C&I LENDING : Part 2 Why and How

by Gail Buyske art 1 of this article introduced the microfinance industry and related the impressive experiences of some of the largest Pmicrofinance lenders. Part 2 addresses the keys to successful microfinance lending, other developments in the international micro- finance field, microfinance today at major international banks, and microfinance in the U.S.

hat can Bank Rakyat Microfinance is based on also shows us that it can be Indonesia teach us? sound lending practices applied to a population that WPerhaps you might say, that seem most commercial bankers a lot about a little. Its $1.3 billion disarm- previously thought portfolio is made up of ingly unapproachable. averaging just $440 each. Here’s sim- the kicker: Despite 65% growth in this portfolio over the past two years, BRI’s loans- past-due ratio is 4.37%.1 The expe- riences and lessons learned by BRI It’s and others can tell us a important to good deal about serving low- ple. In effect, microfinance understand that the income and poor populations prof- reteaches us what we already majority of microfi- itably. knew about good banking, but nance programs are initi-

© 2004 by RMA. Gail Buyske is a non-executive director of several banks in the former Soviet transition economies. She serves as chair of the board of directors of KMB Bank, a Russian bank founded for the purpose of lending to micro and small businesses, with a loan portfolio of over $200 million. The views stated in this article are her own.

94 The RMA Journal June 2004 Microfinance: Part 2 ated with financial and technical support from international donors. I T ’ S IMPORTANT TO UNDERSTAND THAT THE MAJORITY OF This support helps microfinance MICROFINANCE PROGRAMS ARE INITIATED WITH FINANCIAL lenders achieve the economies of scale necessary for sustainability AND TECHNICAL SUPPORT FROM INTERNATIONAL DONORS. as well as for sharing international HIS SUPPORT HELPS MICROFINANCE LENDERS ACHIEVE THE best practices. Support in the T form of subsidized interest rates, ECONOMIES OF SCALE NECESSARY FOR SUSTAINABILITY AS however, is not encouraged because they ultimately compro- WELL AS FOR SHARING INTERNATIONAL BEST PRACTICES. mise the financial sustainability of be taken out of the business), pos- near-term incentives to meet— a microfinance program. Several sible collateral items, and a general and exceed—performance guide- key characteristics are shared by sense of the borrower’s personal lines. successful microfinance programs life. worldwide. Capturing cash flow. New Frequent loan repayments. borrowers are required to funnel Ensuring Loan Quality Loan payments can be as often as the majority of their turnover Cash flow analysis. Unde- daily; more often, they are weekly through the lender’s account facil- terred by the typically rudimenta- or monthly. Such loan repayment ities. In addition, some programs ry information available, microfi- schedules are important both as a (particularly for group lending) nance lenders construct a cash monitoring function and as a have mandatory savings require- flow analysis of the borrower means of training the borrowers— ments for borrowers. based on simple observation of who often have never borrowed the borrower’s business, compara- from a formal financial institu- Maximizing Productivity Decentralized decision mak- tives (such as typical profit mar- tion—in financial discipline. ing. gins) for other borrowers in the Ongoing efforts are made to Zero default tolerance. same business, and review of the maximize decentralization of deci- borrower’s formal and informal Successful microfinance loan offi- sion making, recognizing that financial information. In addition, cers follow up personally with quick loan decisions (same-day it’s essential to probe into the bor- delinquent borrowers within 24 turnaround is not uncommon) can rower’s other obligations: One of hours of the delinquency and, be critical for small traders operat- the most common reasons for depending on the reason for the ing with limited working capital default is the borrower’s lack of late payment, may initiate liquida- and thin margins. Decentralization candor in this area. tion of the collateral. The combi- also keeps the decision makers nation of regularly scheduled close to the borrowers and enables Character analysis. Character principal payments and zero them to respond quickly to analysis is an unavoidable aspect of default tolerance is critical in changes in borrower or overall microfinance lending. Many bor- impressing upon borrowers the market conditions. rowers do not have a track record seriousness of their financial com- Loan officer productivity. and credit bureau records for them mitments. often do not exist. Some successful Even though loan officer salaries Loan officer incentives. microfinance programs even in emerging economies are rela- include a visit to the borrower’s Loan officer compensation is tively low, the small size of the home as part of the analytical structured to reward timely repay- loans still requires high levels of process, because such visits can ments, with as much as 50% of loan officer productivity to provide valuable information about compensation based on portfolio achieve financial sustainability. the borrower’s standard of living performance. In addition, com- Ratios of 100 and more loans per (and thus how much money might pensation is adjusted on every employee are typical for the most payday, thus providing strong experienced lenders, with the

