D+C Development and Cooperation (No. 1, January/February 2001,
p. 15-17)

Out of the manifold experiences of development assistance in the microfinance sector during the last two decades, one of the most promising concepts to have emerged is the founding of micro-enterprise banks that are both socially and commercially oriented. In the meantime, this concept has been realised in a number of countries. It assumes that normal commercial banks are not suitable for engagement in the social sector, but that a business approach is needed if microfinance institutions are to be capable of surviving.

Micro-enterprise banks (MEBs) have come into being in Albania, Bosnia, Georgia and even Kosovo during the last two years. Others are in preparatory stages in countries such as Mozambique, Ghana, Haiti and the Philippines. The MEBs grant many small loans, offer investment opportunities, and handle their customers' payment transactions at home and abroad. They are licensed by and under the control of local banking supervisory bodies. They are growing fast and expanding their branch networks.

Direct observation and simple arithmetics show that the banks make a substantial contribution to local finance systems and thus to their countries' economic development. Their input to development is socially relevant above all because they offer their services first and foremost to the kinds of customers in which existing local banks appear to have no interest. Apart from the jobs in the small enterprises they finance, the banks themselves offer many young people skilled employment. In addition, these small banks make a profit. They also have private investors, who are becoming more and more important to them.

All that appears to be quite astonishing, most of all perhaps because MEB are founded as development assistance projects. A consensus has emerged in development cooperation in recent years in which institutions such as MEBs appear to be a new model.

The list of examples of successful financial institution-building previously cited the Banco Sol and Caja los Andes in Bolivia, Calpiá in El Salvador, and BRI/Unit Desa in Indonesia. The MEBs are the newcomers on this list, and their success can already be noted from their figures. A more precise analysis seeking to isolate the quantitative influence of their various success factors, including that of donor inputs, would require more data than is available due to the newness of the MEBs. But what already appears to be clear is that establishing new banks is a promising new approach in the microfinance sector.

Learning from experience

The new approach is an attempt to draw lessons from the positive and negative experiences of financing development and implement them. An initial and very positive lesson relates to the methods of granting loans. It is indeed possible to grant, with tolerable costs and a very low repayment default rate, microcredits to people whom conventional bankers view as not creditworthy and in whom established banks have no interest.

This methodology is neither a secret nor difficult to learn. However, it is not compatible with the organisational structures and processes of customary banks, which are focused on other business fields and target groups. That is the second lesson, drawn from many so-called downscaling projects. To be successful at granting small-scale and micro-loans, a bank must be capable and willing to go in for far-reaching decentralisation of decision-making, agree to performance-related pay, and offer skilled employees credible job and promotion prospects. And to achieve that the bank must also grow. As a counterbalance to decentralisation, bank staff must be very well-trained and highly motivated, and sophisticated control mechanisms must be in place.

These considerations are good reasons for offering financial services for "small" people through special institutions. This was attempted in the past by the strategy of upgrading existing loan-granting NGOs by external support. The experiences with upgrading were in part very good, but some of them were problematical.

The third lesson is clearly positive. It is indeed possible, with acceptable expenditure of development assistance funds, to upgrade an existing institution and transform it into an efficient bank for "small" customers. The micro-banks in Bolivia and El Salvador are classic examples. Measured by the many upgrading attempts, however, the number of successful cases is small. And that brings us to the fourth and rather negative lesson. Upgrading has inherent limits. Positions based on power and self-interest arise in the process of developing and promoting existing institutions, and they obstruct a project's progress. The manager or founder/initiator of an externally promoted and relatively successful loan-granting NGO naturally has little interest in his or her institution becoming a "proper bank" for whose management they would not be suitable, if due only to the banking supervisory body's qualification requirements. The donors, too, who usually have financed the expensive first stage of an upgrading process, regrettably often do not see themselves as owners and advocates of the promoted institutions and, above all, of the target groups they have not yet reached. As a rule, they are satisfied with what has been achieved. They avoid a confrontation with those who defend their positions and thereby impede further development of the institution, even if this is desirable in developmental terms.

