1. Mainstreaming the Microfinance Practice Mainstreaming the Microfinance Practice Challenges & Opportunities for Commercial Banks as Lenders to Micro-enterprises Finance Forum 2002 June 19, 2002

2. Characteristics of Micro-enterprises  Micro-enterprises are very small and mostly in the informal sector, semi- legal, often low-productivity, frequently family-based, lack transparency  Micro-enterprises are much more vulnerable to the vagaries of economic cycles  Little is known of the micro-enterprises/entrepreneurs, their markets, and their business dealings  Mostly cash-based markets  Informal contracts/agreements – not recorded, not legally enforceable  Property rights are weak or non-existent  Rural-based businesses are dispersed over large geographical areas  High cost to formalize micro-businesses (registrations, taxes, labor regulations, payroll charges)  Informal businesses maintain a low profile in order to avoid high cost of formalization and enforcement of regulations by authorities

3. Implications for Commercial Banks Micro-enterprises:  Very small transaction sizes (credit, savings, payments) --- Very high transaction costs  No formal status – can’t transact  Lack of formal properties – no collaterals  Little prospects for growth fearing formalization  “Fearful” of banks and don’t trust themBanks:  Lack experience of transacting with the poor, have a negative pre- disposition, don’t trust micro-entrepreneurs  Lack knowledge and understanding of markets of micro-enterprises  Lack credit information, unable to assess credit risk and thus perceive micro-enterprises as high risk  Distrust NGOs that provide financial services to the poor

4. Globalization of the Financial Services Industry  Globalization and technology are fundamentally changing the financial services industry worldwide  Competition has accelerated and is fierce for “best credits”/corporates in most countries  New competitors have entered the market  Margins and fees are narrowing significantly  Development of securities markets is providing additional competition for banks

5. What are the Opportunities for Banks? Right pre-conditions to develop a microfinance business line?  Large underserved market estimated by some at 500 million micro-entrepreneurs in emerging and transition economies  Banks are increasingly facing stiff competition in their traditional businesses (e.g. large corporates & trade finance) and are starting to pursue other market segments including SMEs and consumers in order to achieve growth and profitability  Microfinance as well as SME finance are prospects to consider but how to target these markets profitably?  Financial and information technologies can be leveraged to reduce transaction costs and improve portfolio risk management

6. What are the pre-requisites for Banks to enter the microfinance market?  Sound macro-economic policies and appropriate regulatory and prudential framework  Improved legal framework and effective public institutions to enhance business viability (e.g. property registries, contract and collateral enforcement, security of land tenure for low income populations, simplified processes for licenses, customs, tax, labor) eliminate corruption, to reduce constraint on micro-enterprises to formalize and grow  Reliable credit information on micro-entrepreneurs  Information on past payment history, level of indebtedness  Default information  Understanding the markets of the micro-enterprises  primary & secondary market research to better understand the businesses  Segmentation (size & industries) Are these pre-requisites enough to interest banks?

7. The Theoretical Framework: Shifting the Productivity Frontier Lower unit costs per transaction or service Broader service offerings & higher asset quality Productivity Frontier (Future state of Best Practice) Limited services to limited number of customers Unprofitable How? New financial, information & communication technologies Better credit risk decisions & efficient distribution channels Sustained profitability What are FIs trying to do?

8. Reaching Sustained Profitability in Microfinance Growth Operating Efficiency Asset Quality Value Creation & Sustained Profitability Marketing Strategy Technological Innovation Risk Management Small & Mid Banks Microfinance Institutions

9. What do Banks need to do?  Better understand client needs  Develop appropriate products and services  Develop effective and efficient distribution channels  Implement new risk management technologies, decisioning techniques and appropriate credit allocation processes  Adopt global technologies to local markets

10. Examples  Bolivian MFIs becoming competitive banks e.g. BancoSol  ProFund in Latin America actively building and seeking linkages with commercial banks – (e.g. BancaSol merging with NGO Genesis in Guatemala, Sogesol – microfinance subsidiary of Sogebank in Haiti, Mibanco in Peru)  AfriCap in Africa driving its investment strategy on integrating microfinance in commercial banks  Accion has been an active player in building strong MFIs that are converting to commercial banks – assisting banks create and manage microfinance subsidiaries  Internationale Projekt Consult (IPC) and its investment vehicle IMI – 17 microfinance banks  Few commercial banks in Asia see microfinance as a profitable core business e.g. BRI in Indonesia, Hatton National Bank in Sri Lanka

11. The Future?  Will banks move down-market?  First to the SME market  Then to the micro-enterprise segment  How?  Establish separate subsidiaries?  Acquire existing MFIs and keep them as separate businesses?  Integrate more fully into regular bank operations?  When?  As macro-environment improves, risk profile of micro- enterprises will improve  When banks see that it can be profitable to lend to micro- entrepreneurs (demonstration effect)  As competition increases, pace of change will speed up

12. What are the Developmental Goals to pursue?  Increase the number of MFIs that are part of the formal financial sector, able to offer a comprehensive set of products and services to micro-enterprises  Establish linkages between MFIs and the formal financial sector and capital markets  Support banks moving into the microfinance market – demonstration effect  Identify and develop financial technologies that improve risk management and profitability and increase efficiency