95 Microfinance: Part 2

Equity Building Society (EBS) of ment of a sustainable business. Kenya achieving a high among One classic way to cater to the Other Developments in MIX members of 838 loans per borrower’s convenience is for the Microfinance employee.2 The loan officer com- loan officer to visit borrowers in Performance measurement. pensation programs noted above the market and collect payments Reasons for expansion of the also contribute to maximizing in cash. microfinance field in developing productivity. markets extend beyond the Organizational Issues3 increase in lending already dis- Encouraging repeat bor- Appropriate structure. As cussed. There also have been rowing. Maximizing repeat bor- was noted above, decentralization ongoing efforts to increase the use rowing helps amortize the time is key for any microfinance lender, of standard performance measure- spent on developing a relation- whether it is a dedicated microfi- ments, encouraged by such organi- ship. Microfinance lenders some- nance organization or a commer- zations as MIX. In addition, spe- times make advance commit- cial bank. Understandably, howev- cialized microfinance rating agen- ments so that borrowers know er, such decentralization can be cies are emerging: examples they will be able to borrow a larg- difficult to achieve in banks with include MicroRate, based in er sum of money after they suc- well-honed organizational struc- Washington, D.C; PlaNet Finance, cessfully repay their existing loan. tures and operating procedures, based in France; and Micro-Credit particularly when embarking on a Ratings International Limited (M- Adjustment to Market Specifics new and potentially risky product. CRIL), based in . The major Flexible approach toward The corporate culture of some international ratings agencies also collateral. Successful microlen- commercial banks also can pres- have become aware of microfi- ders are not constrained by stan- ent a challenge to microfinance nance lenders as a client base. dard views of acceptable collater- lending for two reasons: Standard & Poor’s, for example, al. For example, they take into 1. Microfinance is viewed as a rated a bond issued by Financiera account the psychological impor- subset of an existing business; Compartamos, the Mexican micro- tance of a range of types of collat- therefore, its idiosyncrasies finance lender mentioned in Part eral, such as wedding rings and are not sufficiently under- 1 of this article, while both Duff & other personal belongings. Such stood. Phelps and Fitch rated a bond flexibility not only expands the 2. Bankers resist associating issued by Finamerica in range of potential borrowers, but, with this type of clientele. .5 particularly for emotionally mean- Evolving practice indicates that ingful collateral, can also increase promising alternatives for com- Regulatory sup- the borrower’s personal commit- mercial banks could include the port. Regulators ment to timely repayment. creation of a subsidiary or the use are beginning to focus on Recognition of the impor- of the “service company model,” microfi- tance of all-in costs to borrow- in which a separate company nance as ers. Successful microfinance sources and structures loans that well. lenders recognize that interest are booked by the bank.4 Women’s rates are only one of the many World costs that potential borrowers Organizational champion. must take into account. Other A notably large number of suc- expenses include travel time and cessful microfinance programs are loan approval time. By ensuring characterized by the presence of that these other costs are satisfac- an organizational champion who torily addressed, these lenders are is committed to the product and able to charge interest rates and able to support its development fees that allow for the develop- within the institution.

