Republication, copying or redistribution by any means is expressly prohibited without the prior written permission of The Economist The Economist November 5th 2005 A survey of micronance 1

The hidden wealth of the poor Also in this section

What do you know? A beginner’s guide to micronance. Page 3

From charity to business In its short history, the micronance industry has undergone profound changes. Page 4

Giants and minnows Big banks are discovering the market for poor customers. Page 6

Critical acceptance The emergence of rating agencies attests to the industry’s growing maturity. Page 7

Bankable banks Are the poor a good investment? Page 8 are at last spreading from the rich to the developing worldand even making money, writes Tom Easton

Micro no more N RICH countries, nancial services on such as foreign direct investment and mul- Financial services for the poor and the rich Ithe whole work remarkably well, de- tilateral aid. But if the money is being sent, are becoming increasingly alike. Page 9 spite the exotic salaries, the crackpot deals say, from America to , charges and the occasional bust. The vast majority can amount to as much as 34% of the sum of people have access to interest-bearing involved, according to Dilip Ratha of the savings accounts, mortgages at reasonable . rates, abundant consumer credit, insur- Why are the poor so badly served? The ance at premiums that reect the risk of easy answer, that people who have little losses, cheap ways of transferring money, money do not make suitable clients for so- and innumerable sources of capital for phisticated nancial services, is at most a funding a business. half-truth. A better explanation, this sur- By contrast, nancial services for poor vey will argue, is that the poor have been people in developing countriesa busi- hurt by massive market and regulatory ness known as micronancehave failure. Fortunately that failure can be, and mostly been awful or absent. With no safe increasingly is being, remedied. place to store whatever money they have, In most developing countries, the barri- the poor bury it, or buy livestock that may ers to providing nancial services for the die, or invest in jewellery that may be sto- masses are all too clear. Ination tends to len and can be hard to sell. Basic life and be high and volatile; government is often property insurance is rarely available. incompetent; and the necessary legal Home are costly, if indeed they can framework for nancial services is often be found at all. For many people, the only missing. Property laws can make it impos- Acknowledgments source of credit is a pawnshop or a money- sible for poor borrowers to use assets such Writing this survey would have been overwhelming with- out the help of Jonathan Morduch of New York University, lender who may charge staggeringly high as their home as collateral for loans. co-author of The Economics of Micronance, and Stuart interest and beat up clients who fail to pay In the past, many countries have out- Rutherford, author of The Poor and Their Money. Special on time. In the Philippines, lenders who lawed usury, and today many Islamic thanks are also due to Jonathan Conning of Hunter Col- lege, Raghuram Rajan of the IMF and Luigi Zingales of the zip from town to town on motorcycles ex- countries prohibit the charging of interest. University of Chicago, co-authors of Saving Capitalism pect six pesos back for every ve they lend. Governments in developing countries of- from the Capitalists; Vanessa Ward, editor of Micronance That translates into an annual interest rate ten impose caps on the interest rates Matters; Christina Barrineau, chief technical ocer for the United Nation’s Year of , and the UN’s adviser of over 1,000% on a for a month. charged on loans for the poor. Despite on that project, Princess Maxima of the Netherlands. For workers from poor countries who their popular appeal, such caps under- venture abroad to earn a better living, mine the protability of lending and thus A list of sources can be found online sending money home to relatives can be reduce the supply of loans. www.economist.com/surveys hugely expensive. Such remittances have Incomplete and erratic regulation of - become an important source of income in nancial institutions has also undermined An audio interview with the author is at many developing countries, dwarng the condence of the poor in the nancial www.economist.com/audio other inows of capital from overseas services that are available. When they can1 2 A survey of micronance The Economist November 5th 2005

