The poor lack the array of options we take for granted in wealthy nations, and are more vulnerable to shocks. Their incomes and expenses may be more volatile. Insurance services are limited, and a comparatively minor medical emergency, or such interruption to their lives, can have a major adverse impact. We are familiar with the arguments. Financial services can offer protection against this volatility.
A recent article by Chris Dunford suggested distinguishing between microfinance which alleviates poverty by providing income smoothening services; and that which reduces poverty by enabling the poor client to build an astonishingly profitable enterprise and be miraculously catapulted out of poverty. The latter is euphemistically described as “the minority”.
This is a valid point, and not the first time this has been made. The book Portfolios of the Poor revolves around such principles; Dan Rozas has written eloquently on the topic; chapter 2 of Roodman’s Due Diligence is a must-read.
I wish to discuss how we can easily offer the poor what they want. In fact we already have the product and technology well developed. I will then suggest reasons why we have failed to do this to date.
The ideal product is simply an instant-access savings account with an overdraft facility. This is the standard banking product of the developed world. It pays a paltry interest rate on savings, perhaps enough to cover inflation. I can deposit as much as I want, whenever I want, and when I need funds I have instant access. When I need additional funds, perhaps because of higher than expected expenses, lower than expected income, or to pounce on some investment opportunity, I have an overdraft facility that I can dip into. This limit is set periodically depending on an analysis of my capacity to repay, credit history, income and wealth etc., similar in concept to the analysis performed by MFIs.
When I need funds I first use my own funds, depleting savings. This is my cheapest source of capital – it merely costs me the interest foregone on my savings. When I need additional funds I use the overdraft facility, and I pay only for the money I borrow, for the days I borrow. As soon as I have available excess cash I begin repaying the overdraft, reducing my interest expense immediately, and eventually I start accumulating savings once again. If my savings ever reach a sufficiently high level (disappointingly rarely) I can take a proportion to a fixed-term savings product where I forego instant access in exchange for an elevated interest rate. If I require a longer-term loan, or a loan that exceeds my overdraft facility, I apply for precisely such a loan, if and when I need it (also rare, thankfully).
This is an extremely useful product for me, and appears to well meet the income smoothening needs of the poor. It is possibly one of the simplest retail banking products in the entire developed world, but denied to the poor. It is not perfect, clients in cash-based commercial businesses will likely keep much of their float outside a bank simply to avoid endless trips to the bank to deposit and withdraw funds, but it is merely one of an array of products we need to offer the poor, but currently do not.
MFIs in fact offer the precise opposite to such an account. They prefer locking clients into longer-term, fixed repayment loans. If income smoothening is the problem we need to solve, why oblige a client to take out a 6-month loan if they only need the money for a short-period? Sure, if the loan is to be used for a longer-term investment then a microfinance loan may be wiser, but as noted above, the majority of microfinance is not used for such investments. Indeed, most MFIs charge penalties for early-repayment of loans – precisely the opposite of a current account. Some do offer instant access savings accounts, which I applaud, but the majority of MFIs are not regulated to take deposits from the public, and if they do, tend to offer savings that are not instant-access, and may in fact be impossible to withdraw during the life of the loan – forced savings for example, or savings used as a “guarantee”. Again, this is the precise opposite of a reasonable current account that many of us use each day.
Indeed, if a client needs financing for a week or two, it may be rational and preferable for the client to go to an illegal moneylender and pay an APR of 200% p.a. for a fortnight rather than go to an MFI for a 6-month loan at an APR of 100%. Moneylenders still operate abundantly in microfinance zones, and a current account product could actually be a more viable tool for eliminating such predatory lending.
Given the prevalence of the savings account with an overdraft facility across the developed world, why could this product have been so slow to arrive in the hands of the poor? The technology and know-how clearly exists. There are 4 key reasons:
- Longer-term, fixed repayment loans generate more interest income for the MFI than an overdraft facility, and are therefore more profitable. When clients suffer a short-term crisis necessitating additional liquidity the ability to dip into their own savings is a missed opportunity to the bank, who could otherwise have offered a nice 6-month fixed rate loan to cover the one week or one month dip, and given that this may be the only source of quick credit available, the poor have little choice. It’s perhaps not surprising that the evil moneylenders still exist, in part to plug this precise gap in the market.
- MFIs prefer fixed term savings as they are less volatile for the MFI, who can on-lend these funds at high interest rates. Instant access savings accounts require the bank to maintain a larger cash buffer to cope with unexpected withdrawals by clients. Thus adding flexibility to the clients reduces flexibility to the MFI. Instant access savings are less profitable for the MFI.
- Instant, or near-instant access to savings is a direct expense to the MFI, depending on the method of access: passbooks require a branch visit, ATM withdrawals require investing in cards and cash machines, or paying fees to use an existing network. Mobile technology can potentially reduce this cost further, as M-Pesa has demonstrated, but while this reduces the cost to the MFI to offer such access, the other reasons cited prevent the MFI from leaping at these products. They are not as profitable for the MFI.
- Offering such a product requires the MFI to be regulated in most countries. This is an expensive process to undergo, incurs increased ongoing operating expenses, and applies additional scrutiny to the bank from the regulator. MFIs, and indeed most players in the entire microfinance sector, are weary of regulators. Thus the fascination of self-regulation – formal regulation is a hassle and may limit profitability.
The astute reader will note these four points are actually identical: offering such a product to the poor may better meet their actual needs, but it is less profitable to the MFI.
A fifth reason, less related to the MFIs or product per se: banks that mobilize substantial local savings are less dependent upon external funding from microfinance investment funds (MIVs), and it may be in the interests of the MIVs to not push such activities, as they reduce their own income streams in the process. Isn’t it strange that Banco Compartamos, one of the most profitable (and vulture-like) MFIs on Earth, with such massive ROE as to be able to launch almost any product it wishes, does not offer a single savings product at all?
The poor with savings become ever so slightly more autonomous. Those with loans become enslaved.
Look at the evolution of almost every developed country financial sector – they generally began with savings and loan co-ops. Roodman’s third chapter is an excellent summary of the historical origins of the financial sectors of such countries. Savings were integral in the evolution of many European, American, British and Canadian banking sectors and structured as co-ops. We now seem to believe that savings are barely necessary: credit-only institutions (many of which are privately owned and for-profit) still dominate the entire microfinance sector. Is this what Ha-Joon Chang would refer to as Kicking Away the Ladder?
Indeed, it is likely that those best suited to offer such a loan product, who may in fact already offer such a product to their wealthier clients, are the commercial retail banks. They have the regulatory structure and technology/back-office in place to manage such a product. A principal justification of microfinance, if I recall correctly, was a consequence of the hesitance of precisely these banks to lend to the poor, forcing them into the arms of the evil moneylender. If the commercial banks could further downscale their operations into the microfinance segments this problem may be solved, and this is precisely what we observe in some countries currently. Look at Banco Guayaquil and Banco Pichincha in Ecuador, CrediScotia in Peru etc.
We know microfinance did not eliminate the evil moneylender, but perhaps these commercial banks downscaling and offering suitable products (which already exist) to the poor could eliminate the evil MFI? Wouldn’t that be a huge success? Good products offered to the poor at fair rates by commercial, regulated banks? Indeed, surely the goal of the microfinance community is to make itself redundant?