MICROFINANCE MATTERS - Engaging the Private Sector

In the discussion about access to financial services we tend to hear mainly about why it is important. Thus we hear about its role in supporting social cohesion, its contribution to economic growth and poverty reduction, the way it confers on people the freedom to transact and so on. What often seems to be missing is a discussion about how governments should engage with the financial services industry to promote financial access. It puzzles me, from a South African perspective, that other governments in sub-Saharan Africa are not busy negotiating "financial access charters" with the private sector. We argue that by promoting the agreement of a financial access charter a government would signal a clear political commitment to changing the nature of financial markets in favour of greater access. It would also act as a practical framework for cooperation between a government and its private sector.

Box 1

Financial Access Charter - A Definition

At its core, a financial access charter is a contract entered into by key stakeholders (government, industry bodies representing private sector groups, e.g., banks and insurers, as well as labour and civil society groups) under which the parties commit to work together to transform the state of access to financial services for the poor. The charter would not be statutorily imposed but would be acted upon as if it had the force of law.

The document would acknowledge that financial intermediation has a social as well as a commercial function and that the opportunity to save or transmit money, to borrow or insure, should be accessible by a broad spectrum of the population. Thus commercial providers should strive to provide products and services suited to the needs of poorer, as well as wealthier, people. The document should confirm the enabling role of government in creating an environment in which commercially provided financial services can flourish.

The charter would acknowledge the poor state of access today, expressed in terms of the percentage of people of a certain income or wealth group using financial products, and would set targets for an improvement in access within a certain timescale. The product categories would be defined according to the characteristics of the particular market but would fall under the broad functional headings of transaction/transmission, credit, savings and insurance.

It would also provide for the establishment of a representative monitoring board, or council, which would agree generic access definitions (e.g., what "appropriate product" means for a particular market), set detailed targets for relevant players and oversee progress.

The charter therefore presents a particular vision for the state of financial access at a future date and articulates the process by which that vision is to be achieved.

South Africa's Financial Sector Charter

Box 1 proposes what the key elements of a financial access charter might be. To take the South African example, the Financial Sector Charter in South Africa (SA) was originally conceived as a transformational blue print for the financial industry (i.e., deracialising the financial sector in terms of its (hitherto predominantly white) ownership, employment and procurement practices), but it also includes very specific targets for an improvement in financial access. Signatories to the Charter include government, industry bodies (representing banks, insurers, the collective investment industry, and so on) and representatives of labour and civil society.

Crucially, while government set the political ground rules for the processes which eventually gave rise to SA's Charter, and facilitated much of the discussion, the Charter can be seen as the financial sector's own proposal for the transformation of the sector which the government has considered acceptable. There is a fine, but significant, distinction between this approach and that of a national strategy where "ownership" clearly resides with the government. Whether the financial sector's "ownership" of the Charter in SA leads to greater commitment to achieve its goals remains to be seen but we argue that it might and the early signs are also reasonably encouraging in terms of working group activity and concrete output. It should be recognized that the Charter is an "agreement to agree"; whilst there is risk in this, with some very material issues unresolved between government and the financial sector, it is also positive in that it is not unworkably rigid, despite its level of detail.

Under the Charter, signed in October 2003, banks and insurers have committed to provide certain products and services to lower income people by 2008. Essentially the targets have to do with physical access (e.g., people should not have to travel more than 20 kms to be able to access first order banking products), affordability and appropriateness. A copy of the Charter can be downloaded from the Banking Association of SA's website at www.banking.org.za.

The banking industry's most visible achievement, driven by the Charter, has been the launch by the major banks and the Postbank of the entry level bank account, known as Mzansi. After only nine months, 1.3 million people, the vast majority of whom (according to the Banking Association of SA) were new to that particular bank, had opened an Mzansi account - a significant start towards banking SA's 15.5 million unbanked.

Would this have happened without a Charter? Well, other factors certainly contributed, but the Charter, with its call for the industry to address issues of access as a joint effort, set the context for a development in the market of far greater scale and impact than any one bank on its own would likely have achieved.