2 nd an institution that will accept their vices are available to them, the poor, just tiny deposits, it often lacks the sort of gov- You don’t have to be rich, but it helps 1 like the rich, snap them up. ernment deposit insurance that is routine Prevalence of bank accounts at different income levels In one sense, micronance has been in rich countries, so when a bank goes un- 100 around for a long time. What is now gener- der, savers suer. For example, Indonesia’s Singapore ating so much hope and excitement is less PT Bank Dagang Bali, once known for its the discovery of some entirely new way to work with poor clients, was closed by reg- Spain deliver nancial services to the poor than ulators last year after it was discovered to 80 the eect of the rapid innovation that has be insolvent and riddled with fraud. Many Greece taken place in the past three decades. Regression line savers did not get their money back. Czech Republic based on 54 countries Corruption is also commonplace in Malaysia Saudi Arabia From pawnshop to Citigroup many developing countries. A recent 60 The oldest nancial institution in the study by the World Bank found that in two Thailand Americas is a pawnshop on Mexico City’s poor states in where the nancial Turkey central square. Set up in 1775 under an Chile system is largely controlled by the govern- 40 edict by the Spanish crown to assist people ment, borrowers paid bribes to ocials in nancial trouble, it is called Monte de Romania Mexico amounting to between 8% and 42% of the Piedad, variously translated as the moun- value of their loans. Corruption raises the tain of mercy or the mountain of pity. Pity Philippines cost of every nancial transaction, allows 20 or mercy come in the form of cash in return undesirable transactions to take place and Russia for valuables. Unclaimed items end up for Estimated share of households with bank accounts, % Pakistan undermines consumer condence in the Kenya sale in a series of glittering rooms near the Iran nancial system. This, and the related Bangladesh main banking hall. curse of cronyism, explains why access to 0 By transforming trinkets into capital, nancial services in countries where the 0 5 10 15 20 25 pawnshops perform an important (if un- GDP per person, 2003 PPP $'000 state has control over the nancial sector is der-appreciated) service, but they have poorer than where it does not. Source: World Bank three limitations. They advance cash only Inadequate basic public services add to to people with assets. Their loans are the burden on nancial rms. SKS, a fast- can end poverty. A World Bank report by based on the value of collateral, not of a growing micronance institution in India, Thorsten Beck, Asli Demirguc-Kunt and business venture. And the valuables held has had to build back-oce systems that Soledad Martinez published last month as collateral cannot be used to fund busi- can work on two hours of power a day; it shows a strong correlation between lack of nesses, as banks’ cash deposits can. closely monitors voltage when its comput- nancial access and low incomes (see There have been two notable attempts ers are running and keeps a diesel genera- chart 1). Earlier research by the rst two au- to nd alternatives. One has been the cre- tor on hand. Many others simply give up thors and Ross Levine concluded that a ation by developing-country governments on the idea of modern technology and sound nancial system boosts economic of state banks, particularly to nance the continue to use paper instead. This makes growth and particularly benets people at rural poor. These have mostly been a dis- them vulnerable. The tsunami in Decem- the bottom end of the income league. A aster. The other, much more successful one ber 2004 wiped out nancial records at long-term study in Thailand by Robert involved a number of organisations ex- many small Indonesian banks. Townsend of the University of Chicago tending uncollateralised loans to very But not all the blame goes to poor-coun- and Joe Kaboski of Ohio State University poor borrowers. In 1971, Opportunity In- try governments. Financial-services rms showed that families with access to credit ternational, a not-for-prot organisation too have failed to do enough to deal with invested more, consumed more and saved with Christian roots, began lending in Co- the lack of the sort of data (for example, less than those without such access. lombia. ACCION International, also not- about a client’s nancial history) that are What makes micronance such an ap- for-prot, made the rst of what it called taken for granted in rich-country nancial pealing idea is that it oers hope to many micro loans in 1973. systems, and to nd ways of reaping econ- poor people of improving their own situa- started in 1976 and soon became extraordi- omies of scale. Many have simply dis- tions through their own eorts, says Stan- narily famous for oering microcredit to missed the possibility that serving the ley Fischer, former chief economist of the women in small groups. poor might be a viable business. World Bank and now governor of the Bank To qualify, Grameen’s customers had of Israel. That marks it out from other anti- to be extremely poor, probably earning The start of something big poverty policies, such as international aid less than a dollar a day. To overcome the In recent years, at least in some parts of the and debt forgiveness, which are essen- lack of collateral or data about creditwor- world, this bleak picture has begun to tially top-down rather than bottom-up thiness, group members were required to change, rst in credit, then in savings and and have a decidedly mixed record. monitor each other at weekly meetings, more recently in remittances. Even insur- Studies by Stuart Rutherford, who runs applying varying degrees of pressure to ancenot only the basic life sort but also an experimental bank that provides loans ensure repayment. As loans were repaid, more sophisticated forms for things like and takes deposits in the slums of Bangla- people were allowed to borrow more. The cattle and weather riskis gradually being desh, show that the poor attach great value group replaced the security that pawn- introduced. to having a safe place to keep money and shops gained from collateral. The model is These changes have recently received a some means of providing for life’s risks, ei- not perfect, but it does have real virtues lot of attention in policymaking circles. ther through savings or, better still, and has since spread around the world. Grand claims have been made that credit through insurance. When nancial ser- Why did these organisations start with1 The Economist November 5th 2005 A survey of micronance 3

2 providing credit? They assumed that poor cronance oces in Nepal. The head of a stopped repaying her loan. She is not alone people were unable to save, and that their micronance eort in Afghanistan was in her misfortune. A report in 2002 by sole need was for capital. But that was not murdered, possibly by drug traders. CARD, a micronance organisation in the the whole story. When BRI, a failing state- To drug lords in Afghanistan, the avail- Philippines, oers the following explana- controlled rural lender in Indonesia, was ability of credit is unwelcome because it tion for borrower attrition: It is a tragic fact transformed into a bank for the poor in gives a choice to farmers who were previ- that over time, husbands will fall sick, sari- 1984, it oered not only the usual loan pro- ously forced to grow poppies for want of sari [variety] stores will be robbed, har- ducts but also a government-guaranteed other ways to nance their crops. For the vests will be poor and children will die. savings account with no minimum de- elites in closed markets running inecient Yet micronance institutions typically posit. This has been an extraordinary suc- monopolies, credit raises the prospect of claim extraordinarily low loan losses of cess: BRI now has 30m savings accounts. future challenges from entrepreneurs. For 1-3%, a bit better than the rate for big banks Nobody knows how many institutions radical Muslims, it means that women in rich countries and much better than for are providing micronance in some form, (who in many countries make up the bulk the big credit-card companies. Given the but the number is certainly huge (see box). of micronance borrowers) are able to run diculties facing businesses in poor areas, They are growing fast and serving a vast viable businesses and become indepen- some critics question the accuracy of these number of people in absolute terms, al- dent. And for everyone in poor countries, gures. Many of the banks lending to the though still only a small proportion of the credit can mean social upheaval as merit poor are not-for-prot organisations billions who earn only a few cents a day. and enterprise replace inheritance, family whose accounts are rarely scrutinised by Local banking giants that used to ignore ties and position. outsiders. Much of their capital has been the poor, such as Ecuador’s Bank Pichin- Nor does microlending always have a provided by governments or philanthro- cha and India’s ICICI, are now entering the happy outcome. The clients of K-Rep, an pists, and often does not have to be repaid, market. Even more strikingly, some of the excellent Kenyan micronance bank in a so perhaps micronance institutions are world’s biggest and wealthiest banks, in- small town on the fringes of Nairobi, are a being quietly lenient with their customers. cluding Citigroup, Deutsche Bank, Com- pretty resourceful lot, but when the gov- Indeed, large-scale defaults in micro- merzbank, HSBC, ING and ABN Amro, are ernment stopped repairing roads, picking nance may go unreported. The Townsend- dipping their toes into the water. up rubbish and spraying for malaria, some Kaboski research project in Thailand infor- were at their wits’ end. Drainage in the mally tracked hundreds of micronance The downsides marketplace was plugged by uncollected institutions and found that in the ve years Not everyone has been pleased with the garbage and customers stopped coming. before the Asian nancial crises, 10% failed prospect of better nancial services for the Maria Njambi, a single mother with a ten- and a quarter stopped lending. poor. Islamic fundamentalists have year-old child, used to have a viable busi- So there is room for scepticism, but also bombed branches of Grameen in Bangla- ness selling fruit and vegetables she plenty of reason for hope. The biggest of desh and attacked loan ocers of other in- bought with credit from K-Rep, but she these is just how much progress the indus- stitutions in India. Maoists have looted mi- had to watch her inventory rot and has try has made in the past 30 years. 7

