Commercial microfinance and the challenge of efficiency
Commercial microfinance presents quite a few challenges but it seems to be the only way to go if microfinancing is to fulfil its mission of lifting many out of poverty. It is the form of microfinance that happens when those services are provided by profit oriented organizations that form part of the formal financial system (such as banks, and non-bank financial institutions), as opposed to charity or not-for-profit organizations, often referred to as Non-governmental Organizations (NGOs). Some more formal approaches to the definition of commercial microfinance have been proposed, including those of authors like Poyo and Young, and Christen, who respectively defined it as “the application of market-based principles to microfinance” and “the expansion of profit-driven microfinance operations.”
Today, the microfinance sector in Nigeria features both categories of service providers – commercial and not-for-profit institutions, and each category of operators is regulated by a different set of laws and regulatory institutions. While the Central Bank of Nigeria and the Nigerian Deposit Insurance Corporation take responsibility for the regulation and supervision of the conduct of commercial microfinance, the Not-for Profit operators, largely the NGOs, are essentially regulated by the extant cooperative laws.
The Nigerian financial system has been the focus of considerable reforms, over the past couple of decades. The result has been significant positive changes in structure, institutions and instruments. The most significant reforms, as far as the microfinance subsector is concerned, is the introduction of the Microfinance Policy Framework of 2005, which created the opportunity for interested individuals and organizations to embark on the provision of microfinance services on commercial basis. Prior to this time, microfinancing was largely a preserve of NGOs that were largely donor-dependent.
Adoption of commercial microfinance has considerable implications with regard to the operation of the institutions. First, regarding organization and management, it implies the resort to professional conduct and strategies for running the institution – creation of structures that help the organization to run objectively and impersonally. Also, the operator must have to function as a formal for-profit or commercially-minded financial institution that is subject to existing prudential regulations, and supervision by the relevant regulatory authorities. Second, the operator must lean towards increased self-sufficiency, both operationally and financially. Major determinants of success in these areas are operational efficiency, outreach and cost recovery through appropriate loan pricing.
Second, with regard to funding sources, if the operator was inexistent prior to the adoption of the policy of commercialization, it must begin to wean itself of any reliance on donor funds. The following financing sources will invariably gain ascendancy: commercial bank, development finance institutions such as the Bank of Industry, the Central Bank and multilateral financial institutions like the International Finance Corporation (IFC) and the World Bank, Equity Investments, debt instruments and deposit mobilization.
Third, and regarding products and services, the creation of demand-driven products and services, and the application of effective cost recovery strategies, will become critical in the milieu of commercial microfinancing.
There are many bright sides to the introduction of commercial microfinance, just as it comes with its own challenges. First, we can look at the positives. Apart from the creation of a determinable regime of rules and industry structure, which should be a natural concomitant of any effective licensing regime, the system created opportunity for capital inflow to that subsector. Expectedly, a lot of commercial financing has found its way into the industry, particularly by way of capital investment for the formation of microfinance banks. This situation is positive and has the potential to boost outreach, if the licensing rules are religiously applied. Unfortunately, several years after the introduction of commercial microfinance, outreach improvement has remained a challenge and could at best be described as slow. However, that is not a peculiar problem for Nigeria. It reflects the general experience in other climes following similar trajectories in developing their microfinance sector.
The inflow of commercial funds by way of capital investment in microfinance banks has brought considerable pressure on operators. They naturally owe it a duty to the investors to return acceptable profit. Commercial microfinance institutions are like any other profit oriented institution. They are set up to make profit. In other words, they can only justify their existence if the investors make reasonable returns. Thus, there is an increased emphasis on efficiency and this has serious implications for cost containment.
One of the central issues in commercial microfinance is efficiency. Efficiency is an expression of the relationship between cost and output. An entity is said to be efficient if it produces more using less resources. An efficient microfinance institution is one that runs a low cost operation. Unfortunately, this seems contrary to the nature of microfinance. By its very nature, small loans granted to a large number of small clients, microfinance loans do not promote efficiency. Moreover, commercial microfinance presupposes less reliance on donor funds and more access to commercial funds. The result of this mix is a reduction of the spread (the difference between revenues from lending and cost of funds) available to operators. This spread must be large enough to cover loans losses, administrative costs and adjusted capital costs. Therefore, commercial microfinance presupposes greater emphasis on efficiency.
Given the large number of operators in the country and the attendant hike in competition, efficiency may be low in the short run. It is therefore advisable for operators to moderate their appetite for large bottom lines at the outset, to avoid chucking up huge non-performing loans. Experience has shown that efficiency improves as a microfinance operation matures. This is a long-term attribute and requires time. A longer view of profitability might be helpful.
Emeka Osuji