Looking at Microfinance IPO Controversies (SKS and Bank Compartamos)

This is the second part of a two-post series on IPOs in microfinance.

Coming to the next point, two recent articles published by The Economic Times accuse SKS of gross mismanagement and low levels of transparency. The claims of these articles, entitled ”Top 3 microfinance companies used poor as puppets” and “ How top 3 Microfinance cos raised funds in the name of poor?”, were refuted by Vikram Akula, but that did little to change the newspaper’s stance.

The case of Bank Compartamos was documented in detail as well in terms of shady management practices. There were rumours about public aid money, intended for running the microfinance institution, going into the pockets of shareholders. However, CGAP released a case study about the IPO in which the authors say:

“Our view is that the public aid money given to Compartamos has not been inappropriately diverted to private pockets.”

Many people are of the view that there is nothing wrong with helping the poor and making profits at the same time, as long as one remembers that microfinance must first create social value. Huge market potential as been realized in the bottom of the pyramid and as a result, microfinance should be no different.

A moral debate lingers nonetheless.

A detailed account of how the initial shareholders of Compartamos made a rate of return of around 300% over 6 years will shock many. Similarly, the fact that Vikram Akula and 60 other SKS staff employees became millionaires after the IPO [4] by virtue of their stock options, was not warmly welcomed either.

As previously mentioned, Bank Compartamos and SKS started out as NGOs, attracting massive amounts of donor funds, so the transformation into for-profit public entities was a little hard to digest, even though it was completely legal.

Let us also remind ourselves that Indian regulators left SKS with little choice when it came to generating money on a large scale. This was because as a non-banking finance company (NBFC), SKS was not permitted to utilize public deposits for growth, like Grameen Bank did. In other words, Indian regulations prevented SKS from going down the well-trodden path of offering micro-savings to expand their lending portfolio, and so the organization had few alternatives for spearheading growth.

Professor Yunus is quick to point out that SKS could have encouraged policy makers to favourably change regulations, but that is not easy.

The positive result of both IPOs was that it proved microfinance is a good investment opportunity for both public and private investors. Bringing microfinance to mainstream financial markets ultimately helps the poor. Concerns over profit-maximization at the cost of client welfare abound, but shareholders in any successful company know customers come first. Almost four years after the Bank Compartamos IPO, we haven’t seen our fears come true – interest rates were lowered, client protection principles were adopted and lending portfolios were increased. Despite this, it is still too early to say how favourable or harmful these events were, and all our assessments are merely educated guesses.

From an investor’s point of view, these firms have weathered the storm and are still doing well – their stock prices have fallen slightly and settled over time (they were previously said to be over-valued owing to the unrealistic hype about returns). This can be interpreted in several ways – some may say the bubble has burst, while others may feel that it proves microfinance is a resilient model after all.

IPOs in Microfinance – Introduction and Issue of Interest Rates

The issue of commercialization of microfinance through access to capital markets clearly divides the microfinance sector. Some, like Vikram Akula, the Chairperson and founder of SKS, feel ‘McDonald’s style growth is the fastest and most effective way to alleviate poverty for most people’ [1], while others such as Muhammed Yunus, founder of Grameen Bank, feel this ‘endangers the whole mission’ of microfinance. In reality, the debate isn’t as simple as this, and we take a look at two examples to highlight the potential benefits and drawbacks of the incidence of commercial investment in microfinance.

Some background stats

• SKS

Country: India

Nature of Capital Market Activity:  Initial Public Offering (IPO) on July 28, 2010

• Bank Compartamos

Country: Mexico

Nature of Capital Market Activity: IPO on 20^th April 2007

Bank Compartamos and SKS are the two most popular microfinance IPOs and both were highly controversial transactions. Both MFIs were attacked against various factors, such as high interest rates, the sudden wealth acquisition of original shareholders, etc. Despite this, growth expectations were unrealistically high, which is why despite the negative attention dished out by the media, Bank Compartamos and SKS shares were heavily over-subscribed prior to their IPOs.

The IPOs were justified by the management citing the need to make microfinance commercially viable (better outreach, greater efficiencies, improved product diversity, and so on and so forth ). While Bank Compartamos expressed concern over stiff competition from MFIs backed by commercial banks in Mexico, SKS expressed frustration over not being able to rely on public deposits (micro-savings) to reach out to new communities in need.

This argument is perfectly aligned with economic theory and it will take a few years before observers can truly judge whether SKS and Compartamos followed through with their plan. However, the media, NGOs (and the Indian government in the case of SKS) have been quick to highlight various issues that tarnished the images of these MFIs. Since these reports have been both vehemently supported and opposed (some of the more popular contentions, along with their negations, have been summarized below) it is difficult to know where the truth lies.