A beginner’s guide to What do you know? micronance

ICROFINANCE may be intended for many micronance institutions there are. livery vehicle and as family transport? Mthe masses, but its vocabulary can Indonesia alone says it has in excess of For people who have very little, money be understood only by professionals, and 600,000, and Bangladesh and Uganda and assets are fungible. then only up to a point. The industry is so too claim to have many thousands. Even The foggiest place in the industry is fragmented as to be virtually unfathom- on stricter criteria, such as recognition by on the ground (another favourite micro- able. There is not even a proper denition a regulator, Indonesia alone has perhaps nance term), where familiar words sud- of the term, which could mean anything 60,000 nance companies that provide denly become oddly unintelligible. An from what a village priest provides when credit of one sort or another, often to peo- item labelled prot lets you keep mum handing out alms to what state banks and ple who have very little income and al- about the losses transferred to a money- credit unions oer to their least auent most no assets. Self-professed experts losing charity aliate. An operationally clients. The coveted title of a genuine mi- distinguish between institutions provid- sustainable business is one that can pay cronance institution from a practi- ing consumer nance (which they do not for its running costs but not its capital, tioner may owe less to what the count as micronance) and business - which is often the largest single expense institution does than to its public-rela- nance (which they do). But how do you for a nancial rm. But the worst thing are tions skills. Fortunately none of this mat- classify the purchase of a stove that is the acronyms, which make learned ana- ters to the customers, who simply want a used for cooking both the family meals lyses of micronance next to unreadable. service that makes their lives richer. and the food for sale on a tiny stand? Or a All this may sound trivial, but industry Nobody knows even roughly how motorscooter that serves both as a de- practitioners seem to care deeply. 4 A survey of micronance The Economist November 5th 2005

From charity to business

In its short history, the micronance industry has undergone profound changes

O ANYONE familiar with banking in women but criticised for charging exces- poor people in the world is to become Tthe rich world, the world of micro- sive rates. protable and operate much like conven- nance can seem rather odd. The main pro- Rather than pursue prot, micronance tional rich-world nancial rms. Ulti- viders have not been motivated by any- providers at this end of the spectrum often mately that will include things like issuing thing as straightforward as making seek to be sustainable, a exible concept debt and equity and securitising loans. money, at least until recently. The core of that can mean anything from covering all Only this way, the institutions argue, the industry today consists of some three costs to covering all costs but capital. How- will they be able to raise capital in su- dozen multinational networks of micro- ever tenuous the sustainability, there cient quantity, at suciently low cost and nance providers, which despite their su- seem to be plenty of donor funds, particu- with sucient speed to transform micro- percial similarities and inspirational larly for institutions that can generate lots nance from an interesting niche into a rhetoric compete ercely and ght over of good publicity. During 2004 the big de- ubiquitous service. This argument is be- everything. velopment-aid agencies committed about ginning to convince a growing number of The main areas of strategic disagree- $1 billion to micronance, according to policymakers interested in development ment are whether the nancial needs of CGAP, a donor consortium aliated to the and poverty eradication, who until re- the poor are best met by group or individ- World Bank. Further signicant sums have cently would have regarded trying to prot ual loans; by market or capped interest come from private hands. Added to that from the poor as inherently evil. rates; by catering for all the poor or only must be the benet of very low-cost capi- the very poorest; by concentrating on tal and free technical assistance. Time for ACCION credit only or oering savings accounts As these nancial institutions have The evolution of micronance from a char- and insurance too; and whether nancial grown, however, demand for their funds itable social service into something resem- services should be provided alone or in has often expanded beyond what can rea- bling modern commercial banking can be conjunction with education, health care sonably be obtained from donors and spe- seen in the work of ACCION Interna- and, in a few cases, religion. cial funding deals. Retained earnings help; tional, a network of nancial institutions The biggest networks include Opportu- deposits, if they can take them, help far based in Boston and Washington, DC, nity International, FINCA, ACCION, Pro- more, but still not enough. A growing with 27 loosely aliated members in 22 Credit, Women’s World Banking and argu- number of micronance institutions, tak- countries and direct investments in ten. ably Grameen (which has no formal ties to ing their cue from the success of banks in ACCION has an odd history. It was other banks but a replication pro- developed countries, have concluded that founded in 1961 by Joe Blatchford, a young gramme that it says encompasses more the best way to reach the vast number of law student and accomplished tennis1 than 100 institutions around the world). There are also national networks, regional networks and even networks of networks, each with their own set of institutions and strongly held views. At one end of the spectrum are those organisations and networks that, by in- tent, are barely protable and concentrate on providing credit, such as Grameen and most of FINCA’s and Opportunity’s opera- tions. They oer relatively lenient repay- ment terms and interest rates that do little more than cover costs. Typically, these groups are not-for-prot, or owned by cus- tomers or by investors of the religious and philanthropic sort, rather than by share- holders seeking a nancial return. Beyond their core operations in nan- cial services, some of these institutions are also involved in a range of other activities, both charitable and for-prot. Grameen Bank has a loose relationship with a va- riety of other companies, including a highly protable mobile-phone business that has been praised for providing jobs for Can I borrow a lollipop? The Economist November 5th 2005 A survey of micronance 5

