Role of the Government in Providing Access to Financial Services to the Poor

Kiatchai Sophastienphong Sriyani HulugalleSenior Financial Specialist Senior Economist

Private and Financial Sector Unit South Asia Region

World Bank

Professional Bankers Association – Annual Convention 2007September 22, 2007

Importance of Access to Finance

Sri Lanka’s lack luster economic growth and poverty reduction has not kept pace with the East Asian countries

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1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002

GN

I per

cap

ita (c

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nt U

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M alaysiaThailandSri LankaKorea, Rep.

Economic Growth 1960-2005

Country attracts significantly lower amounts of both domestic and foreign investment than many of its competitors

0123456

India

Malays

iaSri L

anka

Philiph

ines

Thaila

nd

Chilie

China

Vietnam

Net FDI to Sri Lanka and comparator countries

As percentage of GDP - 2005

Growth is concentrated in the western province and there is a lop sided development phenomena in the country

50.8%

8.9 6.3 8.4 4.4 4.8 8.9 4.3 3.1

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20

40

60

11%

25% 28% 27%21%

37% 34%

0%

10%

20%

30%

40%

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Sou

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Nor

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Wes

tern

Nor

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tral

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Sab

ara-

gam

uwa

Provincial Vale Added (% of GDP) 2005

Poverty Head count by province 2002

Cost of finance remains one of the most important constraints toenterprise and access to finance is a problem in the rural sector

Top Five Urban Constraints (and their rural ratings)

UrbanRural

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50 UrbanRural

Electricity Policyuncertainty

Macroinstability

Finance(cost)

Laborregulations

N/A10th5th

Urban rank15th2nd

3rd2nd1st

Rural rank

5th4th

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20

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Electricity Policyuncertainty

Macroinstability

Finance(cost)

Laborregulations

N/A10th5th

Urban rank15th2nd

3rd2nd1st

Rural rank

5th4th

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Transport

Rural

Urban

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Finance(cost)

Finance(access) DemandElectricity

9thUrban rankRural rank

Top Five Rural Constraints(and their urban ratings)

1st 2nd

5th 12th

3rd

NA4th

1st

5th

Some Common Constraints → Finance and ElectricitySome Urban Area Constraints → Labor Regulation and Policy Uncertainty

Some Rural Area Constraints → Market Demand, Transport, and Access to Finance

Current Financial Landscape

3,9313,5162,9462,219Total No. of Bank Branches

and Other Outlets

39353232Other outlets

22201615Private Savings and Development Banks

28272726Housing Finance Institutions

11112323Long-term Lending Institutions

114114112112National Savings Bank

201197196194Regional Development Banks

376369374370Branches

415404406402II. Total No. of LSB Branches and

Other Outlets

3222Private Savings and Development

Banks

2333Housing Finance Institutions

2222Long-term Lending Institutions

1111National Savings Bank

6666Regional Development Banks

14141414I. Total No. of LSBs

Licensed Specialized Banks (LSBs)

• Banking Sector dominates the financial sector

• State and the largest 5 commercial banks have a wide branch network.

• Foreign bank work only in niche areas.

1,8001,501978310Student Savings Units

186194188188Pawning Centres

39373340Foreign Bank Branches and Other Outlets

1,4911,3801,3411,285Domestic Bank Branches

1,5301,4171,3741,319Branches (c)

3,5163,1122,5401,817

II. Total No.of LCB Branches and Other Outlets

12111111Foreign banks

11111111Domestic banks

23222222I. Total No. of LCBs

Licensed Commercial Banks (LCBs)

Housing Finance Sector

• Housing demand is 5 million households and the existing stock is around 4.7 million.

• The national housing shortage is 7.5% of the existing stock (350,000).

• Half of the population can service a mortgage loan but have no access.

• Effective demand for home loan is one in 7 householders and is mostly confined to upend of income groups.

n.a.12.4%62.27.72Registered finance companies

0.1%24%16,5874,010Regional development banks

0.3%98%8,6108,475State Mortgage and Investment Bank

0.2%99%7,9007,850Housing Development Finance Corp. Bank

0.4%44%25,50011,120National Savings Bank

2.3%11%647,90076,223Licensed commercial banks

As a % of total assets

As a % of total loans

Total loans (advances)

Total mortgage loans 2005 (Rs. Mn.)

