ABN AMRO S REAL MICROCREDITO:

ABN AMRO S REAL MICROCREDITO ABN AMRO S REAL MICROCREDITO: A MULTINATIONAL BANK S ENTRY INTO THE MICRO-CREDIT MARKET A TEACHING CASE FROM KENAN-FLAGLER BUSINESS SCHOOL UNIVERSITY OF NORTH CAROLINA Authors Yerina Mugica and Frederico Moura, under the direction of Professor Ted London, Kenan-Flagler Business School, University of North Carolina, Chapel Hill Abstract In 2002, Banco ABN AMRO Real, the Brazilian subsidiary of global financial services firm ABN AMRO, recognized a market opportunity in providing credit to micro-entrepreneurs in Brazil. An estimated 15.7 million people in Brazil work in the informal economy as micro-entrepreneurs, outnumbering formal sector entrepreneurs by more than three to one representing an estimated market for micro-credit of approximately US$3.7 billion annually. Banco ABN AMRO Real launched its Real Microcredito program in partnership with ACCION, a non-governmental organization (NGO) specializing in microcredit worldwide. ACCION provided the technical expertise in micro-lending while ABN AMRO provided its financial background, infrastructure and banking network in Brazil. Its first branch office was opened in 2002 in Favela Heliopolis, on the outskirts of São Paulo. This case examines the opportunities, challenges, and risks inherent in this microfinance partnership. Keywords: 2004 Kenan-Flagler Business School, University of North Carolina, Chapel Hill, NC, USA. This case is intended to serve as a basis for class discussion, rather than to illustrate the effective or ineffective handling of an administrative situation. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form by any means without permission. ABN AMRO, banking industry, finance, micro-finance, microfinance, micro-credit, micro-enterprise, Brazil, international development, sustainable development, base of the pyramid, ACCION Available online at www.cse.unc.edu. Clarifications or comments may be directed to cse@unc.edu. C04-002

ABN AMRO's Real Microcredito: A Multinational Bank s Entry into the Micro-credit Market This case was prepared by Yerina Mugica and Frederico Moura under the direction of Professor Ted London, UNC s Kenan- Flagler Business School, as a basis for class discussion rather than to illustrate the effective or ineffective handling of an administrative situation.

Table of contents Background... 3 Brazil s Micro-credit Market... 4 Origins of Real Microcredito (a BOP business)... 4 Real Microcredito Business Model... 5 Mission... 5 Ownership and Governance Structure... 5 Current Status... 6 Target Market... 7 Marketing Mix... 8 Product... 8 Pricing... 9 Promotion/Placement... 10 Program Results Double Bottom Line... 10 Financial Results... 10 Social Results... 11 Challenges... 11 Risks... 12 Key Lessons & Opportunities... 12 Adapt the product to the client's needs... 12 Venture Scalability/Transferability... 13 Exhibit 1... 15 Exhibit 2... 16 2

1. Background ABN AMRO s origins date as far back as 1824, when its predecessor Nederlandsche Handel-Maatschappij was founded in the Netherlands. More recently the Dutch-based international bank is the result of the 1991 merger of ABN bank and AMRO bank. Today, ABN AMRO ranks 10th in Europe and 22nd in the world based on tier 1 capital 1. It has over 3,000 branches in more than 60 countries, a staff of over1105,000 full-time equivalents and total assets of EUR 560 billion (as per end 2003). The firm is listed on several exchanges, including the Amsterdam, London and New York Stock Exchanges. 2 ABN AMRO focuses on three principal customer segments: Consumer & Commercial Clients, Wholesale Clients and Private Clients & Asset Management. Its stated objective is to maximize the value of each of these businesses as well as the synergies between them. In 2003, ABN AMRO had total revenues of 18.793 billion euros (US$ 21.443 billion) 3 and a net profit of 3.161 billion euros (US$ 3.607 billion). ABN AMRO has had been operating in Brazil since 1927. In 1998 ABN AMRO acquired Brazilian bank Banco Real. As a result of this acquisition, ABN AMRO owns 97% of Banco ABN AMRO Real. 4 Headquartered in Sao Paulo, Banco ABN AMRO Real has a countrywide presence with 2,350 branch offices. It is Brazil s seventh largest private bank. 5 1 Tier 1 capital is a term used to describe the capital adequacy of a bank. Tier 1 capital includes equity capital and disclosed reserves. 2 ABN AMRO website http://www.abnamro.com/com/about/about.asp 3 Based on exchange rate of 1 USD:0.81 EUR, January 16, 2004. Source: http://finance.yahoo.com/m5?a=1&s=usd&t=eur 4 ABN AMRO Financial Statement 2001, http://www.abnamro.com/annualreport/2002/pdf_statements/aa_eng_statements2002.pdf 5 Where We Work, Real Microcredito (Banco ABN AMRO Real), ACCION website 3

