Executive summary Background In recent years, there has been increased focus on lending to the poor. One landmark study was the Foundation for Development Cooperation's major report, Banking with the Poor (1992). The study found that the poor are good credit risks—given opportunity and motivation, they are fully bankable. It also found that banks can meet the credit needs of the poor on a commercially sound basis by adopting appropriate delivery systems, using non-governmental organisations (NGOs) and self-help groups (SHGs) as financial ‘middlemen’. In the Philippines, the government has recognised the importance of access to credit as a poverty alleviating strategy, and has attempted to address the issue by enacting laws that require banks to earmark a portion of their resources for lending to special sectors. On a broader front, the importance of credit in poverty alleviation was recognised by a landmark Social Pact on Credit forged in the first half of 1993 by a multi-sectoral group of banks, government institutions, cooperatives and farmers’ groups. The Pact acknowledged the weakness of the current financial system to meet the credit needs of the majority and, in particular, the poor. This has led to an increased interest among banks to explore alternative ways of delivering credit to the poor. Several initiatives have been tested to explore alternative ways of delivering credit to the poor. A key approach that has been evolved has been the bank–NGO–SHG–poor linkage. This approach consists of successive layers of a principal–agency relationship where (1) a bank lends to an NGO; (2) the NGO lends to an SHG; and finally (3) the SHG lends to individual members of the group. Under this approach, the NGO or SHG secures loanable funds from various sources, including a bank, and acts as a credit intermediary to reach individual poor borrowers. This approach works under the assumption that the agency in each of the successive layers has comparative advantage over its principal in lending to the poor, thus minimising transaction costs. This, in turn, contributes to the viability and sustainability of lending to the poor. This study attempts to determine and quantify the components of transaction costs of lending to the poor through linkages. More specifically, it aims to address the following issues:
Methodology of the study For the subjects of our study, we focused on the credit programs of two NGOs which target the poor using SHGs as delivery channels: Kabalikat para sa Maunlad na Buhay Inc. (KMBI), and Alalay sa Kaunlaran sa Gitnang Luzon Inc.(ASKI). These two NGOs are part of the Bank of the Philippine Islands bank–NGO/SHG linkage program. The process of lending to the poor using self-help groups has several important features which differentiate it from the usual retail lending of banks and even of cooperatives. The significant differences noted include a deliberate focus on the poor, the organising of client/members into groups, the use of group mutual accountability and peer pressure as a substitute for traditional physical collateral, and lending in very small amounts over relatively short maturities with weekly repayments. In the estimate of costs, lender transaction costs were defined by the equation: LTC = LC + FC + GC + OC
In the case of the NGOs, the identification and formation of SHGs was included as a separate activity grouping in the equation. The costs allocation method was used to estimate transaction costs. All staff of the NGO involved directly and indirectly in lending were asked to complete a time allocation chart of activities classified according to the transaction costs equation. Borrower transaction costs were estimated through interviews with program beneficiaries. The results of a study by Casuga (1994) on transaction costs of banks and non-bank financial intermediaries were used to compare the transaction costs of these intermediary types with NGO transaction costs. To allow for differences in scale of operations, the transaction cost estimates were compared across intermediary types using the following ratios:
Comparisons of transaction costs While the commercial banks had lower costs than the rural banks, they had much higher average loan sizes. Transaction costs per peso of loans granted and per peso of loans outstanding for the commercial banks were Ps 0.061 and Ps 0.080 respectively, substantially lower than the Ps 0.151 per peso of loans granted and Ps 0.121 per peso of loans outstanding for the rural banks. However, the commercial banks had an average loan size of Ps 149,000, compared with only Ps 13,000 for the rural banks. Credit cooperatives had much higher transaction costs per peso of loans granted of Ps 0.371, compared to Ps 0.185 for multi-purpose cooperatives. The credit cooperatives had the lowest transaction costs per peso of loans outstanding at Ps 0.063. However, the very high estimate for loans outstanding indicates either a predominance of long-term loans or problems with collections, requiring caution in using the loans outstanding figure. KMBI/UKMA had total transaction costs per peso of loans granted of 0.140 while ASKI had costs of 0.471. KMBI/UKMA's transaction costs per peso of loans granted compare quite well with the other intermediaries. The ratio was second only to that of the private commercial banks, and was lower than those of the rural banks, the cooperative rural banks, the