2 player who was sent on a goodwill tour of the agencies . After working on the conver- Latin American cities by the American Leaner and meaner 2 sion of various not-for-prot institutions government. Appalled by the poverty he Operating expenses of institutions into banks in the 1990s, as ACCION had witnessed, he created an aid group to build as % of average gross portfolio done, Mr Zeitinger became convinced that schools, install electricity and the like. 24 it would be cheaper and faster to start - An experiment in Brazil in 1973 played Average of 35 leading Latin American MFIs nancial institutions afresh. Backed by in- 22 an important part in dening ACCION’s vestment from various development agen- future role. The Brazilian unit kept clear of Average of 14 20 cies such as the World Bank’s International regulated Peruvian MFIs the usual development-agency activities, Finance Corporation, he started out in Bos- instead concentrating entirely on provid- 18 nia and Hercegovina in 1996 and has since ing what at the time were called micro 16 founded banks in 14 other countries and Average of 5 members of Colombia’s loans. Initially, the separation of nance Women’s World Banking network taken a controlling position in four others. from social services was controversial. But 14 The most recent addition came this slowly a consensus has begun to form, par- month in Congo, which speaks volumes 2000 01 02 03 04 ticularly in , that this kind of about what ProCredit considers an oppor- Source: MicroRate specialisation makes it easier to build e- tunity. There is vast potential (60m people cient (and therefore sustainably helpful) - and only 50 bank branches), coupled with nancial institutions. tion. As time went on, clients started to de- many evident risks (decades of intermit- Early on, nancial institutions aliated mand more products, particularly savings tent war; nearby genocide; no local cur- to ACCION oered solidarity loans accounts, but regulators were reluctant to rency; frequent famine; sporadic govern- small loans to groups of ve people that grant the necessary banking licences to mi- ment coups). Into this chaos, ProCredit were collectively guaranteed. Variations cronance institutions that had no clear introduces a consistent model (with minor on this model remain essential to Gra- ownership structure and little prospect of local adjustments) that relies on the com- meen, FINCA and many smaller micro- prots. Success also increased the demand pany having full control: We are not po- nance providers. Each member of a group for capital. lite, we know what we want, we have it has a tiny amount of money allocated to In a major strategic change, in 1992 Pro- our way, explains Mr Zeitinger. him or her, and as they collectively meet dem, a small Bolivian not-for-prot orga- The back-oce systems of ProCredit their obligations the members establish a nisation in the ACCION network, turned banks and its branding are identical credit history that allows them to increase part of its operations into BancoSol, a nor- around the world, and supervised by the size of their loans. mal bank run on commercial lines, albeit some of the same people. Their credit sys- There are virtues to this model, notably still seeking to serve the poor. The transi- tems depend on careful analysis of the the way that social pressure from group tion was marred by bitter internal ghts. cashow and business prospects of every members encourages repayments and Interest rates charged on loans were ini- client, and even competitors concede that avoids the twin problems of moral hazard tially set at 65%. Yet in the end the transfor- they are unusually good at detecting pro- (an unwillingness to repay) and adverse mation worked, enabling the bank to grow blems before loans are granted. ProCredit selection (being stuck with bad payers and to bring down its interest rates by two- does not do group lending, partly because who inate costs for everyone). Credit thirds. True, BancoSol has not been an un- Mr Zeitinger thinks it only really works in screening costs the lender next to nothing. qualied success, but it has remained via- rural settings where people are genuinely Group meetings may also have other ad- ble even as has suered huge nan- close, and partly because he feels that indi- vantages, such as the sharing of clients and cial problems. It is now seen as a model for viduals should not have to be responsible eective business techniques. similar transformations in Latin America, for the failures of others but should be1 Even so, a growing number of the insti- and , with ACCION playing a tutions tied to ACCION soon discovered critical role in managing the change. limitations to the group-lending model. Several other micronance groups fol- Businesslike 3 Over time, businesses nanced by group lowed ACCION’s lead. FINCA, another All ProCredit banks in eastern Europe, ¤m members grew at dierent rates, and so re- organisation with aliates all over the Profits quired dierent amounts of capital. The world, last summer created a number of Technical-assistance Loan members whose businesses grew fastest for-prot subsidiaries, which allowed it to grants received* portfolio felt constrained in what they could bor- tap outside investors and almost double its 35 1,400 Year of bank establishment row, and those whose businesses grew capital. But the best example of this trend 30 1,200 more slowly found themselves guarantee- is a Frankfurt-based organisation now 25 1,000 ing big debts for other people. The meet- known as ProCredit. ings themselves became a problem, con- 20 800 suming time members wanted to devote A credit to the industry 15 Bosnia Albania, Georgia Kosovo Moldova Bulgaria, Serbia Ukraine Romania Macedonia 600 ACCION to their businesses. And, perhaps most im- Like , ProCredit came to banking 10 400 portantly, as group members developed by an indirect route. Its founder, C.P. Zeit- 5 200 personal credit histories through their inger, began his career in the 1970s by + + 0 0 loan payments, the need for collective examining Latin American nancial insti- – – guarantees disappeared. tutions that were getting money from Ger- 5 200 At the beginning, simply providing man development agencies. When he 1997 98 99 2000 01 02 03 04 05† 06‡ credit was reason enough to start a small pointed out that the whole thing was a *Mainly for training †Estimate ‡Planned not-for-prot nancial-services organisa- waste of money, he was, in eect, red by Source: ProCredit Holding 6 A survey of micronance The Economist November 5th 2005