Bank Compartamos is famous for its interest rates which are exorbitant by international standards, yet low by domestic standards. A few years ago, the effective annual interest rate (APR) was over 100%  and we know many factors contribute to high interest rates in microfinance, the main reason being high operational costs involved in the high-touch lending model. The bank, not surprisingly, justified their figures by pointing out labour costs were exceptionally high in Mexico compared to those in large Latin American countries and Asia, and that their loan sizes are pretty small.

Also, let’s not forget that Bank Compartamos drastically lowered its interest rates in the years following the IPO [2] citing policy changes.

While SKS’s interest rates are low by international standards, and significantly low compared to Bank Compartamos’s rate, the MFI still faced much heat. At the time of the IPO, the figures were a little over 26% but the spate of suicides among microfinance clients in India angered many and the government imposed stricter regulations on the sector.

SKS is not directly implicated in these reports but the incidents added fuel to the IPO storm. It is also worth mentioning here that the Indian state-government ran a rival shelf-help group in the province of Andhra Pradesh [3] so politico-economic conflicts cannot be ruled out. Soon afterwards, SKS voluntarily lowered their interest rates by around 2%, but the move was not entirely welcomed.

Part 2 of this article will discuss two other controversies related with the IPOs.

Information Technology Can Develop Economies Through Social and Natural Capital

This is a continuation of an article about the importance of technology in the development sector; part one covered development through physical and financial capital with the help of different modes of technology.

Social Capital for Development and Information Technology

(Includes hints of physical capital)

Social capital covers networks, communities, and institutions that enrich the social fabric of individuals. Even though this form of capital is highly intangible, it is no less important than the others because social contracts and cultural contexts play a central role in the lives of people in developing countries. Because of the over-arching nature of technology, physical capital (technology, equipment, etc.) is vital in enhancing social capital, and hence, examples mentioned previously are applicable here as well.

Before we discuss how information technology enhances social capital, it is important to link social capital to the Millennium Development Goals of gender equality and global partnership for development. The latter MDG is vague and expansive, and can loosely be accomplished by creating a global knowledge sharing database/platform where individuals and groups come together to discuss specialized ideas. The former goal can be addressed less indirectly through information technology, and three renowned business models come to mind:

• Kopernik is a website that connects breakthrough technology providers with technology seekers (individuals in the field) with the support of generous donors around the world who finance the transactions.
• M-Pesa is a mobile banking platform that is slowly changing the way Kenya’s society handles cash and empowers entrepreneurs to take out loans and save money for rainy days.
• E-Chaupal is a network of computers with access to the internet, which farmers in rural India can use to get the latest agricultural marketing (prices of farm inputs, weather updates, affordable suppliers, etc.) and information from.

These examples not only serve to augment information sharing between groups and communities, but also have a spill-over effect on Millennium Development Goals previously mentioned. For instance, the elimination of intermediaries (through e-Chaupal) strengthens ties between farmers and improves their bargaining power, which impacts the MDG related to ending poverty and hunger. Similarly, the provision of new technology solutions, such as home solar panels and water purification systems (through Kopernik) impacts MDGs related to environmental sustainability and elimination of poverty and hunger.\

While gender equality may not be a direct result of these innovative solutions, it may, however, be an indirect result of strengthened communal ties and empowerment of end-consumers (both men and women). Additionally, new software solutions can be designed to improve literacy levels of girls and women and these programs can be delivered through mobile phones, and SMS campaigns can be launched to positively change public opinion about women rights.

Natural Capital for Development and Information Technology

Natural capital covers natural resources such as land, water, minerals, and anything else naturally available for man’s consumption. The relevant Millennium Development Goal is environmental sustainability, the lack of which is detrimental to the progress of the poor. Issues such as water sanitation and food security plague developing countries, especially those that have been inflicted by natural disasters and wars. Inadequate availability of natural resources also hinders economic progress of individuals because along with knowledge and skills, people need access to good quality raw materials to run their businesses.

There aren’t many examples to go by in this case, but here is a promising mobile phone application:

FLOW (Field Level Operations Watch) is an open-source, Android application that allows field workers to use mobile phones to document how well water pumps and sanitation points in the developing world are functioning, then transmit that data to create an online tagged map of target regions. (Source: Mobile Active)

Environmental sustainability also includes the use of renewable energy sources (solar and wind power, for instance) and reliance on other means to reduce the carbon footprint left on the ecosystem by man. Although the environment may not be the biggest priority of development professionals, who have more pressing issues to deal with (such as poverty, hunger, disease, etc.) its importance cannot be undermined because the poor are most vulnerable to environmental shocks, as recently witnessed by Pakistan and Brazil.

