A Microfinance Path for Commercial Banks

A Microfinance Path for Commercial Banks

By Mohamad Nazirwan*)

In the recent years we have witnessed the flourishing of microfinance around the globe – particularly after the United Nation launched the International Year of Microcredit 2005. Perhaps, the greatest indication of this growing trend was when Professor Muhammad Yunus, the founder of Grameen Bank and the pioneer of microcredit for women was awarded a Nobel Prize. In many perspectives, microfinance has been proven an effective tool to support the Millennium Development Goals campaign in reducing the half number of poor people.

Microfinance has come a long way from its beginnings as a non-profit program to combat chronic poverty in developing countries. The best practice in the past was that the government created state owned banks to channel subsidized loans to farmers to produce food crops and many international NGOs gave charity to poor inhabitants in order to help them climb up from chronic poverty trap. Furthermore, microfinance gradually evolves from social intermediation to financial intermediation which adopts market mechanism and commercial practices. Surprisingly, this approach has worked well in the bottom of the pyramid (BOP) economy mainstream and it has generated good impact on the prosperity of low income households and the poor.

The presence of microfinance institutions in local community has successfully opened financial access to microentrepreneurs and under banked clients who need loans for working capital and investment. The spectrum of commercial microfinance also broadens through providing saving products, remittance and payment system to the entire society efficiently and profitably. A key feature of this approach is double bottom lines that are to seek profits and also to create social values. One of the best examples and also the pioneer of commercial microfinance is BRI-Unit microbanking system which developed over two decades ago, after BRI struggled with massive losses during the rice self sufficient program (Bimas).

Today, for profit microfinance is becoming an emerging business. Banks of all sizes, from global institutions such as Citibank, HSBC, Standard Chartered Bank, Deutche Bank, ANZ Bank, Credit Suisse, ABN Amro and many more including leading investment companies are actively entering this sector and developing different business models of microfinance. Based on data published by Consultative Group To Assist the Poor (CGAP), a unit of World Bank that dedicated to microfinance, shows that the amount of global funds invested to microfinance in 2004 reached approximately US$ 1.1 billion and nearly half came from private sector.

Regionally, there is a long list of commercial banks in Latin America, Africa and Asia have microfinance portfolio. In Indonesia, such as BRI, Danamon and Mandiri are noted as banks that owned commercial microfinance business. Indeed, this mainstream has driven more commercial banks and venture capitalists to notice of the commercial viability of microfinance. This issue was discussed in the microfinance forum for commercial banks during the Asian Banker Summit 2007.

There are several incentives driving commercial banks to be quite aggressive in entering microfinance market. The findings of a study by Hatice Jenkins from HIID Harvard University suggest that a leading driver of commercial banks having microfinance business is profit motive. Most of commercial microcredit schemes can generate double digit profit margin which is substantially above the returns of SME loans and corporate lending. Another trigger is the changing market conditions and increasing competition in consumer finance, lending to medium and large enterprises. Other factors, such as regulations imposed by the government, innovations in banking technology, and awareness of poverty alleviation and social values have influenced the appetite of commercial banks to penetrate unbanked segment. In addition, commercial banks have a number of competitive advantages, for instance, management expertise, systems and physical infrastructure in place, ability to mobilize deposits and accessibility to other sources of funds.

However, microfinance does not mean a simple business. The business of microenterprise lending is complex and requires significant technical capabilities although its basic principle is derivedfrom conventional banking practices. Some experiences show that many commercial banks were unsuccessful in tapping the microfinance customers. The most common cause is lack of knowledge and information on informal sector which is the core of the target market of a microfinance institution. Generally, the costumers have lower educational background, enterprise ownership under family based, multiple sources of income and lack of marketable collateral. Moreover the typical of business is very dynamic, has fast turn over and high returns which are also important to take into consideration. Clearly, a good understanding on BOP segment will help banks to design products, term and conditions, operational framework etc. The second issue is high operational cost and initial investment. The big challenge in doing microfinance is how to control cost of each unit lending that is relatively high due to “a to z” processes that should be personally handled by credit officer. In other words, employment payroll is a critical issue in microfinance operations. Oftentimes, limited infrastructures particularly in remote areas also contribute to the overhead cost and network developments.

Drawn from the success and failure of commercial microfinance ventures, there are fundamental lessons that should be learned by commercial banks interested in entering the industry. The foremost consideration is to build a cost-effective business model through designing streamline organization and operations. In this regard, the essence of simplicity is very important, particularly related to products and services. Simple products and services will reduce operational costs and it can easily be understood by customers. Another critical element is pricing policy that is interest rate and transactions fees must be set based on commercial practices in order to achieve profits and sustainability. Finally, common requirements of a successful business also need to be in place. This includes clear vision, strong commitment and solid management; robust control and supervision frameworks, accounting and information systems, well-aligned promotion and compensation policies, great products and good customer service and so on.

*) Mohamad Nazirwan is observer and activist of global microfinance forums (iwan@bri.co.id)