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Globalization Of Microfinance Banca Regional Andino


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A perspective discussion as part of the Microfinance course under Prof. M S Sriram

A perspective discussion as part of the Microfinance course under Prof. M S Sriram

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  • 1. Microfinance Management End-Term Assignment Banca Regional Andino: Facing the Globalization of Microfinance Case Analysis Submitted to Prof. M S Sriram By Shuvabrata Nandi On 27th August 2009
  • 2. Context of the Case: Microfinance started as a small-scale, philanthropic experimental movement to provide credit to the neediest and the poorest of the world, but growth has been enormous in recent years and it is now firmly established as a major supplier of a wide range of financial services to millions of people around the world. Nowhere has the commercialization of microfinance proceeded more rapidly than in Latin America. Although in microfinance circles, Latin American microfinance is talked in the same breath, there is a huge diversity among the nations of Latin America in terms of their economy and subsequently need and delivery of microfinance. In this case, we are particularly concerned about the three such nations, Bolivia, Peru and Ecuador, as BancoSol, Mibanco and Banco Solidario hail from these three countries respectively. The following table (data compiled from the exhibits of the case) gives us a very good idea of how these three countries stack up against each other in terms of broad economic parameters that are relevant to microfinance sector. As we can see there is wide disparity between them in terms of poverty, interest rates and the size of the microcredit portfolio. Country Ecuador Peru Bolivia GDP (USD billion) 36.2 78.4 9.3 GDP per Capita (PPP, USD) 4,272 6,226 2,856 % population below poverty Line 37.2% 32.1% 42.9% Total Microloan Portfolio (USD million) 1,344 2,023 585 Commercial Bank Rate 13.8% 15.5% 9.3% The biggest common thread that runs into microfinance sectors of these three countries is that all of them have embraced market-based approach to microfinance and have very well-developed regulatory framework for the same; actually in terms of business environment for microfinance, Peru, Bolivia and Ecuador ranks top three in entire Latin America. Another major feature of Latin American microfinance has been their focus on microenterprises and not only the poor in general. With this backdrop, we need to look at the development of a common banking platform between BSE, Mibanco and BancoSol, all of whom received technical assistance of Accion International and have significant equity participation from Accion Investments. ~2~
  • 3. Common Banking Platform: Before we start looking at the implications of the common banking platform between the banks, we need to look at the rationale behind why there should be a common platform at all. First, the nature of competition in each of these microfinance markets is changing, with newer competitors having a better cost effective model to expand across geographies, like ProCredit. At the same time, local commercial banks have been a testimony to the success of these MFIs and they have started pushing the frontier as well. On top of it, came increased interest in microlending from global behemoths like Citi, ABN AMRO, Banco Santander and BBVA. Effective collaboration was seen as a way to ward off potential competition, since 70% of their work was similar and motivated by the same Accion design. Second, there is a change in political environment in Latin America and there is growing fear of a state dominated economy regime coming back, which is going to destroy credit culture affecting repayment and putting interest rate caps affecting the profitability of the banks. Effective collaboration gives them more room to survive. Third, joint procurement of systems (especially large and complex IT systems described in the case) makes them more cost effective and deployment can be easier through knowledge sharing. Last but not the least, there is a scope of immense learning which can be achieved via an effective partnership thereby emulating one success story in other countries as well. The Accion patronage goes a long way in helping sort out operational issues. How much is Common: Bank BSE Mibanco BancoSol Avg. Loan Size (USD) 1,499 1,368 2,019 Loan Size as % of per Capita GDP 35.1% 22.0% 70.7% Avg. Interest Rates (local currency) 39.6% 40.6% 27.8% Operating Cost as % of Assets 14.0% 15.0% 8.5% Deposit to Loan Ratio 96.1% 78.4% 79.4% RoA 0.7% 4.7% 2.4% But at the same time, we need to also do beyond the surface and look at how similar these banks are so that there can be a common platform driving all the three. The above table shows some broad parameters compiled from the banks’ financial statements ~3~
