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Commercial banks take a fresh look
Alan Beattie

The traditional image of microfinance -- providing small-scale financial services to the poor -- has often been as close to aid as it is to business. Despite its remarkable successes, much of its business has been conducted by non-profit organisations divorced from the wider financial system.
In this "year of microfinance", as the UN has declared 2005 can the sector begin to shake off its image of charity and mobilise traditional commercial banks and the capital markets?
The Grameen Foundation, which pioneered microfinance in Bangladesh, itself argues that providing finance to the poor needs to become more than just a limited niche.
Though hard data and even definitions of microfinance -- who, for example, counts as the truly poor? -- are hard to pin down, it estimates that market demand is reckoned to be more than $300bn against a current supply of $41m.
"If microfinance institutions are to close the significant supply-demand gap, vast external resources need to be tapped," says Jennifer Meehan, director of capital markets for the Grameen Foundation in the US and herself once an employee of Chase Manhattan, now JPMorgan Chase. "In the long term, only financial markets have the available resources for optimal growth."
The barriers to traditional commercial banks becoming involved with very smallscale finance are obvious, and considerable.
The unit costs of administering a large number of small loans or accounts are high. And unless they have deep knowledge of the communities they are serving -- which is difficult and expensive to acquire -- commercial banks may struggle to achieve the sort of spectacularly low default rates for which microfinance has become famous.
Indeed, one of the factors that has often made microfinance a success has been its ability to tap the knowledge of locals and appeal to the collective interest of poor communities to prevent their members defaulting.
The Consultative Group to Assist the Poor (CGAP), a consortium of 29 development agencies headquartered at the World Bank in Washington, says that great potential exists to bring mainstream financial institutions closer to the poor. But so far, it says, this potential has yet to be achieved.
True, it estimates there are 750m savings and loan accounts around the world in what it calls "alternative financial institutions" including credit co-operatives and mutual associations, state agricultural and development banks and postal savings banks -- that serve borrowers below the income levels generally targeted by commercial banks.
But it stresses that many of these accounts are helped by people who would not generally be defined as poor.
Moreover, about 80 per cent of these accounts are savings rather than loans, suggesting that poorer entrepreneurs often have to save to accumulate capital for investment rather than the faster if higher-risk route of borrowing it.
Elizabeth Littlefield, the CEO of CGAP, says that, previously, few commercial banks were interested in microfinance, preferring to lend to big corporations and the government.
Even when some tried it, as in Costa Rica, they were taken over by new ownership that had little understanding or interest in pursuing the sector.
But, seeing the high rates of return available, and the fact that microfinance profits appear far less vulnerable to economic downturns than corporate finance, commercial banks have been looking at the sector afresh.
In a recent book, Malcolm Harper, an international consultant, and Sukwinder Singh Arora, at the UK department for international development, gave examples from 18 countries of how commercial banks had got involved.
In India, ICICI Bank, which has a large network of local branches, entered the microfinance market in 2001 and increased its portfolio from $16m to $63m in two years.
Ms Littlefield says she has herself been converted from scepticism to optimism. One big reason is the development of technology that obviates the need for expensive networks of bank branches.
Projects in Senegal and South Africa have shown that cheap point-of-sale machines in local shops or gas stations can bring financial services within the reach of the very poor by enabling them to make deposits or withdrawals as part of their shopping, the shopkeeper receiving a fee for each transaction.
"When you have got transactions costing a third of a cent on machines costing $75, it entirely changes the argument about the cost and technology barriers to microfinance," Ms Littlefield says.
These days, with the culture within banks changing, it may well be the institutional restraints that are now holding back their involvement.
Banking regulation in developing countries is rarely characterised by a light touch. The point-of-sale technology used in Senegal and South Africa, for example, is blocked in India by the Reserve Bank of India's view that shopkeepers would require a banking licence to operate one.
Commercial banks in developing countries are frequently subject to regulatory caps on interest rates, which NGO-backed microfinance providers are not.
Some of the traditional barriers to the commercialisation of microfinance may have been lowered. But in some cases that has revealed others that remain in place.
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