Although the accounts are marketed competitively by the banks, whose pricing structures differ, Mzansi is above all a collaborative effort between the banks, in which the marketing costs to develop the brand and establish the standard were shared. It has taken the implementation of a Charter, a voluntary agreement but negotiated under pressure from the government, to encourage the banks to collaborate to find a workable solution to the provision of a basic banking product and its success has taken everyone (including the banks) by surprise.

These 1.3 million people may not generate significant profits for the banks in the short term (but nor will they lose the banks money) and as the economy grows and people become wealthier over time, and gradually become users of more profitable banking products, these new customers could well prove to be very worthwhile addition to the customer base.

Developing Access Charters in the Country Context

Of course, SA's Financial Sector Charter emanates from SA's particular context and we would certainly not promote this particular charter as an automatic blueprint for access charters elsewhere. Indeed, the power of any charter, as we see it, resides in the fact that it would be negotiated and agreed by key stakeholders in the financial markets of a particular country in a highly participatory way, thus capturing a shared vision and conferring legitimacy on its terms.

For governments, this is surely a more constructive route to the development of the financial sector than coercive legislation which research indicates tends to deter investment and encourage avoidance rather than stimulate competition and innovation. Since a charter would be negotiated under the direction of the government it would also satisfy the political need to be seen to be "doing something" to encourage banks and insurers to provide services relevant to the needs of the poor. Essentially it places the onus of pro-poor financial sector development on commercial providers, in return for which the government holds back from intervening directly in the market at the retail level and desists from introducing other measures that may be directly hostile to the interests of commercial providers, such as special taxes or directed lending or the use of state banks or insurers to distribute subsidized services.

We recognize that collaborative approaches can lead to anti-competitive practices which may not always be easy to spot and guarding against these practices may be a particular challenge for under resourced governments. In the case of Mzansi, SA government intervention effectively ruled out fixed pricing (somewhat late in the development process) and hence the banks now compete on price.

The Benefits

Aside from the political benefit, there would be two primary benefits for governments to the adoption of a financial access charter.

First, and most importantly, a charter would help create a vision of the desired shape of financial markets at a point in time in the future and would enable stakeholders to plan jointly towards achieving that goal. With their target dates, charters would fundamentally be forward looking documents and their adoption would elevate the importance of financial access in government planning priorities.

Secondly, a financial access charter would give governments a practical framework for discussion with the private sector. If the South African experience is anything to go by, once access targets are agreed, the real discussion begins as to how those targets are to be achieved across the various sub-sectors of the market, in banking, savings, housing finance, enterprise finance, and so on. It would encourage stakeholders to visualize financial markets as a whole, broadening the discussion beyond access to credit or savings mobilization, which may be the immediate priorities, encouraging a debate about the scope for insurance, pensions and other more advanced financial products.

It would also identify where it might be appropriate for government to play a supporting role, for example, in offering fiscal incentives, mitigating bank risk in certain areas, developing key infrastructure or encouraging innovation. In other words a charter offers the basis for a partnership approach in which service providers agree to develop the market competitively, thereby increasing the size of the market, contributing financial resources, infrastructure and skills, and governments offer them limited support in return for the additional economic activity that increased access will generate.

So, what is in it for the banks? For one, it would counter the negative perceptions that banks often have as being excessively profitable and not interested in fulfilling the unique social role that they have as intermediators in the wider economy. It is surely in the banks' interests to demonstrate a commitment to extend access to financial services than to run the risk of punitive taxes on their profits or some other form of unwelcome government sanction. Secondly, it would allow the banks a constructive platform from which to argue for the removal of barriers to providing services effectively, such as aspects of anti-money laundering legislation.

In many countries in sub-Saharan Africa the caricature of financial markets is all too often close to reality: the private sector, typically subsidiaries of foreign parents, responding to commercial incentive by occupying narrow and often comfortable niches (in, say, payroll lending to government employees or commercial banking for a small number of large corporates) and a fragmented microfinance institution (MFI) base with relatively modest outreach overall. The stasis that results from banks' reluctance to move outside of these niches, and from MFIs' inability to grow to sufficient scale, is what perpetuates financial exclusion and a financial access charter could start to address this. In the long run, banks cannot assume that the comfortable niches will continue to generate the level of profits that they do today; competition from new market entrants will see to that. At some point, they will need to identify new and underserved market segments in order to sustain profitable growth.

