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

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.
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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
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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.
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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.
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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.
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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.
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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.
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