Information technology can step in by improving the distribution of low-cost alternative energy sources (such as Kopernik) and remote monitoring systems (similar to the one used in FLOW) can be used to curtail illegal mining, logging, fishing, poaching, etc. Lastly, disaster alert systems can be developed to alert inhabitants about approaching storms, floods, tsunamis and fires, and consequently, minimize damage to human property.

These ideas seem viable and appealing, to say the least, but it is vital to remember these solutions will fail if cultural contexts are not examined prior to implementation.

This post series drew inspiration from a UN Working Paper, Using Information and Communications Technology to Achieve the Millennium Development Goals.

Technology Important For Development Through Human and Financial Capital

This blog has previously defined the need for good information systems in the microfinance model and detailed the various roles technology can play in this regard, such as improving functional performance, managing credit risk and improving outreach through different tools, to name a few. This was followed by an article that explained why Cloud Computing, which includes the Software as a Service (SaaS) model, is an appropriate medium for the delivery of such an information system to microfinance institutions, as opposed to propriety and off-the-shelf software solutions. Following the same drift, this article explores the benefits cloud computing can offer to the development sector in general, and to the Millennium Development Goals, in particular.

There has been plenty of excitement over the role information and communication technology can play in the development sector – that it can reduce poverty by overcoming the digital divide. It may take several years before the benefits and drawbacks of this theory are tested, but the idea seems promising, despite the unreasonably high expectations. Technology can corroborate any efforts in the area of poverty eradication along the lines of the UN’s Millennium Development Goals (MDGs) and Amartya Sen’s five ‘capacities’ that can make a difference between poverty and welfare: human capital, social capital, physical capital, financial capital, and natural capital. These capacities, which loosely cover the MDGs, are assessed against current and potential technological contributions.

Human Capital for Development and Information Technology

(Includes hints of physical capital)

This includes education, skills, health and other such capacities can help achieve Millennium Development Goals related to universal education, child health, maternal health and HIV/AIDS. A few notable efforts in this area have recently emerged as the ubiquitous power of mobile phones became eminent. The safest way of achieving universal primary education is through capacity building of the education system (teachers, curriculum, school facilities, etc.) and here, information technology can deliver gains in the areas of training sessions for teachers in remote locations across the worlds, and enriching the course curriculum by creating knowledge-sharing hubs that offer access to quality educational resources related to academic and vocational education. The One Laptop Per Child (OLPC) program is also relevant here.

Mobile phone penetration has shot up in many developing countries during the last decade, such as India, Kenya, Brazil and Pakistan, and software developers are keen to explore the development potential of mobile phone applications. Mobile Health, commonly referred to as mHealth, is the practice of managing health service through the use of mobile phones. This field is gaining popularity in Sub-Saharan Africa, where a few mobile phone applications have been developed by different software vendors with a vision to help the masses.

These applications can send out text messages to villagers in remote areas to share information about medicine dosage and timings, medical appointments, HIV/AIDS, and offer basic health advice for common problems, such as headaches. If the symptoms get worse, patients are given directions to the nearest medical clinic. One mHealth application goes a step further by combining mobile banking elements into the service by helping customers save money for the desired delivery plan. The service has been successfully tested in Uganda with the help of MTN (the chosen cellular network provider). These applications not only improve patient monitoring over large distances, but can also implicitly train rural health workers by giving them access to a global knowledge base about specialized medical services, rare diagnosis and breakthrough medical practices.

The above ideas about improving human capital in developing countries also implicated physical capital, which covers equipments and technologies, such as software and hardware. Such services would require seamless integration between the software developers (to create these applications), cellular carrier (to transmit information via text message), cloud computing providers (to deliver relevant information to the masses), and third party players (such as hospitals and clinics).

Financial Capital for Development and Information Technology

Financial capital includes financial services such as savings, loans, insurance, and the list can go on. Even though formal financial services are scarce in developing countries, the poor have numerous financial needs that are covered by informal money lenders (ROSCAs, Susu collectors, etc.), which may offer convenience, but are fraught with risk of fraud and mismanagement. Microfinance helped establish the link financial services to economic and social development, which incidentally covers the Millennium Development Goal of eradicating extreme poverty and hunger. The significance of technology in microfinance has already been highlighted on this blog through a variety of articles, which you can read by clicking on the various links.

Leaving aside microfinance, information technology can assist other development programs aimed at tackling hunger and poverty by reducing transaction costs faced by individual low-income traders (consider use of mobile banking and informational mobile applications that reduce information asymmetry in markets for farmers in rural areas).

