Strategic Commentary 30YEARS Vision, Experience, Partnership 1980 2010 Volume 21 October 2009 www.speerandassociates.com Evolution of Programs for the Unbanked in Latin America: Microlending at the Forefront As the global economy continues to falter, most developing countries are struggling to cope with already weak fundamentals. While Latin America as a region has fared reasonably well, it is also undergoing challenges. Economic growth has stalled in many countries, unemployment is rapidly rising, and domestic demand is weakening. Against this backdrop, the underbanked and unbanked segments in Latin America, representing about 55% to 75% of the total population, are bracing to hold on to what little progress it has made in gaining access to formal credit and the banking sector. In this Strategic Commentary, Speer & Associates, Inc. (S&A) provides an overview of trends and developments in non-traditional bancarization of key Latin American markets with special emphasis on microlending initiatives. Apart from issues of social responsibility, government mandates, and political pressure, there are real opportunities in understanding and penetrating the unbanked segment something many mainstream banks have failed to do, leaving the field open to specialty lenders and retailers. Microlending initiatives provide valuable insights into the unbanked segment, as well as significant credit and customer management experience that banks should be leveraging, to reach a market estimated to be 360 million people by 2012 and a large percentage of that population unbanked.
Page 2 October 2009 The Unbanked in Latin America Despite progress at expanding the scope of conventional financial services, a vast majority of the Latin American population remains marginalized from mainstream banking. As Figure 1 shows, in major Latin American markets like Brazil, Mexico, and Argentina, over 50% of the population is unbanked. Figure 1 Population with Limited or No Access to Financial Services 100% 91% 80% 75% 70% 66% 60% 40% 59% 58% 57% 50% 40% 20% 10% 2% 0% Source: World Bank (**) Superintendencia Bancaria Peru and S&A As a general rule, the unbanked are characterized as lower-income individuals who do not have access to formal banking services, formal credit products, and / or non-cash payment mechanisms. This segment typically relies on retailers for credit (and increasingly banking services in the form of savings accounts), specialty lenders, and informal or unregulated lenders. Not surprisingly, the price for credit is often exorbitant. While reasons differ by market there is broad agreement that distrust of banks, pricing, risk issues, regulation, and distribution all play a role in the limited reach of mainstream financial services across a broad audience. Pricing and risk are closely intertwined with segment income. Given that a vast majority of the unbanked group overlaps with the lower income / informal sector, traditional credit models have been challenged to accurately predict risk. Added to this is the limited information that banks have on the unbanked segment which compounds the limitations of traditional credit management and adds to reluctance to operate in this space. Retailers and specialty lenders on the other hand, have been bold. They have provided credit, albeit at a high price, but have gained considerable segment insight allowing for a steady expansion of fundamental banking products and services. Elektra and Banco Azteca in Mexico, Falabella in
Page 3 October 2009 Chile, and Wong (now Chilean Cencosud) in Peru are noteworthy examples of retailers leveraging their credit experience to successfully expand into the banking business. To gauge banking and credit penetration in major Latin American markets, S&A reviewed several leading indicators as shown in Figure 2. The most telling is perhaps credit as a function of GDP which is less than 35% (Chile is a notable exception) compared to 174% in the U.S. COUNTRY Figure 2 Bancarization in Latin America Leading Indicators Private Credit / GDP Stock Market Capitalization Private Bonds / GDP Online Bill Presentment Households Financial Strength Index Argentina 12% 62% 6% 10% 0% Brazil 33% 36% 0% 10% 24% Chile 75% 86% 10% 19% 58% Mexico 18% 18% 21% 3% 42% Colombia 23% 15% 3% 0% 24% USA 174% 118% 121% 113% 77% Spain 111% 71% 157% 24% 77% The lack of banking distribution outside major cities has been a key impediment to serving the unbanked. As Figure 3 shows, on average there are fewer than 8 branches per 100,000 people in Latin America. This is in marked contrast to countries with high banking penetration, e.g. Spain with 35 branches per 100,000 people and the U.S. with 31 per 100,000 people. Figure 3 Average Number of Branches Per 100,000 People 40 35 30 25 20 15 10 5 0 35 31 15 13 10 10 10 9 9 9 8 Latin American Avg. 7.35 6 5 4 4 3 2 1 Source: World Bank and S&A