2. Brazil s Micro-credit Market 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. However, 84% of these microentrepreneurs do not have access to credit. 6 It is estimated that 50% of these microentrepreneurs would effectively demand a micro-credit loan, representing a potential of R$ 11 billion per year in loans, or US$ 3.7 billion. 7 3. Origins of Real Microcredito (a BOP business) The idea for Real Microcredito originated from ABN AMRO s Corporate Social Responsibility department in 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 knew that ACCION had been successful in helping Banco do Nordeste, a development bank for the northeast region of Brazil, launch its micro-credit program called CrediAmigo. The program focused on the urban micro-entrepreneur market in the northeast region, and had significant growth and success with its client base. ABN AMRO recognized that ACCION had the expertise that it needed to help launch its micro-credit initiative. In 2001, Banco ABN AMRO approached ACCION for assistance in 6 Banco do Nordeste s Micro-credit Programme, A Banco do Nordeste Presentation 7 Democratização do Crédito no Brasil - Principais Desafios, Banco Central do Brasil publication, Feb 2003 4

launching a for-profit micro-lending subsidiary. 8 On its side, ACCION was interested in helping develop and taking an ownership stake in a microfinance 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%. With start-up funding provided by ABN and USAID, Real Microcredito began operations in July 2002. Its first (and to date only) branch office was opened in 2002 in favela Heliopolis, one of the largest shantytowns in Sao Paulo City. 9 4. Real Microcredito Business Model a) Mission 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. 10 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 VP of micro-credit Flavio Weizenmann. 11 Real Microcredito s goal is to breakeven by 2007. b) Ownership and Governance Structure Real Microcredito is an independent for-profit organization, jointly owned and jointly managed by ABN AMRO and ACCION International with each owning 80% and 20% 8 Where We Work, Real Microcredito (Banco ABN AMRO Real), ACCION website 9 Interview with Christel Scholten, ABN AMRO Real Microcredito 10 Where We Work, Real Microcredito (Banco ABN AMRO Real), ACCION website 11 ABN AMRO Launches Micro-credit Unit, Business News America, September 9, 2002 5

respectively. ACCION provides the technical expertise in micro-lending, while ABN AMRO provides its strong financial background, infrastructure and banking network in Brazil. Real Microcredito is comprised of one general manager (ABN Senior VP Flavio Weizenmann), one commercial manager (ACCION Manager Marcello Pinto), 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. c) Current Status 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). Micro-borrowers are charged monthly rate on their loans which can be used to expand an existing business, buy equipment or as working capital. The rate is consistent with the interest rate charged by other microfinance institutions including CrediAmigo. Typical loan sizes range from R$500 (US$176) to R$5,000 (US$1,760). 12 The maximum loan size allowed is R$10,000 (US$3,521)and the average repayment time is 7 months. (See Exhibit 1) Its repayment rate is 98.12% (less than one month late) or 92.36% on time. 13 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 12 Maria O Brien, Bridging the Credit Divide, Latin Finance, December 01, 2002 13 Interview by Frederico Moura with Marcello G. Melo Pinto, Commercial Manager Accion-Real Microcredito, July 25, 2003 6

people to create the trust relationship required to form a solidarity group, thereby responding 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. d) Target Market Real Microcredito s first target market is the low-income community of Heliopolis, a shantytown outside of Sao Paulo City with approximately 100,000 inhabitants and 3,000 small, mostly informal businesses. 14 As one of the largest shantytowns in Sao Paulo City, this was a logical choice of location due to its close proximity to the ABN AMRO Real headquarters in Sao Paulo and its large number of low-income micro-entrepreneurs. 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 15 the largest private Brazilian bank with 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 loans disbursements are below R$3,000 (US$1,000). (See Exhibit 1) 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. As a rule, in order to be approved for a loan by Real Microcredito a customer must have: no outstanding bounced checks, a business where the loan will be applied to (there's no threshold on years in business), and an underwriter. 14 Tony Smith, Small Loans to Small Concerns in Brazil, The New York Times, September 26, 2002 15 Interview by Frederico Moura with Marcelo Pinto, Commercial Manager Accion-Real Microcredito, September 16, 2003 7

