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Commercial Banks as Microlenders Summary of the Last Lecture • Incredulity, Ignorance, and Indifference • Microlending Needs Its Own Room • Models of Downscaling Service Company Models • They do not own their own portfolios and are therefore not regulated as financial institutions. Instead, they receive fee income from the parent bank for identifying clients, marketing products, appraising applications, and disbursing and recovering loans. Service Company Models • The loans stay on the banks’ books. Service companies are easy to set up, since they require little capital of their own and no financial institution license. Where the regulatory framework allows, they are a good way to go. Service Company Models • Banco Pichincha, Ecuador’s largest bank with 1.7 million customers, leads the financial system with nearly a third of all deposits and a quarter of total credit portfolio. Service Company Models • In the late 1990s, Banco Pichincha found itself with excess liquidity and a network of 235 branches, many of them underutilized and unprofitable, due to a deep economic crisis in Ecuador. The bank and Service Company Models • ACCION launched Credifé in 1999 as the first microlending service company experiment. Pichincha established Credifé (which means “trust credit”) with a distinct brand to approach the microentrepreneur market without diluting its mainstream brand name. Service Company Models • The Credifé window is inside Pichincha branches, but the segmentation of the market is clear, and Credifé creates its own brand presence in ways that work for microenterprise clients. Service Company Models • Credifé is now a top competitor in the microfinance market in Ecuador, offering a range of products for the informal sector including working capital, fixed asset, and personal loans. Service Company Models • In December 2007, Credifé measured its success by its $184 million portfolio, more than 80,000 active loans averaging around $2,300, and a portfolio at risk rate of 1 percent. Service Company Models • By sharing infrastructure with Banco Pichincha, Credifé lowered its start-up costs, allowing it to break even in less than two years. Service Company Models • The service company has had very high returns on equity, and, more important, contributes a disproportionate share to Banco Pichincha’s total profits. Service Company Models • It represents a more serious attempt to penetrate the BOP market than does the BWS example. The attempt has yielded higher portfolio volume, more profits, and deeper reach, though as loan sizes suggest, Credifé serves mainly the upper and middle BOP tiers and leaves the lower tiers for others. Service Company Models • Sogebank in Haiti formed a similar microfinance entity in 2000— Sogesol— motivated by financial-sector liberalization and the offer of technical assistance financed by the Inter-American Development Bank. Service Company Models • With its own board of directors and staff, the service company Sogesol shares interestrate margins with its parent bank. As with other service company models, Sogesol benefited from Sogebank’s infrastructure, expertise, and systems. Service Company Models • At year end of 2007, despite exposure to Haiti’s continuing political, economic, and weather catastrophies, Sogesol had nearly 12,000 borrowers with loans averaging $1,000, a portfolio at risk ratio of 6.8 percent, and an ROE of 47 percent. Financial Subsidiaries • A third model is for banks to open a financial subsidiary. Ecobank, a regional banking group in West Africa, is doing just this in several countries, beginning in Ghana. Financial Subsidiaries • Operationally, a financial subsidiary and a service company can be quite similar, so the choice between these models is dictated mainly by legal and regulatory issues. Financial Subsidiaries • In Ghana, a savings and loan institution was a known quantity, acceptable to the central bank, while a service company was not. For this reason Ecobank Ghana decided to create a savings and loan, EB-ACCION, in which it is the controlling investor together with ACCION. Financial Subsidiaries • The subsidiary leans heavily on Ecobank operations for support. As different from a service company, this choice required a substantial up-front application of equity to the new institution in order to meet minimum capital requirements. Lessons from Downscaling • Enough experience exists regarding banks and microenterprise lending that no bank needs to make major mistakes in plotting its entry. Lessons from Downscaling • The pioneering banks such as those mentioned above have shown the best paths and where the pitfalls lie. What follows are some of the lessons: Choose the right bank. • Not all banks are equally prepared to launch microfinance services. The right bank will have a strategic vision to become a major retail— not corporate—bank. Choose the right bank. • Important features include a network of branches in the relevant markets and a range of products already reaching down to the consumer level, such as savings, consumer lending, and payment services. Choose the right bank. • These features reduce start-up costs for microfinance operations and result in lower long-run operating costs, distributed among a portfolio of services. Find an internal “champion.” • The chances of successfully creating and maintaining a microfinance operation are greatly increased with the personal support of an influential member of the bank’s management team. Find an internal “champion.” • This person can serve as a liaison between the bank and the microenterprise operation, and can help define the roles of each. Allocate tasks to the most qualified entity. • Banks should do what they do best, including treasury, accounting, and legal functions. The microfinance unit should focus on its own comparative strengths, such as credit methodology and branch operations. Allocate tasks to the most qualified entity. • Some areas will require intensive coordination, particularly human resources and information systems. Anticipate internal problems. • One of the most common difficulties involves internal competition, as service companies must compete for services with other subsidiaries or divisions of the bank. For example, congestion at branches can result in poor customer service for microfinance clients. Anticipate internal problems. • More generally, an internal negative perception can mean that the service company does not receive priority attention when it experiences problems. Create effective agreements. • In structuring a service company or subsidiary to carry out microlending, it is essential to allocate risk, return, and responsibility carefully to create incentives that work for the parent bank and give the microlending operation a good chance to succeed. Create effective agreements. • Clear agreements address funding sources and costs, fees— especially for clients’ use of the bank for transaction processing—and credit risk sharing, particularly the method of calculating provisions and how potential losses will be distributed. The First Credit Cards • Bank experimentation with microfinance is still in its early days. It is instructive to remember that in the 1960s, when a relatively small regional bank introduced credit cards, its first experience with this new technology was not very successful. The First Credit Cards • During its first years, the product was not profitable. However, continuous experimentation and innovation with the cards led Bank of America to become one of the major players in the banking industry, and led the credit card industry to explosive growth. The First Credit Cards • This example gives me confidence that modest beginnings such as we see now with bank downscaling will eventually take off, making lending to low-income people a standard part of the banking landscape. Summary • Service Company Models • Financial Subsidiaries • Lessons from Downscaling