Page 4 October 2009 Growth of Non Financial Entities The regulation of the Corresponsales No Bancarios (CNBs), which are non financial entities offering banking services on behalf of a traditional financial institution, is spurring the growth of these companies across Latin America. CNBs generally serve as an extension of the bank, providing deposit collection services, payment services, and increasingly serving as a money transfer sales point. The CNB model has been successful due to the convenience offered to customers and the support from government bancarization efforts. This has proved popular in Brazil, Colombia, and Peru. In December 2008, Mexico s Central Bank approved an amendment to the Credit Institutions Act allowing banks to recruit other business entities to gather deposits and perform certain operations on their behalf, and several institutions, including Walmart de Mexico, have taken advantage of this regulatory relaxation to effectively expand their distribution. Services offered by CNBs depend on the relationship they have with each financial institution, but in general provide the ability for bank customers to make deposits and withdrawals, transfer funds, and receive remittances. Additionally, the CNBs provide collection services for banking related documents, e.g. account opening forms, credit applications, credit supporting documents, etc. CNBs in Brazil In 1973 the Central Bank of Brazil authorized the commercial banking sector to contract with third parties for sending and receiving payments and collections, as well check cashing. However, major growth has been driven by a new resolution passed in 1999 that allows CNBs to provide a greatly expanded suite of services. In many ways, several characteristics have made Brazil the ideal environment for CNBs to expand. The country has some 1,400 municipalities with fewer than 5,000 inhabitants a wide geographical spread; also 55% of traditional bank branches are located in the southeast, the richest region of the country. Some noteworthy CNB alliances in Brazil include: Caixa Economica Federal, which ventured into the CNB market via lottery agency sales chains, although more recently it has also been signing contracts with supermarket chains. Caixa has an estimated 14,000 CNB arrangements with broad national coverage. Bradesco entered the CNB alliance sector through a contract with the Brazilian Post Office in 2001 to use 5,300 of the 10,000 postal agencies in the country. Since then, using the Postal Bank brand, it has expanded its reach to 7,900 service centers serving more than 14 million people. Brazil currently has over 40,000 CNBs with more than 90,000 distribution points throughout the country. It is estimated that in the past five years CNB arrangements have benefited nearly 40 million people, and that 37% of companies with fewer than five employees operating in the informal sector
Page 5 October 2009 operate most of their financial business through these entities. The CNBs now represent 56% of access channels in Brazil. CNBs in Colombia Part of the government s long term initiative, Banca de las Oportunidades (Bank of Opportunities), includes incentives for financial institutions to extend services to the unbanked and under banked areas through CNBs. According to recent industry figures (February 2009), just over a year and a half since the program formally started, nearly 5,000 CNB arrangements are in place surprisingly, most are led by private sector banks. Figure 4 below provides a list of banks and the number of their CNB arrangements. Figure 4 Number of CNBs and Branches / Offices by Bank in Colombia (February 2009) Financial Institution # of CNBs # of Bank Branches / Offices Citibank 3,987 23 Bancolombia 340 713 Banco Agrario De Colombia 228 700 BBVA 108 254 Banco Popular (*) 101 170 AV Villas (*) 89 41 HSBC 38 30 Banco De Bogota (*) 26 274 BCSC 17 32 Banco de Occidente (*) 4 161 Grand Total 4,938 2,398 (*) Part of Grupo Aval. Source: Banca de las Oportunidades Colombia, Bank Websites, and S&A CNB agreements have been made with various types of organizations but primarily retail including pharmacies, supermarkets, cellular communications dealerships, and general stores. While 75% of these distribution arrangements are in communities with 100,000 people or more, considered urban areas, current trends indicate solid expansion into traditionally excluded, or hard to reach rural areas as well. CNB related transactions continue to exhibit strong growth as shown in Figure 5 reaching over 950,000 transactions in February 2009. Transactions are strongly influenced by Bancolombia and Citibank. The transactional mix has been generally steady with loan payments and collections representing 74% of transactions with cash deposits / withdrawals comprising the balance.