Item

Contractual Savings

• There are also large contractual savings institutions

– Employees Provident Fund (EPF)– Employees Trust Fund (ETF)– Approved Provident Funds– Insurance

• These account for 28% of the GDP

Let’s focus on access to finance by the poor !!

SME Sector

0.64Long-term Debt/Equity

40Credotrs (days)

2.3Current Ratio

LIQUIDITY

34Debtors

Inventory days (Work-in-progress)

30Inventory days (RM)

ASSET MANAGEMENT (Days)

21Return on investment

39Average gross margin

14Growth in turnover

PROFITABILIYTY

43.6Sales Turnover (Rs. Mn.)

21.1Asset Size (Rs. Mn)

SME AverageGeneral Profile of Firms - SME

• Constitutes 80-89% of the total establishments in the country.

• Accounts for 20% of the value added.• Accounts for 70% of the employment in the

business sector.• Average gross margins are in the region of 39%.

4.727.755.210.510.9%

PrimarySchool.

Mid school

High Schoo

lGradPost GradPhD

Education of Owner

6.328.240.3223.2%

>6051-6041-5030-40<30Age of owner (Yrs)

14.219.718.115.816.715.5%

>10041-10021-4011-206-101-5Employees

4029.416.910.33.4%

>2011-206-103-50-2Age of firm (Yrs)

5.819.82747.3%

>70 mn.

31-70 Mn.

30-11 Mn.

0-10 Mn.

Assets (LKR Mn)

GENERAL PROFILE OF FIRMS

Micro Finance• There is wide range of intuitions formal and

informal.

• Participation of the private commercial banks in micro finance is minimal.

• Reportedly there are about 14,000 units all over the country providing Micro finance.

• Majority are not specialized in micro finance; combine with development and welfare programs.

• Tsunami has exacerbated this situation further.

• Government plays a major role through Samurdhi with 1,038 banking units.

• HNB has been working over 15 years in micro finance and has about 12,500 borrowers.

Micro Finance

• Most of LSBs (RDB, SDB) and one finance company (LOLC) engage in financial services to the low-income category.

•The cooperative sector has about 1,500 CRBs while there are about 3,400 unregulated cooperatives in the country.

•Money lenders account for about 6.2% according to CBSL.

•National Development Trust Fund (NDTF) is engaged in wholesale lending.

•In 2004, there were 15 million deposits and outstanding loan portfolio of Rs 48 billion (CGAP Study)

Issues relating to Access to Finance• Lack of long term credit due to GOSL

preempting funds from contractual savings institutions.

• Lack of Policy framework for SME and Micro finance.

• Dominance of state sector in the SME and micro finance.

• Lack of capacity in development lending.

• Lack of coordination among micro finance donors.

• Lack of capacity of the CBSL to supervise all the MFIs.

• Lack of a more comprehensive regulatory framework for housing finance.

• Lack of comprehensive data base for housing finance.

• Lack of risk management in mortgage lending.

Cross Country ExperienceIs lending to the poor profitable?

• Are the poorest of the poor not being served ?

• Is the solution would be to provide loans at low interest rates and not enforce good practices including loan recoveries?

• Is a recovery rate of 50 % acceptable?

Why is lending to the poor profitable and thus sustainable? (1)

• Training would be minimal and focus on the credit technology rather than the business needs of the client.

• The clients are natural entrepreneurs.

• Every client needs a loan and can use it effectively

• Markets are available

• The clients would be more than happy to receive the loan.

• Governments will fulfill their responsibilities, etc.

Why is lending to the poor profitable and thus sustainable? (2)

• The poor can afford to attend meetings.

• The poor can pay weekly too, since all their undertakings can produce cash everyday.

• The poor can also save…but compulsorily.

• Need enforcement of the contracts.

• Need a legal /regulatory framework to protect lenders and commercialize microfinance to tap cheap sources of funds and extend outreach.

The Bangladesh Experience (1)• Muhammad Yunus’s Grameen Bank established in

1976.

• Replication of Grameen Model around the world.

• Lending networks in small communities with individuals compelled to repay loans by group pressure.

• From a donor-backed enterprise to a sustainable self-financed operation.

• Other profitable NGOs include Association for Social Advancement (ASA), Bangladesh Rural Advancement Committee (BRAC),and Palli Karma-Sahayak Foundation (PKSF)

Mechanisms that can reach the poorBangladesh Story

• Total population is about 140 million, with 80% people in rural areas.

