ABN AMRO / Real Microcredito Self-sustaining micro-finance programs to help Brazil s poor

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1 DEDICATED TO MAKING A DIFFERENCE World Business Council for Sustainable Development Case study 2004 This version of the Real Microcredito case study is based on the full business school case prepared by Yerina Mugica and Frederico Moura under the direction of Professor Ted London at the Kenan-Flagler Business School, University of North Carolina. ABN AMRO / Real Microcredito Self-sustaining micro-finance programs to help Brazil s poor An estimated 15.7 million people in Brazil work in the informal economy as microentrepreneurs, outnumbering formal sector entrepreneurs by more than three to one. Of these informal micro-entrepreneurs 93% run profitable businesses, 84% of whom do not have access to credit. 1 It is estimated that 50% of these micro-entrepreneurs would apply for a micro-credit loan if they had access to banking services. 2 This figure represents a potential of R$ 11 billion or US$ 3.7 billion per year in loans. ABN AMRO, a Dutch-based bank with 3,000 branches in 60 countries, has recognized this potential market. Its subsidiary, Banco ABN AMRO Real, headquartered in Sao Paulo and with a countrywide presence through 2,350 branch offices, has been working with ABN AMRO s Corporate Social Responsibility (CSR) Department on Real Microcredito since the mid-1990s. The CSR department recognized that many of its initiatives to date had focused on providing assistance (for example, its initiatives included child assistance programs and support for recycling efforts), and decided that it wanted to develop programs that could be self-funded as well as generate benefits for society. As a result, it began studying the potential for micro-credit in Brazil, seeing this as a service that could both help the community and be self-sustaining. Its research led to ACCION, the non-governmental organization that specializes in micro-credit across the world. ABN AMRO recognized that ACCION had the expertise that it needed to help launch its micro-credit initiative as ACCION had been successful in helping Banco do Nordest, a development bank for the northeast region of Brazil, launch its highly successful CrediAmigo micro-credit program. In 2001, Banco ABN AMRO approached ACCION for assistance in launching a for-profit micro-lending subsidiary. ACCION was interested in helping develop and taking an ownership stake in a micro-finance venture in Brazil. These two interests were combined to form the for-profit company, Real Microcredito, with ACCION owning 20% of the company, and ABN AMRO owning the other 80%. ACCION provides the technical expertise in micro-lending while ABN AMRO provides its strong financial background, infrastructure and banking network in Brazil. With start-up funding provided by ABN and USAID, Real Microcredito began operations in July Its first (and to date only) branch office was opened in 2002 in Favela Heliopolis, one of the largest shantytowns in Sao Paulo City 3. With approximately 1 Banco do Nordeste s Micro-credit Programme, A Banco do Nordeste Presentation 2 Democratização do Crédito no Brasil - Principais Desafios, Banco Central do Brasil publication, Feb Interview with Christel Scholten, ABN AMRO Real Microcredito

2 WBCSD page 2 100,000 inhabitants and 3,000 low-income micro-entrepreneurs 4, as well as its close proximity to the ABN AMRO Real headquarters, this was a logical choice of location. Business, not charity Real Microcredito offers small loans to growing businesses that lack access to conventional forms of credit. Through the provision of micro-credit, Banco ABN AMRO Real is committed to the economic and social development of its borrowers, and to promoting Brazil s economic growth. While there is clearly a social component to the Real Microcredito initiative, as the organization falls within the CSR department, ABN AMRO has made it clear that this is not a philanthropic initiative, Our objective is not to do charity; we want to make Real Microcredito a sustainable company, says Banco Real s senior vice-president of microcredit manager Flavio Weizenmann. 5 Real Microcredito s goal is to breakeven by Real Microcredito is comprised of one general manager, one commercial manager, 13 loan agents and three support staff. All major decisions are made jointly between ABN AMRO and ACCION during a daily credit committee meeting, from the business plan to the loan approvals. The majority of Real Microcredito s loans (86%) are used for working capital. The remaining 14% are used for either home improvements or equipment purchases. Micro-credit supply in Brazil as a fraction of demand (by total size of loans and region) 6 Source: Jaime Mezzera, Microcredit in Brazil: The Gap Between Supply and Demand, MicroBanking Bulletin, November Tony Smith, Small Loans to Small Concerns in Brazil, The New York Times, September 26, ABN AMRO Launches Micro-credit Unit, Business News America, September 9, Source: Jaime Mezzera, Microcredit in Brazil: The Gap Between Supply and Demand, MicroBanking Bulletin, November 2001