  • 4. given in the case and we find three strikingly different institutions despite common methodology and philosophy. Combining the country data from the previous table and the bank data from this table we can see that BancoSol is providing much bigger loan size than Mibanco, an observation that might suggest that the kind of clients served are vastly different. Similarly, BancoSol’s lower operating cost and lower interest rate suggests stiffer competition in Bolivian microfinance compared to Peru or Ecuador, while BSE’s low returns might be due to the high operating costs. The savings mobilization is also much higher in BSE than BancoSol or Mibanco. Hence, in terms of financials, size of the portfolio, segments of client served and profitability, there are huge differences between the three Banco Regional partners. The Implications of a Common Platform: Now we need to concentrate on the effects of a possible common banking platform on the performance of these three banks. We are looking at the effects on the competitiveness of the banks, clients served & loan size, and the institutional shareholders. Competitiveness Microfinance is an activity which needs constant flexibility to adapt to changing local situations and crisis, and hence it does not make much sense to have rigid sets of procedures and systems. Hence, if the banks need to actually change their operating systems to suit the need of the MIS, they are bound to become less competitive. And in markets like Bolivia, Peru and Ecuador, they all face very stiff competition. But we also need to understand whether they need to actually change their operating procedures to suit MIS requirements, as MIS would mostly be at the backend and hence would impact the frontend activities of the bank less severely. Also, another point to note is that as industries mature which is certainly the case with Latin American microfinance there are more and more standardizations. And if same operating procedures and MIS can’t operate in different geographies of the world, we would not have had global banking giants like Citi or HSBC or Banco Santander as mentioned in the case. So, the trick lies in effectively shielding the frontend while integrating the backend both for economies of scale and scope as well as better risk management for the banks. Hence, there can be temporary concerns over competitiveness when the common platform is being rolled out, but post that we don’t see competitiveness getting affected in a big way. ~4~
  • 5. Clients and Loan Size A frequent debate in microfinance forums is whether the push towards sustainability and, ultimately, the commercialization of microfinance is driving institutions up-market from where they would naturally situate themselves. It is neither possible nor worth a try to settle this debate for in this report. Evidence has shown that regulated MFIs have bigger loan sizes than unregulated NGOs. This initial evidence seems to indicate that the more commercial approach to microfinance in seems to have left poorer clients behind. The bigger question that we need to address is whether mission drift is an inevitable consequence of the push for commercial viability. As the three banks collaborate to roll out a common banking platform and try to meet the needs of all of their clients, it is most likely that they will have to exclude some clients for systemic reasons of non- customizability and they are more likely to focus less on the poorest of the poor. There would be considerable mission drift as well since the only mission for the collaboration could be to increase profits and shareholder value rather than benefit the poor people of three different nations. Also, the income level disparity among the countries will make a common platform exclude the poorer rather than include since poverty is defined very differently in the three nations. Shareholder Perspective – Internationalization There will be a conflict of interest if any of the three partner banks in Banco Regional decides to set up an international operation in future. And hence the move is not likely to be supported by institutional shareholders who dream of going global organically. Hence the only route that the common banking platform will lead to is a merger among the three banks, which might be more value accretive, rather than only a loose collaboration and the common underlying banking platform with different goals and objectives. Merger vs. Collaboration: Microfinance institutions operating successfully beyond one’s home country has been very few and a potential merger between BancoSol, BSE and Mibanco would be a big example to prove that microfinance can operate globally as well, albeit in countries geographically and culturally similar to each other. But the merger would bring in its own set of advantages and disadvantages. Let’s first look at the benefits that the merger might create for the banks. ~5~
  • 6. First, 70% of the activities of the banks are common, being inspired by the same set of guiding principles from Accion and then implemented with local flavours. So, it makes sense to build economies of scale through a merger and become more lean and efficient to take on the increased competition. Second, there is strong organizational learning that can be leveraged in such a deal. For example, BancoSol was good at credit scoring, BSE had the best practices for managing group loans and Mibanco was exceptional in guarantees and recovery of delinquent loans. Hence, a merger would necessarily build upon each of their complementary strengths. Third, through this merger, all the three banks would have potentially better access to liquidity which would come in very handy in times of crisis. This borrows from the idea that better balance sheet strength gives the merged bank better stability. Fourth, a merger would help offset the ill-effects of covariance risk that a microfinance portfolio bears. Microfinance portfolios are more susceptible to broad systemic or natural catastrophies (like recession in Bolivia or floods of ’98 in Bangladesh) and a diversification into different countries with different economic drivers