Cloud Computing (Saas) in Microfinance – Benefits, Challenges and The Future

Last week’s article covered a comparison of cloud computing solution for microfinance institutions, with off-the-shelf software and propriety software. The article went on to discuss three benefits of cloud computing in the context of microfinance, and this post continues under the same topic.

4. Improved Internal Control Through Cloud Computing

Once automated procedures and real time reporting are in place, the microfinance institution can exercise better control over its operations across all its branches. Specific benefits of such a step can be:

• Reduced default rate through the administration of sound credit underwriting procedures – these procedures can be created to minimize default risk and loan officers will be obliged to adhere to these steps while approving loan applications.
• Better customer service through instant data availability – any queries from clients about the status of their loans can be immediately answered and any alarming behaviour on the part of clients can be promptly identified through real time data availability. Additionally, loan officers will have more time on their hands to deal with clients because paperwork will be minimized.
• Greater accuracy of internal and external reports – microfinance institutions need to give a detailed account of their activities to investors and creditors, as well as donors, which is a tedious and time consuming task, susceptible to deliberate and accidental inaccuracies. Automated reporting procedures eliminate this risk and provide instantaneous reports to multiple stakeholders.

5. Greater Data Security

Data security and protection is vital in every type of business and microfinance is no exception; however, microfinance institutions often setup numerous branches in far off areas, each collecting their own sets of client data, which makes back-up a hassle. Cloud computing software providers take care of data security themselves, regularly backing up all information and protecting servers against viruses as well.

Some Challenges of Cloud Computing For Microfinance

Cloud computing, like any other software solution for microfinance providers, is not without its risks, the biggest one of which is related to regulatory hurdles. Microfinance institutions are bound by different laws about reporting and information management across different countries and software solutions need to abide to those laws too. For instance, sometimes the main server must be hosted locally to ‘prevent discontinuation of operations during an internet blackout, and to keep a copy of all customer data locally’. For this reason, several information system hubs may be setup in different countries to cater specifically to local microfinance institutions.

Secondly, microfinance institutions with other forms of information system may face trouble adopting the new cloud computing solution, because employees must be retrained, data must be shifted to the new database, etc.

Thirdly, a large gap will be left behind by cloud computing vendors that go out of business, even though that is an unlikely scenario. Microfinance institutions must chalk out what happens to the data in such an event, before signing any agreements, and may further avoid this risk by selecting vendors with previous experience in this area.

The Future of Cloud Computing and Microfinance

Cloud computing has a lot of potential in the context of microfinance, as explained previously. The future will see greater penetration of this software solution as the microfinance sector transforms into an industry. Some notable cloud computing developers are setting up information system hubs in microfinance hotspots around the world, such as India, Kenya, and Brazil. These hubs will have the capacity to serve multiple MFIs simultaneously, drawing the benefit of scale economies to further drive down costs and improve outreach as well as product development.

The strategic implications of setting up microfinance information hubs around the world have been mentioned by Ashta and Patel (2010):

It would strengthen knowledge sharing across the region (and) increase opportunities for pricing discounts from vendors…regional coordination would enables sharing of IT staffing costs, which in turn offers opportunity to lower IT costs at the affiliate / partner level and can further lower their operating costs.

The dream is to enable high transferability of microfinance clients, whether it is from one MFI to another, from one mobile banking carrier to another, or even from an MFI to a commercial bank, if need arises. Of course, all this is only useful if costs are well under control, which is something cloud computing promises to offer.

Importance of Third Party Technology Players in Microfinance

One may appreciate that despite numerous challenges, the microfinance sector at the global level, over the last three decades, has experienced a sustained growth. However, the original objectives of microfinance and the business models adopted by a number of market players did not complement each other as some microfinance institutions saw this as an opportunity to maximize the return on their investment, instead of optimizing it. In support for this approach, some stakeholders may seek refuge in higher risks associated with microfinance lending as well as higher operational costs for doing the business; however, a number of risk mitigation options are now available to such MFIs.

Since the microfinance sector has been a seller’s market and consumers with no alternative were receptive to any financing options offered to them at the seller’s (microfinance institution’s) conditions. The microfinance sector is still largely an unexplored world with tremendous potential and it was eventually realized that microfinance clients need to be served in new ways, with new tools and products.

Initially, a number of microfinance institutions, some with a view to make quick money and others willing to make a positive difference, entered the field with great ease and aplomb but little or no tactical tools to assure and sustain their growth. These players having suffered from a lack of efficiencies and without operational controls or risk discipline indulged in wayward financing that not only harmed themselves, but also their clients.

