Best Practices for Banks in Small Business FinanceWorld Bank WorkshopSME Financing – Reaching Scale Dar es Salaam, Tanzania June 26-27, 2007 Glenn Westley Inter-American Development Bank
Contents of the Presentation • Intro to Microlending in Latin America • Possible Microlending Structures • Internal unit • External organization: Service company • External organization: Lightly regulated subsidiary • External organization: Heavily regulated subsidiary • Best Practices (besides choice of structure) • Advantages and Disadvantages of the 4 Microlending Structures • Final Comments
Growth in Latin American Microlending (mid 2001- end 2005) Compounded Annual % Growth Rates
Loan Delinquency Rates by Type of Institution (%) 30-Day Portfolio at Risk Source: Marulanda and Otero (2005), The Profile of Microfinance in Latin America in 10 Years: Vision and Characteristics.
Why Banks Are Entering Microfinance in Latin America • Increased competition in banks’ traditional markets (such as corporate and even SME and consumer lending) – 1990s reforms • High profits in microlending (MIX Market, MicroRate, press, etc.) • Large unserved market • Ample proof that microlending works, even in bad economic times (e.g., in MIX Market data for the 1998-99 and 2001-02 recessions, loan delinquency and ROA largely hold up in LAC) • Diversification (1000s of tiny loans; often low correlations with traditional bank business lines – very different types of clients, resilience in bad times) • Burnishes the bank’s public image • Possibly the existence of underutilized capacity (in branches, MIS, excess liquidity, etc.) • The availability of donor assistance
4 Possible Microlending Structures 1. Internal unit: microlending done in house 2-4. External organizations: normally corporations with own board of directors, management, & staff all focused on microfinance; may be either fully or partially owned by the parent bank. There are examples of all 6 cases in LAC. 2. Heavily regulated subsidiary: for example, a financiera or banco de desarrollo that is directly regulated by the banking superintendency 3 and 4 are “auxiliary providers of financial services,” which many countries allow. They engage in 1 or more of the bank’s permitted operations. Common examples: leasing or factoring companies set up as bank subsidiaries. Many auxiliary providers have been created in LAC to do microlending. Little or no direct regulation: generally consolidated with parent. 3. Service Company: doesn’t own the microloan portfolio (the bank does). Bank pays service company a fee for loan origination and collection services. 4. Lightly regulated subsidiary: owns the microloan portfolio and therefore receives its income from the interest on this portfolio.
Best Practices (besides choice of best structure) … antidotes to the revolving door syndrome (entry and exit) include… • If you do microfinance, do it right! • Leaning on the bank • Special considerations for internal units: • Should have high bureaucratic rank • Should not be located in the bank’s corporate lending department • Should have specialized loan officers • Special consideration for external organizations - how to reduce startup delays • Special consideration for service companies - setting the service company fee to maximize bank profits • Get specialized technical assistance • Beyond champions: institutional commitment
4 Possible Microlending Structures, with Examples There are many important pros and cons associated with each of the microlending structures, and so the choice of structure will often have a major impact on the success of the bank in this new venture .... …. especially since the best structure for microlending depends on many individual bank and country characteristics. There is no single microlending structure that is best for all banks!
2) Service Company vs. Subsidiary Note: An asterisk (*) indicates those factors where the effect is (or may be) different depending on whether the comparison is made to a heavily regulated subsidiary or a lightly regulated subsidiary.
Final Comments • It’s been shown innumerable times that microfinance is a highly profitable market segment that’s greatly underserved • However, banks continue to suffer from the revolving door syndrome • To avoid this, banks need to employ best practices. One of the key best practices is to choose the best structure. • How much operating freedom do I need? How much more freedom would an external organization offer? How much more expensive would it be? • Although there is no universal answer to the question of best structure, it is clear (at least in most cases) that the best structure must be chosen based on more than the trade-off between Cost vs. Flexibility. • There are many more factors to consider, and thebalance of these pros and cons varies enormously from bank to bank. • The best structure depends upon each bank’s particular situation, its objectives, and the legal and institutional environment in which it operates.