Commercial Banks of Tanzania and Poverty Alleviation Through Microfinance

COMMERCIAL BANKS OF TANZANIA AND POVERTY ALLEVIATION THROUGH MICROFINANCE By KYANDO Eusebius1 Abstract Commercial banks dominate the financial markets in most countries. They have finance and infrastructure. Therefore, it is essential that they should be involved in microfinance. Without Commercial Banks’ involvement in Microfinance Market, any impact that microfinance can have on global poverty alleviation will be negligible. The demand of funds in microfinance can be met if commercial banks will be willing to change their attitude towards microfinance market and hence become important actors. Some Banks in Tanzania such as CRDB Bank, Akiba Bank, The Tanzania Postal Bank, The Mkombozi Bank and National Microfinance Bank have shown their willingness and interest in this market by offering Microfinance Services and products for the purpose of poverty alleviation. This will enable Microfinance to be a critical element of an effective poverty reduction strategy. Efficient provision of savings, credit, and insurance facilities in particular can enable the poor people in Tanzania to smooth their consumption, manage their risks better, gradually build their asset base, develop their micro enterprises, enhance their income earning capacity, and enjoy an improved quality of life. This indeed constitutes what is called poverty alleviation. Key words: Microfinance, Poverty alleviation, financial exclusion/inclusion, Sustainability JEL Classification: G22-23, H81, H132, L31, N86 1. Introduction According to the World Bank reports about 1.1 billion people live in extreme poverty for less than US$ 1. The extreme poverty being in the developing countries of which 9% are from East Asia and the Pacific and 41% are from Sub-Saharan Africa2. Tanzania remains one of the 10 1 Eusebius Kyando is a lecturer in the Faculty of Business Administration at St. Augustine University of Tanzania in Mwanza-Tanzania 2 Deutsche Bank Research, December 19, 2007 poorest countries in the world. Poverty remains widespread and deep, with half of Tanzanians living under conditions of deprivation, concentrated in the rural areas. According to CGAP, extremely poor people who do not have any stable income such as the very destitute and homeless should not be clients of microfinance because they will only be pushed further into debt and poverty by loans that they cannot repay . However, there is another group of relatively poor people. This group constitutes economically active people who can act in an entrepreneurial way but lack opportunities to explore their capabilities because governments and financial institutions such as commercial banks have been denying and leaving them without essential infrastructure and financial facilities. In some countries this group has become a prey of some grid money lenders and those engaged in usury. For instance, a loan shark in Philippine charges an annualised interest rate up to 1000% for a monthly loan.3 Microfinance has been the rescuer of this category of people in various places in the world including Asia, Latina America, Eastern Europe and Africa. For more than 40 years now microfinance has been recognised worldwide as a tool for poverty reduction in both developing and developed countries. The main service of microfinance has been the provision of microcredit. The contributions of organisations like that of Grameen Bank, Accion International, and Opportunity International, have been impressive. However, the precise natures of contributions seem to be less clear. It is an area which requires more research. Today there are more than 2,000 Microfinance Institutions in Tanzania which include credit unions, Cooperatives, NGOs, government agencies, private and commercial banks. Despite the increase of these institutions, the demand for microfinance services and funds is still high. The demand of funds in microfinance can be met if commercial banks will be willing to change their attitude towards microfinance market and hence become important actors. Mr. Bill Clinton the former President of the United States of America had this advice to banks: 3 The Economist, November 5, 2005 “I think it is quite important to get more of our traditional banking institutions involved in bringing microfinance to the necessary level of density to have an impact on the individuals’ lives of those who receive the loans”.4 Banks are the key to economic development because they channel society’s savings to entrepreneurs. On the other hand, microfinance can play an important role in financial development by strengthening the link between economic growth and poverty alleviation (Bar, 2000). 