Ruth Goodwin-Groen, 1998 (xiii + 82 pages)
Microfinance in the Asia-Pacific region: some success but huge demand
Microentrepreneurs (the self-employed poor) have little access to the formal financial system in developing economies. At best, formal financial institutions reach the top 25 per cent of the economically active population, which leaves the bottom 75 per cent without access to formal financial services. In 1997, it was estimated that 200 million poor households needed access to microfinance services in the Asia-Pacific region.
Microfinance institutions have grown rapidly to try to meet this demand. However, their outreach remains very small compared with the demand – less than 5 per cent of those 2—million poor households had access to microfinance services. Similarly, very few institutions involved in microfinance are profitable. It was estimated that less than 10 per cent of all MFIs in the region were financially self-sufficient.
Nevertheless, this region houses six of the current microfinance ‘giants’, each of which now has over a million clients: Grameen Bank in Bangladesh, Bangladesh Rural Advancement Committee (BRAC), the Association for Social Advancement (ASA) in Bangladesh, Bank Rakyat Indonesia (BRI) in Indonesia, the Bank for Agriculture and Agricultural Co-operatives (BAAC) in Thailand and the Sri Lanka National Savings Bank.
Only four commercial banks in the region had a profitable microfinance business
Of the six microfinance giants, only BRI is a commercial bank (albeit government owned). BRI together with three small private commercial banks (Bank Dagang Bali in Indonesia, Hatton National Bank in Sri Lanka, and Krishna Bhima Samruddhi Bank in India) comprise the four commercial banks in the Asia-Pacific region which treat microfinance as a profitable core business. There are many more regulated institutions that provide financial services to microentrepreneurs such as rural banks and credit unions, but these are not covered by the study. In addition to these Asia banks, a 1997 USAID study found eight commercial banks in Latin America and three banks in Africa where microfinance is a small but profitable business.
The majority of commercial banks that undertook microfinance lending in the region did so because it was required of them by their governments.
Our research findings came from in-depth interviews with over 40 bankers in 22 banks in India, the Philippines and Australia, and from speaking with 17 other banks in the other seven countries covered in the study. A great deal of microfinance undertaken by commercial banks was found, but it was undertaken because of government mandates to lend to this sector rather than for business reasons.
The types of commercial bank involvement in microfinance can be classified as follows:
Sustainability and scale in microfinance by commercial banks were only found in the market-based programs
When assessed on the basis of achieving both high portfolio quality and significant scale of outreach to the poor, most of the commercial bank microfinance programs that were mandated by governments can only be considered as failures. The exceptions were those programs that charged a commercial rate of interest. They had a higher portfolio quality than other programs but they were still not profitable. This almost universal failure is not explained by the different policy contexts across the region. Further, because microfinance has not been a profitable business, government mandates have been unsuccessful in encouraging commercial banks to become involved in microfinance. The banks must have the incentive to design better products for microentrepreneurs, which can be profitable.
In stark contrast to this majority, BRI’s Unit Desa system (its microfinance arm) has the best financial results of any microfinance institution in the world. In 1996-97 it earned a profit of $170 million on loans of $1.7 billion to 2.5 million clients, with no subsidies. This is an approximate return on performing assets of 10 per cent – a very competitive rate by commercial standards. The success of BRI’s Unit Desa systems can be attributed primarily to the fact that the system has adhered to the fundamentals of banking and finance for the rural microentrepreneurs, including the provision of competitive savings services. The microfinance savings and loans of the Unit Desa system perform consistently for BRI and continue to grow quickly. BRI’s microfinance business may not compete with the most spectacular returns, but it does achieve these strategic goals:
BRI’s achievements demonstrate that financial services to microentrepreneurs (that are provided in an appropriate policy context) can generate a commercially competitive rate of return and fulfil important strategic goals for commercial banks.
Commercial bankers distrust the poor and NGOs
The large majority of commercial bankers interviewed had little positive experience of banking with the poor. They experience non-payment by the poor, look at the high costs, and assume the problem is with the poor rather than with the design or delivery of their bank’s products. They also distrust NGOs that provide financial services to microentrepreneurs, because they are not-for-profit institutions and not subject to regulation. As a result, the majority of commercial bankers perceive microfinance as risky, unprofitable and not fitting with their core business. By contrast, commercial bankers with a positive perception of microfinance had seen successful microfinance in practice, undertaken a comprehensive analysis of the size and performance of the microfinance market, and designed lending and savings products that were profitable and could reach significant scale.
Sound macroeconomic policy and a non-restrictive regulatory environment are critical
The most effective way for governments to encourage commercial banks to become involved in microfinance is to ensure an appropriate regulatory and prudential framework. The elements of an optimal policy context are:
Having all these elements in place will not guarantee that commercial banks will start microfinance lending. However, there certainly would not be external constraints.
Key success factors for commercial bank involvement in microfinance
Based on our research, and corroborated by other studies, the following were found to be key success factors for microfinance in commercial banks:
AusAID should support the development of a viable microfinance industry
It is strongly recommended that AusAID support the development of only those MFIs which are committed to moving towards profitability and thus are able to be clients of commercial banks. This includes those institutions which plan to develop into specialist formal institutions for microfinance on a significant scale. It would also be of benefit to MFIs and commercial banks for AusAID to facilitate the establishment of national performance standards or a rating system for MFIs, so that banks can easily understand which are sound MFIs and lend accordingly.
It is also recommended that AusAID work with other donors to enable interested bankers to learn how microfinance can be a profitable business; to develop and share appropriate lending technologies; and to remove policy restrictions.
These recommendations show an important and exciting role for AusAID in facilitating the growth of a new and profitable sector of economic development.