UNITED NATIONS CAPITAL DEVELOPMENT FUND    Microfinance

Issue 17 / October 2005

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By María Otero, President & CEO, ACCION International

ACCION's approach led to the first transformation of an NGO microlender into a commercial bank, BancoSol in Bolivia. Photo Credit: Rohanna Mertens for ACCION International


Hortense Zevonnou, client of ACCION affiliate PADME in Benin. Photo Credit: Rohanna Mertens for ACCION International

The vision of microfinance is quite simple - to create systemic change in financial systems worldwide. Instead of the exclusive financial systems that have for decades benefited and protected the wealthy, microfinance intends that they serve the impoverished majorities, help lift them out of poverty, and make them full participants in their country's social and economic development. In the next ten years, our task is to make certain that millions of poor men and women currently unserved can access financial services. How do we get there?[1] As we look forward, I will focus on what institutional channels we will use to extend financial services, who we will reach, what innovations we will need, and what role governments and donors will need to play.

Before we consider what developments in microfinance we can expect by 2015 and what we need to have in place to reach our goal, let us examine where we are today. With that end in mind, ACCION sponsored a study in early 2005, "The Profile of Microfinance in Latin American in Ten Years: Vision & Characteristics[2]," co-authored by Beatriz Marulanda of Colombia and myself. The study explores the principle tendencies that characterize microfinance and its development in the coming ten years.

We noted the consolidation of two approaches to the provision of financial services to low-income people in the region. They both have commercial criteria, which we think will prevail as a model in the coming years. We see first that MFIs still primarily operating as NGOs will undergo "upscaling," or transformation into regulated entities. At the same time, commercial banks entering the microenterprise sector will adopt "downscaling" to provide a range of financial services to the poor. This reality creates important opportunities for microfinance and new challenges as well.

The study also demonstrated an ongoing (though evolving) role for NGOs as innovators in the field, developing new ways to extend credit to population sectors as yet not adequately served, including those in the poorest levels of society, people in rural areas, and those involved in small animal husbandry or agriculture. In countries where regulated entities have significant market penetration, we see a crucial role for NGOs in the provision of other services such as training and business advisory services for microentrepreneurs.

"The good ones will survive and be well positioned to serve certain market niches throughout the world. The weak ones that have not been able to reach efficiency and profitability will die." Carmen Velasco, Pro Mujer

"NGOs that demonstrate efficiency, knowledge of the market and are capable of adapting will be highly needed in specific niches where commercial banks will be reticent to go." Alex Silva, ProFund, Costa Rica

As we have learned more about the financial needs of microentrepreneurs, it is clear that the target market for microfinance should be the entire microenterprise household. In addition, in Latin America, the target market is expanding to include low-income salaried workers. Within this expanded market, the industry agrees on the importance of offering a wide range of integrated financial services, including: ATMs and other aids to transactional efficiency, savings accounts, credit products such as consumer and housing loans, and insurance policies that would allow families to protect themselves against potential misfortune.

"The fundamental recommendation is to see this market as one with vast potential where financial services and products such as savings, insurance and transfers can all be linked." Carlos Labarthe, Compartamos, Mexico

"There will be more products that permit the low income individual to efficiently manage risk and plan for the future. That means greater equilibrium between savings and credit products in the future; there will be more products directed towards asset accumulation for education, housing and retirement." Mónica Brand, ACCION International

ACCION's experience in Latin America and those of other leading MFIs around the world inform the next ten years. I emphasize here the leading microfinance institutions. Estimates indicate that there are 7,000 to 10,000 microfinance institutions worldwide, but in fact, just 150 to 200 of them are serving the vast majority of current clients. These leading MFIs share important commonalities: 1) a range of products developed specifically for their clientele; 2) the ability (and agility) to operate in competitive environments, and 3) consistent maintenance of a portfolio at risk of less than five percent and repayment of 97-98 percent or higher. Their overall operation falls under what we call the "commercial approach" to microfinance, an approach that most industry players now embrace because they understand that to make a real impact on poverty, microfinance institutions must be permanent, economically viable entities capable of reaching ever-increasing numbers of people.