has its advantage in mitigating this covariance risk. Fifth, as a bigger diversified bank with lower risk the merged entity would have better access to capital markets globally and it is expected that the cost of capital would come down significantly than their current levels. But, the proposal to merge the three banks is not all that hunky-dory; there are huge challenges and problems along the way that can negate all the benefits cited above. Let’s look at the disadvantages of a merged entity. First, cost of regulation would be a burden for such an entity. For an evolving industry like microfinance in an unstable regulatory environment, reporting to three different financial regulators would be a big burden. Second, Latin America has been the hotbed of commercial microfinance. But with political turmoil in most countries, especially in Bolivia among the three concerned in this case, there is no regulatory clarity over the future course of action on market based microfinance. Political risk might play a spoilsport in a scenario of merger. Third, globalization in microfinance has never been tried before. Hence all the three parties need to learn their ropes very slowly and act according to the changing situation. This is likely to consume a huge amount of management bandwidth, which is very precious given the nature of competition in all three markets. Fourth, the problem of mission drift might become larger as the combined entity strives to become more profitable and hence the poorer clients would be left out, as discussed previously in this analysis. ~6~
  • 7. Hence, we see that while there are valid and attractive reasons for considering a merger between the stalwarts of microfinance in Bolivia, Peru and Ecuador, the path is fraught with danger and challenges that might cost them the leadership in the market. The Perils of Overlending: After years of neglect for the last two decades, microfinance markets are in the centre of attention for big private investment bankers and profit-seeking lenders. From the case facts, we see that between 2004 and 2006, capital is rushing into microfinance and for the first time in the history of this sector, capital looking for investments has outgrown the potential for investments. From the given data, we see that USD 640m of debt funds and USD 425m of equity funds is waiting to come into microfinance. The situation is the same for Indian microfinance, where in recent times we have seen the same rush of capital from the following sources – big private Indian banks looking forward to meet their priority sector lending targets and big PSU banks following suit realizing the exciting potential. Rush of NBFCs in the sector is also ensuring that overlending is a very genuine threat in Indian microfinance. Risk management has traditionally been not a strong point of most microfinance institutions and the same is true for both India and Latin America. But a common banking platform is more likely to offer better risk management capability, where they can learn from each others’ best practices and implement them jointly. Lessons for India: Microfinance delivery model in India is vastly different compared to Latin America; Indian microfinance is woman-focussed group-based savings-led microfinance. But as newer MFIs are entering the market along with gush of private equity investment and flood of debt from Indian as well as global banks, there is a strong shift towards the regulated NBFC style MFIs than unregulated NGO driven microfinance. Hence India is following the footsteps of Latin America and states in the South have already reached a state similar to that of Bolivia. Hence there is some learning to take home for Indian microfinance sector. First, it is important to check overlending. Over-indebtedness combined with a bad economic climate might mean disaster for small and average sized MFIs operating in India. And since most MFIs are focussed on a particular geography, they bear significant systemic risk, which can be diversified through consolidation at the national level. ~7~
  • 8. Hence diversification of specific location based risks to the portfolio would be an important stepping stone. Second, collaboration is a key to better risk management. In the absence of a regulator driven credit bureau in microfinance, the market participants can maintain their own information system and share it among themselves to mitigate overlending risk. This also calls for some degree of standardization. Hence, it’s time for Indian microfinance to realize the benefit of a standard operating model. Third, India is yet to have a consolidated regulation on microfinance. Hence all the MFIs do carry some amount of regulatory risk, which can be tackled through creation of standardized reporting framework for through collaboration among MFIs. This would also ensure a lot of concern regarding governance standards in Indian microfinance. Last but not the least, the Latin American experience should teach us the benefits of economies of scale in operations not only to drive down costs, but also to take care of the liquidity risk. In the wake of the global financial crisis, lot of Indian MFIs might face potential refinancing risk and the enormous amount of leverage might come down. Hence, consolidation among regional microfinance players would not only help mitigate the covariance risk, but also lower the liquidity and refinancing risk as well as bring down the cost of capital as more and more Indian MFIs become publicly listed enterprises. ~8~