• Outreach of all microfinance institutions is about 21 million clients.

• Total hardcore poor not yet reached 12 million (May 2006).

• Despite 30 years of microcredit history, many MFIs still use hand calculators to prepare their financial statements.

• An estimated 50 % of the population live below the poverty line (< I dollar a day).

Ultra poor program of Palli-Karma Shahayak Foundation(PKSF)

• The ultra poor have no access to financial services.

• The hardcore poor have access to < 1800 calories per head per day and are deprived of basic human needs.

• No land, at most < than 13 decimals, no own house, no savings, weak asset base, earn meager income by selling manual labor for a few months in a year.

• Cannot have 3 meals a day, meet only minimum clothing needs and suffer instability and frustration in their everyday lives.

• These are : beggars, seasonal laborers, domestic help, old people, physically disabled and those without alternative sources of income.

Group lending with the following features :

• No fees backed with a flexible voluntary savings scheme…Tk.1-2 per week and not a requirement for taking out a loan.

• Flexibility in terms of repayment terms, weekly, monthly, six monthly, yearly etc.

• Six months seasonal loans with bullet payments.

• Reduced wholesale lending interest rates from 4.5% to 1 % and the PO (Partner Organizations) lends at 9-10% p.a.

• First loan size Tk.500-4000($10-$60) and progressively increases up to Tk. 5000 for the third loan.

• Grace period 1-6 weeks.

• Orientation and IGA training for self/wage employment.

• Special social assistance programs in health, social awareness, rights of women etc.

PHYSICAL COVERAGE

• 84 Participating POS

• $ 70 million in loans

• $ 5 million in savings

• Repayment rates of 99.57%

OTHER COUNTRY EXPERIENCES

• Afghanistan

• India

• Nepal

• Pakistan

AFGHANISTAN EXPERIENCE• Microfinance emerged in the reconstruction process in 2002 as a means of

social protection and employment promotion and, later, as part of the agenda for promoting alternative livelihoods to opium-growing.

• Experience international NGOs such as BRAC and AKFED were invited to establish microfinance services.

• In 2003, the government and donors supported the creation of theMicrofinance Investment Support Facility for Afghanistan (MISFA), financing and capacity-building apex institution.

• MISFA’s operations focuses on – scaling up outreach rapidly, development of sustainable MFIs, and ensuring that international NGO-managed microfinance operations become registered Afghan microfinance institutions.

• By 2005, MISFA was supporting 12 NGOs with microfinance programs. The first commercial banking license was granted to a microfinance bank, the Aga Khan-sponsored FirstMicrofinance Bank

INDIA EXPERIENCE (1)

• Cooperatives and Regional Development Banks (RDBs) met the needs of rural poor in the 1970s but plagued with corruption and other problems.

• Microfinance loans extended through the Integrated Rural Development Program (IRDP) but faced problems of high subsidy (25-50% of investment cost), misuse of funds, low repayment rates.

• Vacuum filled by development organizations like SEWA Bank, Working Women’s Forum, etc beginning in the late 1990s. This movement gained momentum with entrance of large number of NGOs.

INDIA EXPERIENCE (2)• Creation of mutually aided cooperative societies (MACSs) with 5 states

enacting the MACS Acts. Currently, over 1000 NGOs/MACS engaged in mobilizing savings and providing microfinance services to the poor. Initially funded by donor support through revolving funds and operating grants.

• Recent years seen development of Apex FIs such as Agriculture and Rural Development (NABARD), Small Industries Development Bank of India(SIDBI), etc.

• NABARD refinances commercial bank loans to Self Help Groups (SHGs). The bank-SHG link program has increased banking system outreach.

NEPAL EXPERIENCE (1)• As in India, the origins of microfinance began

with the credit cooperatives and government’s welfare-oriented rural development programs.

• This was followed by establishment of The Agricultural Development Bank of Nepal (ADBN) and the Small Farmer Development Program to provide credit to small groups of farmers on a group guarantee basis. These farmers’ groups evolved into the Small Farmer Cooperatives Ltd.

• Microfinance took off with the establishment of the first gender-focused program, Production Credit for Rural Women, in 1982. These group-based borrowings got their funding from commercial banks (NBL and RBB) and ADBN.

