What commercial banks can learn from microfinance banks

Commercial banks must move Know Your Customer (KYC) procedures beyond mere filling of forms.

Commercial bank funding to micro, small and medium-scale enterprises (MSMEs) as a share of the total loan portfolio of banks in Nigeria dropped from a high of 46 percent in 1992 to less than 5 percent in 2017. There are a number of reasons for this huge drop in lending to what is considered a critical segment of the economy. Bank's high cost of fund, which has led to persistently high lending rates, has made it difficult for most MSMEs to obtain financing from commercial banks.

Another reason is the proliferation of finance houses over the same period. Many of these companies are focused on lending to the MSME segment. Particularly, microfinance institutions (MFIs) have been picking up the slack as a result of the financing gap by commercial banks. In 2005, the Central Bank of Nigeria (CBN) had introduced a Microfinance Policy Framework to enhance the access of microentrepreneurs and low-income households to financial services. This led to an increase in the number of players in that space. There are currently over 600 microfinance banks (MFBs) in the country.

Consequently, whilst commercial banks’ lending to MSMEs dropped, lending by MFIs to MSMEs has grown exponentially since 2006. The MFIs have been able to expand their lending to small and micro-enterprises by devising some strategies, from which perhaps commercial banks can learn a thing or two. 1. Commercial banks must realise that a large percentage of microentrepreneurs in Nigeria are in the agriculture value chain. These enterprises require prompt financing to coincide with the seasonality of the commodities they deal in. This means a potential lender must have an understanding of those commodities. Microfinance banks seem to have garnered considerable knowledge of the businesses they finance.

Oftentimes, commercial banks jump into sectors they don’t understand. And they invariably lose money as a result of not having sufficient knowledge of the markets. If commercial banks want to serve the MSMEs segment profitably, they need to associate more with individuals and businesses in the agricultural sector. They need to understand the various crops and products – including knowing what seasons they grow in and which regions of the country are profitable to grow them. They need to understand the entire value chain of the various commodities.

2. Most small businessowners don’t require bankers in the strict sense of it. Rather, they want partners. The MFB loan officers visit the borrowers regularly at their marketplaces and in their homes. They know their borrowers’ children, their borrowers’ customers, and their buying-andselling patterns. They are true partners to the businessowners.

Commercial banks must move Know Your Customer (KYC) procedures beyond mere filling of forms. They must strive to know their customers, especially the micro and small businesses, up to where they live. 3. Every business, especially small businesses, require funds that are enough to enable them to comfortably cover their cost of operations. They also want to be able to earn a decent profit in the process. There is no point in the lender earning considerable interest income and making the borrower bankrupt. This approach is neither sustainable for the bank nor the customer.

Whilst a number of people have criticised the commercial bank’s model of charging interest on a monthly basis, the MFIs have devised means whereby the borrowers are able to pay back loans over a period without really feeling the interest burden. The repayments are usually, daily or weekly, just as sales are being made.

4. MFBs have realised that every sector’s client base is different. So, they often design products that cater to the peculiar needs of various groups. It is, therefore, not unusual, for instance, to see products designed specifically for women groups, traders, fishermen, farmers, school children, etc. The MFBs take product development very seriously as this is what differentiates them from their larger competitors.

Commercial banks must go beyond tweaking the traditional current and savings account products, to designing products that address the peculiar needs and aspirations of individual groups and sectors.

5. MFBs have also been able to create

considerable value for themselves and potential borrowers through the cooperative-based lending model. This model has a number of advantages. Firstly, it reduces their cost of administration and monitoring, because they are able to bunch intending customers into specific groups overseen by a loan office, branch or region as the case may be.

Secondly, it offers an inbuilt repayment mechanism because each member of the cooperative group acts as a check on the other borrowers. Commercial banks might not be able to use this cross-guarantee model to secure loans, but they can adopt variants of the model through a sort of cluster-based or partnership model. They can bunch potential borrowers in the same value chain, industry or cluster to reduce costs and achieve scale within the MSME segment. The banks will receive some sort of comfort, knowing that businesses within a cluster share common facilities, use the same set of service providers and almost always have to abide by certain rules within that community.

6. Another area where commercial banks can learn from MFBs is in the area of business support services. For most MFB borrowers, they are not given loans at the first time of applying. Rather, they have to go through some sort of business development and entrepreneurship training. The MFBs pair potential borrowers with business trainers and mentors; the potential borrowers attend weekly meetings where they learn things like bookkeeping, marketing, and the like.

The MFBs don’t view this expense as a cost, but rather as an investment into the future repayment capacity of the borrowers. Their philosophy is hinged on the fact that lending to this segment of the society must go hand-in-hand with business development services and entrepreneurship training. They invest in these services either through an in-house department or in partnership with external experts in this field.

7. The MFIs also adopt an insurance model for most of their loans. They strive to ensure that most of the loans/borrowers are insured, with the MFBs named as beneficiaries in the case of death. This is a good risk management tool, which could work well for the banking industry as well as the insurance industry. Insurers and bankers need to come together and design risk management products to mitigate some of the risk in the MSME space.

Whilst I have highlighted areas where commercial banks can take a cue from MFIs in the area of lending to MSMEs, there are also areas that MFIs can learn from commercial banks as they seek to profitably serve small and microenterprises. Some of these areas include the standardisation of service offerings.

Oftentimes, when MFIs decide to expand their network beyond their primary base, they lose the quality standards of their products. They can definitely take a cue from the commercial banks that are able to grow their branch networks exponentially, while maintaining seamless service quality across the country.

The most important thing though is for both sets of institutions to realise that they need to work together and not against each other in order to share information, experiences, jointly finance customers, and perhaps share infrastructure to bring down cost of lending to the MSME segment.

One of the ways that have been suggested for collaboration is for commercial banks to lend to MFBs who will in turn lend to the MSME clients. Some commercial banks, by virtue of their structure, might not be able to service the itinerant, informal businesses. But the MFBs have seemingly mastered this segment. The commercial banks might also be more comfortable taking on the risk of the MFBs as opposed to the microborrowers themselves. However, this presupposes that the MFBs have gotten to a level where their operations and risk profiles are acceptable to the commercial lenders.

Essentially, every party has work to be done with regard to improving their processes to cater to this critical segment of the economy. The MSME segment is arguably the most important in the economy. It has the potential to create jobs, increase incomes and lift many out of poverty. Institutions in the financial services industry must continue to find ways of collaborating to profitably serve this segment.

There are also areas that MFIs can learn from commercial banks as they seek to profitably serve small and micro enterprises.