3 WBCSD page 3 Product, pricing and promotion Real Microcredito s agents go door-to-door to their customers homes and/or businesses to explain Real Microcredito s offering and to sell them credit services. The turn-around time from the time a customer applies for a loan and the time he/she receives the loan (if approved) is 48 hours. Not withstanding this short turn-around, Real Microcredito performs an extensive check to verify the customers creditworthiness. Once the customer decides to apply for a Real Microcredito loan, it is processed as follows: 1. The client finds an underwriter and provides proof of his/her income via a tax report, invoice, verbal confirmation of a business, or other means. In addition to the client providing documentation of his/her income, the loan agent can also verify the client s credit-worthiness by reviewing inventories, sales history, or third-party testimonies. As such, a formal proof of income is not always required. The agent evaluates the borrower's capability of paying the loan based on past business performance. The main function of the underwriter is to pressure the borrower to pay his loan (moral/social responsibility). 2. The loan agent performs a socio-economic interview with the applicant. Most of the questions in this interview are business related, such as questions relating to contribution margins (gross and net), outstanding debts, profitability, supplier relationship, credit policy, etc. The social questions include how many employees the borrower has, what is their family income and how many family members they have/support. 3. The loan agent talks briefly with other local people to confirm information provided by the loan applicant. 4. A credit committee, composed of the general or commercial manager and three loan agents analyze the potential customer s business potential, verify the potential clients credit/default history, check for bounced checks, and approve or decline the application 5. If the application is approved, the loan is disbursed to the client in cash or deposited to the client s bank account. (Approximately 65% of Real Microcredito clients have bank accounts). However, as it has become difficult to obtain new borrowers that meet all of these criteria, the bank is starting to ease some of these rules. A recent survey conducted by the bank shows that 70% of applicants have outstanding bounced checks, and as a result the bank decided to ease this rule and now has 18% of loans (8% of all disbursement) based only on judgments about client's trustworthiness/reliability. 7 Once the loan has been granted, the loan agent makes regular visits to the borrower three to four days before a payment is due. During this visit, the loan officer can get an idea of how his/her client s business is doing, remind the borrower about the upcoming due date, and gauge the borrowers willingness and ability to pay on the due date. The visit is more of a social follow-up, to strengthen ties with the borrower. If the borrower does not make his/her payment on time, the loan officer will revisit the client every three to four days, to follow up. Once the payment is made, the agent returns to his regular monthly schedule. Real Microcredito charges a monthly interest rate on its micro-credit loans, that is consistent with industry standards for retail (non-subsidized) micro-finance institutions. It is in fact a much lower rate than the rate charged by predatory lenders who have been known to charge as high as 300% 8 interest and use forceful methods to collect. Loans can be used to expand an existing business, buy equipment or as working capital. 7 Interview by Frederico Moura with Marcelo Pinto, Commercial Manager Accion-Real Microcredito, September 16, Mario Osava, Brazil: Huge Market for Small Loans, ProutWorld News