The provision of financial services to the poorest people does not have to be contradictory to commercialization. However, it is quite clear that microcredit can only be provided to those people (or population segments) that have an established minimum capacity to repay a loan. Financial services for the poor are not a substitute for critical social services that are the responsibility of governments.

The Next Ten Years

In 1992, ACCION's commitment to building sustainable MFIs capable of tapping the capital markets for their lending funds led to the first transformation of an NGO microlender into a commercial bank, BancoSol in Bolivia. Transformations of other ACCION affiliates followed: Mibanco in Peru and Compartamos in Mexico, and outside of our network, KREP in Kenya, and today many others. This model has led to enormous growth. In the last four years, the ACCION Network has added over one million clients, from 450,000 in 2000, which took two decades to achieve, to 1.7 million today. ACCION intends to double this number in the next three years.

What Is Ahead?

1. New sources of commercial funds will emerge. MFIs will issue bonds in their local capital markets, as several have already done in Latin America, including two that are NGOs. Together these MFIs have placed over US$100 million in bonds in their local capital markets, most of which were oversubscribed by two or three times. We will see more microfinance institutions follow their lead, relying on the local and international capital markets to grow their institutions. In addition, we will have an explosion of interest from private capital, especially social investors, in both equity and debt investment in microfinance. The next step will be what BRI in Indonesia has already done with its issuance of the first initial public offering (IPO).

   While private sector investment will dramatically widen the pool of funds available for microfinance, it will also demand that MFIs operate in the most business-like manner, with rigorous transparency and increasingly better client service. Interestingly, as private sector funding for MFIs increases, the influence of multi- and bi-lateral donors will decrease over time.

   The increasing interest of investors has led to the formation of more than 40 funds that provide debt (the majority of the investment) and equity investment in MFIs. Recent studies show that the equity funds have over US$600 million invested in MFIs worldwide, with debt funds adding hundreds of millions more in private monies. Because of the importance of tapping into private debt and equity investments for the expansion of financial services to the poor, ACCION sponsored the formation of the Council of Microfinance Equity Funds (www.cmef.com) in 2003, the first membership organization bringing together the leading private entities that make equity investments in microfinance institutions. It is important to note that CMEF members seek both social and financial returns from their investments. They work together to advance equity investment in MFIs through a number of initiatives and research projects, the most recent focused on strengthening the governance of shareholder-owned MFIs.

2. Additional microfinance institutions will join the 200 leaders as the lessons of good, transparent performance are applied. Some of these will continue to operate as NGOs and will play the role of pioneers and innovators - working in very remote areas, or testing self-sufficient models that may include education or health services. But microfinance leadership must develop new, more sophisticated skills. with the challenge of commercial banks entering the field. The dominance of today's microfinance leaders will last only if the leadership of these institutions develops a set of skills that they largely do not possess today. They need excellent governance and management with strategic planning skills to avoid the complacency of success. They must continue evolving and improving their products and their professionalism. In addition, the capital available in the private sector, capital that will fuel enormous growth in microfinance, will demand this higher level of governance and management.

3. Conventional banking will enter microfinance in a big way. As local banks lose their corporate clients to large international banks, they need to look for new markets. They see the resilience of microenterprises and the MFIs that serve them during economic downturns, political and financial crises. They are reading about the fortune at the bottom of the pyramid. In preparing the study in Latin America, we interviewed over 30 key players in microfinance in the region. All but one believes that in Latin America these commercial banks will become important players in the next ten years. I believe that will be the case in most of the rest of the world as well.

   For those of us dedicated to a social mission, the large infrastructure, internal systems and ready capital of banks make them very attractive for enlarging access to financial services for the poor much more quickly. In Haiti, Ecuador and Brazil, ACCION is working with large banks with what we call the ACCION Service Company model. With this model, we create a separate private company that operates much like a microfinance institution, but that uses the bank's capital and systems. This model significantly reduces start up costs and the service company can reach profitability within just 18 months. Other large banks in Egypt, east Africa and India are already becoming active in microfinance, utilizing a variety of models.

