Forecasting the future of MFBs as DMBs deepen microfinancing (1)

The idea of small credit for small people (microloans) is age old, even though microfinance as currently practiced is relatively new. Different forms of informal credit schemes have been in existence since the 15^th century when Catholic monks introduced the pawn shops in Europe to help the poor. However, what we call microfinance today is the result of the opportunity created in the 90s by the reluctance of deposit money banks to lend to those who had no collateral. Microfinance institutions (MFIs) were quick to fill the gap and there began the new world of microfinancing.

Although the gap was never really filled, operators of microfinance institutions in the world such as 51Give (China), Bank Rakyat Indonesia (BRI), BRAC (Bangladesh), Grameen (Bangladesh) and such have done a lot. Back home here players led by LAPO, Grooming Centre, ASA and others have been doing their bit to tackle poverty. They have inspired many across the world to get involved with the provision of credit and related services for the poor.

An important development in the industry is that the banks that created the financing gap, which microfinance institutions exploited to become important are returning to microfinance, with even greater force and focus. A number of them had their own subsidiaries carrying out microfinancing before the Central Bank came out with the Holding Company structure for banks. This forced the banks that didn’t want to go the Holding Company rout to hive off their microfinance institutions.

But some still have considerable interest in formal microfinance. With what is trending in that sector the return of deposit money banks to classical microfinance is a possibility. And when that happens, that will spell tough time for the present crop of microfinance banks that are trying to wear the image of banks.

There is real danger that microfinance institutions in Nigeria may be greatly challenged if not endangered anytime the banks, which gave them the window of opportunity to thrive, get their acts together and really pursue microfinancing. That will bring them into direct competition with the banks and we need not predict who will win in such a contest. Microfinance has not achieved the aim for which it was heralded into the finance space with much pomp and pageantry – poverty reduction. This failure is not entirely the fault of operators. Poverty has continued to rise and even worsen in certain countries, especially those in Africa involved in the rampant wars and insecurity caused by poor and failed governance in the continent. But some degree of the failure may be attributed to the operators.

The arrival of purely commercial microfinancing brought with it certain changes in the features of the operators that have affected their effectiveness in delivering on their poverty reduction mandate. Truly, commercial microfinance is devoid of its social element, which is a vital component of the nature of a real microfinance institution. Although there are still many operators in the mould of non-governmental or not-for-profit organizations (NGO), it does appear that the introduction of the profit motive took considerable steam off them.

The existing NGO-type microfinance institutions were quick to convert to commercial microfinancing, which had a dampening or downsizing effect on their operations. It also changed the fundamental character of the business as operators jumped at the idea of being called banks. This has made it difficult for them to get at poverty where it is rooted – the rural areas.

The result is that microfinance banks have failed to distinguish themselves both in terms of their image and character, as well as in their services. Except for their small size, most operators are like commercial banks, repeating the mistakes made by commercial banks that gave rise to the niche they exploited. They have commercial bank structures and have overheads that mirror those of commercial banks. Their lending philosophy has become similar to that of commercial banks thereby changing the character of their clients.

By booking large, rather than small ticket loans, they violet their established criteria on size and direction of credit. This has also distorted the structure of their loan portfolios, which tends to lean more towards large individual loans rather than groups and cooperatives. In this manner, microfinance banks have failed to democratize microloans among the very poor. Instead of having the bulk of their clients coming from the rural poor, they mostly come from among urban dwellers. This has come about because they prefer to locate in the urban centres and there may be any number of reasons to justify this.

Fund gap and fund gap ratio

Owing to their inability to attract significant deposits, microfinance banks rely on funds purchased from the open market. Their deposit bases are therefore very shallow. This is partly due to their faulty business models that fail to recognize the critical place of savings, voluntary and compulsory, in their scheme of things. In microfinance, assets such as loans and deposits, are usually of the short term variety, while liabilities such as compulsory savings are usually long term. This often gives rise to what is called FundGap.

By definition, fund gap is simply assets less liabilities, at a given time bracket. A fund gap ratio is assets divided by liabilities. When the funds gap or fund gap ratio is zero (which is a rarity because of the structure of the funds of MFBs), it means that its assets are exactly and properly matched with liabilities at the given time bracket. A fund gap greater than zero means that there are more interest rate sensitive assets than liabilities for the given period.

This is a positive development if the MFB expects interest rates to rise. It creates a chance for it to renegotiate rates at ahigher rate on its favour. So when expecting interest rates to rise an MFB would maintain a positive short term fund gap. If the fund gap or ratio is less than one or negative, the MFB faces a liability sensitive position.

The kind of investors who were attracted to the industry is also one of the challengesthe players face. The focus on profit puts pressure on operators and affects their conduct.