We argue, therefore that a charter will strengthen the banking sector's relationship with the relevant government and, by creating a vision for the development of the financial sector and clarifying where government can play a role in creating the enabling environment or mitigating risk, bring the opportunities for profitable growth in future into sharper focus.

The Role for NGOs

So where do NGO MFIs fit in to a debate which appears to be geared towards the formal financial industry? In countries where access to banking is as low as it is in, say, Zambia, it could be argued that it is a distraction to focus on the formal providers when clearly the vast majority of the adult population obtains financial services from outside the formal sector.

We would suggest that where MFIs are significant players it is entirely appropriate to include them in the agreement of charter terms although it is difficult to see how, like the banks, they could accept the obligation of delivering greater access (as there would be no realistic sanction against them, were they to fail). Whilst it could be argued they would be more appropriately positioned as monitors of the progress of commercial providers' against charter targets, they are nevertheless financial service providers in their own right and not just members of civil society.

Nonetheless, as the story of Mzansi shows, the formal sector has the resources and scale to make a huge difference quickly when it sees the incentive for doing so and thus, we argue, governments should see the formal sector as their primary charter counterparty. We also suggest that donors or multilaterals may find the specificity of a financial access charter useful in their advocacy with host governments around financial sector development.

Potential Obstacles

First, the conditions must be right overall. Clearly some countries in sub-Saharan Africa have more urgent priorities to deal with - wars, famine, and so on.

Secondly, for the targets to be credible, they must be based on good quality information. There must be agreement on what the state of access is today across the various sub-sectors and where it needs to move to over time. Many countries lack the capacity to create robust statistics, and serious political instability will make the gathering of this type of information practically impossible. For most countries, however, demand side surveys such as FinMark Trust's FinScope will provide good quality baseline data on usage and attitudes towards financial services which can then be tracked over time.

A benefit of facilitating this kind of demand side information would be to enable financial access indicators to be captured. It seems likely that countries' progress towards improving access to financial services will be monitored in future (by the World Bank and others) on the basis of agreed indicators of access which would capture informal as well as formal usage patterns.

Thirdly, a government must have the capacity to negotiate the sort of charter it wants. This is partly a matter of having the requisite technical expertise or the resources to buy it in: compared to the resources the private sector can muster in terms of market information, financial analysis, legal skills and negotiating experience, government resources are often stretched. But it is also a matter of a government being able to negotiate from a position of authority, in other words to be able to demonstrate that it has a credible and legitimate position and is serious about seeing its vision fulfilled.

Above all, changing the way financial markets operate takes time. Without belittling the challenges in extending basic services such as electricity, clean water or telecommunications, we argue that these can be done relatively quickly if we make the (admittedly sweeping) assumption that the necessary capital is available. The financial sector is not like this; its development is held back by numerous factors, some fixable (e.g., an inappropriate regulatory or legislative environment) but many that depend on the confluence of factors that are very difficult to direct - namely, the emergence of formal products and services appropriate to the needs of poor people, better consumer financial literacy, an improvement in economic circumstances which encourages people to take more risks and to overcome their natural conservatism in the way their money is managed. It is also simplistic to attempt to rank these challenges by importance: improving banking legislation without addressing financial literacy issues would be a positive but inadequate step forward. What is required is a comprehensive plan to address all of them and a charter can act as a framework for multiple parallel actions.

In other words this is a very long term business but we suggest that the adoption of access charters - which would illuminate the problems and gear effort towards their resolution - would accelerate the processes that countries will need to go through before they can claim to have properly inclusive financial markets.

It is easy to conceive that developing countries in sub-Saharan Africa will make very substantial progress in the delivery of basic needs such as electricity, water and telecommunications in the next decade and yet fail, due to the complexity of the challenge and for want of a coordinated approach to financial market development, to make a material change in access to financial services, a situation which the International Year of Microcredit is surely aiming to prevent.