However these experiences underscored that the latest challenges for the microfinance business world were:

• Risk management,
• Ever-increasing operational expenses,
• Outreach to far-off areas
• Difficulties in repayment process, and
• Loan recovery processes.

Therefore, issues like business efficiency, reduction in operational costs, software development and communications are becoming increasingly relevant to the success of microfinance.

There are two ways to overcome these challenges:

• Invest substantially in relevant business areas which, at the end of the day, would affect return on investments (ROI), or
• Engage third party players that offer specialized services related to overcoming these challenges.

Whichever path is taken, it can be safely assumed that today, for the success of any microfinance business model, the role of third parties is becoming increasingly important.

Similar to commercial banking, the dynamics of microfinance needs better technical tools for almost every step of the model, be it evaluation of prospective borrower’s profile, monitoring of repayment schedules, anticipating impending threats and taking remedial measures.

Understandably, credit bureaus are well positioned to fill in this void as they have the infrastructure in place and by adding information regarding microfinance borrowers and other clients, credit bureaus can offer to significantly reduce credit risk for microfinance institutions. Real time integration between credit bureaus and MFIs is enabled through the telecommunications sector, which also have a role to play in enhancing service outreach while controlling transport and other costs. Mobile banking can significantly lower the cost of delivering these services, as stated in a recent CGAP report.

In today’s business, manual or semi-computerized environments in microfinance institutions is a recipe for disaster. Only sound office management policies and operational controls can ensure effective risk management and reduction in administrative expenses. However, improving business efficiency often requires investment in software development and communications and that is where the real obstacle lies, because capital cost of such inputs is beyond the capacity of most microfinance institutions.

In such a scenario, specialized third party solution providers (be they manufacturers of off-the-shelf solutions or software hosted in the cloud) emerge as viable alternatives. These outfits have in-depth knowledge about microfinance as well as ability to service numerous customers under bilateral fee based agreements without compromising the information security of the constituents.

Such an arrangement, on one side, enables microfinance institutions to avoid related capital cost for technological implements and on the other, improves capacity building processes within the organization, and allows them to focus on their core business.

While operational efficiency and telecom related solutions are easy to handle, presently the concept of cloud computing is likely to face two major obstacles:

• local regulations for microfinance institutions vary from country to country,
• under the existing mind-set, microfinance institutions prefer to have physical control over their database.

Naturally, the first challenge is far easier to overcome than the second.

People are normally resistant to change so it would entail a long continuous awareness campaign on part of stakeholders (technology firms, microfinance investors, etc.) to change the psyche of microfinance practitioners engaged and to convince them that the emerging role of specialized third party players is going to change the dynamics of microfinance in favour of the MFIs.

Cloud Computing (Saas) in Microfinance – Risks and Benefits

Microfinance is witnessing a revolution on the front end, as microfinance institutions engage in product innovation and market exploration to serve diverse needs that venture beyond the financial realm. Naturally, this front-end revolution has driven a back-end revolution, that of the microfinance sector infrastructure, where cloud computing is the next big thing.

Cloud computing is also known as ‘Computing as a Service’ (CaaS), which includes the famous ‘Software as a Service’ (SaaS) model that is quickly gaining acceptance among microfinance institutions who wish to streamline their growing operations while keeping costs under control. SaaS models involve the provision of a complete suite of software applications through the internet to microfinance institutions (clients), who only access the software as and when needed, i.e. the software is provided on demand. Cloud computing goes a notch above SaaS because it covers the provision of on-demand software and hardware.

Before we go any further, one may stop and wonder why it is important for microfinance institutions (MFIs) to shift from manual processing to automated processing in the first place, considering MFIs have been relying on manual systems for years. This topic has been previously discussed through a blog post series about the role and importance of technology in microfinance. Once we determine the high-tech way is the right way for quickly growing microfinance institutions, the question arises as to why cloud computing is a good idea in the microfinance context, and the answer lies in the multiple benefits cloud computing has to offer MFIs.

The benefits of cloud computing are immense, but there are two sides to every story. This article discusses the advantages cloud computing promises to deliver to the microfinance sector and mentions a few problems associated with this model, accompanied by their solutions.

Benefits of Cloud Computing for Microfinance

The following benefits directly apply to microfinance institutions and indirectly impact microfinance clients and the microfinance sector.