4 WBCSD page 4 Real Microcredito uses a door-to-door sales technique to communicate its product offerings to potential customers. In addition, the fact that Real Microcredito is located on the boundaries of Heliopolis shantytown and not in downtown Sao Paulo adds convenience for its customers and allows Real Microcredito to promote itself more effectively in the community it serves. In contrast to other micro-credit institutions, Real Microcredito provides micro-credit through individual loans, not solidarity group loans. Although group loans (where a group of usually three to five individuals cross-guarantee each others loans, such that if one group member does not repay his/her loan the other members in the group must make up the payment amount) have been successful in many other parts of Latin America and the world, Real Microcredito has determined that individual loans are more effective for its target market in Sao Paulo. It chose this strategy over group loans because it found that its clients from the metropolitan Sao Paulo are more individualistic and don't have strong enough links to other people to create the trust relationship required to form a solidarity group, and therefore respond better to individual loans. Real Microcredito does offer group loans but as of September 2003, only one group had signed up. The other 400 clients have preferred individual loans. Achievements As of July 2003, Real Microcredito had a total of 400 clients and has made 500 transactions (more than one loan per client on average. Typical loan sizes range from R$ 500 (US$ 176) to R$ 5,000 (US$ 1,760) 9. The maximum loan size allowed is R$ 10,000 (US$ 3,521) and the average repayment time is 7 months. The repayment rate is 98.12% (less than one month late) or 92.36% on time. 10 As of September 2003, 61% of Real Microcredito participants are male, 40-45% of participants are between 30 and 45 years old and 65% have bank accounts (70% of these are savings accounts from Bradesco bank 11 the largest private Brazilian bank with a strong presence in low income markets). 65% of borrowers have monthly income below R$ 800 (US$ 280), which is the average loan taken by its clients. 77% of loan disbursements are below R$ 3,000 (US$ 1,000). Sustainability Since Real Microcredito has only existed for one year it is too early to assess its longterm financial performance. However, Real Microcredito s stated goal is to achieve breakeven by In contrast to its aggressive growth targets, Real Microcredito has not established profitability targets beyond breakeven. Since Real Microcredito is part of the social responsibility group, all profits after breakeven will be reinvested into new loans or other social program 12. While it is too early to firmly identify the social impact of the Real Microcredito program, evidence of improved living conditions, especially home improvements can be seen among Real Microcredito clients. Additional time will be needed to assess the full social and economic impact on the community. 9 Maria O Brien, Bridging the Credit Divide, Latin Finance, December 01, Interview by Frederico Moura with Marcello G. Melo Pinto, Commercial Manager Accion-Real Microcredito, July 25, Interview by Frederico Moura with Marcelo Pinto, Commercial Manager Accion-Real Microcredito, September 16, Interview by Frederico Moura with Marcelo Pinto, Commercial Manager Accion-Real Microcredito, September 16, 2003

5 WBCSD page 5 However, in contrast to CrediAmigo, whose goal includes performing a social impact assessment of its micro-credit program, Real Microcredito has opted not to include specific social measures as part of its measure of success. Real Microcredito has determined that its social impact is too difficult to measure and has therefore chosen to remain focused on the financial results of this venture. Real Microcredito Loan Disbursements as of September Loan Amount <R$800 (US$282) R$ (US$ ) R$ (US$ ) R$148,917 (US$52,436) R$ (US$ ) R$117,862 (US$41,501) >R$5000 (US$1760) Total R$37,339 R$139,225 disbursement (US$13,148) (US$49,023) Participants Percent of 16% 35% 27% 13% 10% total participants R$158,747 (US$158,747) Monthly Income Level of Real Microcredito Customers as of September Income <R$500 (US$176) R$ (US$ ) R$ (US$ ) R$ (US$ ) R$41,030 (US$14,447) >R$1500 (US$528) Total R$127,163 R$166,660 R$165,577 disbursed. (US$44,776) (US$58,683) (US$58,302) Participants Percent of 32% 32% 23% 5% 8% total participants R$101,659 (US$35,795) Challenges One of Real Microcredito s biggest challenges to date has simply been acquiring customers. Real Microcredito s goal for 2003 was to have 1000 micro-credit clients. 15 However, as of August 2003 it had only approximately 400 total clients (300 active clients). It is paradoxical to have thousands of small entrepreneurs in the region and have difficulty finding clients willing to take advantage of the loans offered by Real Microcredito. However, there are a number of other credit options available in the sophisticated, urban Sao Paulo market. Competitors include stores that allow customers to make payments in installments (some with interest rates lower than micro-credit), credit cards, informal loans and stores that allow the consumer to purchase and pay later. In contrast to micro-finance institutions in less metropolitan areas, Real Microcredito faces a broader set of competitors. This is a specific challenge for Real Microcredito due to the highly urbanized region in which it operates and even more due to its aggressive long-term growth targets. 13 Source: Interview by Frederico Moura with Marcelo Pinto, Commercial Manager Accion-Real Microcredito, September 16, ibid 15 Interview with Christel Scholten, ABN AMRO Real Microcredito