96 The RMA Journal June 2004 Microfinance: Part 2

Banking, for example, is working Credit-scoring advances. capitalized at $25 million, will with BIS officials on interpreting Some microfinance lenders have invest in and advise international Basel principles as they apply to been exploring scoring as a path microfinance and SME lenders.10 microfinance lenders. to increased productivity. One of On the funding side, several the main challenges has been microfinance organizations have New credit products. finding the appropriate balance issued debt in their local capital Insurance products, mortgage between quantitatively and quali- markets. The first unsecured debt finance, and credit cards are tatively based decision making. market transaction was achieved among the new products being The cost of introducing scoring by Financiera Compartamos, developed. Given the high fixed can also be prohibitively expen- which issued an unsecured peso cost inevitable with a large vol- sive for small lenders, in addition bond for approximately $15 mil- ume of very small loans, the to sometimes creating cultural lion (two tranches) in the Mexican increase in products can only be problems in organizations that capital markets in July 2002. welcomed as a means of increas- have been founded to help the It might not be an exaggera- ing overall yield. poor, yet find themselves borrow- tion to say that microfinance has Deposit taking. Another ing tools from Wall Street.8 become “big business,” partly in trend in the field is to emphasize response to the economic devel- Expanding funding sources. microentrepreneurs as a possible opment funds available to microfi- As microfinance lenders create source of deposits; the 66 self-suf- nance practitioners. Successful track records, they can begin to ficient microlenders noted in Part lobbying, for example, played a look beyond donors for more sus- 1 of this article had an average role in the development of the tainable sources of finance. A num- total savings level of $3.3 million, U.S. Microfinance for Self- ber of dedicated equity investors or approximately 33% of their Reliance Act of 2000, which states have emerged; the MicroCapital loan portfolio.6 Although in some that 50% of all resources provided Institute tracks 15 microfinance cases the cost of collecting small by the U.S. Agency for funds with total assets of almost deposits may be counterproduc- International Development to $500 million as of year-end 2002. tive from a commercial point of microenterprises must be targeted The largest investor by far is view, it is certainly useful from an to the “very poor,” which are Oikocredit, with total assets of economic development perspec- defined as those in the bottom $222 million, followed by Calvert tive. One study of 15 credit 50% below a country’s poverty Community Investments ($65.2 11 unions in provides line. The UN’s designation of million), the Foundation for a useful per- 2005 as the Year of is International Community spective on another sign of the recognition Assistance (FINCA) ($49.5 mil- the cost that microfinance has achieved in lion), ACCION International issue; the developing world. ($30.5 million), and International credit Micro Investitionen Aktienge- Increased interest by inter- unions sellschaft (IMI) ($25 million).9 national banks. Large interna- with sav- Although not included in the tional banks also are beginning to ings of MicroCapital data, it is relevant to take a serious look at microfi- under $1 note that Chicago-based nance, both internationally and million had ShoreBank Corporation, with 30 domestically. Their involvement a savings years of experience in lending in may include: expense ratio low- and moderate-income com- • Equity investments in micro- of 8.43%, munities in the U.S. and advising finance banks. compared to international micro and SME • The service-company model, 3.26% for sav- lenders, has recently created in which a subsidiary arranges ings of $1 mil- ShoreCap International. This fund, microfinance loans that are lion to $5 million.7