   While banks offer many advantages, they face significant barriers in reaching a market they have excluded or ignored. They suffer deeply rooted, negative cultural preconceptions regarding the poor; and they lack the methodology that can lend with little or no collateral. Banks will do well to form partnerships and proceed hand in hand with well performing microfinance institutions.

4. New massive markets, to date not significant in the development industry, will open to microfinance, namely China and India. The sheer size of these countries carries with it the potential of affecting the whole microfinance industry in ways that are complex and not readily discernible. Success will hinge on the application of the lessons of successful MFIs: 1) understand your market, 2) price loans to cover costs and yield a profit, 3) keep operating costs low, and 4) think long-term survival.
5. MFIs will concentrate more and more on mobilizing savings. Bank Rakyat Indonesia has been a global pioneer in the mobilization of savings, demonstrating both the great need as well as the magnitude of the collective wealth of the poor that can be unlocked with appropriate products and distribution channels. Several members of the ACCION Network are covering half of their portfolios of $100 million with deposits; most Latin American institutions have been far less successful at mobilizing savings and can learn a lot from their Asian and African counterparts.
6. There will be explosive growth in new products and in the use of technology. New products will include credit cards and smart cards. We will use technology to add points of sale, to make the administrative work of the loan officers more efficient, and to transfer information quickly, all of which will improve client service and lower costs.

"I see technology as being a key element of bringing more products and larger volumes of funds at a lower price to the target market." Jean-Philippe de Schrevel, Blue Orchard Finance, Switzerland

The next ten years also raises important challenges for others who influence the development of microfinance, particularly governments. The rapid growth of microfinance has left the regulatory and supervisory framework far behind; it urgently needs to catch up. I salute the UN for adopting this challenge as one of its goals for the International Year of Microcredit 2005 by building awareness of this issue.

Success in meeting the challenge of providing access to financial services on a massive scale will depend largely on the support given by governments to the adoption of a prudent regulatory framework. We already have widespread consensus on the key elements of a regulatory framework designed specifically to work well for microfinance., but we need to press for their adoption throughout the world. We also need systemic conditions that permit the growth of a thriving microfinance industry, an environment where there are no legal constraints on interest rates, and where there is no distortion of the competitive framework by the presence of state-run financial entities offering subsidized interest rates and/or laxity in the recovery of loans outstanding.

Furthermore, it is fundamental to reform regulatory norms that complicate, impede or add to the cost of providing other financial services (funds transfers, insurance, savings deposits, among others) to the poorest households and informal businesses, including those located in remote areas as yet unserved. We need to insist that the regulatory framework supports our industry in its desire to offer a full range of financial services. It will take lobbying, drafting the regulatory norms, and equipping supervisory agencies to provide good oversight to MFIs. It is a large and expensive job, and we need donors involved.

Donors have other important roles to play. Particularly in the context of the Millennium Development Goals, donors can provide the resources required to develop the institutional capability necessary to expand significantly access to financial services by the world's poor majority. Donors should concentrate their funding efforts on 1) technical support to overcome bottlenecks to growth for MFIs with proven records of accomplishment, 2) support for outreach to poorer, more remote populations, 3) development of products and services before they are financially viable.

In addition, as more microfinance institutions apply the lessons of the industry leaders by depending upon commercial funds, other MFIs will gradually run out of funds to lend, and they will close their doors. However, if donors continue to provide soft funds to finance portfolios of weak institutions, those MFIs will continue to survive, a fact that could injure the industry as a whole.

The task will continue to be enormous and will require the open hand, the committed spirit, the restless brain of many of us. Our vision is grand and it may require new ways of operating, new ways of thinking. We must not be afraid to reinvent ourselves along the way and we must remain steadfast and unwavering in our mission of helping lift the poor out of poverty.