MICROFINANCE for BANKERS and INVESTORS

UNDERSTANDING THE OPPORTUNITIES AND CHALLENGES OF THE MARKET AT THE BOTTOM OF THE PYRAMID

By ELISABETH RHYNE

The McGraw-Hill Companies, Inc.

Copyright © 2009 Elisabeth Rhyne
All rights reserved.
ISBN: 978-0-07-162406-0

Contents

PrefaceIntroductionPart 1. Understanding Clients, the Market, and the Opportunities1. The BOP Market Up Close (and Personal)2. Who Serves the BOP Market—and Who Doesn't?3. Four Critical Challenges in the BOP Market4. Products for the BOP Market5. Three Products: Insurance, Housing Finance, and RemittancesPart 2. Models and Corporate Choices6. Corporate Choices7. Commercial Banks as Microlenders8. Partners at the Last Mile: Retailers, Banking Agents, and Insurance
Companies9. Models of Financing Inclusive FinancePart 3. The Emerging Industry of Inclusive Finance10. Building the Infrastructure for Inclusive Finance: The Enabling
Environment11. Credit Bureaus and Credit Scoring12. Last-Mile Technologies13. The Technological Base: Payment Systems and Banking Software14. Building the Market for Investing in MicrofinancePart 4. Socially Responsible Returns15. Approaches to Social Responsibility16. Client Protection and Proconsumer Inclusive Finance17. Measuring the Social Bottom LineCases 1. Banking ModelsCases 2. New Players: Retailers, Insurers, and TelecomsCases 3. Industry DevelopersCases 4. Financing ModelsCases 5. Social ResponsibilityAcknowledgmentsEndnotesReferencesIndex

Excerpt

CHAPTER 1

THE BOP MARKET UP CLOSE (AND PERSONAL)

The $5 Trillion Invisible Market

The World Resources Institute's project, "The Next 4 Billion," has taken on thechallenge of quantifying the opportunities at the base of the pyramid. Itstarget, the estimated 4 billion people in the world who get by on incomes ofless than $3,000 per person per year, are, in fact, a majority of the world'spopulation. The project declared that this population segment constitutes aglobal consumer market worth an estimated $5 trillion, broken down as follows:

• The Asian BOP market contains 70 percent of the total spending power ($3.5trillion). Latin America, Africa, and Eastern Europe each account for roughly 10percent of the total.

• In Africa, despite recent growth in the middle class, the BOP market is stillthe market. It involves 95 percent of the population and 71 percent ofpurchasing power.

• Even in Latin America, the BOP market constitutes 70 percent of the populationand 28 percent of total spending power.

• The Eastern Europe/Central Asia BOP market is worth close to $500 billionannually.

While the overall market includes many people living somewhat above theirnational poverty lines, an important subset is the 1 billion people who live onless than a dollar a day, the poorest segment of humanity. This group requiresspecial attention if it is not to remain excluded while the high end of the BOPmarket receives more services. Much of the BOP market is rural, especially thelower-income portions, and this too poses special challenges.

Profiles of the Working Poor

Global facts and figures show the market potential in the broadest terms. We nowshift to a human scale to gain an understanding of the people involved. Thethree portraits that follow give us insights about real people from the BOP.Knowing the people is essential for learning to serve this market effectively.Before you turn to the rest of this book, please make sure to read theseprofiles.

Delia

A pueblo joven (new town) in Lima, Peru

At the start of the day, Delia unlocks a padlock and swings back the metal gatesthat protect her shop at night. The shop carries groceries and a little bit ofjust about everything else. Delia's business sits in the middle of a densemarket, an environment of concrete and metal. The pace is as fast as the beat ofthe Latin music coming from radios and boom boxes on all sides. Delia greets thefriends who arrive to open their neighboring market stalls and the tenants whorent rooms in the three-story house she has built on top of the shop. She spendsher day purchasing inventory, chatting with special customers, and looking overthe shoulders of her employees.

