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.

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.

Technology and Microfinance Services Part II: International Remittance

Migrant worker sent over $550 billion in remittances to their home countries in 2008, which is almost 20 times the total US budget for international aid. No doubt, international remittance services offer a lucrative opportunity for microfinance institutions (MFIs) and mobile banking operators because most workers rely on informal methods to send money home since they lack access to banks.

To offer international fund transfer services to clients, MFIs and mobile banking operators must leverage linkages with money transfer operators (MTOs) within migrant-sending countries (Pakistan, India, Philippines, Bangladesh, Mexico, Poland, etc.) as well as within migrant-receiving countries (Saudi Arabia, USA, Australia, Russia, Germany, among others; see map). Since this post series is about the role of technology in microfinance services, this particular article limits itself to international remittances. (Part 1, which looked at the different technological elements of mobile banking, is a supporting post.)

Basic Requirements of Information Systems That Handle Remittances

Any effective remittance system must possess the following capabilities (Hastings, 2006):

Managing large volumes of low value transactions at low costs

Ensure speedy delivery of funds across the globe

Ensure safety and privacy of transaction orders (encrypted files are sent through different servers to communicate details about credit card numbers, bank account numbers, remittance amount, subscriber’s mobile phone number, etc.)

Interlinking with different MTOs (microfinance bank, exchange firms and money service bureaus, such as Western Union, Dollar East, MoneyGram, etc.) and clearance houses in numerous countries.

Getting Money From Customers

Customers can send remittances in a variety of ways, some of which are:

Visit MFI in person and hand over funds that are to be remitted,

Use their mobile wallets to transfer funds internationally (see previous article on mechanics of mobile banking), and

Deposit cash through specialized kiosks or extensive ATM networks electronically integrated with a variety of MFIs (details in next week’s article).

Processing in Banking Hub

Transaction details are conveyed to the information system so they may be processed along the following dimensions.

Service pricing: Each MTO has a unique service charge for different countries, and an MTO’s information platform must select the most economical option for each transaction. The World Bank has published a list of remittance prices across the world for various MTOs, which individuals as well as MFIs can leverage.

Exchange rate handling: banking systems (of the remittance-sending bank) must also determine the most favourable daily exchange rate, which varies from MTO to MTO by a few decimal points. (These decimal points make a big impact when the aggregate transaction size is large.) Exchange rates also come into play when MFIs deposit funds as floats in their bank accounts with various banks in the remittance-receiving countries.

Communicating transaction details: payment instructions and details (credit card number, account number, amount, receiver’s mobile phone numbers, etc.) are sent via the internet to the partner MTO’s system. If the remittance-sending MTO relies on its own processing system, a bridging interface may be used to connect the two portals, or the sending partner’s interface may suffice on its own.

Account settlement: the final account is settled by the core banking system (through an auxiliary application system, in the case of mobile banking – read more) behind the scene as the individual draws money out of the system. There are two ways this transaction is finalized:

Pull transaction: sometimes, a remittance-sender may not specify a bank from which his/her family can collect the money. In that case, the MTO stores transaction details and instruction in cloud computing system which can be accessed by various banks in the remittance-receiving country (provided the MTO owns bank accounts into those institutions). All transactions are pooled in the cloud and ‘pulled’ individually by banks as needed.

Push transaction: when remittance-senders specify the receiving bank, MTOs simply push the transaction instructions to that bank.

Compliance: lastly, information systems ensure compliance with regulatory standards related to customer authentication, documentation, reporting, fraud prevention, etc.

Giving Money to Customers

Three basic options allow the remitted funds to come under the possession of family members back home:

Place money in the relevant bank account at the microfinance institution

Deliver cash directly to individual, or

Deposit the funds in the relevant mobile wallet account, where it can be used for various purposes (read more).

This concludes the second article in the post-series about the role of technology in microfinance services. Part 1 looked at the various technological elements of mobile banking. Next week’s post will discuss how technology enables the setup of ATM networks and POS terminals in microfinance.

