A microfinance path for commercial banks

Apr 2007
Jakarta, April, 16 2007 - Today, profit microfinance is becoming an emerging business. Banks of all sizes, including Citibank, Standard Chartered Bank, Deutche Bank, ANZ Bank, and ABN Amro, are actively entering this sector and developing different business models of microfinance.

We have in recent years witnessed a flourishing of microfinance institutions around the globe -- particularly after the United Nations launched the International Year of Microcredit 2005.

Perhaps the greatest indication of this growing trend was when the founder of Grameen Bank and the pioneer of microcredit for women was awarded a Nobel Prize.

In many ways, microfinance has proven an effective tool to help support the Millennium Development Goals campaign and to help halve the number of poor people.

Microfinance has come a long way from its beginnings as a non-profit program designed to combat chronic poverty in developing countries.

Previously, the most successful step towards combating chronic poverty came when the government created state-owned banks to channel subsidized loans to farmers.

These loans helped to produce food crops and many international NGOs gave charity to our poor to help them escape chronic poverty.

Furthermore, microfinance gradually evolved from social intermediation to financial intermediation. It adopted market mechanism and commercial practices.

Surprisingly, this approach has worked well in the bottom of the pyramid (BOP) economy mainstream and it has had a 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 systems to the entire society, efficiently and profitably.

One of the best examples and also the pioneer of commercial microfinance is the state-owned Bank Rakyat Indonesia (BRI) microbanking system which has developed over past two decades.

Today, profit microfinance is becoming an emerging business. Banks of all sizes, including Citibank, Standard Chartered Bank, Deutche Bank, ANZ Bank, and ABN Amro, are actively entering this sector and developing different business models of microfinance.

Data published by Consultative Group To Assist the Poor (CGAP), a unit of World Bank that is dedicated to microfinance, shows that the amount of global funds invested in microfinance in 2004 reached approximately US$1.1-billion -- and nearly half of that came from the private sector.

Regionally, there is a long list of commercial banks in Latin America, Africa and Asia that have a microfinance portfolio.

In Indonesia, banks including BRI, Bank Danamon and Bank Mandiri, own commercial microfinance businesses.

Indeed, these big banks have driven more commercial banks and venture capitalists to realize the commercial viability of microfinance.

This issue was also discussed in the microfinance forum for commercial banks during the recent Asian Banking Summit in Jakarta.

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 suggests a leading driver for commercial banks to have a microfinance business is profit.

Most of commercial microcredit schemes can generate a double-digit profit margin, which is substantially above the returns of small and medium-scale enterprise (SME) loans and corporate lending.

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 the unbanked segment.

In addition, commercial banks have a number of competitive advantages, for instance, management expertise, systems and physical infrastructure, 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 derived from conventional banking practices.

Some experiences show that many commercial banks have been unsuccessful in tapping microfinance customers.

The most common cause is lack of knowledge and information on the informal sector which is the core target market for a microfinance institution.

Generally, the costumers have a lower educational background, their enterprise ownership is family based, and while they have multiple sources of income, they lack marketable collateral.

The typical business is dynamic, has fast turn over and high returns, which are also important to take into consideration.

The second issue is high operational cost and initial investment.

The big challenge in microfinance controlling the cost of each lending unit. These can be relatively high due to 'a to z' processes that should be handled by a credit officer.

In other words, employment payroll is a critical issue in microfinance operations.

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 a streamlined organization and operations. In this regard, the essence of simplicity is very important, particularly when related to products and services.

Simple products and services will reduce operational costs and can be easily understood by customers.

Another critical element is pricing policy. 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.

Source : The Jakarta Post

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