Innovations in Microfinance in Southeast Asia_2 potx

Rather, credit scoring is seen as a tool which would supplement and refine the traditional credit technology by add-ing a “third voice” to the credit committee and making credit risk man

230 Mark Schreiner

• Formal savings account

o Date opened

o Passbook and/or time deposit

• Frequency of receipt of remittances

Business “Demographics”

• Sector (manufacturing, services, trade, agriculture, other)

• Specific type of business (construct a list of 30–50 context-specific)

• Year started

• Formalisation

• Tenure status of place of business (owned, rented, other)

• Person-months of full-time-equivalent workers per year

• Installments on other debts (business and household)

Business Financial Stocks

• Cash and savings-account balances

Can Credit Scoring Help Attract Profit-Minded Investors to Microcredit? 231

Aspects of the Loan Contract

• Date application submitted

• Date loan disbursed

CHAPTER 13:

Credit Scoring: Why Scepticism Is Justified

Christoph Freytag

Managing Director, IPC GmbH

Providing loans to micro and small businesses has been at the heart of IPC’s tivities for more than 20 years In 2005, ProCredit Banks in Eastern Europe, Af-rica and Latin America disbursed more than 60,000 business loans per month The ProCredit Banks achieved a return on equity of 15% in 2005

ac-IPC also advises private commercial partner banks on behalf of international nancial institutions (IFIs) in “downscaling” projects, which are designed to build capacity in MSE (micro and small enterprise) lending These banks disburse 75,000 MSE loans per month An indicator of the profitability of the partner banks

fi-in the downscalfi-ing projects is that only about 15% of their combfi-ined MSE loan portfolio is being funded by IFIs The remaining 85% is financed with resources these banks have mobilised in their domestic markets

The levels of profitability implied by these figures are being achieved because the lending methodology – or “credit technology” – which the banks use is effi-cient and keeps credit risk under control A recent in-depth vintage analysis of bad loans within the ProCredit Group revealed that only 0.5% of all loans disbursed were not recovered From this analysis, we also learned – once again – that in the vast majority of cases, loan defaults are triggered not by the borrower’s “individ-ual” inability to repay the amount outstanding, but rather by an unwillingness to repay or by an inability to fulfil payment obligations brought about by events such

as crises, natural catastrophes, civil unrest or fraud Another type of risk – tional risk” – that can contribute to loan delinquency is a lack of institutional dis-cipline, which in most cases is a result of insufficient management attention, spe-cifically on the part of middle management staff

“opera-Credit scoring will not protect lenders against these risks That is something that only conscientious, well-qualified employees can do Accordingly, IPC and the ProCredit Group are investing on an increasing scale in staff and management training at all levels – as evidenced by the creation of training centres in the indi-vidual banks, regional middle management academies and a central academy for senior management training We strongly believe that investments in people are of paramount importance in identifying and managing risk Trying to “revolutionise”

mi-All of this makes scoring even more attractive for banks: They usually have large databases and strong IT support Banks that serve corporate and retail cus-tomers are usually very centralised and, as a rule, their procedures are highly stan-dardised A traditional microfinance approach, however, requires decentralisation, which conventional bankers are afraid of Credit scoring, a radically centralised and standardised loan approval system, therefore fits perfectly into the kind of corporate culture that is characteristic of large, mainstream banks

A thorough analysis of the borrower’s repayment capacity and his or her ingness to pay are at the heart of IPC’s credit technology This is due not only to reduce risk-related costs, but also to a fundamental desire to implement socially responsible lending practices We must not forget that credit – a loan from the banker’s point of view – is a debt for the borrower Lending that leads to the over-indebtedness of clients must be avoided: especially for those who might have limited skills in financial planning and tend to overestimate their repay-ment capacity

will-Credit scoring creates a temptation for the lender to take a different approach: By replacing the well-trained, expensive loan officer with a machine, costs amounting

to at least 3-4% of the portfolio can easily be saved The temptation is to allow higher losses in order to gain a larger market share and lending volume Nobody today would deny that over-indebtedness of households due to aggressive credit card, consumer, car and mortgage lending is a social problem in Western markets

In most cases, the rapid expansion of these types of lending has been based on the use of scoring techniques, often in conjunction with nontransparent pricing prac-tices and aggressive marketing This has caused traditional lenders to be crowded out of traditional credit markets In certain emerging and transition economies, similar trends can already be observed In Turkey, for example, credit card and consumer debt increased by 800% between 2001 and 2004 and the NPL (nonper-forming loan) level reached 9% As Schreiner rightly notes in the preceding chap-ter, such practices can have – and indeed have had – a disastrous impact on micro-finance markets, as is shown by the example of Bolivia