The underwriter can be a family member with whom the borrower does not live, or a friend. The main function of the underwriter is to pressure the borrower to pay his loan (moral/social responsibility). 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 seventy percent 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. 16 e) Marketing Mix i. Product 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 creditworthiness by reviewing inventories, sales history, or other people s 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. 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 8

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 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). 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. ii. Pricing Real Microcredito charges monthly interest rate on its micro-credit loans, or 51%, that is consistent with industry standards for retail (non-subsidized) micro-finance institutions. Although this may sound high, it is in fact much lower than the rate charged by predatory lenders, which 16 Interview by Frederico Moura with Marcelo Pinto, Commercial Manager Accion-Real Microcredito, September 9

is often one of the only options that low-income informal sector workers have if micro-finance does not exist in their area. Informal-lenders have been known to charge interest rates as high as high as 300%, 17 and some use forceful methods to collect the money (violence, threats, etc). iii. Promotion/Placement Real Microcredito uses a door-to-door sales technique to communicate to customers about its product offerings. 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. 5. Program Results Double Bottom Line a) Financial Results Since, Real Microcredito is only one year old, it is too early to assess its long-term financial performance. However, Real Microcredito s stated goal is to achieve breakeven by 2007. This is an extremely aggressive internal target given that in July 2003 it had only R$400,000 (US$ 140,845) outstanding loans. 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 18. 16, 2003 17 Mario Osava, Brazil: Huge Market for Small Loans, ProutWorld News 18 Interview by Frederico Moura with Marcelo Pinto, Commercial Manager Accion-Real Microcredito, September 16, 2003 10

b) Social Results 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 seem among Real Microcredito clients. Additional time will be needed to assess the full social and economic impact on the community. 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. 6. Challenges One of Real Microcredito s biggest challenges to date has simply been acquiring customers. Real Microcredito s goal for 2003 was to have 1,000 micro-credit clients. 19 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. 19 Interview with Christel Scholten, ABN AMRO Real Microcredito 11

7. 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 Microcredito s loan or the competing banks loan. Real Microcredito can mitigate this risk by working with Brazilian bank regulatory institutions to ensure that there are appropriate regulations in place to 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 system infrastructure in place that keeps track of individuals that have defaulted on loans, which is a significant help to micro-credit providers. 8. Key Lessons & Opportunities a) Adapt the product to the client's needs 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 12

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. b) Venture Scalability/Transferability There is tremendous growth opportunity for microfinance firms in Brazil. A recent study suggests that only 0.3% of the demand for micro-credit in Southeast Brazil was being met. (See Exhibit 2) With three million micro-enterprises in Sao Paulo alone, there is a huge underserved market for micro-credit. 20 As described previously, the challenge will be developing appropriate products and procedures that profitably meet the needs of this large target market. Other microfinance institutions such as Prodem FFP have demonstrated that this can be achieved 21. If Real 20 Where We Work, Real Microcredito (Banco ABN AMRO Real), ACCION website 21 What Works: Prodem FFP s Multilingual Smart ATMs for Microfinance Innovative Solutions for Delivering Financial Services to Rural Bolivia, World Resources Institute Digital Dividend, Roberto Hernandez and Yerina Mugica, August 2003 13

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. 14

9. Exhibit 1 Real Microcredito Loan Disbursements as of September 2003 Loan Amount <R$800 (US$282) R$801 1500 (US$282 528) R$139,225 (US$49,023) R$1501 3000 (US$529 1057) R$148,917 (US$52,436) R$3001 5000 (US$1057 1761) R$117,862 (US$41,501) Total disbursement R$37,339 (US$13,148) Participants 66 149 113 56 41 Percent of 16% 35% 27% 13% 10% total participants >R$5000 (US$1760) R$158,747 (US$158,747) Monthly Income Level of Real Microcredito Customers as of September 2003 Income <R$500 (US$176) R$501 800 (US$176 282) R$166,660 (US$58,683) R$801 1200 (US$282 423) R$165,577 (US$58,302) R$1201 1500 (US$423 528) R$41,030 (US$14,447) Total disburs. R$127,163 (US$44,776) Participants 136 138 96 23 32 Percent of 32% 32% 23% 5% 8% total participants >R$1500 (US$528) R$101,659 (US$35,795) Source: Interview by Frederico Moura with Marcelo Pinto, Commercial Manager Accion-Real Microcredito, September 16, 2003 15

10. Exhibit 2 Micro-credit Supply in Brazil as a Fraction of Demand (by Total Size of Loans), by Regions Source: Jaime Mezzera, Micro-credit in Brazil: The Gap Between Supply and Demand, MicroBanking Bulletin, November 2001 16