Delia is one of millions of urbanites swelling the populations of the Andeancapitals: Lima, La Paz, Quito, Bogotá, and Caracas. Though only a generationaway from the campo, she has never known any other life than that ofPeru's urban "informal sector," estimated to include more than half of the totalurban Peruvian labor force. The informal sector includes all those people whosurvive by operating micro- or small enterprises. Most informal-sectorenterprises involve a single microentrepreneur working alone, with his or herfamily or with a couple of employees. The mom and pop shop and the small farmerare both part of the informal sector. Their enterprises are generally notregistered formally with the government. They exist to satisfy immediateeconomic needs.

Some economists regard informality as a choice. They assume that people canchoose to be formal, keep proper books, register their businesses, and paytaxes. If they "decide" to be informal, their motivation is presumed to beavoidance of the costs of formality. In this view, informals are seen asshirkers who do not pull their weight in society and compete unfairly withupstanding formal businesses. Delia would be angry and bewildered to hear talklike that. For her, informality is simply the life she knows.

Today Delia thinks of herself as a successful businesswoman. But years ago, shefound herself with three young children, no livelihood, no way to earn a living,and no one to help her. Her husband had abandoned her for another woman, takingwith him the proceeds from selling their market stall.

Delia and some women friends formed a group to get a loan from what is nowMibanco, Peru's leading microfinance bank. They borrowed as much as they dared,having nothing more to offer as security than each other's group solidarity.Delia's first and probably biggest hurdle was to save enough for a new stall.She invested and improved her business and her family life, upgrading the stallseveral times, increasing her inventory, building rooms in her house to rentout, and educating her three daughters. Over many years, she has worked her wayup from a $100 or $200 group loan to an individual loan of $3,000.

Delia's first steps in launching her microenterprise were small and may haveappeared unpromising. When she started, the shelves had only a few items. Manyretail businesses like hers crowd the market, so she had to keep her prices verylow. It was hard to obtain a large enough sum of money to make significantimprovements. Today the walls are filled from floor to ceiling. Every bit ofspace provides an opportunity to stock something else.

Before her microloan, Delia had never been a customer of a bank. If she needed alarge sum of money, she had a few choices, none of them good. She could borrowfrom the local moneylender. She and her friends called him chupasangre,the bloodsucker. She could buy on credit from the wholesalers who supplied herinventory, but they would raise their prices, squeezing her profits. She couldborrow from friends, but they tended to be in the same situation as she was.

When Delia first borrowed, several important things happened. First, andpossibly the most significant, she turned something she was richin—friends— from social capital into real money through the groupguarantee. Second, she gained independence from the chupasangre and astronger bargaining position with her suppliers. Third, her interest costs wentdown considerably from informal rates. Fourth, she gained permanent access tofinance, which gave her the courage to plan and invest because she could counton accessing a loan when she needed it, as long as she paid it back faithfully.And finally, she had the experience of being trusted and valued by a formalinstitution. She had gone from invisible to included.

Xavier

Hulene, a caniço (cane town) settlement on the edge of Maputo,Mozambique

Xavier, whom we met in the preface, is one of very few Mozambicans of hisgeneration with some secondary schooling. After some years of military serviceduring Mozambique's long civil war, he learned elementary bookkeeping and got ajob in the accounting department of a nongovernmental organization (NGO), partof the huge reconstruction effort to assist Mozambique to rebuild after the warended. With an office job and a steady salary, Xavier had become a part of thetiny Mozambican professional class. He had made it.

Well, not quite. After a few years, the funding ran out and the NGO went away.Xavier was let go. His tiny pension from the Mozambican army was not enough tolive on. So he started a business selling frozen fish and a few other items. Heturned to microenterprise when he had no alternative.

Xavier sells from a two-room concrete block structure at the intersection of twoof the broad, red-dirt paths that lace the settlement of Hulene, a suburb thatcombines the density of a city with the rural feel of a traditional Africanvillage. Each family in Hulene lives behind a low hedge or fence enclosing anopen area, perhaps a tree or a few bushes, and one or two huts, though most ofthe mud and thatch has by now given way to concrete bricks. Chickens andchildren scrabble in clean-swept dirt yards. Much of the living and nearly allof the cooking is still done outdoors. The overall impression is irregular,unplanned, and unorganized.

