Monday comment2

A national microfinance bank cannot cure the ills of microfinance banks, argues Tiko Okoye

According to figures contained in the 2016 Financial Inclusion Survey Report released by Enhancing Financial Innovation and Access (EFInA), a financial sector development organisation that promotes financial inclusion in Nigeria, the proportion of financially excluded persons rose from 39.7% in 2012 to 41.6% in 2016.

The same EFInA survey report indicated that between 2010 and 2012, the number of adult population with access to microfinance banks increased by 1.4million, followed by a major decline between 2012 and 2016 from 4.6million to 1.8million.

Despite the fact that the apex bank has over the past decade rolled out policy instruments and programmes aimed at improving the performance and contributions of the sub-sector towards poverty alleviation and national economic development, the impact of microfinance banking activities as a contributor to the GDP has remained marginal despite their multiplicity of numbers.

To further compound matters, currency circulating outside the formal banking system is on the increase – an area microfinance banks are supposed to be big players – along with its negative implications for monetary policy formulation and implementation.

The foregoing may have prodded the CBN Governor, Godwin Emefiele, to rue that “those microfinance banks that we have today” are not doing what they are supposed to be doing. Still, you cannot just give a dog a bad name just to hang it or throw away the baby with the bath water because it is convenient to do so.

Emefiele’s antidote to the shortcomings of the microfinance subsector is the establishment of a National Microfinance Bank jointly owned by it and the Bankers’ Committee. Let me proceed to state reasons why this is toxic medicine that will ultimately end in failure, because any wrong diagnosis will culminate in wrong prescription and treatment.

First, due cognizance has hardly been taken of the reality that the increase in the number of financially excluded persons is due to a milieu of factors such as the effects of the relatively long recession, job losses, business failures, etc. It would be foolhardy to point to microfinance banks as the cause.

Second, it is an open secret that top management staff at the banking regulatory agencies lack understanding about what typical business models of sustainable microfinance. Studies done by Symbiotics – a leading global investment boutique specialized in emerging, sustainable and inclusive finance – indicate among other things that microfinance institutions are very labour intensive (Group Lending Methodology), with 15% operating expenses on the average – a figure 10 times higher than that of commercial banks!

The cost of funds of a typical microfinance bank can exceed that of a typical commercial bank by as many as 15 times. When you have this kind of lethal combination – high operating costs and high cost of funds – the inevitable end-product is reflected in “usurious” rates.

Although microfinance banks have a social mission to escalate access to financial services to the economically active poor – unlike commercial banks that tend to focus solely on profit maximization – microfinance is still not a charity but a business relationship with obligations. Microfinance operators must aim at full coverage of costs plus an ample return to shareholders in order to remain in business on a sustainable basis.

Besides, foreign investor outflows have been on the rise (for reasons outside the purview of this essay), rising from N402billion in 2017 to N606billion at the end of November 2018 (a whopping increase of 51%!). This is bound to pile more pressures on our external reserves. And when you consider that this has been an election year marked by a tight monetary policy – as the apex bank seeks to maintain a tight lid on inflation arising from runaway campaign spending – one can understand why the question of high and rising interest rates would continue to remain worrisome!      

The CBN Governor equally lamented that “microfinance banks have made it nigh impossible for many small and medium enterprises to access the federal government’s loans aimed at stimulating local production and boosting non-oil export.” But who is really to blame for this sorry state?

It has been universally proven that about 70-80% of new businesses fail before they reach the age of five. Are microfinance banks set up to bear such colossal losses?

Let’s next consider a key prudential guideline for the composition of a microfinance bank’s loan portfolio: the 80/20 rule. The apex bank requires each microfinance bank to lend 80% of its deposits in the form of microcredits and 20% to SMEs (the microcredit figure is a Minimum while the SME figure is a Maximum).

The operating costs associated with building an 80/20 loan portfolio is far, far costlier than building a 20/80 loan portfolio because the clientele base is atomistic and the loan size is very small, unlike when the operator is principally dealing with few SMEs with fairly large loan applications.

Since the CBN governor slammed the microfinance banks for charging “outrageous and exorbitant” interest rates on microloans, does it mean that its proposed national microfinance bank would heavily subsidize its clientele by charging below-market rates? This would not only amount to an inefficient deployment of scarce public funds, but it will also go against the grain of a basic CGAP Microfinance principle to the effect that subsidized credits and interest rate caps are very injurious to the economically active poor in the medium to long term. It might even encourage the SME borrower to place the borrowed fund at a much higher interest in an investment vehicle without the higher risk embedded in actual production!

While it is true that the CBN has established several intervention funds aimed at stimulating local production and boosting non-oil export, the fact is that the apex bank has largely left undone what it should have done to empower the subsector. For instance, the National Microfinance Policy provided for the establishment of a Microfinance Development Fund to provide the much needed liquidity to the subsector.

Under the policy, the three tiers of government are mandated to donate one per cent of their budgets to the Fund. But it has remained a mirage since its launch in 2005 due to a lack of will on the part of the apex bank to enforce the directive. Compare this with a country like India where a law that requires commercial banks to allocate 10% of their deposits to microfinance banks for on-lending is very robustly monitored to guarantee compliance.

Believing that the plethora of challenges facing the sub-sector is chiefly attributable to lack of sufficient capital to engage in intermediation activities – and given its inability to make the microfinance development fund a raving success – the apex bank recently gave existing various categories of microfinance banks a grace period of 18 months to significantly shore up their capital, while new applicants are to immediately comply with the new directives.

In all this, the apex bank has not bothered to take cognizance of the relatively high cost of equity when compared to other sources of funding and why equity investors seek more financial leverage rather than less. Evenly more confusing is that the apex bank had hardly rolled out the new directive than it announced plans to establish its own national microfinance bank! What is to be made of such ill-advised impatience and policy flip-flopping?

While the number of financially excluded persons has risen, it is also true that there is a very wide disparity in their proportions among geopolitical zones. The Southwest has the least number of financially excluded persons, with the Southeast, South-south, Northwest, North-central and Northeast following in an increasing order of financial exclusion.

Microfinance banks in zones that have achieved a very high level of financial inclusion inevitably continue lending to already financially included persons, resulting in repayment challenges associated with over-borrowing. On the other hand, zones with high proportions of the financially excluded witness an alarming paucity of activities even when the need for microfinance services is crystal-clear.

Furthermore, the profile of microfinance customers by geo-political zones, in terms of financial literacy, access to mobile phones, occupational type and rural/urban nature is very revealing.

What the combined picture goes to show is the imperative of decentralisation rather than centralisation. As long as the apex bank seems hell-bent on foisting a one-size-fits-all policy on the sub-sector so will the operators continue to fall short of targets and expectations. A clear and present danger also exists that a government-led initiative like a monolithic National Microfinance Bank would foist its processes and procedures on the operators in the subsector without their buy-in.

 Okoye is an Abuja-based Microfinance Management Consultant