Reference:

Hastings, A. (2006). Entry of MFIs into the Remittance Market: Opportunities and Challenges. Available: http://www.google.com/url?sa=t&source=web&cd=1&ved=0CBQQFjAA&url=http%3A%2F%2Fwww.microcreditsummit.org%2Fpapers%2FWorkshops%2F23_Hastings.pdf&ei=G2-STM6YNc6XceeSxLUG&usg=AFQjCNED_bGYoqf7J0NvrtI-4NrIO. Last accessed 10th Sept

Technology and Microfinance Services Part I: Mobile Banking

Over the last decade, microfinance has quickly evolved into a complex sector with a lot of third-party service providers participating in the overall supply chain. Telecom operators, credit information bureaus, ATM and POS network providers, and specialized information system developers are some of the new entrants in the sector, each offering a unique benefit to microfinance institutes (MFIs). This post-series looks at how technology has shaped the dynamics of the microfinance sector, making it more resilient and expansive.

Mobile banking has taken certain economies in the developing world by storm, in some cases acting as a link between the microfinance mission and the poor (even though the reach of mobile banking solutions is far beyond this market segment). Made possible by specialized technology platforms that enable the delivery of financial services through mobile phones, mobile banking is now accessible to anyone with a cell phone and mobile reception. This article specifically looks at how technology enables the provision of the mobile banking service.

Interoperability of Mobile Banking Technology Solutions

The type of mobile banking technology solution depends on where it is hosted and who interacts with it, (as depicted in the Figure 1; credit: Gauravonomics.com), which is sometimes determined by the mobile banking model being followed (bank-focused, bank-led and non-bank-led models). For instance, a bank may operate its own mobile virtual network (MVN) in a bank-focused model, while a mobile operator hosted mobile banking platform is more appropriate for a non-bank-led model (which are run primarily by telecom firms, e.g. Kenya’s M-Pesa and Philippine’s Smart Money).

Any solution hosted with selected banks or mobile operators will limit branchless banking’s progress in the long run as new entrants must evaluate the capital requirements of self-hosting or the ramifications of collaborating with old players in the market. The diagram shows a third alternative, ‘third party hosted mobile banking platform with bank and mobile operator interoperability’ (labelled ’8′), or in other words, cloud computing (which is particularly suited to add value to the developing world). As a number of participants (telecom firms, banks, credit bureaus, network agents, retailers, utility firms, etc.) connect to one another through a single interface, they can gain certain efficiencies that can lower costs and drive growth.

Functions Performed by Mobile Banking Technology Solutions

The range of services supported by advances mobile banking technology platforms is impressive by all means, as it includes:

Airtime purchase / balance recharge

Funds deposit and withdrawal

Fund transfer from one client to another

Mobile wallet functionality

Microloan distribution and collection

Foreign remittance handling, and

Interbank funds transfers.

Different functions are performed to process these transactions in a safe, accurate and timely manner, as explained next.

Sending Data Over the Wireless Carrier

Text messages sent by clients reach the bank’s database instantaneously and securely thanks to advances in technology. Data travels in the form of Short Message Service (SMS) through a wireless carrier network (MNO’s network) and reaches a Short Message Service Centre (SMSC), which acts as an intermediary between the MNO and bank. Once these instructions are converted into a format that can be sent over the internet (HTTP or SMPP), the SMSC interacts with the bank’s specialized mobile banking application, which deals with the bank’s core financial technology solution. (See a detailed diagram). Data is sent back the same way.

These SMSCs have the capability of instantaneously processing messages in bulk so the mobile banking experience is as smooth as possible for client.

Types of Mobile Banking Applications in the SMSC

Each type of mobile banking transaction needs a different application. For instance, the process explained above starts from the customer’s end as s/he requests specific information from the bank’s database, hence a ‘Pull’ application is used to receive customer requests and forward them to the bank’s technology platform.

Alternatively, the bank could initiate the communication through an ‘E-mail to Mobile’ (E2M) application which converts promotional/informational e-mails received from banks into an SMS that can be forwarded to multiple users. The third type of mobile banking application is called ‘Database to Mobile’ (D2M) where any changes made to the client’s account (use of credit card, money deposit, etc.) are automatically conveyed to the client’s cellphone.

Data Security in Mobile Banking

Mobile banking offers no value if transactions are not secure. In order to avoid spam and theft of personal/financial information, all text messages are encrypted, passed through a firewall and verified through digital signatures.

Next week’s post will focus on the role technology plays in transactions related to international remittances services (published).