Prof. Savita Shankar, Keio Business School, shares the second part of her research into how to bridge the missing middle in micro-financing.
By Tom Gamble. Related research: The role of credit rating in addressing gaps in micro and small enterprises
High-touch and hand-holding: Where the solutions lie
So how can these challenges be overcome? The top ingredients for success are highlighted in Prof. Shankar’s research results, successful models in all three countries having two features in common. First, credit appraisal of potential borrowers must involve a specially designated lending officer who spends considerable time observing the business, interviewing the owners, cross-checking the records, analyzing the business model and assessing suppliers and customers.
Altogether, it is a very high-touch and hand-holding experience and it is often the case that these officers themselves draw up cash flow statements for the potential borrowers. The second essential feature often involves training the potential borrowers in financial accounting practices – either formally or informally.
In addition, other in-the-field factors have an important impact. The issue of collateral can be circumnavigated by banks accepting notional security such as original land documents or identity cards. Pragmatically, microfinance banks can also develop in-house model cash flow statements for specific sectors that are commonly financed. And on another level – that of eliminating bias – banks can offer a more objective treatment of potential missing middle companies by separating the credit function from the sales function within their organisation.
‘The problem is that these strategies call for upfront investment in employee time before obtaining any financial returns from the enterprise,’ states Prof. Shankar. ‘But if microfinance institutions manage to build a robust lending model, in the long term the benefits of this strategy can pay off by way of potential repeat business as well as savings in recovery and loan write-off costs.’
Bridging the gap
On a more macro level, Prof. Shankar’s interviews and analysis pinpointed other measures that could help increase the availability of funds to missing middle enterprises. For example, in India, Bangladesh and Pakistan it has now become easier for microenterprises to open and operate bank accounts due to the availability of mobile-based digital finance and debit cards. ‘So it should be possible for them’, argues Prof. Shankar, ‘to switch to account-based transactions.’ However, this will take time – their entire ecosystem, including suppliers and customers, needs to change. And this is where Intervention from NGOs and government may be required to nudge things forward through policy, technical help, funding and training initiatives.
Other recommendations include developing new, customized financial products to address entrepreneurs’ specific needs and constraints – one criticism being that microfinance banks tend to offer a one-size-fits-all model. Another way is what is termed value chain financing: microfinance providers can analyse the value chains of small enterprises and finance the various participants with a view to improving the overall efficiency of the chain. ‘This would involve assessing the enterprise’s suppliers and customers,’ explains Savita Shankar, ‘and financing all of them as a cluster so as to reduce overall risk for the lender.’
And finally, other areas for hope include the role of credit bureaus. In India and Pakistan at least, most large microfinance providers now report to them. This means that if individuals have borrowed from these institutions in the past, their credit histories will now be available – a way to both check a small enterprise’s legitimacy for a bigger loan and also reduce risk for the bank. Moreover, the payment history for utility and telephone bills of potential borrowers can also be scrutinized to check creditworthiness. Not to mention the fact that specialized credit rating agencies focusing on small firms may soon develop.
Steps at the micro level
‘In India, the infrastructure to cater to this segment is being put in place,’ says Prof. Shankar, something that can be seen in the launch of a public sector financial institution, the Micro Units Development and Refinance Agency, known as MUDRA. Its job is to assist micro-finance banks – which report to credit bureaus – with a hefty Rs200 billion available for onlending and Rs30 billion for provision of credit guarantees.
‘Bangladesh, the earliest microfinance market, has also been the first to observe and address the needs of microfinance graduates,’ states Shankar. Larger MFIs dominate the segment as smaller ones are constrained by availability of funds. ‘However,’ she continues, ‘the lack of a credit bureau increases risk levels considerably and is a significant drawback in the Bangladesh microfinance sector.’
This high risk reduces the incentive for lenders to provide larger-value loans and Prof. Shankar stresses the importance for regulatory action to address this lacuna. The prevailing uncertain political climate in Bangladesh also increases the riskiness of microenterprise loans, as small businesses are often adversely affected by shutdowns and at times even sustain damage during political disturbances.
In Pakistan, microfinance banks providing microenterprise loans have met with success and two banks are in the process of scaling up the product to cater for the missing middle. ‘As the loan sizes and number of loans increases,’ asserts Prof. Shankar, ‘the availability of a credit bureau in the country should help lenders. An area for concern,’ she adds, ‘is that the overall penetration of the microfinance sector in the country is low, though the recent efforts being made to increase funding for MFIs may be helpful in this regard.’
Prof. Shankar points to the fact, however, that the political disturbances in the country and prevailing shortage of electricity are risk factors that could affect the performance of microenterprise loans.
‘In all three countries, governments need to support lenders with funding options, make reporting to credit bureaus compulsory, fund financial literacy campaigns targeted at microenterprises, introduce measures to reduce use of cash-based transactions, and make registration of enterprises easy and universal,’ concludes Prof. Savita Shankar. ‘Catering to the financing needs of missing middle firms has great potential to invigorate South Asian economies – making them more inclusive and dynamic.’
View Part 1 of Prof. Savita Shankar’s feature article
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