97 Microfinance: Part 2

issued more than $11 million in C OMMERZBANK’ S EVOLVING EXPERIENCE IS ITS ABILITY grants to microfinance intermedi- aries from 1999-2002; its recipi- TO INTEGRATE THE CLIENTS OF THE INVESTEE BANKS INTO ents are in more than 50 coun- ITS INTERNATIONAL NETWORK.DAIMLERC HRYSLER AND tries, including more than 30 recipients in the U.S. Meanwhile, S IEMENS, AS EXAMPLES, EXPORT PRODUCTS TO THE Citigroup also has played an CLIENTS OF THE INVESTEE BANKS. important role in helping microfi- nance lenders access capital mar- booked by the parent bank. amounts; two of the banks now kets directly. As one example, the • Structures that provide loans lend up to 500,000 euros per bor- stock brokerage arm of Citigroup’s and grants to microfinance rower.12 Banamex, Accival, placed the intermediaries. It is relevant to note that very Financiera Compartamos bond Commerzbank has made the few large international banks have issue discussed earlier.15 largest direct microfinance commit- taken on microfinance lending ment of any multinational commer- directly. One exception is ABN Microfinance in the U.S. cial bank. The bank initially invest- Amro, whose Brazilian subsidiary, There are three points of ed approximately $10 million (since Banco Real, has created a comparison between the U.S. and increased) in seven banks founded microlending subsidiary—Real developing-country microfinance to serve the microfinance and SME Microcredito—which opened its markets that are particularly rele- markets in Bulgaria, Romania, doors in 2002. Real Microcredito vant for RMA members: the size Albania, Georgia, Bosnia, Kosovo, is organized according to the serv- of the markets, the creditworthi- as well as Serbia and Montenegro. ice-company model noted earlier; ness of the borrowers, and poten- Commerzbank holds an ownership it sources and structures the loans, tial productivity levels. share of 12-21% in each bank which are booked by Banco Real. (except Georgia, where the share is The program benefits from a 1. Size. The U.S. microfi- 3%). All of the banks are managed grant made by the U.S. Agency nance market is considerably by Internationale Projekt Consult for International Development.13 smaller than those in developing (IPC), the German consulting arm Deutsche Bank and Citigroup countries: the Association for of the IMI investment company both have taken an approach that Enterprise Opportunity estimates noted earlier. The other sharehold- emphasizes funding microfinance that microenterprises account for ers are a range of development-ori- intermediaries. Deutsche Bank 16.6% of private (nonfarm) ented organizations, such as the has housed its microfinance activi- employment in the U.S., com- International Finance Corporation ties in the Deutsche Bank pared to up to 75% in developing (IFC), the European Bank for Microcredit Development Fund, countries. The simplest explana- Reconstruction and Development which was founded to work with tion for the difference is that (EBRD), and IMI. One of the most private-banking clients to provide there are not as many poor and relevant aspects of Commerzbank’s long-term, equity-like debt to low-income people in the U.S. evolving experience is its ability to microfinance providers. As of Furthermore, not only is it harder integrate the clients of the investee year-end 2002, the fund had $1.67 to establish a new business in the banks into its international net- million in loans outstanding to 19 U.S., but low-income individuals work. DaimlerChrysler and organizations, three of which have a wider range of financial Siemens, as examples, export prod- operate in the U.S. More recently, survival options, including relying ucts to the clients of the investee Deutsche Bank has been develop- on the social safety net and using banks. Furthermore, the banks ing a $50 million debt fund to be more readily available consumer 16 have built on their experience to able to expand its activities.14 credit. expand their lending capacity both Citigroup has established the Although the U.S. market in terms of loan maturities and Citigroup Foundation, which has might be smaller, it is not insignifi-