1. Ease in Setup and Administration

The importance of a technology-based information system for microfinance institutions has already been established, and the next step is to determine which type of software is most suitable. A basic comparison of the three choices available to microfinance institutions in this regard explains why it is easiest to select cloud computing:

Comparison of Technology Solutions for Microfinance Institutions (Limited to Setup and Administration)
Technology Solution	Pros	Cons
Off-the-shelf software solution	Costs less (investment in plenty of hardware, such as servers, PCs, air conditioners, administrators, etc.)	Mew features May not cater to unique needs of MFI Need to train employees to use the software, Need to contact software developers for troubleshooting and support Regular maintenance required
Propriety software solution	Feature savvy	Costs more (investment in plenty of hardware and software programming fees) Need to train employees to use the software Need to contact software developers for troubleshooting Regular maintenance required
Hybrid between the two options, i.e. a software hosted in the cloud (cloud computing)	Costs are moderate (reduced hardware cost, no software programming fee, usage fee applies) Feature savvy Cloud computing service provider takes care of maintenance, support and software up-gradation	Employees need to be trained in the front-end area only (i.e. software usage) Internet connectivity is a must Cost of data migration

2. Cloud Computing and New Microfinance Services/Facilities

The cloud computing SaaS solution helps microfinance institutions introduce new services with relative ease, because the software developers handle all technical elements while the MFI can focus on product details (as well as serving their clients and maintain good repayment rates). For instance, together with a telecom firm, the CaaS team can setup a single mobile banking application on their platform that can be accessed by a variety of MFIs as they begin to roll out the service to their clients. In this instance, all that is needed is to integrate the microfinance provider’s information system with the mobile banking solution and they are ready to go.

Similarly, any decisions to rely on ATM networks and Point of Sale devices for remittances or loan disbursement can be quickly implemented throughout the microfinance sector if a centralized cloud computing hub integrates these applications. These hubs enable the easy portability of various financial and non-financial applications that are relevant to microfinance today, as mentioned in the following excerpt:

The network of partners in the hub permits interface with payment networks, remittance networks, credit bureaus, proprietary applications, ATM Networks/ switches, Mobile devices and national banking networks.(Jimenez 2008b).

3. Cloud Computing and Cost Control for Microfinance Institutions

The cloud computing SaaS solution uses an affordable pricing policy where microfinance institutions pay in accordance to the software usage (a fee is typically charged on a per-user basis), apart from a subscription fee. As a result, a small MFI can get away with using the information system for a small fee as a limited number of employees use the system to communicate details about a limited number of clients. The biggest benefit is that small microfinance providers can can enjoy the benefits of economies of scale despite their size.

On the other end of the spectrum, large MFIs pay discounted user-fees owing to the sheer size of their users (the aggregate fee is obviously more but the pricing is constructed in a manner that makes it economical compared to proprietary software). As their scale grows, the comparison between stand-alone solutions and cloud computing may shift in favour of the former, but as far as small and medium sized MFIs are concerned, the balance is in favour of the former.

This infrastructure-sharing mechanism along with the lower system development and maintenance cost enable microfinance institutions to control their operational expense in the long run, which will theoretically lower the high interest rates charged on microloans.

Next week’s article mentions a few other benefits of cloud computing in microfinance as well as a few risks.

Reference:
Jimenez, Alberto. 2008b. Microfinance Processing Hub: Latin America, Presentation at Asia Microfinance Forum, August 26 – 29, Hanoi, Vietnam.

Credit Scoring in Microfinance – Collecting Data and the Role of Technology

We have previously looked at the various benefits credit bureaus could deliver to microfinance clients, microfinance institutions, as well as to the entire economy, as well as ways to overcome challenges associated with credit bureaus in microfinance . This week we look at the variety of information sources used in credit scoring and the role of technology in this system.

Collecting Data for Credit Bureaus

Credit agencies typically develop credit data and risk profile based on data obtained from a variety of sources, such as banks, retailers, utility companies and government agencies; however, these sources are not always applicable in the microfinance context. The high-touch nature of the microfinance model means loan officers personally gather such information by analyzing the applicant’s business and family demographics. Even if all this information is freely available, which is often not the case, this leads to a more qualitative credit profile, rather than a quantitative credit score, giving way to accuracy problems.

Microfinance credit bureaus eliminate these problems, as loan officers instantaneously gain access to a wide array of verified information, allowing them to take well-calculated risks.

