Management of Financial Institutions


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Management of Financial Institutions - MGT 604
Lecture # 21
Microfinance in its broadest terms can be defined as provision of a range of financial
services such as deposits, loans, payment services, money transfers and insurance to poor
and low income households, and their micro enterprises (Source: Asian Development bank
report on microfinance development strategy). While a commercial bank is a financial
institution that offers a broad range of deposit accounts, including checking, savings, and
time deposits, and extends loans to individuals and businesses.
The decision as to whether the commercial banks be involved in microfinance is a sensitive
and debatable issue which requires a deep analysis of many factors.
Primarily, the microfinance customers are large in number, scattered in far-flung areas with
very minute transaction sizes. Only government or state bank alone cannot reach out to
millions of potential Microfinance beneficiaries; a whole well knitted network with almost
doorstep reach is required, which is only possible when the commercial banks will be
involved in microfinance. In Pakistan it is estimated that as many as 5.6 million households
need microfinance services but these services reach only to less than 1 percent, most
probably because of the absence of commercial banks from the microfinance sector.
(Source: Pakistan microfinance Network PMN) This way a poor person just need to visit his
local commercial bank to get access to microfinance benefits, which will help reduce many
economic problems.
One criticism over involving the commercial banks in microfinance is that commercial
banks will charge higher interest rates, further lower the standard of living and will exploit
the public. The ground realities are totally different; empirical evidence has demonstrated
that participants in microfinance programs have improved their living standards at both the
individual and household level, and that this has provided increased educational
opportunities for children. For example, the clients of the Bangladesh Rural Advancement
Committee increased household expenditures by 28% and assets by 112%. It was also
demonstrated that Bangladeshi children were sent to school in larger numbers and stayed for
a longer time ­ almost all girls in Grameen Bank (A commercial bank!) client households
had some schooling, compared with the rate of 60% in non-client households. (Source:
World Bank group, 30 August 2005) No doubt on the other hand the loans provided by the
commercial banks to the microfinance beneficiaries are a bit expensive, its not to discourage
the poor but there is a sound reason behind it; Providing financial services to poor people is
quite expensive, especially in relation to the size of the transactions involved. A $100 dollar
loan, for example, requires the same personnel and resources as a $2,000 one thus
increasing per unit transaction costs. Loan officers must visit the client's home or place of
work, evaluate creditworthiness on the basis of interviews with the client's family and
references, and in many cases, follow through with visits to reinforce the repayment culture.
It can easily cost US$25 to make a micro loan. While that might not seem unreasonable in
absolute terms, it might represent 25% of the value of the loan amount, and force the
institution to charge a "high" rate of interest to cover its cost of loan administration.
If commercial banks are to be involved in the micro finance by no means it would be a
wrong decision for them as regard to their primary aim, profitability. Yes it can. Data from
the Micro Banking Bulletin reports that 63 of the world's top MFIs had an average rate of
return, after adjusting for inflation and after taking out subsidies programs might have
received, of about 2.5% of total assets. This compares favorably with returns in the
commercial banking sector and gives credence to the hope of many that microfinance can
be sufficiently attractive to mainstream into the retail banking sector. Many feel that once
Management of Financial Institutions - MGT 604
microfinance becomes mainstreamed, massive growth in the numbers of clients can be
According to a recent analysis conducted by the Consultative Group to Assist the Poor
(CGAP), the compound annual growth rate of the world's leading microfinance providers
over the last five years has been a whopping 15%. Worldwide, these leading Microfinance
institutions are nearly twice as profitable as the leading commercial banks. The trend is not
new. In fact, in the last decade, microfinance has been a more stable business than
commercial banking in emerging markets. During Indonesia's 1997 financial crisis, for
example, commercial bank portfolios imploded, but loan repayment among Bank Rakyat
Indonesia's three million-plus micro-borrowers barely declined at all. During the more
recent Bolivian and Colombian banking crises, microfinance portfolios suffered slightly, but
remained substantially healthier than commercial bank portfolios, and the microfinance
institutions remained more profitable. (Source: The banker, 04 July 2005)
There are 70million savings and loan accounts in the world in micro finance sector and
about 80 percent of these accounts are savings rather than loans, suggesting that poor
entrepreneurs often have to save to accumulate capital for investment rather than the faster
if higher-route of borrowing it. Thus it's absolutely favorable for the commercial banks to
operate in the micro finance sector. For example in India ICICI bank, which has a large
network of local branches, entered the micro finance market in 2001 and increased its
portfolio from US $16m to US $63m in two years. (Source: Financial Times, 14 September
I see the commercial banks in micro finance in action, independently...without any
government back, mandate or subsidy.
On the whole microfinance is not an area commercial banks want to overtake. The majority
of commercial banks that undertook microfinance lending were because it was required of
them by their governments. Research findings came from in-depth interviews with over 40
bankers in 22 banks in India, the Philippines and Australia, and from speaking with 17 other
banks in the other seven countries covered in the study. A great deal of microfinance
undertaken by commercial banks was found, but it was undertaken because of government
mandates to lend to this sector rather than for business reasons.
(Source: The Role of Commercial Banks in Microfinance: Asia-Pacific Region Ruth
Goodwin-Groen, 1998)
The involvement of commercial banks in micro finance is important because all those micro
finance programs, which were directly run or backed by the government, faced a total
failure. Sustainability and scale in microfinance by commercial banks were only found in
the market-based programs when assessed on the basis of achieving both high portfolio
quality and significant scale of outreach to the poor, most of the commercial bank
microfinance programs that were mandated by governments can only be considered as
failures. The exceptions were those programs that charged a commercial rate of interest.
They had a higher portfolio quality than other programs but they were still not profitable.