2 judged on their own merits. ProCredit also extremely dicult environments. Even in help of Deutsche Bank at an interest rate of expects clients to come to its branches to Haiti, where it has lost money in euro just over 5%. Its banks in three countries repay loans, rather than sending out col- terms because of a 30% currency devalua- have been able to raise money via local lection agents to villages, as many other tion, it continues to operate protably in bank syndicates. It has also seen a huge micronance institutions do. local money. Any anarchy is frightening, growth in deposits. ProCredit’s experience shows that says Mr Zeitinger. But it is an opportunity In the not-too-distant future, Mr Zeitin- there is a pent-up demand for credit and as well, because it allows you to impose ger foresees ProCredit becoming entirely saving in even the poorest corners of the your own structure and grow faster and independent of international nancial world, and that poor people will seek out become more important and become organisations. In some poor countries, he institutions that provide these things eec- more protable. hopes to be able to borrow and lend at tively. Its growth has been remarkable. It ProCredit has not yet left the not-for- rates below those for the government’s now has 7,500 employees, of whom 2,500 prot world entirely. When it moves into a own debt (which in well-run countries is were hired in the past year. With $2 billion new country, it often accepts subsidies for usually the best-quality credit), reecting in assets, it remains tiny by multinational the rst two or three years, a time of high his clients’ and his rm’s superior record of banking standards, but it is not insubstan- start-up costs and little revenue. But its repayment. That would demonstrate the tial. Fitch, a leading rating agency, recently good performance is now opening up virtues of normal banking. But what do gave it an investment-grade rating, noting other sources of funds: it recently raised the mainstream banks themselves make that it had operated successfully in some $54m in the German bond market with the of micronance? 7 Giants and minnows

Big banks are discovering the market for poor customers

NE of the most encouraging trends in usual critics in non-governmental orga- One exception is Citigroup, which hap- Omicronance is that the world’s larg- nisations. But they are also worried that if pily proclaims that, leaving aside its phil- est banks and insurers are becoming inter- they turn micronance into a real busi- anthropic activities, it is also getting into ested. At a minimum, they can do some- ness, they will be slammed for proteering micronance for its potential prots. But thing that small local institutions cannot: from the poor. And there are people work- the foremost example is Bank Rakyat Indo- move money around the world through ing in the big banks who honestly do not nisia (BRI). Founded by the Dutch in 1895 their own systems, and tap and raise huge believe that micronance can, or should, as an institution for the elite, by the 1970s it pots of capital. They can also reduce the be a business. had become yet another badly run state risk and increase the liquidity of small in- bank with an impossible mandate. It was stitutions by packaging and reselling their supposed to help farmers to increase rice loans, and even provide savings products Outshining Citi 4 production, but the government reserved through tiny institutions. The most profitable microfinance institutions the right to approve borrowers and re- So-called bottom of the pyramid rated by MicroRate quired BRI to pay more for its deposits than strategies (named after a bestselling book Return on equity, 2004, % it received for its loans. Not surprisingly, called The Fortune at the Bottom of the 0 1020304050 the bank did not bother to collect deposits, Pyramid, by C.K. Prahalad) are currently Compartamos and many borrowers did not bother to re- in vogue among the world’s leading com- CMAC Trujillo pay their loans. According to a report by panies in many industries. The idea is that CMAC Cusco Marguerite Robinson of Harvard Univer- big business has so far ignored a huge CMAC Arequipa sity, an analysis of BRI’s 3,600 lending un- number of people who have very little Emprendamos its concluded that not a single one of them money but nevertheless represent a poten- WWB Cali made money. tially lucrative market. The big banks have Confia Facing disaster, in 1983 the bank em- noticed, but they are moving slowly and CMAC Sullana barked on a complete reorganisation in with great caution. ICICI Bank of India CMAC Ica which it reversed every policy. It increased reckons that providing $1.3m in loans to CMAC Tacna its loan rates by half and shifted its target micronance clients currently requires 40 Crear Arequipa client group from the well-connected to times more manpower than a corporate WWB Bucaramanga poor people without any ties to govern- loan of the same size. FIE ment or nancial companies. It actively Typically, the big global nancial insti- Proyecto D-Miro marketed deposits and abolished mini- tutions are moving into micronance via Crear Tacna mum limits on account. Success followed BRI their corporate-responsibility or commu- WWB Popayan rapidly. The formula has since been nity-development departments, not their Proempresa emulated around the world. core for-prot banking operations. Most of In some ways, a successful nancial in- Citigroup them are pleased to do something that stitution may nd it tougher to move into may win them good marks from their Source: MicroRate micronance than an ailing one. Bank Pi-1 The Economist November 5th 2005 A survey of micronance 7

2 chincha, the leading bank in Ecuador, has created an entirely separate subsidiary, CREDIFE, to serve poorer customers. Its re- sults have been remarkable: small loans now make up 5% of its assets but 8% of its prots. Unibanco in Brazil and Banco San- tander Chile took similar steps to attract the unbanked poor. Such eorts are not al- ways welcomed by existing micronance providers. In Colombia, for instance, Women’s World Banking complains that mainstream banks are increasingly poach- ing its best clients. The seeds of a better life