Xavier is a small, perky man. If he were older, he might be described as spry.Painted across his shop is a slogan in Portuguese: O PEIXE DA MAMÁ (Mom's Fish).He participates in a simple franchise operation selling carapão, thecheap frozen fish that is a main source of protein for Maputo's poor.Carapão tastes so foul that it is never eaten by people who can affordbetter. Xavier says it is a good business.

Residents of Hulene pass Xavier's shop on their way home every evening afterthey alight from the chapa— the ragged commuter minibus—up on themain road. Xavier's path aspires to be a road but is so rutted and uneven thatan ordinary sedan car struggles in dry weather, and even the lumbering Coca-Coladistributor's truck has trouble in the rainy season. Xavier's customers standoutside in the heat, waiting for the attendant in the dark interior of the shopto take the fish from the deep freeze, weigh it on an old-fashioned balance, andwrap it in a plastic bag.

Xavier has borrowed two or three times from Tchuma, a credit cooperative thatbegan in 1998. One of his first loans was used to repair the roof of his shopafter thieves broke in. His current loan is 5 million meticais, about $260. "Theloan is good, but it is too small," he says. "I want to help my wife start abeauty salon so she will have a business, too, but the money is not enough." Hehas already helped his mother-in-law, an immigrant to Mozambique from SouthAfrica, to open a small retail store and soda shop across the street. She, too,had slipped backward from a more professional job—as an Englishteacher—and struggles with chronic illness, which creates financial stressfor Xavier and his family.

Sonali

Kherwadi, a slum in Mumbai, India

Sonali's house sits along an alley of broken pavement with an open sewer runningalong the middle. Bundles of pipes have been laid helter-skelter on top of thepavement. Doorways are open to bring some relief to the dripping heat, andinside them sari-clad women sit on the floor in semidarkness, Sonali among them.A delicate young woman with two small children, Sonali's much older husbandworks when he can, but lately has been at home because of a heart problem.

Sonali has a skill: beadwork. She can take small metal bits and string themtogether to create necklaces and anklets. She sits with a tray on her lap, apair of needle-nosed pliers in her hand, twisting wires hour after hour. Many ofthe women in Kherwadi do beadwork or a similar handicraft such as tailoring orembroidery. This kind of work suits their need to stay home, as cultural normsrequire, and allows them to look after the children. It is not a truemicroenterprise, however. Sonali actually works for a middleman who comes once aweek to bring her the raw materials and take away the finished products. He paysher by the piece. She earns only a few rupees for hours of back-twist andeyestrain. Most of the work she does is of low quality and will be sold in smallshops to people in Mumbai, but some of the residents of Kherwadi undoubtedly sewproducts that end up in handicraft markets around the world.

Sonali's earning power is fixed by the hours of her labor. One of her mainfinancial needs is for what economists call "consumption smoothing": managingthe ups and downs in her income. Sonali used her first microloan to help pay theunexpected expense of her husband's fees at the local health clinic. Althoughrepaying the loan will be hard unless he returns to work, she is better off thanif she'd gone to the moneylender. Many of the local moneylenders charge onlyinterest, not amortizing the principal. This practice leads clients intopermanent debt. If a borrower cannot get a large enough sum together to repaythe principal, she will pay the interest forever. If she faces another emergencyand has to borrow again, her debt burden grows.

What Do We Learn from Delia, Xavier, and Sonali?

Even the briefest look at life stories of the working poor provides greatinsight into their financial needs and the kinds of customers they can be.

Without stable employment in a formal-sector job and with little or nogovernment-sponsored social safety net—in fact, with few connections toany large institutions—vast numbers of the working poor survive byoperating microenterprises. In Egypt and Indonesia only 10 percent of thepopulation works in the formal sector, and in Mexico only 20 percent. Theseenterprises range from retail shops to family farms to artisanal manufacturing.Families often piece together several income-earning activities: Delia operatesa shop and rents rooms in her home, Xavier's family runs two separatemicroenterprises and is trying to start a third, and Sonali supplements herhusband's labor income with beadwork.