A variety of data may be amalgamated by credit bureaus, and updated regularly, to create reliable credit risk scores. These include:

Financial information about microfinance clients

• About the business: type, length, financial statements, outstanding dues to suppliers, receivables from customers, mobile banking accounts
• About the credit history: Number of previous loans (from all microfinance institutions), total outstanding loans, missed loan repayments, late repayments, on-time repayments and repayments made before schedule, nature of loan collateral, number of scheduled installments, details of previous affiliation with other microfinance institutions, nature of loan contract (group based or individual, and performance against each type of contract), types of loans taken out (housing loans, education loans), other financial products used (micro-savings, micro-insurance, etc.)
• About the family: assets (such as telephones, ownership of house), businesses run by members
• Other: any previous fraudulent behavior

Non-financial information about microfinance clients

• Identification information (to eliminate chance of fraud), family size and particulars of members
• Education and age of client, as well as length of time spent as client

Role of Technology in Microfinance Credit Bureaus

A solid information system is at the heart of a credit bureau, considering the plethora of information gathered and analyzed by these systems on a regular basis.

Microfinance Credit Bureau Architecture

The diagram briefly explains the information flows in a typical credit scoring setup (considering an external credit bureau is involved). Initially, the microfinance credit bureau database is loaded with information from various sources (banks, government, microfinance institutions, mobile banking firms, etc.) to form risk profiles, which are shared with loan officers from different MFIs, as and when requested. Since the communication channel is two-way, information about microfinance clients (new clients, loan repayments, etc.) is regularly sent to the credit bureau in different ways, as discussed later.

Client data is private, and is therefore sent in a secure environment where information is encrypted and password protected. At the same time, the credit bureau must ensure compliance with the regulatory framework of the company it operates in.

Nature of System Integration of Credit Bureau with Microfinance Institution

Credit bureaus can be integrated with the information systems of microfinance institutions in a manner that caters to the informational needs of loan officers. There are two basic types of system integration in this case:

• Real time information sharing: the credit bureau database can be linked directly with the core system of (large) microfinance institutions to instantaneously update the credit profile of borrowers.
• Intermittent information sharing: light-volume (small MFIs) users automatically transmit client information through internet connections in batches, at the end of the day, or when authorized. Similarly, when loan officers wish to determine a client’s credit score, they may send hundreds of queries in a single batch, or make individual inquiries. In return, microfinance institutions may simply receive blacklists of clients with poor credit scores, or detailed credit reports.

Having said this, the information system provider should preferably have a history of managing large sets of data, and attention should be paid to whether the firm has the relevant skills and capabilities of delivering such a complex project.

Reference:

Dutheil, M. (2006). Microfinance Bureaus : Balancing Vision and Pragmatic Solutions. Available: info.worldbank.org/etools/library/latestversion.asp?235943. Last accessed 2, April, 2010.

Credit Scoring in Microfinance – Overcoming Challenges

Last week’s article looked at the various benefits of credit scoring in microfinance; this week’s entry looks at different challenges related to setting up external credit scoring systems in microfinance and the ways to overcome them.

Setting up credit information bureaus in microfinance is no easy feat. Here are some challenges (and suggested solutions) that project developers must look out for:

MFIs Lack Technological Capability

Good credit scoring systems are complex and technology-dependant; however, many microfinance institutions lack the technological capability to use these systems. For instance, internet connectivity may be a problem in rural areas of developing countries, or the loan officers may lack the skills needed to fully utilize the functions of the credit bureau.

Solution: A variety of communication channels may be used to deliver credit scores, such as the internet, text messages, telephones, etc. MFIs may also have to undergo capacity building exercises to ensure they are ready to use the system; these would include trainings imparted to loan officers as well as build up of technological base as well as the setup of formalized credit screening and approval processes.

Asymmetry of Information

True, microfinance credit bureaus overcome the problem of information asymmetry for loan officers, but obtaining this information can be difficult to begin with because most information sources are informal and disparate.

Solution: microfinance institutions must all be on board to willingly share vital information about clients, which may help other microfinance institutions. This information must also be update regularly, so direct communication links between MFIs and the credit bureau may be formed.

Unrealistic Expectations From the Credit Scoring System

Microfinance institutions should not expect the technologically driven credit scoring system to replace a loan officer’s risk assessment activities. Experiences from the developed world show that complete reliance on credit scoring systems can often be detrimental. Technology is not always fool-proof.

Solution: MFIs should be aware that credit bureaus simply assist and complement a loan officer’s work because sometimes, qualitative analysis is more importance (e.g. a dishonest applicant). The following excerpt adeptly explains the role of credit scoring in a typical microfinance institution:

Scoring is a third voice in the credit committee, helping the loan officer and credit manager finalize decisions on cases that, without scoring, would be approved. In microfinance, scoring does not approve applicants who, without scoring, would have been rejected. Rather, scoring highlights cases that are riskier than the credit committee thought, leading to in-depth review and perhaps changes to the loan contract. Some very high-risk cases are rejected, and very low-risk cases are rewarded to improve loyalty (for example, with a line of credit or reduced interest rates). Source: Credit Scoring, Banks, and Microfinance: Balancing High-Tech with High-Touch

Reluctance on Part of MFIs to Use the Credit Scoring System

Microfinance institutions may be resistant to the idea of relying on credit scores, simply because the idea is foreign and requires money, or because it requires basic technological know-how, or even because it requires additional effort. Additionally, some MFIs may not wish to share detailed client data for fear of losing out on the competitive arena. Even a stellar credit scoring system is a failure if microfinance institutions do not use it.