This almost universal failure is not explained by the different policy contexts across the
Asia-pacific region. Further, because microfinance has not been a profitable business,
government mandates have been unsuccessful in encouraging commercial banks to become
involved in microfinance. The banks must have the incentive to design better products for
micro entrepreneurs, which can be profitable.
Management of Financial Institutions - MGT 604
A real world example of a successful micro finance commercial bank is of BRI's Unit Desa
system (its microfinance arm) has the best financial results of any microfinance institution
in the world. In 1996-97 it earned a profit of $170 million on loans of $1.7 billion to 2.5
million clients, with no subsidies. This is an approximate return on performing assets of 10
per cent ­ a very competitive rate by commercial standards. The success of BRI's Unit Desa
systems can be attributed primarily to the fact that the system has adhered to the
fundamentals of banking and finance for the rural micro entrepreneurs, including the
provision of competitive savings services. The microfinance savings and loans of the Unit
Desa system perform consistently for BRI and continue to grow quickly. BRI's
microfinance business may not compete with the most spectacular returns, but it does
achieve these strategic goals. (Source: The Role of Commercial Banks in Microfinance:
Asia-Pacific Region Ruth Goodwin-Groen, 1998)
The types of commercial bank involvement in microfinance can be classified as;
government-subsidized lending programs channeled through the banks, government
mandated lending targets met by banks subsidizing interest rates, government-mandated
lending targets with banks charging commercial interest rates and microfinance as a
profitable business. Only the last one "micro finance as a profitable business" has seen
success. Thus the involvement of commercial banks in micro finance sector should not be
based on any government mandate, subsidy or target. The sole benefit of the society as well
as commercial banks is the adoption of micro finance as a business. (Source: The Role of
Commercial Banks in Microfinance: Asia-Pacific Region Ruth Goodwin-Groen, 1998)
Involving commercial banks in micro finance would be a step to take these services at the
doorstep of the potential customer, because if only some government agency or state bank is
involved the extensiveness as regard to area covered cannot be brought.
On the other hand commercial banks need not to make any special arrangements to cater for
micro finance operations. Only a new "micro finance" counter might be needed in the
existing branches. Thus there would be no high setup cost for the commercial banks to
venture into this sector.
In short I see micro finance as a very promising sector for commercial banks and on the
other hand simultaneously it would help the standard of living to rise; and attached with it
the literacy rate, employment level, socio-economic development would also take place.
Table of Contents:
  1. Financial Environment & Role of Financial Institutions:FINANCIAL MARKETS &INSTITUTIONS
  2. FINANCIAL INSTITUTIONS:Non Banking Financial Companies
  3. CENTRAL BANK:Activities and responsibilities, Interest Rate Interventions
  4. POLICY INSTRUMENTS:Open Market Operations, Capital Requirements
  5. BALANCE OF TRADE:Balance of Payments Equilibrium, Public Policy and Financial Stability
  6. STATE BANK OF PAKISTAN:History, Regulation of Liquidity, Departments
  10. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Human Resources Department
  13. PAKISTAN ECONOMIC AID & DEBT:Macroeconomic Stability, Strengthening Institutions
  14. INCREASING FOREIGN DIRECT INVESTMENT:Industrial Sector, Managing the Debt
  15. ROLE OF COMMERCIAL BANKS:Services Typically Offered by Banks, Types of banks
  16. ROLE OF COMMERCIAL BANKS:Types of investment banks, The Management of the Banks
  17. ROLE OF COMMERCIAL BANKS:Public perceptions of banks, Capital adequacy, Liquidity
  19. ROLE OF COMMERCIAL BANKING:Private Deposit Insurance,
  20. BRANCH BANKING IN PAKISTAN:Remittances, Online Fund Transfer
  22. Mutual funds:Types of international mutual funds, Mutual funds vs. other investments
  23. Mutual Funds:Criticism of managed mutual funds, Money Market Fund
  24. Mutual Funds:Balanced Funds, Growth Funds, Specialized Funds, Measuring Risks
  25. Mutual Funds:Cost of Ownership, Redemption Fee, Reports to Shareholders
  26. Mutual Funds:Internet Fraud, The Pyramid Scheme, How to Avoid Investment Fraud
  27. Mutual Funds:Investing In International Mutual Funds, How to Pre-Select a Mutual Fund
  28. Role of Investment Banks:Recent evolution of the business, Possible conflicts of interest
  29. Letter of Credit:Elements of a Letter of Credit, Commercial Invoice, Tips for Exporters
  30. Letter of Credit and International Trade:Terminology, Risks in International Trade
  31. Foreign Exchange & Financial Institutions:Investment management firms, Exchange Traded Fund
  32. Foreign Exchange:Factors affecting currency trading, Economic conditions include
  33. Leasing Companies:Basic Purpose of Leasing, Technological Benefits
  34. The Leasing Sector in Pakistan and its Role in Capital Investment
  35. Role of Insurance Companies:Indemnification, Insurer’s business model
  36. Role of Insurance Companies:Life insurance and saving
  37. Role of financial Institutions in Agriculture Sector:What is “Revolving Credit Scheme”?
  38. Agriculture Sector and Financial Institutions of Pakistan:What is SMEs
  39. Can Government of Pakistan Lay a Pivotal Role in this Sector?:Business Environment
  40. Financial Crimes:Process of Money Laundering, Terrorist Financing
  41. DFIs & Risk Management:Managing Credit Risk, Managing Operational Risk
  42. Banking Fraud & Misleading Activities:Rogue Traders, Uninsured Deposits
  43. The Collapse of ENRON:Auditing Issues, Corporate Governance Issues, Corrective Actions
  44. Classic Financial Scandals:Corruption, Discovery, Black Wednesday