Credit Scoring: Why Scepticism Is Justified 235

It is clear that the aggressive use of credit scoring will have severe negative pacts in the long run and hinder the development of a healthy credit culture One could argue that the answer is simply to fine-tune the scoring system by applying more rigid criteria But even if this is done, the temptation inherent in credit scor-ing, as described above, will continue to exist as long as advocates of shareholder value continue to seek to maximise profits regardless of the social costs involved

im-It is interesting to note that a conservative lender, a major Austrian bank, has cently adopted a policy designed to facilitate micro-lending using a rather rigid scoring system This system requires data from tax declarations and information

re-on bank transactire-ons, and automatically rejects businesses that have existed for less than two years.1

We do not believe that such approaches are in any way compatible with the velopment goals which microfinance pursues Almost invariably, the more rigid the criteria and rules which are applied, the sooner a microfinance provider will end up lending in the “comfort zone”, where lending staff can rely primarily on narrowly defined systems to assess creditworthiness, without having to assume responsibility for analysing borderline cases As a consequence, a large number of low-income clients that would be able to repay loans tailored to their personal repayment capacity will be denied access to credit In essence, microfinance is about building relationships between finance providers and clients among the low-income target group Abandoning this type of relationship banking for the sake of potentially more efficient banking transactions will neither be beneficial for indi-vidual microfinance providers nor in terms of the sound development of microfi-nance markets For all of these reasons, we cannot see why credit scoring would

de-be a worthwhile activity for donors to support

Schreiner and others do not advocate a complete shift from the traditional crofinance credit technology to credit scoring Rather, credit scoring is seen as a tool which would supplement and refine the traditional credit technology by add-ing a “third voice” to the credit committee and making credit risk management more explicit and consistent In principle, we agree Learning from statistical evi-dence, drawing lessons from practical lending experience and implementing grad-ual improvements to the credit technology must be an ongoing process Thus, credit scoring offers very little that is really new, given that the truly useful as-pects of this approach are already being applied by a substantial number of micro-finance providers in various parts of the world A new buzzword is certainly not necessary in order to drive institutional development in microlending

1 This is in line with the bank’s strategy, as expressed by its CEO, who wants to “select the cream of the cream of customers” See: “Expansionist where others fear to tread”, interview with Raiffeisen International’s Chairman Herbert Stepic, The Banker, Feb 5,

2006

P ART III

Partnerships to Mobilise Savings and Manage Risk

Introduction to Part III

Two topics are presented in part III While they may seem quite different, they have in common the management of risk where risks are relatively high and where transaction costs are also high, at least at early stages of development Microinsur-ance and micropensions, at the bottom end of the market, is one member of this odd couple At the top end of the market is structured finance and securitisation, the other part of this odd couple In each case the motivation is to increase access

at the bottom end of the pyramid In each case the initiatives are innovative and complex, involve coordination by many different parties for successful execution, have the potential to serve very large numbers of clients, and create new structures with the capacity to achieve far-reaching developmental effects

Stuart Rutherford in Chapter 14 explores the challenges of security in old age among the poor, and the ameliorating role that microfinance can play His insights rely in part on “financial diaries” of poor people that he and his team have re-corded over years of research in South Asia This empirical basis makes it clear that poor people do want to save, but that facilitating formal institutions are not yet sufficiently in place to meet demand A tremendous market for micropensions could be built, but many challenges must first be overcome Rutherford describes these issues and lessons from attempts at institutional development, and suggests what might be done to create a market

In Chapter 15 a team of authors describe the ins and outs of finance and old age

in Sub-Saharan Africa Demographic and other changes add a sense of urgency to the challenges of maintaining or improving safety nets as populations age Unfor-tunately, low-income Africans rarely plan for old age Very few attractive formal financial practices, instruments and institutions are close at hand for the majority, whether urban or rural, who live on a dollar or two a day However, informal and non-financial activities provide support in emergencies, more young people are becoming aware of problems they are likely to face as they grow older, and incen-tives are strong

In Chapter 16 Michael McCord explores risk management possibilities in income insurance markets He foresees a large potential market that will enable people of modest means to manage the risks they and their families face, offering greater security and protection against catastrophic risks His scope includes health, accident and life coverage His structure is based on coverage, premiums, delivery channels, terms and benefits Examples from Ghana, Georgia, India, Mexico, the Philippines, Uganda and elsewhere are provided, offering lessons for further development and opportunities for development assistance

low-240 Introduction to Part III

Two chapters by KfW authors round out this book Each deals with structured

finance and securitisation as innovative means of overcoming barriers or features that constrain access to global capital markets Harald Hüttenrauch and Claudia Schneider provide a road map for securitisation in Chapter 17, specifically target-ing its application to microfinance The mechanics of this relatively new tool are explained, and its complexity is sorted out These aspects include explanation of the roles of all parties concerned plus legal and data requirements Pioneering deals are described

In the final chapter, Klaus Glaubitt, Hanns Martin Hagen, Johannes Feist, and Monika Beck discuss structured finance as a means of promoting microfinance, specifically through mechanisms that attract more private funds Diversifying, broadening and deepening the supply of funds can be achieved by reducing barri-ers and constraints in capital markets Construction of an enabling framework for securitisation and structured investment funds in emerging markets is essential for massive outreach Regulatory issues are a critical factor in facilitating securitisa-tion, while potential benefits reach far beyond specific deals because they create new structures with longer time horizons The mechanics and advantages of struc-tured investment funds are illustrated by the example of the European Fund for Southeast Europe, in which KfW has an important role

CHAPTER 14:

Micropensions: Old Age Security for the Poor?