NEPAL EXPERIENCE (2)

• In 1994, NGOs played a role in converting these intermediaries into MFIs. Microfinance got a boost in 1992 with the establishment of Regional Rural Development Banks (RRDBs). The role of NGOs and cooperatives grew until 2001 when insurgency’s activities brought it to a halt. ADB then supported the establishment of Rural Microfinance Development Center (RMDC) to provide wholesale fund to MFIs.

• As in Pakistan, microfinance gains prominence with the establishment of an enabling legal framework and provision of funding through apex institutions

PAKISTAN EXPERIENCE (1)

• The Aga Khan Rural Support Program (AKRSP) began its integrated rural development program in 1982 and became the first NGO to transform itself into a privately-owned microfinance bank. Its growth was initially supported by grant funding from bilateral donors. Later its operation was sustained by investment income from employment of surplus funds rather than income from its lending operation.

• AKRSP spawned the rural support program (RSP) which today accounts for 70% of the NGO outreach in microfinance. Grant funding began to flow to NGOs in a big way during the early 1980s.

PAKISTAN EXPERIENCE (2)

• Two other RSPs including National Rural Support Program (NRSP) were established in 1989 and 1992. It depends on subsidized funding from PPAF and commercial borrowings.

• Other players began to enter the market including Network Leasing Company (1994), Bank of Khyber (1995) owed by a provincial bank, The First Women’s Bank, and KashfFoundation (set up exclusively to provide microfinance services to women). Kashf became the first MFI to be profitable after adjusting for subsidies.

• In 1999, Musharraf government made microfinance promotion one of the pillars of its poverty reduction strategy. PPAF –which was modeled after PKSF in Bangladesh - became operational in 2000 with government and World Bank funding.

PAKISTAN EXPERIENCE (3)

• In 2000, the government established Khushhali Bank, a microfinance bank set up under a special ordinance. Funding came from the government, private banks, and multilateral financial institutions.

• The MFI Ordinance was passed in 2001 to permit the creation of microfinance banks under the supervision of the State Bank of Pakistan. The First MicroFinance Bank was established by AKRSP and the Aga Khan Fund for Economic Development (AKFED) under this Ordinance. Six microfinance banks have so far been set up

SUGGESTIONS FOR IMPROVEMENTShort-Term

• Eliminate\minimize subsidized interest rates (LPB, Samurdhi, CBSL).

• Encourage and show case good practices (SLP, CRIB, Forward Sales Contracts).

• Encourage public private partnerships (SLP and commercial banks).

• Reduce state involvement where the private sector and NGO sectorare effective and utilize the existing institutional structure.

• Reconsider the role for Lankaputra as a second tier agency for SMEs.

• Enhance skills development in banks and MFIs.

SUGGESTIONS FOR IMPROVEMENTShort-Term

• De-link welfare and banking.

• Increase the threshold for MFI supervision to a more manageable level and introduce self regulatory guidelines to the others.

• Establish a functional land registration and titling system for the development of primary mortgage markets.

• A data base property and house price indices to develop active and efficient mortgage markets.

SUGGESTIONS FOR IMPROVEMENTMedium-Term

• Reduce active state participation in delivery of credit (LPB, Samurdhi, RDB).

• Introduce new products (Micro insurance, Micro leasing, weather insurance) after assessing the capacity of the MFIs.

• Share technology platforms\infrastructure (ATMs).

• Continue the current government strategy of housing finance liberalization and withdrawal from directed credit and other government interventions.

• More aggressive growth in primary mortgage markets is constrained by the availability of long term funds.

• Replace existing interest rate subsidies which are distortive and costly to the budget with transparent, direct, and well targeted subsidies to lower income groups.

CONCLUSIONS AND RECOMMENDATIONS

• Need genuine partnership arrangements between institutions and governments, at national and local levels.

• Evaluation of the current credit delivery mechanisms.

• Donors attention should be focused on provision of funds for social mobilization and assistance to support good inclusive financial services delivery mechanisms.

• Reduction poverty through provision of financial services to the hardcore poor should be prepared to support a combination of financial services delivery mechanisms and social assistance programs.

• Last but not least…the graduation of the hardcore poor to sustainable microfinance implies a reduction in the government social costs and could enhance accountability of the political leaders that spend most of their efforts in applying economic models that do not work for the poor.

THANK YOU.