It is precisely successful institution-strengthening that aggravates the dichotomy between those who have attained influential and prestigious positions and want to protect their interests and the interests of the target groups and the bank's employees in expanding the institution. This conflict, for which there is plenty of empirical proof, has a structural cause. NGOs have no owners that have an "objective" interest in the long-term financial and developmental success of the projects and will therefore assume a constructive role. Formalising the institution changes nothing so long as there is not at the same time a substantial change in the ownership structure.

Setting up new
microfinance banks

The new approach differs in two respects from customary institution-building by upgrading. First, the phases of institution-strengthening ahead of formalising and transforming are leapfrogged. Instead of expanding and converting an NGO, it is about setting up a new microfinance bank. Second, the issues of ownership and governance are clarified from the start based on the perspective of medium-term development. But the more technical problems of granting loans and the design of the institution can be solved largely according to proven models.

Setting up a bank from scratch in a developing or transformation country involves a number of steps. The first is project identification. The main question here is whether the project could make developmental sense. The second step is to assess whether a new bank is really necessary and meaningful in developmental terms, economically sound and politically feasible. Economic soundness is assessed under the assumption that for the initial phase technical assistance and refinancing of the first loans on favourable terms can be procured. Without these, the projects could not be implemented at precisely the time when they appeared to be particularly important for development.

In the third step, provisional consensus must be reached among potential investors and the so-called sponsor, who is to build up the bank in technical terms and manage it during its early days. In addition, knock-on financing from one or more donors must be secured. Potential investors are national and international development institutions such as the German Reconstruction Loan Corporation (KfW), the German Investment and Development Company (DEG), the Dutch FMO, the European Bank for Reconstrcution and Development (EBRD) and the World Bank's International Finance Corporation (IFC). Private foundations such as the DOEN Foundation, holding companies such as IMI or Profund, and commercial banks (Germany's Commerzbank is an investor in the Kosovo MEB) are possible players as well. Local partners can be local banks (as in Georgia, Haiti and Mozambique), foundations (Albania), and companies (the Philippines). What is decisive for potential inclusion as an international investor is first to be willing and able to play an active role as an owner and be present on the board of the new bank. The second requirement is to contribute to the success of the project above and beyond having a capital stake in it. The third condition is to share the concept of a commercially-oriented strategy of institution-building that is nevertheless committed to development.

The second condition can be fulfilled by, for example, an investor also functioning as a donor and providing Technical Cooperation funds or loans or procuring them from pure donors. If the other two conditions were not met, coordination would be too difficult. The group of possible investors who fulfil all the prerequisites is very limited. Investors who had only capital to offer would be quite easy to find. But including them in the setting-up phase would only hamper coordination. In principle, the development institutions are possible project sponsors, who should also be investors. But in practice there is more a tendency to call in a private company with relevant experience. In the examples cited above, the sponsor is the IPC company, of Frankfurt, and in Latin America the Accion company plays a similar role.

The fourth step is to develop a business plan. This forms the basis for a binding commitment by the investors, the sponsors and, if applicable, the donors. The plan also covers the founding of a local company as the legal entity responsible for the future bank, the application for a bank licence, and the technical preparation for opening the bank including recruiting and training local staff.

If the entire process is completed quickly, it takes a year. Based on experience, compared with upgrading projects the time needed for setting up a functioning bank is shorter, the cost to donors lower and the chances of success greater.

Success depends on
natural trust and experience

The success of the new banks promotes their employees' commitment and loyalty and strengthens the link between investors and sponsors. It thereby reinforces precisely the factors that are required of them to allow this success to occur. That is why time and again the same actors get together in various projects as international investors, sponsors and donors. All parties must know each other well and have well-founded trust in each other for fast and successful handling of the process. And only a rapid sequence of similar projects involving the same actors offers the opportunity of transferring knowledge, including qualified staff, from one "building site" to the next. Where if not in similar projects, can someone who is to set up and manage a microfinance bank or their loans department learn how to do it? Where, other than in a "sister" project, are local staff to be trained before the bank is opened? Where, other than in similar and effectively linked banks, are there the opportunities of advancement which must be offered to the best local staff in order to strengthen their motivation and retain them?

