Sustainability of

Financial Institutions:Financial Services for Poor People. What Works ?

Hanns Martin HagenSenior Sector Economist, KfW

European Forum forRural Development Cooperation

Montpellier, 4 - 7 September, 2002

Overview

1. Financial sustainability Definition & prerequisites KfW’s conceptual approach

2. Project examples Village Banks in Mali Microfinance Bank of Georgia

3. Lessons learnt Supporting sustainable rural (micro-)finance

4. Conclusions and issues for discussions

Financial SustainabilityDefinition

A rural financial institution is sustainable ...

if it is willing and able to provide self-reliantly and permanently financial services to the rural poor without external assistance or after assistance by donor or government has ended.

Financial SustainabilityPrerequisites (I)

(1) Lasting commitment to rural poor

(2) Adequate credit-technology and financial products (I)

(1) Unless it is clear to borrowers that the access to credit at the lending institution is permanent, repay-ment discipline is fairly likely to deteriorate.

(1) Only micro-loan technologies allow to grant loans to poor people that have never before received a loan by banks and may not have bankable loan securities.

Financial SustainabilityPrerequisites (II)

(2) Adequate credit-technology and financial products (II)

(3) Financial self-sufficiency

(1) The loan sizes must be small enough to be repayable in frequent, small instalments, but large enough for generating additional income.

(1) As long as the institution cannot cover all operating expenses with income form its financial operations, it remains dependent on donors or government.

Financial SustainabilityPrerequisites (III)

(4) Will to improve efficiency

(1) If competition is limited there is a danger that inefficiencies and delinquencies flourish, but remain hidden under cost-covering interest rates.

(1) Only cost-efficient institutions ensure that as great a portion of funding as possible reaches the hands of the poor.

Financial SustainabilityKfW‘s conceptual approach (I)

Reasons for support of sustainable rural financial institutions by German Financial Co-operation:

(1) contribution to rural poverty reduction(2) contribution to financial sector deepening and broadening

by integrating poor households into the system by developing and introducing new financial products

Financial SustainabilityKfW‘s conceptual approach (II)

Support mechanisms of German FC(1) support of financial retail mechanism

– “down-scaling”-strategies of commercial banks,– “up-grading” of finance NGOs,– “greenfield” establishment of new (micro-)

institutions,– refinancing garantees

(2) support of financial whole sale mechanisms– public sector whole-sale banks,– private refinancing institutions,– revolving loan funds.

45,6

54,275,1

28,9

Europe

Asia

Africa/MENA

Latin America

Summe laufendes Portfolio:DM 2,2 Mrd DM

Regional Structure of KfW‘s Current Microfinance Portfolio (EUR million)

Total current Portfolio:

EUR 204 Mioapprox. 30 % of total fin. Sect. Portfolio

(as of 12/2001)

Project example: Village Banks (caisses villageoises) in Mali

KfWBNDA

Government of Mali

„Service Commun“ VBA VBA VBA

VBVB VBVB VB VBVB

Village banks members

grant

BMZ

Caisses Villageoises: Poverty Outreach, Financial Performance

Poverty outreach: over 500,000 poor clients reached (80 % of which with a

daily income of less than USD 1 per day) 150 village banks with 65,000 members and 8 VBA

Adequate lending technology: Repayment rates of the banks: > 95 % Repayment rates of VBA vis-à-vis BNDA: 100% Total outstanding loan portfolio: US-$ 3.1 Mio

Caisses Villageoises: Financial Self-sufficiency, Efficiency, Structural Impact

Financial self-sufficiency: on average 98.2 % of adjusted operating expenses are

covered by adjusted income from financial operations

Efficiency: Acceptable administrative efficiency: 24 % (1998: 41 %)

Structural impact: Savings collected constitute 2/3 of refinancing volume sustainable linking of self-help groups of the informal

sector with the formal banking sector

Project Example: Microfinance Bank of Georgia

FC (KfW)FC (KfW) Government of GeorgiaGovernment of Georgia

German-Georgian Foundation

MicrofinanceBank of Georgia

Small and micro entrepreneurs (since 1999), Small and micro entrepreneurs (since 1999), Rural Poor (since 2001)Rural Poor (since 2001)

FC

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Mar

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EquityEquity20 %20 %

LoanLoan

Other Other investors:investors:TBC 17 %TBC 17 %IFC 16 %IFC 16 %Co. 15 %Co. 15 %

IMI, FMO, EBRD IMI, FMO, EBRD je 10 %je 10 %

Microfinance Bank of Georgia : Poverty Outreach, Financial Performance

Poverty outreach: 20,550 loans outstanding (12/2001), 97 % of which

granted to micro-enterprises with less than 10 employees since 12/2001 expansion of outreach to poor households

in rural areas (currently less than 2 % of outstanding loans)

Adequate lending technology: portfolio at risk: 1.4 % Total outstanding loan portfolio: US-$ 27.6 Mio

Microfinance Bank of Georgia : Financial Self-sufficiency, Efficiency, Structural Impact

Financial self-sufficiency: return on average assets: 1.7 % (1999: -5.1 %)

Efficiency: Good administrative efficiency: 10.2 %

(1999: 12.4 %)

Structural impact: establishing “green-field” financial institution for micro-

finance first bank in Georgia to offer loans to small and micro

enterprises, some institutions prepare to follow

Lessons Learnt: Supporting Sustainable Rural (Micro-) finance (I)

(A) Providing a TA-Package to assist in either the launching a new financial institution (e.g. case of Georgia) or the development of existing institutions in the direction of sustainability:

1) devising methods of providing loans, deposits, payment services to the rural poor

2) designing and implementing organisational structures that allow an effective and cost-efficient provision of the financial services to the rural poor

Lessons Learnt: Supporting Sustainable Rural (Micro-) finance (II)

(A) Providing a TA-Package:

3) to developing concepts of organisational development that lead to the establishment of a formalised rural financial institutions

4) to implement information technology (IT) systems specifically adapted to rural (micro-) finance institutions

(B) Taking an active role as shareholder in balancing the forces in the management and the supervisory board that advocate a profit oriented approach and those that primarily seek development policy goals

To Conclude...

Even financial institutions which focus solely on the rural poor can attain sustainability, if they meet the outlined requirements (prerequisites).

Donors can foster the development towards sustainability by providing TA packages, funding the start-up phase or by taking an active role as the institution’s shareholder.

I am confident that this forum will help to identify further policy recommendations that may help to tackle rural poverty even more effective through sustainable financial institutions.

Issues for Discussion (I)

(1) The project examples from Mali and Georgia suggest that institutions with larger average loan sizes reach financial self-sufficiency earlier. What is your experience ? Is there a trade-off between poverty outreach and financial self-sufficiency ?

(2) In case of the Microfinance Bank of Georgia, the institution focussed during the start-up phase on micro, small and medium sized enterprises. Only since the end of 2001, the institution has started loans to the rural poor. Are such “mixed” programs suitable for rural poverty alleviation ? a) They have the possibility of cross-subsidizing lending to the rural poor from provitable lending to the less poor. b) There is the risk that funds allocated for the poor are leaked to the non-poor.

Issues for Discussion (II)

(3) What exit strategies can donors as shareholders of rural (micro-) banks chose in order to ensure that the rural financial institution remains pro-poor even after the exit ?