The power of a balance sheet nance providers are responsible for the stitutions to take deposits. After just two years in the eld, ICICI, In- rst 5-12% in loan losses to ensure that they Many of the world’s biggest banks have dia’s second-largest private bank, now has proceed with caution. Returns are good recently launched interesting pilot pro- close to 1.5m customers that qualify as and ICICI wants to expand the scheme. jects. ABN Amro owns a micronance deeply poor, and an associated loan port- There are ample opportunities. Accord- bank in Brazil, Real Microcrédito, jointly folio of $265m. It has achieved this by ing to some estimates, demand for loans with ACCION, and provides credit to ve working through 53 small micronance from poor but creditworthy people in In- micronance institutions in India. Deut- banks, which are superb at marketing dia could amount to $40 billion, 40 times sche Bank recently raised a $75m invest- loans but are constrained by having them the current supply. Nachiket Mor, an exec- ment fund and syndicated a large loan on sitting on their balance sheet. ICICI lends utive director at ICICI, says very little of behalf of ProCredit in Germany. to the micronance institutions at 9.5-11%, the demand could be met from charitable The most obvious way for large banks a bit more than it charges its corporate cli- sources, but billions of dollars could be to get into micronance is through hand- ents, and the micronance institutions re- made available on commercial terms. Lots ling remittances, a business that according lend the money at 16-30%. The micro- more could be raised by allowing small in- to the World Bank is worth $225 billion a1

The emergence of rating agencies attests to the Critical acceptance industry’s growing maturity

HEN representatives in Kenya of ing their own internal credit models, even undermine their perceived objectivity. Wthree of the world’s largest banks if their in-house evaluations come out a MicroRate, the oldest specialist rating were asked what single event would little dierent from those of the rating agency and the only one that sticks purely most encourage their institutions to be- agencies. Without such models, tracking to this particular business, was founded come more involved with micronance, loans, assigning risk capital and manag- in 1996 but did not reach break-even they all came up with the same answer: ing cash would take up far too much man- point until this year. It was red by three the presence of credit-rating agencies. agement time. institutions for being too hard on them, Businesses love to complain about Being relatively small, most micro- but that may have been no bad thing for these agencies, and nancial institutions nance institutions are reluctant, or per- its reputation. Demand from investors grumble more than anyone else. It is rare haps unable, to pay much for a rating. The has steadily grown, and it now rates 45 for companies to get the ratings they be- big agenciesMoody’s, Standard & Poor’s micronance organisations. lieve they deserve. But nor are the users and Fitchhave so far rated only a few in- Many of those brave enough to have of ratings all that happy, because the stitutions, notably ProCredit of Germany, asked MicroRate to run a rule over them agencies are generally not very good at Compartamos of Mexico, Mibanco of have received poor grades for having - predicting default rates. Banks tend to see and Acleda of Cambodia. That nancial, operational or strategic weak- the agencies as a form of competition, leaves thousands unexamined. nesses that have the potential to threaten providing information that outside inves- Several specialist credit-rating agen- their viability. This can mean anything tors use to purchase debt, to the detriment cies have recently stepped into this vac- from inexperienced managers and of the banks’ own lending business. uum. However, they face huge barriers to boards to a lack of internal controls, too Nevertheless, rating agencies provide establishing credibility in the market- much reliance on a single person (often a a relatively objective and consistent place, because ratings need to prove charismatic founder) or an inability to credit benchmark that is a great help to themselves over a period of time. Mean- raise funds for growth. So why do such big investors. Banks, despite their carping, while some have launched other busi- companies bother to get rated? They must rely on these outside ratings for develop- nesses on the side, but these can believe that things can only get better. 8 A survey of micronance The Economist November 5th 2005

2 year and growing strongly. Until now it allows money to be sent to the Philippines and thinks the number could soon grow to has been dominated by transfer agents via the internet and retrieved from local 30. Working through its Banamex subsid- such as Western Union and by informal ar- ATMs. In America, HSBC has just iary in Mexico, it is providing life-insur- rangements, often with high charges or launched a scheme under which anyone ance policies sold by micronance rms high risks. But money transmission is be- with a minimum account balance of and is preparing for various bond oer- coming more competitive, and global $1,500, or willing to pay $8 a month, can ings, private placements and even the se- banks are well placed because they al- transmit money to HSBC’s aliates curitisation of a large micronance institu- ready have systems that can send large abroad without charge. To start with, this tion’s loan portfolio that will be resold to amounts of money around the world may not be protable for the bank, but investors. For its wealthy clients, it has cheaply. HSBC reckons that much of the money created guarantee funds that allow them In September, Bank of America an- could be channelled into savings accounts to put up collateral in America for credit ex- nounced that all its account holders would from which other services might follow. tended in poor countries. The list goes on. be able to send remittances to Mexico The most ambitious big bank in this Citi’s biggest contribution, though, is its without charge; the money can be re- area is Citigroup. It does not deal with belief that micronance can become a trieved at other banks and payment agen- individual micronance customers, but valid, prot-making business. If it is right, cies. HSBC in May announced a joint-ven- has already established relationships with the other big banks will also pile into the ture with Opportunity International that micronance institutions in 20 countries marketand so will investors. 7 Bankable banks

Are the poor a good investment?

