Business magazine Knowledge@Wharton, linked to the prestigious Wharton Business School of the University of Pennsylvania, published in 2009 a list of the 30 most significant innovations of the past 30 years. Microfinance was number 17 on the list.
Microfinance was born 40 years ago in Bangladesh as a social experiment developed by economist Muhammad Yunus, who founded Grameen Bank to develop a credit system for the rural and poor population, which had been excluded from traditional financial services. Soon, microfinance institutions began to grow in different parts of Latin America and the Caribbean with similar socio-economic characteristics. In 2006, Yunus and Grameen Bank were awarded the Nobel Peace Prize.
“From those small projects driven by volunteers convinced that poor people could be good credit subjects, a thriving industry emerged with some 1,000 financial institutions serving more than 20 million clients through a loan portfolio of almost $40 billion,” writes Luis Alberto Moreno, president of the Inter-American Development Bank (IDB) in Microfinance and ICT: Innovative experiences in Latin America.
High risk and low profitability
Microfinance customers are considered high-risk as they don´t pay taxes, are poor and have an irregular income, among other factors. Profitability is also low due to the small size of operations and their dispersion. These two reasons have forced the industry to come up with innovative mechanisms to design financial products and services appropriate to the reality of its customers.
These mechanisms include risk assessment and risk management technologies based on customer relationships. The personal link with clients allows the lender to know their capacity and willingness to pay - since there is no bank or credit history to rely on, and no guarantees to back the loans. As these clients usually live in rural or remote areas, where there are no bank branches, microfinance entities visit their homes or small businesses.
All of this entails high costs for microfinance institutions, known as MFIs, which charge higher interest rates than those offered by traditional banks. The average interest rates for Latin America and the Caribbean are 28.3% per year, with Mexico being the highest (63.1%), followed by Argentina (53%), Dominican Republic (38.5%) and Guatemala (34%). The lowest interest rates are charged in Peru, with around 27% annually, according to the "Financial Inclusion in Latin America and the Caribbean” report.
The bank in the cell phone
There are currently 1.7 billion unbanked adults in the world, according to the Global Findex 2018, the World Bank database. New technologies play a crucial role in reaching these people at a lower cost. The key: two thirds of adults who have been excluded from financial services own a telephone.
“In the midst of the digital era, the expansion of microfinance has been strongly driven by the rapid adoption of mobile telephony and the development of new ICT (Information and Communication Technologies) solutions,” says César Alierta, CEO of Fundación Telefónica, in Microfinance and ICT . These technologies allow MFIs to collect, store and analyze data, and develop credit scoring models, the report said.
About 55% of adults in Latin America and the Caribbean have cell phones with internet access, 15 percentage points higher than the developing world average, according to the World Bank database. This represents a "historic opportunity," says IDB chief Moreno, since six out of 10 adults in the region are excluded from traditional financial services. New mobile applications provide many services that in the past were only available at a bank branch.
Among the new technologies used in microfinance are biometric identification, computerization of operations through management information systems (GIS or MIS) and the adoption of decision support systems (DSS), including risk management, asset and liability management (ALM), profitability analysis, CRM (customer relationship management ) and credit scoring.
All these advances mean better conditions for customers and lower costs for banks, which may continue to invest in new products and services, focused on each segment and geographical area.
Peru: Microfinance champion
A country that seems to have greatly benefited from the digital microcredit revolution is Peru. According to the Global Microscope 2016, prepared by the Economist Intelligence Unit (EIU), Peru shares, with Colombia, the first place in the Financial Inclusion Ranking.
Among the reasons that have contributed to a high demand for microfinance services in Peru, the report singles out an adequate regulatory framework without interest rate caps, reasonable capital requirements and low-entry barriers.
Microcredit financing in Peru is offered by entities that range from non-governmental organizations (NGOs) and rural savings and credit banks to some commercial banks, according to the Microfinance Information Exchange (MIX).
“Between 40% and 70% of the loans placed per month by a microfinance company are for the same client portfolio” in Peru, says John Sarmiento, commercial microfinance manager at Experian Peru, an information services, analytical solutions and marketing company.