1. Sustainability of Financial Institutions: Financial Services for Poor People. What Works ? Hanns Martin Hagen Senior Sector Economist, KfW European Forum for Rural Development Cooperation Montpellier, 4 - 7 September, 2002

2. Overview 1. Financial sustainability  Definition & prerequisites  KfW’s conceptual approach 2. Project examples  Village Banks in Mali  Microfinance Bank of Georgia 3. Lessons learnt  Supporting sustainable rural (micro-)finance 4. Conclusions and issues for discussions

3. Financial Sustainability Definition A rural financial institution is sustainable... if it is willing and able to provide self-reliantly and permanently financial services to the rural poor without external assistance or after assistance by donor or government has ended.

4. Financial Sustainability Prerequisites (I) (1) Lasting commitment to rural poor (2) Adequate credit- technology and financial products (I) (1)Unless it is clear to borrowers that the access to credit at the lending institution is permanent, repay- ment discipline is fairly likely to deteriorate. (1)Only micro-loan technologies allow to grant loans to poor people that have never before received a loan by banks and may not have bankable loan securities.

5. Financial Sustainability Prerequisites (II) (2) Adequate credit- technology and financial products (II) (3) Financial self- sufficiency (1)The loan sizes must be small enough to be repayable in frequent, small instalments, but large enough for generating additional income. (1)As long as the institution cannot cover all operating expenses with income form its financial operations, it remains dependent on donors or government.

6. Financial Sustainability Prerequisites (III) (4) Will to improve efficiency (1)If competition is limited there is a danger that inefficiencies and delinquencies flourish, but remain hidden under cost-covering interest rates. (1)Only cost-efficient institutions ensure that as great a portion of funding as possible reaches the hands of the poor.

7. Financial Sustainability KfW‘s conceptual approach (I) Reasons for support of sustainable rural financial institutions by German Financial Co-operation: (1) contribution to rural poverty reduction (2) contribution to financial sector deepening and broadening by integrating poor households into the system by developing and introducing new financial products

8. Financial Sustainability KfW‘s conceptual approach (II) Support mechanisms of German FC (1) support of financial retail mechanism – “down-scaling”-strategies of commercial banks, – “up-grading” of finance NGOs, – “greenfield” establishment of new (micro-) institutions, – refinancing garantees (2) support of financial whole sale mechanisms – public sector whole-sale banks, – private refinancing institutions, – revolving loan funds.

9. Regional Structure of KfW‘s Current Microfinance Portfolio (EUR million) Total current Portfolio: EUR 204 Mio approx. 30 % of total fin. Sect. Portfolio (as of 12/2001)

10. Project example: Village Banks (caisses villageoises) in Mali KfW BNDA Government of Mali „Service Commun“ VBA VB Village banks members grant BMZ

11. Caisses Villageoises: Poverty Outreach, Financial Performance Poverty outreach: over 500,000 poor clients reached (80 % of which with a daily income of less than USD 1 per day) 150 village banks with 65,000 members and 8 VBA Adequate lending technology: Repayment rates of the banks: > 95 % Repayment rates of VBA vis-à-vis BNDA: 100% Total outstanding loan portfolio: US-$ 3.1 Mio

12. Caisses Villageoises: Financial Self- sufficiency, Efficiency, Structural Impact Financial self-sufficiency: on average 98.2 % of adjusted operating expenses are covered by adjusted income from financial operations Efficiency: Acceptable administrative efficiency: 24 % (1998: 41 %) Structural impact: Savings collected constitute 2/3 of refinancing volume sustainable linking of self-help groups of the informal sector with the formal banking sector

13. Project Example: Microfinance Bank of Georgia FC (KfW) Government of Georgia German-Georgian Foundation Microfinance Bank of Georgia Small and micro entrepreneurs (since 1999), Rural Poor (since 2001) FC or on-lending conditions Market conditions Equity 20 % Loan Other investors: TBC 17 % IFC 16 % Co. 15 % IMI, FMO, EBRD je 10 %

14. Microfinance Bank of Georgia : Poverty Outreach, Financial Performance Poverty outreach: 20,550 loans outstanding (12/2001), 97 % of which granted to micro-enterprises with less than 10 employees since 12/2001 expansion of outreach to poor households in rural areas (currently less than 2 % of outstanding loans) Adequate lending technology: portfolio at risk: 1.4 % Total outstanding loan portfolio: US-$ 27.6 Mio

15. Microfinance Bank of Georgia : Financial Self-sufficiency, Efficiency, Structural Impact Financial self-sufficiency: return on average assets: 1.7 % (1999: -5.1 %) Efficiency: Good administrative efficiency: 10.2 % (1999: 12.4 %) Structural impact: establishing “green-field” financial institution for micro- finance first bank in Georgia to offer loans to small and micro enterprises, some institutions prepare to follow

16. Lessons Learnt: Supporting Sustainable Rural (Micro-) finance (I) ( A) Providing a TA-Package to assist in either the launching a new financial institution (e.g. case of Georgia) or the development of existing institutions in the direction of sustainability: 1) devising methods of providing loans, deposits, payment services to the rural poor 2) designing and implementing organisational structures that allow an effective and cost-efficient provision of the financial services to the rural poor

17. Lessons Learnt: Supporting Sustainable Rural (Micro-) finance (II) ( A) Providing a TA-Package: 3) to developing concepts of organisational development that lead to the establishment of a formalised rural financial institutions 4) to implement information technology (IT) systems specifically adapted to rural (micro-) finance institutions (B) Taking an active role as shareholder in balancing the forces in the management and the supervisory board that advocate a profit oriented approach and those that primarily seek development policy goals

18. To Conclude... Even financial institutions which focus solely on the rural poor can attain sustainability, if they meet the outlined requirements (prerequisites). Donors can foster the development towards sustainability by providing TA packages, funding the start-up phase or by taking an active role as the institution’s shareholder. I am confident that this forum will help to identify further policy recommendations that may help to tackle rural poverty even more effective through sustainable financial institutions.

19. Issues for Discussion (I) (1) The project examples from Mali and Georgia suggest that institutions with larger average loan sizes reach financial self- sufficiency earlier. What is your experience ? Is there a trade-off between poverty outreach and financial self-sufficiency ? (2) In case of the Microfinance Bank of Georgia, the institution focussed during the start-up phase on micro, small and medium sized enterprises. Only since the end of 2001, the institution has started loans to the rural poor. Are such “mixed” programs suitable for rural poverty alleviation ? a) They have the possibility of cross-subsidizing lending to the rural poor from provitable lending to the less poor. b) There is the risk that funds allocated for the poor are leaked to the non-poor.

20. Issues for Discussion (II) (3) What exit strategies can donors as shareholders of rural (micro-) banks chose in order to ensure that the rural financial institution remains pro-poor even after the exit ?