The importance of micro finance

The gini-co-efficient, the indicator of the economic chasm between rich and poor, shows South Africa in second place position behind Brazil for the widest gap. Most third world countries suffer extreme economic imbalance, resulting in political and economic instability. Most dual economies of the third world have long since determined that closing the gap depends on employment creation.

Traditional industries, however, will not provide sufficient opportunity for the majority of job seekers. Enabling of small and micro enterprise is embraced as a key strategy of wealth creation and employment in the third world by mainstream development agencies such as the World Bank. The main impediment to micro enterprise development is access to capital, rather than lack of capital in the financial market itself. What is needed is an improved capacity of the financial sector to meet the financial needs of micro enterprises.

Billions of AID dollars are channeled each year into developing financial markets to increase the diversity and aggregate numbers of players involved in the delivery of basic financial services to low income clients. Developing the micro finance sector depends on being able to make a business of intermediation at the low end of the market and the same rules apply here as with high street banking.

Efficiency and service provide the keys to success. Information technology (IT), which is so critical to commercial banking, is no less so for micro banking. Delivery of sustainable quality banking solutions for micro finance is now being seen as a cornerstone of this development strategy.

Most commercial banks lack the experience and incentives necessary to service micro entrepreneurs. Equally, small enterprises are unable to meet requirements of banks for obtaining loans. Cooperation therefore exists between banks and government in an attempt to enable an environment conducive to providing capital to small enterprise. But this, too, has had limited success.

The risk profile of a small business is prohibitive for banks to offer credit at usual commercial rates and the true costs of credit are too high for the small enterprise to sustain. Cross subsidisation between products exposes the bank to the risk of losing high value accounts on price, while it risks a skewed business focus. The usual reaction by banks to pressure from the social sector is to seek to attempt to secure micro credit with tangible assets.

The conundrum faced by small business is that of the chicken and the egg. Without access to capital, assets will not be accumulated and without assets, capital is not available from formal banks. The market is then left to a wide range of non-bank financial service providers that specialise in these niche markets and which are able to provide some level of service without conventional security.

These institutions target the small enterprise borrower and aim to provide financial services to low income clients. High volumes of relatively low value accounts characterise their portfolios. These financial institutions include:

* Credit Co-operatives: Savings and loan operations based on financial cooperative legislation and international conventions.

* Saving and Loans companies: Small-decentralised groups of micro bank niche players providing basic savings and loans services.

* Small and Micro Banks: Small decentralised groups of micro bank niche players providing basic savings and loans services.

* Development Credit Schemes: Usually government financed development schemes focussed on micro enterprise development

* Managed Loan Schemes: Internal credit schemes managed by employers associations, usually with payroll based savings products.

* NGO`s & Micro Finance Organisations: Credit providers for socio-economic development, some with forced savings/deposits related to lending but most with savings mobilisation as a component of their business development strategy.

* Other non-bank financial service providers

These players are numerous but tend to be dispersed, localised and limited in their scale of operations. The demand for services vastly outstrips supply.

Emerging markets, especially those undergoing structural adjustment, are producing many new small bank and non-bank financial intermediaries. We can count more than 100,000 formal registered players in the micro finance market in only 70 emerging market countries, not including China. These are co-operatives, savings and loans companies, NGOs and various other financial service providers registered with or affiliated to national and international associations.

There are many new entrants to the micro finance sector every day. Estimating the true numbers of players is only possible by extrapolating from known registered players and available data. The majority of private micro lenders do not show up on the radar.

Price and efficiency lie at the centre of the discussion on access to finance. In order to manage the risk of this sector, a comprehensive and efficient portfolio administration system is required. Small banks and micro finance lenders need to be able to lend against the credit worthiness of the borrower and be able to assess and manage risk in an environment where conventional legal and informational support systems do not exist. Various methods and practices are employed in service delivery but it is mainly client relationships and the promise of future services that discipline credit. Credit rationing should be based on competition. To keep the price of credit within the range of what is affordable while maintaining a profitable and attractive lending business administrative efficiency is critical.

Efficiency in banking comes from the use of modern baking information technology. Banking is information management. Micro lenders understand the needs of their clients and specialise in managing relationships. They operate in a very specific niche.

Typically, micro lenders are using outdated semi automated or manual systems to manage their business. This adds cost and detracts from their ability to serve their clients efficiently. The cost is passed on to the borrower, limiting the effectiveness of the institution and compromising access to financial services to micro entrepreneurs.

Champions of the micro-finance industry have often cited a lack of response from the IT industry to the need for appropriate banking solutions for micro finance. No doubt there is a role for credible providers of affordable technology to the many under-served small banks, financial co-operatives and other types of financial institutions in "emerging" financial markets. These institutions have a need for banking technology, but for them, the cost of entry-level banking systems is too high, or otherwise not available. Micro finance software should offer a range of established product definition options, adequate depth of client information and flexible standard reports.

It must also cater for the idiosyncratic methodologies, rare classes of client information and reports unique to micro banking. System design should be based on the kind of industry experience that comes from real industry knowledge from many installed sites over a period of years and a thorough knowledge of modern retail banking environments. Banking systems mature and stabilise over a period of a few years and cannot be built out of a limited experience. In addition to broad functionality, a modern banking application should be able to be scaled down to single user PC level or scaled up to large multi-branch environments. It takes business experience, credible in-country business partners, a constant investment in R&D and a long-term financial commitment to a market, to be successful over time.

Sponsors of micro finance can safely invest in the purchase of hardware, software, training and services without undermining the commercial viability of the relationship between the micro bank and the solutions provider. These are infrastructure investments. But the micro lender needs to be able to carry the real commercial costs of the on-going support and services agreements that accompany banking solutions in order for the technology to be sustainable.