Stuart Rutherford

Chairman, SafeSave, and Senior Visiting Fellow, Institute for Development Policy and

Management, University of Manchester, UK

How can microfinance be expanded to include approaches to the problems facing poor and very poor people in developing countries when they become too old to support themselves? Microfinance clients have long been signalling their demand for such services by doing their best to use current microfinance products, such as microcredit, in ways that create assets that can help protect them in old age How-ever, “micropensions” will not, at least at first, look like miniature versions of developed-country private pensions, because most would-be clients are not for-mally employed and do not “retire.” The most promising platform for developing suitable products can be found in medium term “commitment savings” plans for the poor that are now growing in popularity and scale in a number of countries This chapter describes the challenges that face the microfinance industry as it strives to scale up these financial instruments and to make them ever more appro-priate for their users and potential users

A Framework for Micropensions

Pensions are generally understood as a regular flow of receipts from retirement to death They became common in the rich world as industrialisation advanced and formal employment replaced casual or self-employment as the main source of income for most people Pensions are therefore coupled with the notion of “re-tirement.” Rich-world pensions answer the question “what happens after I retire and stop earning?”

To the extent that formal employment has grown in the developing world – where microfinance has its main focus – employment-based and private pensions resemble those in advanced economies Government and private sector formal employees are usually enrolled in retirement pension schemes, and some workers buy private annuities

But in many developing countries formal employment is not the norm Most poor people in villages and slums patch their livelihoods together from a mix of

242 Stuart Rutherford

self-employment, casual employment, or low-grade formal employment – time, part-time or intermittent To them, the idea of “retirement” is foreign The question they raise about their old age is “what happens when I can no longer support myself?”

full-Two forms of pension provision can help them answer that question The first

is the public or “social” pension, where the state raises revenue (sometimes from general taxation, sometimes through dedicated contributions) and redistributes it

to citizens when they reach a stipulated age in order to guarantee them a dignified life Such schemes command huge public support from taxpayers (and pension-ers), are virtually universal in the developed world, and are spreading to develop-ing countries And, the debate on how to fund them is fierce in both the developed and developing worlds

The Case for Social Pensions …

Some of what we know about pension use and impact on poor people comes from groups that lobby for social pensions The NGO HelpAge International, for exam-ple, estimates that 80% of the old people in developing countries have no regular income and that 100 million old people live on less than a dollar a day By 2050 the number of over-60s in the developing world may jump to 1.5 billion from 375 million today As life expectancy rises, the accumulation of funds that will be needed to deal with pensions grows steadily greater HelpAge has studied the impact of social pensions on health, longevity and child-care (many old people live in multi-generational households where grandparents care for the young) These surveys and case studies have been conducted in poor countries that have advanced social pensions provision, such as Brazil and South Africa Research results make a good case that even low-value pensions can make a big difference

to household welfare (Gorman 2004)

But these figures point in two directions While they make a strong case for tending and improving social pensions, they raise doubt about whether state reve-nues will be able to manage such a massive task

ex-… and for Micropensions

So it looks as if there is plenty of room for micropensions – pensions for poor and

very poor people But formal employment and formal retirement are rare among this group This requires a search for a broad understanding of the purpose of mi-cropensions: to help poor and very poor people answer the question – “what hap-pens when I can no longer support myself?”

Microfinance clients have long been signalling their demand for micropensions Early microfinance was almost exclusively microcredit Loans could be invested

in microenterprises (as most lenders insisted) and some of the resulting businesses have contributed to income and asset growth and thus to improved security in old

Micropensions: Old Age Security for the Poor? 243

age But many microcredit clients have sought more direct ways to invest in their futures Todd (1996), for example, describes the lengths to which some women clients go to retain the capital value of successive yearly loans – repaying them from any available source while storing them in cash at home or with a money guard, or

as livestock or as on-lending – until they had accumulated enough capital to buy a small piece of land that would offer them some security in their widowhood Ruther-ford (2000) points out that saving and borrowing are simply alternative ways of converting saving capacity into usefully large lump sums, and that when poor people have restricted access to safe ways of “saving up” they will find ingenious ways of