HE enthusiasm for micronance rests there is an inow of donor funds. Even the micronance banks are bankable Ton the idea that people who have next when repayment rates are high, a micro- themselves, in the pithy words of Peter to no money deserve nancial services nance institution may charge an interest Kooi, head of the United Nations capital- just as much as those who have plenty. rate too low to cover its overall costs or its development fund’s micronance unit. In This is often justied by notions of equity costs of funds, thus making it more of a other words, are those banks worth invest- or fairness: everyone should have clean charity than a commercial enterprise. Suc- ing in? So far, this test has rarely been ap- water and health care, and everyone cessful micronance banks often charge plied. No micronance institution has should have the right to deploy their tal- vertiginous interest rates, because that is traded seriously on a public stock ex- ent. But on that view micronance be- what poor people must pay to be commer- change. Only one, BRI of Indonesia, has a comes yet another public good, limiting its cially viable customers. genuine public listing, and that has been scope to whatever can be squeezed from A good test of whether micronance going for less than two years, not enough philanthropists or governments. customers are truly bankable is whether to judge its quality. A handful of others, in- A more optimistic justication is that cluding Mibanco of Peru, Banco Solidario micronance can support equity in the in Ecuador and Satin in India, are listed but strictly nancial sense, meaning it can pro- rarely trade. duce prots. If so, it will be able to attract Until recently, when a urry of micro- all the investment the rich world can pro- nance investment funds were launched, vide to fund all the opportunities poor most of the money backing micronance people can handle. institutions came from the least demand- The evidence cited by the optimists ing sources of capital: governments, multi- typically comes down to a single fact: that lateral institutions, not-for-prot organisa- micronance clients repay their loans. Un- tions and socially responsible private doubtedly many of them do, but whether investors who either did not demand mar- the aggregate numbers hold water is less ket rates of return or valued their returns in certain. Industry-wide data are in short unorthodox ways. supply, and those that are available suer There has, however, been one notable from what statisticians call survivorship exception. In 1995, a handful of social in- bias: institutions with terrible repayment vestors, headed by ACCION International, records go bust, taking their bad numbers Calmeadow of Canada, Triodos of the with them and leaving only the better re- Netherlands and Fundes of Switzerland, cords to be examined. raised $23m to create Profund, a Latin Worse, there are widespread suspi- American investment pool intended to cions that some micronance banks hide demonstrate that investing in micro- poor repayment rates by rolling over bad nance could be commercially viable. It loans or extending their due dates inde- was designed to run for ten years, and true nitely, which they can keep up as long as A credit to her business to its mission it sold o its last investment1 The Economist November 5th 2005 A survey of micronance 9

2 this summer. By liquidating its portfolio NGOs into regulated banks, able to receive The fund’s success owed at least as much and turning it into real cash, it became a deposits. During Ecuador’s nancial crises to the eorts of Mr Silva and his investors yardstick for the investment performance of 1998, when all private debt repayment than to the underlying economics of the of a micronance institution. was suspended by the government, Mr industry. One lesson from Profund’s ex- At rst sight, its returns look unexciting: Silva helped to arrange a crucial $5m emer- perience is that interest rates in this busi- just 6% annually, despite lots of risk. But on gency loan to keep one local micronance ness have to be pitched high to make the closer examination this was a remarkable provider aoat. The loan, at an interest rate loans viable. Compartamos charged more performance. All of Profund’s capital was of 15%, was fully repaid within 18 months. than 100% annually when the initial in- contributed in dollars and then invested in Without it, this well-managed bank would vestment was made, and Mibanco over local currency. In every country it oper- probably have died, taking Profund’s $2m 80%, though both of them have since ated in, its dollar returns were reduced by investment with it. dropped their rates somewhat. Initially, local currency depreciations, reecting the potential clients are less concerned about economic chaos in much of Latin America Where’s the exit? cost than access to money. Besides, even during that decade. Two of the countries in Getting out of investments proved equally high interest rates charged by micro- which it had investments, Paraguay and complex. Unlike in developed countries, nance institutions are probably well be- Ecuador, suered system-wide nancial there were no local stockmarkets eager for low those being oered by moneylenders collapse. Haiti, Venezuela and Bolivia new listings, nor hungry groups of local in- in the informal market. faced riots and revolutions. Good banking vestors. Profund had to work hard on each Profund’s investors were suciently is, in the end, no match for bad govern- exit deal, often under pressure from larger impressed by its success to want to see its ment. Most investors in the region shareholders hoping to orchestrate a charter renewed, but Mr Silva has declined watched their money burn. squeeze. In the end, three of Profund’s in- to do so. Unlike in 1995, there is now abun- Initially, Profund had expected to be a vestments did blow up. But the fund’s in- dant capital available for investment in mi- passive investor. It bought stakes in a vestment in Compartamos of Mexico per- cronanceperhaps too much, he says, at dozen institutions, hoping simply to hold formed spectacularly, and investments in least for Latin America to absorb. on and then sell out. But Profund’s man- Mibanco of Peru, BancoSol of Bolivia and In the past three years, new investment ager, Alex Silva, soon found himself at- Los Andes of Peru also did well. Several opportunities in micronance have been tending monthly meetings of the institu- other investments failed to produce re- popping up all the time, and more are on tions he had invested in and getting spectable returns only because of cur- the way. In the largest example yet, Pierre involved in managing them. rency depreciations. and Pam Omidyar, ush with money Mr Silva, with ACCION and a German All this looked very much like the distri- made from eBay, have pledged $100m to consulting rm, IPC, played a crucial role bution of returns typical in venture capi- back micronance projects, a source that is in helping the institutions that Profund in- talplenty of duds, a few stellar perform- as yet almost entirely untapped. It will not vested in to evolve from not-for-prot ersrather than in mainstream banking. stay that way for long. 7 Micro no more

