So far in The Evidence Project posts, I have focused on what the evidence tells us about the benefits for clients. Even when I compared credit groups to savings groups (post # 16) in terms of the “net costs,” I referred to the balance of costs and benefits to the group members, not to the institution that sponsors and supports these groups. I concluded that the evidence indicates savings groups offer members a better deal than credit groups do, but I was not comparing these two delivery strategies in terms of their financial sustainability and therefore replicability to achieve major scale. In this Theme Seven and the next Theme Eight, I examine what we know about the financial viability and replicability to scale of the two delivery strategies—the business case for each.
Integration of group microfinance with various non-financial interventions has been the hallmark of Freedom from Hunger’s work for more than two decades. However, any description of the underlying business model has to start with the financial model of group microfinance and then consider how this model is affected by integration with the non-financial interventions. For credit-led group microfinance as practiced by Freedom from Hunger and its many implementing partners, this mostly means village banking or variations on this model first developed and disseminated by John Hatch of FINCA International.
In simple terms, the business case for village banking is that women in relatively poor, traditional communities will form and manage groups as directed, and through these groups, they will take and repay loans that generate enough interest to cover more than the cost of serving these groups and providing the loans. A business can be built on this model.
The bigger question is this: Can a business built on the village banking model reach sufficient scale to generate enough revenue consistently over time to sustain a financial service institution and enable it to grow further to serve even more people in need?
Village Banking as a Stand-Alone Business
In the September 2000 issue of the The MicroBanking Bulletin, Gary Woller did an analysis of the financial viability of village banking institutions (VBIs) in comparison with individual lending institutions (ILIs)and solidarity group institutions (SGIs)—in those days, microfinance institutions (MFIs) tended to specialize in only one of these three delivery strategies. Gary used the performance data reported by these institutions to The MicroBanking Bulletin, which gave rise to the Microfinance Information eXchange (now called MIX Market). He looked at the averages for the full sample of VBIs, and he focused on nine of them for deeper analysis. These nine had been operating an average of eight years at the time. Six of the nine had already achieved and exceeded operational self-sufficiency and six had financial self-sufficiency above 90 percent—better than SGIs but worse than ILIs.
Judged by the administrative and salary expense ratios, VBIs were slightly less efficient than SGIs and both were substantially less efficient than ILIs. However, judged by cost per borrower and staff productivity, VBIs were by far the most efficient of the three types of institution. The discrepancy reflects the major differences between these efficiency indicators in terms of what they measure about an institution.
Judged by portfolio yield (total interest income divided by the average loan portfolio) and interest spread (difference between the portfolio yield and the administrative expense ratio), the return on portfolio of VBIs compares quite favorably with the other two institution types. Portfolio yield was moderately higher than SGIs and substantially higher than ILIs. Faced with a high cost structure relative to the other two lending methodologies, VBIs appear to compensate by achieving higher levels of productivity of their employees (thanks to single loans to large groups of clients, thereby driving down their average cost per borrower) and by charging higher interest rates. Due to high portfolio yields, VBIs earned a positive, though small, spread over their higher costs—they are profitable. Moreover, they can use these profits to grow to massive scale, the extreme example being Compartamos, a VBI and the largest microfinance provider in Latin America.
Village Banking as One of Several Products Offered by a Financial Service Provider
The modern institutional trend in microfinance is to offer several financial products and services to suit the needs of a variety of clients and to accommodate the changing needs of clients over time. Often VBIs have evolved to retain their clients by offering individual loans for a variety of special purposes as the group members have demonstrated their creditworthiness and moved up the hierarchy of needs. However, Freedom from Hunger pioneered this trend toward diversification from a different angle—the introduction of village banking to existing financial institutions, notably credit unions and rural banks, as a new line of service added to their existing lines. The business case for these local, deposit-taking financial institutions is that village banking enables them to reach poorer, more rural, mostly female clientele who had not been able or willing to use the standard products of these institutions. In offering the new service, these institutions are able to put idle cash on hand to productive, profitable use—putting savings deposits by salaried, urban clients into productive, low-risk loans in rural areas and at the same time capturing savings from a new demographic.
In the June 2009 issue of Enterprise Development and Microfinance, I summarized Freedom from Hunger’s experience with village banking offered by credit unions and rural banks. For the section on the “advantages and challenges” of this business model, I drew on the earlier work of my colleagues Kathleen Stack and Didier Thys in an article they published in the same September 2000 issue of The MicroBanking Bulletin as published Gary Woller’s paper. The following is excerpted from my paper drawing heavily on theirs.
The persistence of the local financial institutions in providing village banking over the years indicates a high degree of satisfaction with the performance of this line of service in helping the institution meet its objectives. In 27 of the 37 cases, the institution had been offering village banking for five or more years (11 of them for 10–16 years)—up to June 2008. Moreover, the village banking add-on had spread within countries (from Rural Bank to Rural Bank, from credit union to credit union) by demonstration and word-of-mouth influence of early adopters on later adopters. There was a similar diffusion internationally—from Burkina Faso to Mali, Togo, Madagascar and Bénin (through the Desjardins network mostly) and from the Philippines to Ecuador (through the World Council of Credit Unions).
Reasons for institutional satisfaction seemed to vary, but the most general one was that village banking is very often a profitable line of service. Of the 20 institutions reporting the operational self-sufficiency ratio for their village banking lines of service, 19 reported greater than 100 percent (all but two of these 19 reported more than 110 percent).
In Burkina Faso, the RCPB initiated its pilot test of village banking in 1993, at which time the federation’s loan-to-savings ratio, or transformation rate, was 22 percent. The transformation rate improved to 150 percent in 1998, partly due to widespread adoption of the group-based line of service, which had allowed credit unions to transform surplus urban savings into loans for a rural market.
The commercial viability of adding village banking to the established services of existing local financial institutions seems amply demonstrated. There is an “economy of scope” in this strategy that reduces the start-up and recurrent costs. Back office and overhead costs can be shared with other self-financing service lines of the local financial institutions. These deposit-taking institutions have the capacity to finance a new service line from internally generated resources (savings). Credit risk can be spread over a diverse loan portfolio. And it seems that cross-subsidy is not required. The group-based service can be fully self-financing, even quite profitable.