special government banks, the credit cooperatives and even the multi-purpose cooperatives. This is in spite of the inclusion of the SHG promotion component in the total costs. The situation changes when we use transaction costs per peso of loans outstanding. From transaction costs per peso of loans granted of Ps 0.140, KMBI/UKMA’s costs per peso of loans outstanding increased to Ps 0.340. For ASKI, the increase was from Ps 0.471 per peso of loans granted to Ps 0.836 per peso of loans outstanding. While these costs are high in comparison with the other intermediary types, there are differences in the average loan size and the average loan maturity period. To provide a more or less equal basis for comparison, it would be necessary to adjust for average loan sizes and maturities. Factors affecting transaction costs The comparison of the different types of financial intermediaries highlighted several key factors that affect transaction costs. Based on our cost comparisons, we noted an inverse relationship between an organisation’s transaction costs and its number of years in existence. This results from an organisation’s capacity to learn and develop. As the NGO programs were relatively new compared with those of the banks and cooperatives, there is much room for the NGOs involved in lending to the poor to improve their transaction costs over time. In lending to the poor, the credit requirements and situation of this segment define some of the critical lending policies, terms and conditions. Specifically, it is necessary to lend out in very small loans, at relatively short-term maturities, and with a higher frequency of loan repayment (that is, daily or weekly as against monthly or quarterly), and without requiring traditionally accepted forms of collateral (for example, land or chattels). Furthermore, to reach the poor effectively and minimise borrower transaction costs, the lender has to go to where the borrowers are rather than the other way around. These conditions combine to make lending to the poor a very labour-intensive process. Our review of the NGOs’ lending costs confirms this labour intensity. Measures to increase productivity These factors mean that if NGOs’ lending programs are to be commercially viable and sustainable, high productivity is very important. The optimum ratios in terms of number of clients to staff and number of loan accounts to staff will have to be worked out and targeted. High worker productivity also requires a short start-up time and a quick build-up to the optimum number of members per field worker. Since training costs form a substantial part of NGO budgets, this means that better, more cost-effective and faster ways of training and motivating field workers must be developed. As substantial social investments are made for a prospective member and borrower, the retention rate of members is also a critical aspect of worker productivity. A high retention rate will also eventually result in higher average loan sizes and thus lower overall transaction costs. Key ways of improving worker productivity would include the introduction of simpler methods or more creative use of the data processing and information handling potential of computer technology. Another way to reduce transaction costs substantially is for NGOs to wholesale to groups in the same way that the commercial banks are encouraged to work through NGOs. This approach, however, is dependent on the success of the NGOs’ SHG building and organising efforts. Through all of these, the lending intermediary has to balance productivity and efficiency with the risk of default. Our review of NGO viability based on KMBI’s experience shows that with an increased loan size of Ps 10,000 and a member to staff ratio of 200, total transaction costs (excluding SHG promotion and development costs) can be reduced from its current 35 per cent of average loans outstanding to 17 per cent. With a reduced default rate of 5 per cent and the cost of funds set at 12 per cent, total lender costs would be 34 per cent which is one percentage point lower than its current earnings on loans outstanding ratio of 35 per cent. Thus, KMBI’s lending to the poor can be a viable proposition if its group building efforts are funded externally and productivity is increased. Borrower transaction costs On borrower transaction costs, we found that the cash outlay incurred by borrowers consists primarily of transportation expenses. During the pre-loan stage the costs ranged from zero to 1.3 per cent of loan principal. Office-holders incurred slightly higher expenses due to their additional responsibilities. Post-loan cash expenses also consisted primarily of transportation expenses incurred in attending weekly meetings, and ranged from 0.3 per cent to 4.6 per cent of loan principal. Borrowers/members of both KMBI’s UKMA and ASKI’s PACAP programs also invested substantial amounts of time in terms of attendance at weekly meetings. Pre-loan time ranged from 16 hours for KMBI to 40 hours for ASKI, and post-loan time ranged from 12 hours to 196 hours per year. As expected, office-holders spent more time than the regular members because of their additional responsibilities. Interviews, however, indicated that the time thus spent also had other non-quantifiable value for them in terms of camaraderie and mutual encouragement. Recommendations
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