98 The RMA Journal June 2004 Microfinance: Part 2

cant. If a third of the estimated 21 microfinance lenders typically use The experience of ACCION million microentrepreneurs in the loans past due as the standard and Innovative Bank is corrobo- U.S. could be served on a com- loan quality benchmark, U.S. rated by the SBA MicroLoan pro- mercial basis (i.e., profitably for lenders emphasize actual loss gram, for which anecdotal reports the lender), and if each of those 7 experience, so the comparison is indicate repayments in the 95- million entrepreneurs borrowed not exact. The key point, howev- 98% range. the $10,670 that is the average er, is that some U.S. lenders have As in the case of international under the SBA MicroLoan achieved results that hint at a tan- microfinance, not all lenders will Program, the total loan portfolio talizingly more creditworthy client be able to achieve these impres- would be almost $75 billion. (The base than some might expect. sive loan quality results. It’s also SBA program, which provides An important example is pro- important to acknowledge that not funding to community-based non- vided by ACCION, a pioneer in all lenders even seek these results, profit microfinance lenders for both international and U.S. micro- because the field includes organi- loans up to $35,000, has made over finance lending. ACCION zations ranging from commercial $220 million in loans since its International serves over 1.1 mil- lenders to nonprofits, whose pri- inception in June 1992.17) lion borrowers in 21 countries, mary objective is poverty allevia- It also should be noted that while the ACCION U.S. tion and who therefore focus on a the gap in to Associate Network is the largest completely different segment of low-income and poor communities microlender in the U.S., having the microenterprise population. in the U.S. is not concentrated in made over $86 million in loans to Nevertheless, for those seeking to microfinance alone. This gap also over 16,800 borrowers since opera- understand the potential commer- includes consumer finance, a mar- tions began in 1991. ACCION’s cial viability of microfinance, these ket that is well developed in the average loss experience in the results deserve attention. U.S. but barely exists in most U.S. over this period has been 3. Productivity. developing countries. Although approximately 5%.19 This third this complex topic is beyond the A newer market entrant with point of comparison with interna- scope of this article, it is worth similarly positive experience is tional microfinance is a pivotal noting that alternative—or the aptly named Innovative Bank issue because of the higher cost “fringe”—financial service in California, whose Small Office base of American lenders. Here, providers, such as payday lenders, Home Office (SOHO) loan prod- the evidence is still evolving. A which serve these communities uct is disbursed in amounts of lesson cited by a number of recognize estimated annual rev- $5,000, $10,000, and $15,000; the American microfinance specialists enues of over $168 billion and loans are largely aimed at borrow- that has been incorporated into the annual fee income of at least $5.5 ers in low- and moderate-income design of the SBA’s Community Express program is that borrower billion.18 The degree of overlap communities. According to chair- training is a key element of suc- between underserved microentre- man and cofounder Tim Jochner, cess. Such training clearly reduces preneurs and consumers is a topic as of February 2004 the bank’s the potential productivity of potentially worth exploring. SOHO portfolio was approximate- ly $21 million, with a loan loss lenders, in addition to increasing 2. Creditworthiness. The ratio of approximately 2.7%. their costs. Some lenders, such as high cost base of U.S. lenders (Approximately 90% of the bank’s ACCION and Innovative Bank, makes it counterproductive to loans are made through the SBA’s address this issue by using third seek the same close-to-perfect Community Express program, parties to provide training. repayment rate that some interna- which provides loans up to A related issue on which tional microfinance lenders $250,000—including collateral- experience is still evolving con- achieve on the basis of intense free loans up to $25,000—to bor- cerns the need for close borrower borrower-lender contact. rowers in low- and moderate- contact, including the importance Furthermore, while international of character analysis. At one end income communities.20)