2. Why Commercial Banks did not involve in Microfinance Market before? Microfinance for most commercial banks was seen to be too risky because small businesses and microenterprises were perceived as bad credit risks. The perception is that small clients do not have stable, viable businesses for which to borrow and from which to generate repayment. Additionally, these potential clients lack traditional collateral to guarantee their loans. The size of loan required by micro-borrowers poses another obstacle. It is very costly to manage small loans because of absence of economies of scale. For instance, making a loan of €100 and €100,000 will require the same management costs but the latter will provide more return. This is the reason why MFIs charge high interest rates (15%-70%). Furthermore, most micro-borrowers cannot keep business records to demonstrate cash flows. Furthermore, Commercial banks are answerable to their shareholders, who demand maximum returns. Most do not feel that microfinance will guarantee them this. The organisational structures, procedures, products and methodologies of commercial banks are not suited to microfinance, and changing them can be difficult, time consuming and expensive. There are significant cultural barriers to be overcome; staff and managers of commercial banks often still perceive the poor as unbankable, and the ways of working required to reach out to them as unbecoming for professional businesspeople like themselves (Baydas, Graham & Valenzuela, 1997). 4 It was cited from, “Moving on Up” by Jaime Pozuelo-Montfort, “Banking for the poor through microfinance”. 3. Why Some Commercial Banks are interested in Microfinance today? A 2005 CGAP survey identified over 225 commercial banks and other formal financial institutions that are engaged in microfinance5. One of the reasons why banks have only recently focused on microfinance is that the strong and structured demand on the part of micro- borrowers has now come fully to the forefront; hence, banks are called upon to provide concrete responses by widening their scope of action. However, Glenn D. West (2006) provides other reasons for commercial banks entering into microfinance markets.6 These reasons include the following: The growing competition in the traditional banking market in serving large and medium size firms. The perceived profitability of microfinance due to some examples of profitable MFIS. For instance, according to Micro-banking Bulletin7 (Issue 11, August 2005) of 52 Latin American MFIs reporting for 2003, the median adjusted ROA was a very respectable 1.8 percent and the median adjusted ROE was 9.5 per-cents. In December 2004 the average ROA and ROE values of the 30 leading MFIs tracked in Latin America were 4.4 and 17.7 percent, respectively, while the maximum values were 17.5 and 48.7 percent, respectively. In Tanzania, according to a 2008 annual report, the CRDB Microfinance Services Company (CRDB MF8) made an annual profit, before taxes, of USD 192,000 Some Commercial Banks enter into microfinance as a diversification strategy. By making loans to thousands of small borrowers, the micro-lending portfolio itself achieves substantial diversification. In addition, the performance of the micro-lending portfolio may have low correlations with traditional bank business lines due to the very different 5 Isern, Ritchie, Crenn, and Brown, “Review of Commercial Bank and Other Formal Financial Institution Participation in Microfinance,” 2003. 6 Glenn D. West, “Strategies and Structures for Commercial Banks in Microfinance”, Publication of the Inter- American Development Bank, August 2006. 7 The Microbanking Bulletin is the premier source of high-quality information on the microfinance industry worldwide and now covers over 200 MFIs (www.MIXmarket.org) 8 CRDB MF founded in 2004, is the microfinance division of CRDB Bank Tanzania nature of the clients and activities and the resilience of micro-entrepreneurs and micro- lending in times of economic recession. In some countries like Tanzania, banks have been compelled by their governments to provide financial services, especially credit, to sectors such as small or agricultural enterprises that are considered social priorities. Using moral or legal compulsion generally has not led to sustainable models of service provision. However, increasingly, commercial banks are investigating for themselves potential market opportunities. The availability of free or cheap donor technical assistance to banks wishing to enter this field. By serving the poor, banks may burnish their public image. The rise of consumer lending in a number of countries has sometimes stimulated banks to enter micro-lending given the similarities between the two in providing large numbers of borrowers with relatively small loans. Despite the impressive expansion of the microfinance industry since then, there are still vast pools of unserved clients in most Latin

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