how low commercial banks are actually willing to go.
Microfinance experts with poverty alleviation agendas say that much more needs to be done bo
th to counter these perceptions and deal with the apparent culture clash between poverty lending and commercial finance.Terms like “character lending, “alternative collateral and “beneficiaries in heavy use in the non-profit microfinance community could be tantamount to red flags to profit-minded bankers. Other challenges, such as persuading banks that there is much more to microfinance than loans, still lie ahead. Complimentary products, such as micro-savings, are just as important to poor clients and the development of the microfinance industry as a whole.