Page 6 October 2009 Figure 5 Number of CNB Operations by Month Colombia In Thousands 800 600 400 200 183 63 215 235 168 199 120 120 122 120 372 399 448 414 378 394 349 293 264 280 274 303 226 247 153 165 0 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Citibank Bancolombia Avg. Others Source: Banca de las Oportunidades Colombia and S&A Volume handled through CNBs has also been growing quite well. According to recent statistics, an estimated US$78.5 million was processed through CNBs in February 2009. CNBs are also playing a role in customer acquisition, and have gained significant traction of late, particularly in account openings and credit applications. According to recent industry data, 54% of non monetary operations were for savings account openings and 46% for loan applications. Banks have generally been positive on the CNB alliance structure with several reporting gains in areas of costs, reach, and low income / unbanked segment penetration. Benefits to the Bank: Extending the banking network to the public with mainly variable costs Increased customer retention and service offerings Increased number of transactions (type and amount) Extended hours of operation Speedy implementation Positive social and political implications Benefits to the CNB: New businesses New revenue Offering banking services to its customers Attracting new customers, potentially serving customers of one or more banks Improved community image
Page 7 October 2009 Microlending Microlending is generally defined as the offering of credit and other financial and business services within the lower income segments to generate and support self-employment. Loans are small, hence the term micro. Additionally, microlending initiatives include training and networking opportunities for borrowers and the self-employed in the informal economy. The goal is to provide credit and the tools for establishing, nurturing, and growing a small business successfully and improving overall living standards. Microcredit is one of the most effective ways to help the poor find a dignified route out of poverty, said Microcredit Summit Campaign Director Sam Daley-Harris, and it does so with payback rates that traditional banks would envy. The World Bank estimates that there are over 7,000 microfinance institutions (MFIs), serving an estimated 16 million people in developing countries. The total cash turnover of MFIs world-wide is estimated at US$2.5 billion and the potential for future growth is immense given the income distribution and population demographics of developing countries. The first Microcredit Summit held in 1997 was attended by more than 2,900 people from 137 countries whose goal was to reach 100 million of the world s poorest families and offer microlending. Among the Microcredit Summit Board members is Muhammad Yunus, Managing Director of Grameen Bank and 2006 Nobel Peace Prize recipient. Mr. Yunus is widely credited for putting microfinance on the map and developing the economic model and business case for serving the low income segment in developing countries in Asia, Africa, and Latin America. Latin America has been an important geography for microlending initiatives. As of 2007, there were 579 MFIs in Latin America and the Caribbean of an estimated 3,316 worldwide. According to Banco Interamericano de Desarrollo (BID), 600 institutions are providing US$8.6 billion in credit to more than 8 million borrowers. This is an impressive achievement considering that in 2001 there were only about 2 million borrowers. Despite these gains, the market is large and generally under penetrated. According to Consultative Group to Assist the Poor (CGAP), the median interest rate for sustainable (i.e., profitable) MFIs was about 26% significantly lower than consumer and credit card rates in most of Latin America. The players in the microfinance business have traditionally been Non- Governmental Organizations (NGOs) with some support from public institutions. Of late however, a multitude of institutions have entered this space, including specialty lenders, banks, and government backed entities. Given the current economic crisis there has been a significant reduction of
Page 8 October 2009 credit as lenders have pulled back, but S&A expects the market to rebound as economies recover. Microlending in Mexico Within these MFIs is a Mexican company which recently went public: Compartamos Banco. In October 2009, Compartamos Banco announced it will apply for a license to expand its banking services allowing third parties (CNBs), such as small locally run stores in rural areas, to take deposits and make loans for Compartamos' microfinance customers. Compartamos Banco Originally created in 1990 as an NGO, and in 2000 transformed into a Sociedad Financiera de Objeto Limitado (SOFOL) or Limited Objective Financial Entity, Compartamos Banco offers credit and insurance products to lower income segments all across Mexico. Although there was criticism after the IPO regarding the loss of innocence and focus and setting aside the issue around high pricing Q4 2008 results explain the attractiveness of these businesses for institutional investors. Net income of US$86 million (MXP$1,120 million) in 4Q08, 27.7% growth vs. 4Q07 50.3% ROAE in 4Q08 Total portfolio reached US$441 million (MXP$5,733 million), 37% growth vs. 4Q07 Non-performing loans (NPL) remained at 1.7%, fairly low compared to Mexico s average of 3.42% at the end of last month 1,155,850 active borrowers Microlending in Brazil One of the first examples of microlending in Brazil is CrediAmigo, a program started in 1997 between Banco de Nordeste and ACCION, a private, nonprofit organization that sets up microfinance institutions worldwide to provide microenterprise loans, business training, and other financial services. CrediAmigo The program began with five pilot branches and quickly expanded to 51 branches in 1998. Today, it is one of the largest microlending programs in Brazil as well as in all of Latin America: Number of Active Clients: 400,413 Active Portfolio: US$154 million Range of First Loans: US$43 US$328
