Ghana: What Commercial Banks Entering the Microfinance Market Must Consider

Mar 2009
Legon-Accra, Ghana, March, 17 2009 - Commercial banks in Ghana are gradually expanding their operations to the microfinance market as the opportunities in the traditional banking sector dwindles. Traditionally, commercial banks have shunned the microfinance sector, allowing it to be dominated by the “Alternative Financial Institutions” which consist of small savings and loans companies and Susu collectors.

The reason for neglecting the microfinance market is simply that the low-income earners, the main clientele for microfinance services, are not “bankable”. They are too risky to be served because they present high default risk and high cost of service due to their low amounts of savings or loans, hence commercial banks serving this market obtain too little from doing too much.

However, the emergence of large scale and well-organised microfinance institutions has made the commercial banks realise the opportunities they are missing by neglecting the microfinance market.

The benefits of banking with the “unbankable” has been advocated for over twenty years in Asia and Latin America where microfinance has gained a strong foothold.

In Asia, for instance, the Grameen Bank of Bangladesh has shown quite clearly that small loans granted to low-income earners can translate into a multi-million dollar financial institution. The Consultative Group to Assist the Poor (CGAP) has also highlighted the vast potential market for retail financial services to low-income earners. The CGAP reports that as at 2003 there were approximately three billion potential clients worldwide for the microfinance market with only one­sixth of this market being served, mostly by the Alternative Financial Institutions.

In Ghana, the increased competition in the traditional banking sector is compelling the commercial banks to seek growth opportunities and the microfinance sector is becoming the obvious choice. Commercial banks entering the microfinance market have advantages over the small savings and loans companies and the Susu collectors. They are more able to roll out a wide range of financial products and services. Furthermore, they have the infrastructure and systems as well as access to capital. According to the CGAP, commercial banks are better positioned to participate in, if not dominate, the future of the microfinance market.

This notwithstanding, experience has shown that not all commercial banks that enter the microfinance market can succeed. Microfinance is different from traditional commercial banking due to many factors. The microfinance market serves a peculiar group of clientele with peculiar financial needs. The clientele is made up of people with relatively low social status and low income. Also, a comparatively large number of clientele needs to be served for the operations to be profitable. There is a high risk of default which needs to be well managed. Commercial banks need to think through their strategies well before engaging in microfinance.

In general, commercial banks that rush to enter the microfinance market mostly rush to quit the market. It is essential to understand that success in the microfinance market is built on outreach and sustainability as well as the ability to manage the trade-off between the two.

Outreach is about the spread of the activities of the microfinance institution in terms of the number of clientele it is able to reach and serve. Like all banking activities, microfinance thrives on numbers. It works on the principle of “small drops of water becoming a mighty ocean”. To provide small loans to a large number of petty borrowers requires a large amount of accumulated deposits from a large number of petty depositors. This makes outreach crucial.

Sustainability is about the survival of the microfinance institution. While increasing outreach, care must also be taken in terms of how the risk associated with large numbers is managed to minimise default and other risks that come with lending to low­ income earners. The institution must be able to sustain itself while it seeks to grow the number of clientele. Appropriate pricing of loans and deposits as well as cost control is essential for profitability and sustainability.

Moreover, the method of entering the microfinance market must be well thought-out. Research shows that there is no single approach to enter the market for microfinance. The decision-making process for entering this market depends on the commercial bank’s business goals, competition, regulatory environment, market size, existing infrastructure and systems among other factors.

Experiences in other countries show that approaches to entering the microfinance market fall into two, namely direct and indirect. The direct provision of microfinance services comes in three forms, as follows:

  • setting up an internal microfinance unit within the commercial bank
  • setting up a specialised financial institution to engaged in microfinance
  • setting up a microfinance service company    ­

The indirect provision of microfinance services also has three methods, namely:

  • outsourcing microfinance operations
  • providing commercial loans to existing microfinance institutions
  • providing infrastructure and systems to institutions in the microfinance market

The CGAP has outlined six critical factors that underlie the success of commercial banks in the microfinance market:

  • commitment from board and management to strong internal champions and alignment with the bank’s core commercial strategy
  • knowledge of microfinance best practices and how to serve micro-clientele
  • infrastructure location convenient to clients
  • products especially adapted for low-income and informal market
  • systems and procedures adapted to the microfinance operations, example systems that support immediate follow-up on missed payments
  • appropriate staff training and incentives on new clients, products, and delivery systems

These factors are necessary to attract and retain clientele, and achieve high outreach and sustainability. In short, engaging in microfinance should be seen as a strategic move to grow and improve profitability in the wake of intense competition in the traditional banking sector.

Consequently, commercial banks thinking of engaging in microfinance need to consider their current operations, the strategic fit with microfinance operations, and define the appropriate entry strategy if they want to be successful in serving the “unbankable” .


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