Solution: microfinance institutions should be encouraged to adopt the credit scoring system by making the system simple, keeping membership fees to a minimum, training workers about using the system, showing them the expected value addition (read article about benefits of credit bureaus in microfinance) and managing the ‘change’ in work practices through change management techniques.

Reference:
Dellien, H and Schreiner, M. (2005). Credit Scoring, Banks, and Microfinance: Balancing High-Tech with High-Touch. Available: http://www.microfinance.com/English/Papers/Scoring_High_Tech_High_Touch.pdf. Last accessed 30th Oct 2010.

Importance of Credit Bureaus in Microfinance – Part 2

Four Types of Benefits of Credit Scoring for Microfinance Institutions…cont.

3. Marketing Benefits

Credit bureaus help differentiate promising borrowers from risky ones, and create micro-segments in accordance with the delinquency rates of prospective clients. Marketers in microfinance institutions can devise financial services to cater to each risk profile (such as micro-insurance for high-risk farmer, or micro-savings for medium-risk craftsman) and develop strategies to improve the collection rate as well.

4. Other managerial implications

Formal credit scoring systems are generally more accurate compared to manual risk assessment tools because they rely on explicit risk variables and employ the collective wisdom of all partner microfinance institutions. This helps promote prompt, standardized and reliable decisions, reduces the chance of fraudulent activities and quickly indentifies any negative trends in the portfolio quality, which may be rectified immediately.

To sum it up, here is what Dellien and Schreiner (2005) have to say:

Scoring for microfinance reduces arrears and conserves loan officers’ time, increasing profits and improving outreach. scoring can both increase portfolio size and reduce arrears. With many of the worst loans avoided, portfolio-at-risk (defined as the balance of any loan in arrears) also decreases. (For evidence, read their paper).

Benefits at Macro Level

Following the logic used earlier, if microfinance institutions benefit, the entire financial sector prospers. As mentioned in the Microfinance Hub Blog, credit bureaus encourage MFIs to collaborate through information sharing, instead of competing, and in the long run, the sector can limit default rates, check multiple borrowing and meet its social and financial objectives while ensuring institutional sustainability.

Data mining of credit bureaus not only helps supervise the microfinance sector’s performance but also facilitates economic research geared towards policy improvement. For instance, the pro-active discovery of negative trends, such as the accumulation of bad debt in a particular region, can alert policy makers and microfinance networks/associations and the problem can be address before it becomes a crisis. This was one of the lessons learned from the microfinance crisis in India and Morocco.

One of the reasons large financial institutions avoid lending to microfinance clients is because profiling clients based on personal information is difficult. However, credit bureaus eliminate this problem to a great extent and the entry barriers faced by large banks are lowered.

The result of all this, is a reduction in poverty.

Conclusion

Formal credit scoring processes can deliver numerous advantages, as explained in this article but credit bureaus may never fully replace the traditional loan approval process. This is because individuals characteristics of clients can make a big difference in the high-touch microfinance model. Nevertheless, credit bureaus do alter the traditional model and shift it towards the high-tech approach to consumer loans used by conventional financial institutions (Dellien and Schreiner, 2005).

Next week’s post talks about exactly that – technological elements, processes and key success factors of successful credit scoring systems in microfinance.

Further Reading and References:

Lenisa, F. (2007). The Importance of Credit Information & Credit Scoring for Micro Lending & Microfinance Institutions. Available: http://siteresources.worldbank.org/FSLP/Resources/FrankLenisa_CreditInformation.pdf. Last accessed 30th Oct 2010.

Dutheil, M. (2006). Microfinance Bureaus : Balancing Vision and Pragmatic Solutions. Available: info.worldbank.org/etools/library/latestversion.asp?235943. Last accessed 2, April, 2010.

Dellien, H and Schreiner, M. (2005). Credit Scoring, Banks, and Microfinance: Balancing High-Tech with High-Touch. Available: http://www.microfinance.com/English/Papers/Scoring_High_Tech_High_Touch.pdf. Last accessed 30th Oct 2010.

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