A rapid sequence of bank foundings amid a largely stable group of partners is indeed a substantial part of the "formula for success". This formula appears so promising to those involved that leading development organisations such as the IFC, KfW and EBRD, whose prestige could be permanently harmed by developmental and financial failures, are tying themselves to it. In addition, individuals such as the private shareholders in IMI, who know what is at stake, are putting large parts of their savings into the foundings.

Reservations and problems

Founding banks for "small" customers as a developmental concept naturally also has weaknesses. Five problems and reservations are taken up here.

1. As already noted, the building up of microfinance banks demands intensive, close and durable cooperation between many partners, who should make substantial inputs. It also requires a great degree of commitment and mutual trust. But trust is largely an interpersonal factor and therefore transient. The people who in recent years developed the informal coalitions from which the MEBs mentioned above emerged, are integrated in organisations that have their own agendas and of course are not adjusted in an ideal way to the requirements of these projects. In addition, these people could at any time lose their positions in their organisations. One also cannot exclude the possibility that one project will prove to be a real failure. Or one partner could abuse the trust of another. So far, no-one knows what happens in such a case. The balance is still unstable. Efforts are being made to achieve stability, but it remains to be seen how effective they will be.
2. The coalition of international investors, sponsors and donors mentioned above is to date the only one of its kind. That creates barriers to market entry for the relevant service offers. Competition is desirable. But due to the tasks to be solved, possible competitors must also be networks and coalitions. There are in fact efforts to enable competition to emerge. The IFC is making a purposeful attempt to set up "dual sourcing" of the services for setting up the banks. But so far they have had little success. Besides these "real" problems, there are others which are problems mainly because they have been declared to be such. They relate to the exit of international investors, the role of local investors, and the general justification of development assistance for projects which according to their concept are to make a profit.
3. To plan the retreat of the international investors from the newly-founded banks at this early stage would throw the incentive into doubt at all levels. Later, there will in any case be a market-based solution to the withdrawal problem for individual investors, meaning a sales opportunity, if the new banks continue to develop as well as they have to date. The more far-reaching notion that a withdrawal of all foreign investors for developmental reasons would be desirable or even required is no longer in keeping with the times. In the age of globalisation there is no objective general reason why a bank in Georgia should have only Georgian owners. By contrast, the qualification of local bank staff is an expectation that makes developmental sense. This can be well achieved by founding new banks. Their managerial staff are in many cases recruited among employees who have learned their trade in other developing and transformation countries.
4. Experience to date also does not reveal why it should in general make sense to have local investors and in particular local banks take stakes in the newly set up institutions. It depends entirely from case to case on whether a local holding tends to serve or harm the project goal of strengthening a country's finance system and improving the offer of financial services for "small" people.
5. Is it at all justifiable to promote the founding of microfinance banks with development assistance funds that are designed to be profitable in a relatively short time? The question is complex. At any rate, public subsidies appear to be justifiable if these banks could not be founded without them. Based on assumptions, and in all previous cases, this seems to be the case. The risks of the projects are incalculable. As is repeatedly and absolutely rightly proclaimed, whoever wishes to create linkages between private initiative and private risk capital and development projects must also accept that these ventures go forward successfully. That is, after all, their developmental goal.

The determination of the MEBs' target groups also appears to make developmental sense. Micro-enterprises can often obtain small loans on the informal market or from permanently subsidised NGOs, and normal banks offer large loans. But there is often a gap between these options, which puts a brake on the growth of small-scale enterprises which would outgrow the status of "micros" if only they could get loans. The MEBs are seeking to close this gap.

All this says nothing about the relative value of promoting the founding of MEBs compared to other projects in the finance sector. Relevant alternatives would be upgrading and downgrading projects, promoting existing loan-granting NGOs, as well as banks for medium-sized and larger businesses such as the "promotion banks" initiated by the KfW, and locally-owned banks. There has so far been no methodically demanding examination of the relative advantages of these developmental alternatives. It is overdue.