6 WBCSD page 6 Risks Real Microcredito faces a number of risks in the micro-lending arena. Recent regulatory developments are pushing both private and government banks to offer micro-credit programs to low income communities at low interest rates. Although most banks have developed programs, they still lack structure, focus and volume enough to threaten Real Microcredito. Also, beyond providing healthy competition, these competitors may create a situation where customers become over-indebted, with the end result being that the customer does not pay back either Real Microcedito s loan or the competing banks loan. Real Microcredito can mitigate this risk by working with the Brazil bank regulatory institutions to ensure that there are appropriate regulations in place that protect against such situations. In addition, although these informal lenders charge much higher interest rates they also give loans much more easily (with a simple phone call it is possible to have a loan approved and the money delivered immediately). Real Microcredito must ensure that it effectively communicates the benefits of its products and services and positively differentiates itself from the informal lenders. Finally as with any lending institution, there is always the issue of default risk. Real Microcredito has a number of procedures in place to mitigate that risk, including performing extensive credit checks on its potential clients and requiring guarantors. Brazil has an infrastructure in place that keeps track of individuals that have defaulted on loans, which is a significant help to micro-credit providers. Key Lessons & Opportunities One important lesson that Real Microcredito learned early on was the importance of adapting the product to the needs and culture of the target market, and not simply replicating what has worked in other areas. Although it is very common to introduce micro-finance into a community through a solidarity group loan model, especially an area where micro-entrepreneurs have had little access to credit, Real Microcredito recognized that the unique characteristics of the urban Sao Paulo culture would be more conducive to individual loans. This level of focus on the locale where one is doing business is key to success for any business model, but especially when working with the base of the economic pyramid. While Real Microcredito customers do have the option of engaging in group loans, Real Microcredito has focused on providing its target market with products that best meet their needs. By designing an individual micro-loan product with appropriate levels of risk control, Real Microcredito has developed a solution that meets both the bank s needs for risk reduction and the customer s need for independence. In response to the challenge of continuing to grow its client base, Real Microcredito will now need to continue to innovate its product offering, focusing on maintaining efficiency as well as increasing the effectiveness of its products and services in reaching its target market. It will need to focus on differentiating itself from its competitors including retail stores that offer payment plans and credit cards, by continuing to innovate and evolve, developing products that meet its client's needs even better.

7 WBCSD page 7 Venture Scalability/Transferability There is tremendous growth opportunity for micro-finance firms in Brazil. A recent study suggests that only 0.3% of the demand for micro-credit in Southeast Brazil was being met. With three million micro-enterprises in Sao Paulo alone, there is a huge underserved market for micro-credit. As described previously, the challenge will be developing appropriate products and procedures that profitably meet the needs of this large target market. Other micro-finance institutions have demonstrated that this can be achieved. If Real Microcredito is able to effectively differentiate its offering from those other types of credit, it will have an advantage in expanding to other urban shantytowns. About the WBCSD The World Business Council for Sustainable Development (WBCSD) is a coalition of 165 international companies united by a shared commitment to sustainable development via the three pillars of economic growth, ecological balance and social progress. Our members are drawn from more than 35 countries and 20 major industrial sectors. We also benefit from a Global Network of 40 national and regional business councils and partner organizations involving more than 1,000 business leaders globally. 4, chemin de Conches Tel: +41 (22) carpenter@wbcsd.org CH 1231 Conches-Geneva Fax: +41 (22) Web: Switzerland