Page 9 October 2009 Average Loan Balance: US$387 Portfolio at Risk: 1.13% Percentage of Female Clients: 65% Microlending in Peru MIBANCO Banco de la Microempresa S.A. is considered the first private bank in Peru specializing in microlending. ACCION International assisted in founding Mibanco's predecessor, Acción Comunitaria del Perú (ACP) as a private, nonprofit community development organization in 1982 with the backing of Banco Wiese, one of the largest banks in Peru. While Mibanco's clients are people in informal activities (street sales, potmakers, and other small home-based business owners), the bank has managed to achieve favorable results. Figure 6 MiBanco 2007 Yearend Results 12 / 2007 Number of Clients serviced 2,240,458 Current Clients 441,372 Total Assets US$599.7 Total Loans US$499.6 Total Liabilities US$533.9 Total Deposits US$305.9 Capital US$65.8 Net Income US$20.4 ROE 35.3 % ROA 4.10% Microlending in Argentina Bancarization in Argentina is considered low given generally robust demographics and per capita income. The history of economic and financial crises, in conjunction with government intervention in the banking sector, explains low banking penetration to some degree. The consumer has been pushed to find non-banking solutions including foreign currency denominated asset holdings. As stated by Argentina s Central Bank s (BCRA) Assistant Manager Jose Rutman, credit to the private sector relative to GDP was 25% in the previous decade, and currently is around 11%. Actions taken by BCRA include launching the Cuenta Basica program, a basic universal bank account. This new type of account includes a standardized set of services with a single purpose. Its owner receives a debit card similar to those already existing in the market place, allowing ATM and POS use, along with the return of 5% of VAT (as of September 2008). This
Page 10 October 2009 program offers no significant benefit to the user since it is almost equal to a conventional savings account. New regulations for Credit Cooperatives (Cajas de Crédito Cooperativas) permit them to join as new players to the financial system. Additionally, they are authorized to open temporary bank branches, a liberty formerly granted only to public banks. The new regulations also allow any type of entity to open mobile branch facilities and expand low-value loan trading. According to the Andares organization, a microfinance development foundation, by early 2007 around 30,000 clients across Argentina were served by approximately 90 to 100 MFIs. Traditional Financial Institution Efforts During the first Latin American Banking Congress on Remittances and Microfinance, held in July 2008, successful examples were cited for Brazil, Peru, Colombia, and Chile. Despite these positive examples, there are significant differences in the evolution of microcredit between countries, along with the issue of transitioning small working capital credit to more mainstream consumer financial services (i.e. checking accounts, debit cards, mortgage loans, credit cards, etc.). Traditional bank borrowers are typically salaried, so assessing creditworthiness can usually be done automatically. By contrast, microlending programs target the entry-level segment with no credit history and require a more labor-intensive relationship between loan officer and client. Even though small loans cost more to administer than large ones, costs should decline through economies of scale as volume builds. Some banks have developed lines of credit, including secured personal loans or credit cards to initiate a low risk lending relationship, but this is not closing the gap as quickly between banks and the target population as microlending initiatives seem to be, yet efforts on both sides are still needed to achieve higher bancarization levels.
Page 11 October 2009 Population 100% Figure 7 Closing the Gap for the Underbanked / Unbanked Banks 70% Downscaling Upgrading 32 % Microfinance Institutions (MFIs) 12 % Social Networks 0 % Source: Fundacion Andares and S&A Leveraging the penetration of cell phone use and the developments in mobile technology will offer one of the biggest benefits of delivering financial services: low operating costs, since transactions made through a cell phone are estimated to be up to six times cheaper than those performed in a traditional office. Adding to its main advantage will be flexibility and availability for all segments of the population. Is it Possible to Achieve an Attractive Return for Banking Institutions in the Microlending Business? Different strategies can be considered by banks to address the unbanked segment: creation of separate legal entities or subsidiaries, partnership with current players, acquisitions, retailer alliances, expansion via CNBs, etc. Some basic conditions and challenges have to be met for traditional banks to be serious contenders in the unbanked space: Need for credit infrastructure (models, underwriting systems, analysts) Ability to price risk Focus on customer life cycle management and ability to migrate customers to basic banking products / services Access to low-cost stable funding High scale / low cost operating infrastructure Risk management infrastructure (collections, fraud)
Page 12 October 2009 MIS / Analytic support Branding Internal talent pool Senior Management Issues When addressing the lower income, entry-level unbanked sector, S&A suggests the following key issues be considered by senior management: Does my bank product set have an adequate offer for this segment? Is its focus business? Are the scoring / risk models strong enough? Has my institution simplified procedures and forms / documentation to suit the culture of the segment? If instituting CNB agreements is an option, is it a good solution for my bank? Can my bank management team handle and gain from this type of relationship? Is there a strategy in place? Are other players cornering the market and gaining valuable expertise that my institution will lack when the time to compete arrives? Strategic Commentary is a publication addressing the strategic and management issues facing financial services executives. It is produced exclusively for Speer & Associates, Inc. clients and friends. It may not be reproduced or copied without permission. The annual subscription rate is $995. For subscription and renewal information, please call 770.396.2528 or visit S&A online at www.speerandassociates.com