99 Microfinance: Part 2

of the spectrum are the microfi- ate success and therefore enable ings sometimes mandated by microfinance nance lenders that provide train- them to focus on developing their lenders. ing themselves and therefore have business. The SBA Community 7 Data cited by Dave C. Richardson, “Going to the Barricades for Microsavings Mobilization: A ample opportunity to observe and Express loan program, as another View of the Real Costs from the Trenches,” develop close ties with their example, does not require collater- MicroBanking Bulletin, July 2003, p. 9. The sav- ings expense ratio is calculated by adding all the clients. Innovative Bank, at the al for loans up to $25,000, despite direct and indirect expenses associated with other end of the spectrum, has a the fact that most lenders instinc- deposit taking and then dividing them by the average annual savings outstanding. scoring-driven model based on tively seek collateral for what they more than 10 years of proprietary perceive as riskier loans. ACCION 8 A useful summary of the status of scoring in microfinance is in Mark Schreiner, “Scoring: The data: Client contact is minimal. USA is at the forefront of evaluat- Next Breakthrough in Microcredit?” CGAP One approach to squaring the cir- ing the appropriate use of deci- Occasional Paper No. 7, January 2003. cle is practiced by FleetBoston sion-making technology, while 9 www.microcapital.org/newsletter. Financial (now part of Bank of FleetBank has expanded beyond 10 Presentation by Mary Houghton, president of America); their close relationships lending to create Fleet ShoreBank Corporation, at Women’s Capital Markets Workshop III, New York, New with community nonprofit organi- Development Ventures, a $100 York, November 4, 2003. zations—such as Trickle Up, million fund with a minimum 11 www.gop.gov/committeecentral/docs/bills/ which focuses on helping low- investment of $500,000, a reflec- 108/1/bill.asp?bill=hr180. income entrepreneurs become tion of FleetBank’s experience in 12 Telephone discussion with Eckard von Leesen, bankable—create a mechanism how to help companies grow Commerzbank, February 4, 2004. for borrowers to graduate to beyond microenterprise status. 13 www.accion.org. Note also that ABN Amro is FleetBoston and a more stream- Perhaps the next innovation an investor in the ShoreBank Corporation invest- lined decision-making environ- will be yours! ❒ ment arm discussed earlier. ment once they no longer need 14 www.cib.db.com/community/downloads/ specialized start-up attention.21 Contact Gail Buyske by e-mail at dbmdf2002_report.pdf. [email protected]. 15 www.citigroup.com/citigroup/citizen/ community/data/microfinance.pdf. Conclusion Notes A number of lessons from 16 A thorough analysis of the differences between international microfinance have 1 Loans past due international and domestic microfinance is in Mark over 30 days. Schreiner and Gary Woller, “Microenterprise been cited in this article in the Development Programs in the and hope that they will pique the 2 MIX, which was the Developing World,” World Development, Vol. mentioned in Part 1 31, No. 9, pp. 1567-1580, 2003. imagination of readers. Perhaps of this article, is the Microfinance 17 Data provided by the SBA. the most important lesson is that Information international microfinance was eXchange, a non- 18 These figures cover check cashing, payday profit benchmarking loans, pawnshops, rent-to-own, and auto-title largely created by economic association and lenders. James H. Carr and Jenny Schuetz, development specialists lacking Web-based information exchange. “Financial Services in Distressed Communities: Framing the Issue, Finding Solutions,” FannieMae formal financial training: it repre- 3 These points are elaborated upon by Lisa Foundation, August 2001. sents an ultimate form of thinking Valenzuela, “Getting the Recipe Right: The Experience and Challenges of Commercial Bank 19 Telephone discussion with Livingston Parsons out of the box. Downscalers,” Chapter 3 in The III, VP, ACCION USA, March 3, 2004. The ACCION It is therefore not surprising Commercialization of Microfinance: Balancing U.S. Associate Network consists of six independ- Business and Development, edited by Deborah ent organizations: ACCION USA, ACCION that some of the most successful Drake and Elisabeth Rhyne (Bloomfield, Conn.: Chicago, ACCION New York, ACCION New U.S. microfinance lenders have Kumarian Press, Inc., 2002). Mexico, ACCION Texas, and ACCION South Dakota. Note also that one of ACCION’s many introduced significant innovations 4 For more information on the service company international activities is a 20% investment in as well. Innovative Bank’s SOHO model, see Cesar Lopez and Elisabeth Rhyne, Real Microcredito, the Brazilian subsidiary of ABN “The Service Company Model: A New Strategy Amro mentioned earlier. loans, for example, have a seven- for Commercial Banks in Microfinance,” ACCION year loan tenor, based on the InSight, No. 6, September 2003. 20 www.sbaonline.sba.gov. belief that longer tenors will 5 Lucy Conger, “To Market, To Market,” 21 Telephone discussion with Maurice Coleman, relieve microentrepreneurs from Microenterprise Americas, 2003, pp. 22-25. SVP, Community Investment Group of NY, FleetBoston Financial, March 15, 2004. the pressure of achieving immedi- 6 These are voluntary savings, as opposed to sav-

100 The RMA Journal June 2004