Many such families face great vulnerability, so much so that we can considervulnerability an integral part of what it means to be poor. Among the threepeople profiled here, two had experienced war, one had multiple thefts, and twohad economically debilitating health crises. Financial services could help themmanage some of this vulnerability. In the absence of inclusive financialinstitutions, they turn to informal sources—friends and family,moneylenders and suppliers. The informal sources respond quickly when needsarise, but they have many drawbacks. These clients used moneylenders onlyreluctantly to solve crises because of their high costs. Other informal sources,especially family and friends, are often seen in a more favorable light, buttheir resources are limited.

The harsh realities of working poor lives, including poor living conditions andexposure to risk, create a daunting picture for businesses contemplating servingthe low-income market. It would be easy to conclude that no prospects lie intheir communities. Looking below the surface conditions, however, reveals adifferent picture, one that brings to mind qualities such as resilience,determination, aspiration, and self-reliance.

The working poor have many assets, but lack mechanisms to leverage those assets.This is the essential insight put forward by Peruvian economist Hernando de Sotoin his book The Mystery of Capital, and it points to a crucial role forinclusive finance. De Soto pointed out that the poor actually control asurprising amount of real assets in the form of housing, business premises, andother physical wealth. In Peru alone, de Soto estimated that these assetstotaled some $90 billion, about 11 times the value of the Lima Stock Exchange.Worldwide, de Soto estimated in 2001 that about $9.3 trillion of dead capital inpoor communities was waiting to be leveraged from informal assets andenterprises.

As important as the untapped physical assets may be, the human and social assetsof the poor may be even more valuable, though far less recognized. Delia andXavier are resourceful businesspeople who have found ways to earn a livingdespite numerous hardships. Delia has friends who help her, while Xaviersupports members of his extended family. Both have become expert money managersthrough years of experience. Their aspirations to improve their lifecircumstances make them value the opportunities offered to them, such as a loan.That value translates into willingness to pay for services and repay credit ontime. Xavier and Delia are ideal—and profitable—customers forinclusive financial products. Sonali faces more extreme poverty and has fewerassets to draw upon. It might be surprising to learn, however, that even Sonaliis a client, having opened a savings account at ICICI Bank through its linkagewith a microfinance institution (MFI), Swadhaar FinAccess.

De Soto's proposed solution to the lack of leverage that characterizes assets ofthe poor involved land titling and other forms of official recognition, forthese solutions would legitimize the fruits of grassroots labor and investment.Another thinker, C. K. Prahalad, proposed a different solution—a businesssolution. Prahalad challenged the world's largest corporations to find their ownways to catalyze the BOP market, contending that the potential rewards of doingbusiness in emerging communities are worth the required adaptations. Hesuggested four components necessary to build a commercial infrastructure for BOPmarkets:

• Improve access through distribution and communications systems.

• Create buying power with financial access and income generation.

• Devise local solutions through targeted R&D and grassroots innovation.

• Shape aspirations through consumer education and sustainable development.

Neither Prahalad nor de Soto are primarily interested in financial services, buttheir arguments point strongly toward inclusive finance as one of the mostimportant keys for unlocking the potential of the BOP market. Financial servicesallow people to leverage their hidden assets (de Soto), and they are a centralpart of the commercial infrastructure needed to make business work in BOPmarkets (Prahalad).

Prahalad's suggestions require rethinking almost every aspect of doing business,whether it be the price/performance equation, brand management, market building,product design, packaging, or capital efficiency. Throughout this book weexplore how such adaptations can work in the financial-services sector.

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(Continues...)Excerpted from MICROFINANCE for BANKERS and INVESTORS by ELISABETH RHYNE. Copyright © 2009 by Elisabeth Rhyne. Excerpted by permission of The McGraw-Hill Companies, Inc..
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