Financial services for the poor and the rich are becoming increasingly alike

HE group of 30 women in the dusty ness or charity. Now all the participants in services, which in turn should help to pro- Tsquare of a poor village outside Hyder- the capital markets, from big banks to in- mote growth. abad, their children on their laps, passing vestors to rating agencies, are beginning to Plenty of obstacles remain. Venezuela, tiny deposits and loan payments to a open up to it. Brazil and Colombia, for example, all im- young man in their midst, seem to be en- The evolution of micronance into a se- pose interest-rate ceilings, and other coun- gaging in a form of nance quite unlike rious and viable business has many bene- tries are considering them. These discour- that practised in the City of London or ts. It means that in future the bulk of the age new nancial rms from entering the Wall Street. But is it really that dierent? capital is likely to go to the most ecient in- micronance market and encourage exist- Micronance oers all the transactions stitutions with the best growth prospects. ing participants to evade regulation. you would expect in any branch of - They will select their clients on the basis of But within a few years, the number of nance: loans, deposits, money transfers, merit rather than cronyism or bribery, of people who have access to nancial ser- insurance. It is distinct only because it in- which state banks (as well as some private vices may expand from hundreds of mil- volves amounts of money so small that in banks) in poor countries have often been lions to several billions. Historical prece- the past conventional rms did not think guilty in the past. dent suggests that this could bring huge them worthwhile. That is clearly changing. Sound institutions will be able to pro- opportunities. In the past, some nancial Many micronance institutions report tect their deposits and attract new ones. In institutions, notably Bank of America, better returns on equity than do large the most optimistic scenario, an open, via- Merrill Lynch and many large European banks. Five years ago, providing nancial ble nancial sector will create a large body insurers, did spectacularly well by nurtur- services to people with little money might of people with economic stakes in their ing clients only slightly too poor to be of in- have been dismissed as a tiny niche busi- society who will demand decent public terest to the leading rms of the day. 1 10 A survey of micronance The Economist November 5th 2005

2 But to reach the vast number of people who currently lack access to the nancial markets, micronance will have to change. Four main areas need particular attention: culture, products, funding and the cost of operations. The cultural challenge is to transform something that started as charity into a proper business. The pursuit of prot may not come easily, but change is already in the air. We are not paternalistic, we do not lend to the poor, says Mónica Hernández of Banco Solidario, a fast-growing and protable bank in Ecuador. We lend to those who do not have access. To reach this new group of customers, Hewlett-Packard’s Ugandan bank-in-a-box however, micronance providers will have to abandon their old attitudes and credit loan portfolios may not be far away, Philippines has declined dramatically be- vocabulary and join the mainstream of though governments in many poor coun- cause of new methods that transfer funds the global nancial system. Transmitting tries will have to strengthen ownership via mobile phones, says John Owens, of funds, insuring risks, extending credit and rights and reduce barriers to foreign invest- Chemonix International, a consultancy. holding deposits for people with almost ment before it becomes commonplace. And that is only one of their uses. Through no money will turn out to be little dierent Crucially, the cost of micronance will arrangements with merchants in small from doing those things for anyone else. have to come down. At present it is far too towns, mobile phones can also be used to manpower-intensive, more like private pay loans, make deposits and get cash, sav- Beyond credit banking for the wealthy than retail bank- ing time and money. Vodafone is testing a One priority is to expand micronance be- ing for the middle classes. Typically, bor- similar system in Kenya, and Hewlett- yond credit into all the nancial products rowers receive visits from their bankers, Packard has just nished a pilot project in on oer in more sophisticated markets. To- sometimes daily, rather than going to a Uganda using a point-of-sale machine day only a few institutions are seriously of- branch or using an automated teller mach- with mobile-phone technology. Such tech- fering insurance, even though it is particu- ine. Credit evaluation relies on character or niques may eventually make branches, larly valuable to the poor; yet death and cashow valuation rather than the statisti- cheques and even cash superuous. illness, for example, are major risks for cal techniques used by credit-card compa- In the past, the two main obstacles to banks making small loans, and inevitably nies in rich countries. This has been made providing nancial services to poor peo- they charge for bearing that risk. BASIX, a possible by low wages and an abundance ple have been lack of information and dynamic micronance institution in India, of highly talented people willing to work costs. Those obstacles are now being over- provides not only basic life insurance, but long hours, but it will not be sustainable. come. Ultimately lower costs and better in- other products that are particularly appro- More competition will help to reduce formation are good not just for the poor, priate to its agricultural clients, notably in- costs, but the biggest hope comes from but for everyone. Micronance may have surance against drought or loss of cattle. new technology. For example, the cost of started as a niche business, but the chances It matters enormously where the sending money from to the are it will soon be micro no more. 7 money comes from. At present, the main sources are charities, governments and in- Future surveys ternational organisations. But serious in- Oer to readers Reprints of this survey are available at a price of Countries and regions terest from large banks and private inves- £2.50 plus postage and packing. tors would greatly increase the amount of A minimum order of ve copies is required. Italy November 26th 2005 capital available and bring down the cost Canada December 3rd 2005 of funds. The emergence of credit-rating Corporate oer Saudi Arabia January 7th 2006 Germany February 11th 2006 agencies to provide an independent as- Customisation options on corporate orders of 500 or more are available. Please contact us to discuss Chicago and the American heartland sessment of institutions will make it easier March 11th 2006 for the banks to come in. Credit bureaus for your requirements. Business, nance and economics and ideas rating individuals too are now being estab- Send all orders to: lished in a handful of countries. The evolution of man December 24th 2005 The Rights and Syndication Department Corporate organisation January 21st 2006 Micronance institutions may also tap 15 Regent Street, London SW1Y 4LR Wealth and philanthropy February 25th 2006 wealthy investors directly. More than a Tel +44 (0)20 7830 7000 dozen institutions recently raised money Fax +44 (0)20 7830 7135 from American investors, including a uni- e-mail: [email protected] versity, in a deal structured by Developing World Markets, a specialised American Previous surveys and a list of forthcoming rm of nancial advisers, and Blue Or- surveys can be found online chard Finance of Geneva, a micronance www.economist.com/surveys fund manager. True syndication of micro-