“saving down” (borrowing) to satisfy their most pressing money-management goals

As Todd’s example shows, these cases include security in old age

Micropension products will enable the poor to focus on managing money for old age These products will consist principally of medium- to long-term saving schemes that produce capital for reinvestment in real, human, social or financial assets that can create a flow of income to support the non-working elderly In some cases the reinvestment will be in real property for rental, or in the businesses

or education of family members in exchange for future income or subsistence support But, crucially, micropension products will also offer the option of rein-vestment in a financial asset that produces a flow of income: either interest in-come, or perhaps by the purchase of an annuity, which is the financial product that specialises in maximising income streams

Microfinance and Micropensions

How far has microfinance travelled on the road to micropensions? At first glance not far – if in early 2005 you had typed “micropensions” into the search engines of

microfinance initiatives such as CGAP or MicroSave, you would have found no

answers

Nevertheless, microfinance products are becoming more diverse and more widely available, and each improvement makes it easier for clients to use microfi-nance for old-age security But as each new opportunity opens up, new challenges appear The opportunities and challenges created by a small selection of microfi-nance products are summarised in Table 1

Growing Old Poor

In Bangladesh, wives are customarily younger than their husbands, and women tend to live longer than men Women must anticipate a long widowhood, a cause

of much anxiety When a panel of near-poor, poor and very poor men and women were asked how they thought they’d survive in old age and widowhood, answers came out in hesitant stages (Rutherford 2002) Many women felt obliged, first, to acknowledge that the matter lies in the hands of Allah They would then say that their children (especially their sons) would care for them But their faces showed

244 Stuart Rutherford

Table 1 Managing money for old age: the opportunities and challenges of a selection of

current and future microfinance products (the products are listed in ascending order of their

direct relevance to pension provision)

Microcredit Clients can store loans and convert

them to larger assets (like land)

that can produce ‘unearned’

in-come for the aged

Business investments strengthen household economies and create

assets, and like social investments

(e.g in health, education, social

links) they strengthen a household’s

capacity to care for its elderly

Compulsory savings (which ten accompany microloans) can

of-build up to valuable ‘terminal’ sums

that can help retiring clients

Relatively few Microcredit is well established and profitably practised

by both specialist microfinance stitutions (MFIs) and, more re- cently, formal banks; and outreach

in-is growing quickly if erratically

Basic

microsavings

Reliable current accounts and

passbook savings help poor

peo-ple to save more (in both senses:

they can deposit more, and can

build up larger balances) than in

most other savings vehicles

avail-able to them: for many poor people,

saving is a better way of building

capital sums for reinvestment than

microborrowing

Safety of deposits: Savings (in

situations where clients hold ings balances that exceed their loan balances) require that MFIs develop new management skills

sav-In many countries only licensed,

regulated and supervised providers

can take deposits, though in some cases MFIs with good track records have been found to be safe savings mobilisers

Matured sums can be reinvested

in real or social assets, or can be

retained as financial assets

produc-ing income streams for the elderly

in the form of interest income (or

even as fixed-term annuities)

Fund management: where these

plans achieve scale, MFIs will need

to master advanced fund ment skills – using these funds purely as loan capital may be risky

manage-In addition, governance, training

and information management need

Privacy and client identity: MFIs

may have to recognise a greater demand for privacy, which may

Micropensions: Old Age Security for the Poor? 245

Table 1 (continued)

be hard to reconcile with the poor

or uncertain legal identities of many poor and very poor people

These challenges have led observers

to recommend partnerships between

MFIs skilled at working with the poor and formal providers with

advanced management capacity

Endowments Endowments attach life insurance

policies to commitment savings

plans and therefore add further

security, especially where the life

insured is that of a main

Formal insurance skills are

essen-tial to handle endowments properly – another reason for advocating

Annuities Could help some

formally-em-ployed low-paid workers, but may

not yet be of immediate relevance

to the mass of self-employed or

irregularly employed poor

Formal actuarial skills are

re-quired: the challenges of ing them for the illiterate self- employed or irregularly-employed poor are formidable

develop-they doubted this, and this sorrow often led them to express bitter feelings: “I hope

to die before my husband,” or “before I’m unable to care for myself,” and even

“an old woman without wealth is kicked like a dog.” They spoke of their envy of women with solid assets like land or housing When they recovered their spirits more than half the women – perhaps because they remembered that we has asked them questions about money – told how nice it would be to save up money against old age, but they said it in a tone of voice that showed that they doubted that would ever be possible This was true even though the sums of money that women thought would be sufficient were often surprisingly small – as little as $300, thought one slum-dweller in Dhaka

This story illustrates how difficult it can be for poor people, especially women,

to plan for a secure old age As many researchers have found:

• traditional systems of inter-generational care are either breaking down or are

no longer perceived as reliable

• assets, especially land and property, are seen as the best way to guarantee old-age security, but seem out-of-reach for many poor people As one near-