Austin Harris, KF11 Rwanda

Microfinance institutes (MFI’s) and large, commercial banks have traditionally offered different loan products and catered to a different clientele.  Most notably, MFI’s offer loans that are too small for large, commercial banks to consider.  In addition, microloans are distinctly different from traditional bank loans in that commercial bank loans are typically secured and offered at interest rates that are lower than those of microloans. Recently, however, large banks have been venturing into the microfinance realm, offering small loans that compete with the loans of MFI’s.  Rwandan MFI’s, like many other MFI’s in developing countries, are now being faced with competition from a large, commercial bank.  This new development may have potentially large impact on Rwandan MFI’s and for the industry in general.  It remains to be seen the extent of the impact from this competition, who will survive and succeed, and what adjustments will need to be made for continued existence.

Banking in Africa

Private, domestic commercial banking is a relatively recent occurrence in many developing countries, especially in Africa. Up until a few decades ago, financial systems in many developing countries were primarily composed of state-owned banks and branches of foreign-owned commercial banks.  Many restrictions, including interest rate ceilings and high reserve requirements, largely prohibited these banks from servicing a higher-cost and riskier microfinance clientele.  With the introduction of structural adjustments and financial liberalization in the 1980’s, private domestic commercial banking expanded rapidly. Even with this expansion, most large, commercial banks favored large accounts of an established clientele. Although the new regulatory environment was more favorable, these new commercial bankers were unlikely to provide loans to micro-entrepreneurs.

Reasons for Avoiding Microfinance

For most large, commercial banks, microfinance was outside of their scope and remained unappealing.  Micro-enterprises were viewed as unstable businesses with small, if any, cash reserves, reinforcing the belief that loans made to this clientele would have a higher rate of delinquencies and/or defaults. Since these micro-enterprises often lacked the ability to provide traditional collateral, they could not guarantee their loans well.  All these factors contributed to the higher risk of these loans and precluded large, commercial banks from offering these products.

In addition to high risk, many bankers believed microloans to be inefficient and costly.  Microloans are typically short term and have frequent repayments.  Administering these loans often take the same, if not more, time than a larger loan, however they yield far less income.  In addition, since a credit history of microenterprises is often unknown, microloans to these enterprises can require great monitoring, contributing more to the cost.

Large, commercial banks have also been reluctant to enter into microfinance due to the structural and operational adjustments required for the bank to offer these products. Microloans are often of shorter duration and given to a group, rather than an individual.  In addition, microloans often do not require collateral, and are based more heavily on character.  Lastly, repayments are much more frequent and monitoring of borrowers is usually more critical.  Adjusting these structures can prove difficult, time consuming and expensive.  In addition, commercial banks are also limited by standards and regulatory requirements, often making unsecured lending, and risky loans inappropriate.

A Change in the Microfinance Landscape

The sustainability and even profitability of many MFI’s have caught the attention of many large, commercial banks.  Banks that are seeing the benefits of operating in microfinance are making adjustments to achieve success in this industry. An increasing number of large, commercial banks have implemented microfinance products, services, and procedures such as high, cost-covering interest rates, flexible short-term loans, frequent repayment schedules, minimal to no collateral, and quick disbursement practices.  These banks have also decentralized the client service model, providing customer service and credit decisions at the branch level.  Also, authority has been delegated to individual loan officers on the local level who have a large role in approving loans.

In addition, these large, commercial banks have started to appreciate advantages they may have over MFI’s, increasing their chance of success in the industry.  They are using some of their following advantages to succeed:

  • The existence of a developed, physical infrastructure, including a large network of branches, enables these banks to reach a substantial number of microfinance clients.
  • Established internal controls and accounting systems increase their ability to keep track of a large number of transactions.
  • These banks already have a large source of funding through deposits and equity capital, making them less dependent on donor funding.
  • They offer other financial services, such as deposits and insurance, that can be attractive to a microfinance clientele.

Some commercial banks have utilized these advantages and successfully moved into microfinance, exhibiting that with the right methodology and practices large banks can be successful with these microfinance products.

Changes in Microfinance in Rwanda

Kenya Central Bank (KCB) is a financial services provider headquartered in Nairobi, Kenya.  It has assets of more than US$ 2 billion, making it one of the largest three commercial banks in the country.  KCB has extended its operations to other parts of Africa, including Southern Sudan, Uganda, and recently Rwanda.  KCB historically operated as a traditional, large bank, offering larger sized loans, however this bank has recently started offering microloans.  In Rwanda, KCB now offers loans as small as RWF 300,000 (approx. US$ 510), putting it in direct competition with MFI’s in the country.  In addition, for the RWF 300,000 loans, interest can be as low as 16.25%, making it significantly lower than that offered by most MFI’s in the country.  For example, the interest on these loans is less than half of the interest of most loans offered by Urwego Opportunity Bank (UOB) and Vision Finance Bank (VFC), the two largest MFI’s in Rwanda who together comprise over half the microfinance market in the country.

The microloans offered my KCB may lure many microfinance clients to these products. There are, however, still differences between the loans offered by MFI’s and KCB that may be reason for many clients not to switch to KCB products.  Many microfinance clients may not qualify for loans as large as RWF 300,000, making these KCB microloans unreachable for many.  For example, UOB offers loans as small as RWF 50,000 (approx. US$85), which is a more realistic starting point for many clients.  Also, KCB still requires collateral, which many of the MFI’s do not.  For many of Rwanda’s poor, they cannot afford to provide collateral, making these loans unfeasible.  In addition, many Rwandan MFI’s have branches in regions where KCB does not operate.  This is especially true for rural regions where large banks do not believe it profitable to operate.  Lastly, MFI’s already have a successful system of loan distribution and monitoring for microloans that KCB has not thoroughly established.

Future of Microfinance

For the most part, microlending still constitutes a relatively small share of the total portfolio for large, commercial banks.  Though a small percentage, it may have a major impact on existing MFI’s.  Those clients who can switch to the lower interest loans of large, commercial banks may do so.  This may threaten the continued sustainability of MFI’s in Rwanda, especially since the larger loan clients, who proportionally generate more income for the MFI, are the most likely to switch to these lower interest loans.

One argument is that the entrance of large, commercial banks into microfinance is both desirable and essential.  The lowering of interest rates on microloans better enables the poor to achieve financial success and overcome poverty.  In addition, large, commercial banks have a much greater presence in financial markets and have the ability to make a much larger impact on poverty.  The potential improvements for microfinance clients, however, may mean the inability for many smaller MFI’s to provide attractive interest rates that can cover their operational costs.

One effect of the movement of large, commercial banks into microfinance is that more MFI’s are operating more like conventional banks in order to compete. Many microfinance banks are taking deposits and adopting more conventional banking strategies to gain customers.  A potential downside of this change in microfinance banks is that it may become too costly to provide competitive interest rates for many of the rural poor, who proportionally are more expensive to serve.

The ultimate effects of KCB’s new microloans remain to be seen in Rwanda.  There are great potential benefits for microfinance clients from the more affordable financing.  There is, at the same time, a potential threat that MFI’s will no longer be able to compete.  These new microloan products from larger commercial banks will, for better and worse, change the landscape of the microfinance industry.

Austin Harris is a Kiva Fellow with Urwego Opportunity Bank in Rwanda.  He is also a member of the Friends of Urwego lending group.

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