COMMERCIAL MICROFINANCE AS A STRATEGY TO REACH THE POOR IN SRI LANKA: A COMPARATIVE STUDY Perera K.D.D.

Department of Accountancy, Faculty of Commerce and Management Studies University of Kelaniya, Sri Lanka dinuja@kln.ac.lk

ABSTRACT The microfinance sector in Sri Lanka suffers from the core problem of poor quality of microfinance services offered, and this seriously threatens the sustainability of the offered financial services and their outreach to poorer households, micro and small entrepreneurs. In early days, financial exclusion; the provision of financial services to those excluded from the formal financial system was a hint of potential breadth of micro financial services which was an expanding focus for microfinance institutions. However, Commercial Microfinance, where microfinance services are provided by commercial organizations that are part of the formal financial system has received increasing attention in todays financial market. Therefore, this study explores downscaling by banks as a model of microfinance commercialization that has used as a strategy to reach the poor. In order to answer the main research question, an explorative case study methodology was chosen, based by a microfinance programme of a well established commercial bank in Sri Lanka, the Hatton National Bank. Their performances were compared with the performances of a well established microfinance institution Sarvodaya Economic Enterprise Development Services Ltd. (SEEDS) specially under commercialization debate areas; sustainability and outreach, financial performances and impact on clients. The findings reveal that commercialization of microfinance is still working towards commercial perspective, and they are largely catering to the entrepreneurial poor segment. Key words: Commercial microfinance, Microfinance institutions, Sustainability, Outreach

1. BACKGROUND Microfinance has received increasing attention in contemporary financial markets, though it is not regarded as a new conception. In early days, this has developed from the basis of microcredit programmes, and today it had become a matured financial industry by adding savings, insurance and money transfers to their products and services chain. In general terms, microfinance can be defined as the provision of financial services to those excluded from the formal financial system. Therefore, this concept has been positioned to overcome a variety of access barriers to a wide range of financial services for the different customers those who were excluded from the formal financial services. Initially, microfinance institutions (MFIs) began shoulder to cater this neglected niche market and many MFIs in different countries have proven that their clients are bankable and institutions are profitable. Most of the bankers, regulated financial institutions in particular, have not regarded microfinance as a genuine option and they have believed it as unprofitable. One major reason for this perception was bankers perceive small businesses and microenterprises as bad credit risks as they do not have a stable, viable business for which to borrow and from which to generate repayment and lack of traditional collateral to guarantee their loans. They further believed that since the microloans are small and for short terms, banking operations will be inefficient and costly. However, surprisingly, many commercial banks in developing countries have begun to examine the microfinance industry by relaxing their previously tough lending conditions and have entered into the microfinance sector with more favorable approaches (Baydas, Graham & Valenzuela 1997). Therefore, commercial banks intervention into microfinance sector has recently received an increasing attention. Some people believe this recent trend as unhealthy, as the MFIs are at a clear disadvantage with the intervention of commercial banks into this field.

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1.1. COMMERCIAL MICROFINANCE Commercial microfinance therefore is broadly defined as microfinance services provided by commercial organizations that are part of the formal financial systems such as banks, and nonbank financial institutions. These organizations are financed by commercial capital and usually confined by regulatory framework (Clerk 2005). 1.2. MODELS OF COMMERCIAL MICROFINANCE Different countries adopt different models of commercialization; Transformed microfinance Non Government Organizations (NGOs), Downscaling by banks, Small Specialized Banks and Finance companies are major in this regard. Downscaling as a model of microfinance allows the programme to take advantage of the funding and infrastructure advantages of a commercial bank while providing the microfinance programme with the necessary space to operate successfully (Bharti, Bhargava & Bellur 2006). Therefore, the researcher focused on downscaling as a model of commercialization of microfinance to continue this study. 1.3. DEBATES IN COMMERCIAL MICROFINANCE The debates on commercial microfinance begins with the argument that whether commercial approach is concerned on the ultimate objective of microfinance; the poverty alleviation. Because, the poverty oriented microfinance institutions will prioritize the impact that the lending programme is having and the level of clients poverty. However, commercially oriented microfinance institutions believe that a permanent impact can only be had if services and products can be provided in a sustainable manner (Bharti, Bhargava & Bellur 2006). Therefore, sustainability and outreach would be a main debate area of commercial microfinance which often identifies a trade-off between these concepts. 1.4. MICROFINANCE IN SRI LANKA The microfinance sector in Sri Lanka suffers from the core problem of poor quality of microfinance services offered, indicated by insufficient outreach, poor repayment rates, low cost efficiency, recurring losses, financial products which are not client driven and significant deficiencies in regulation and supervision (CLEAR 2009). This seriously

threatens the sustainability of the offered financial services and their outreach to poorer households, micro and small entrepreneurs. Commercial banks have made some efforts to serve the poorer population; however, one suspects that these efforts are merely to boost their image. However, there is no national policy for Microfinance Sector in Sri Lanka or an institutionalized mechanism to coordinate microfinance interventions with other policies which have been formulated for rural development and poverty alleviation (Microfinance Industry Report 2009). 2. THE RESEARCH ISSUE OF THE STUDY

Due to some structural deficiencies in the microfinance institutions (MFIs) and the unstable financial environment created due to the collapse of unregulated financial institutions in the recent past of Sri Lanka, many MFIs are at a great risk and it is arguable that whether they are sustainable enough to reach the poor. However, from the regulated commercial banks perspective, entering into the microfinance sector would be a natural sign of growth as they have a number of competitive advantages over the exsisting players in microfinance. This would indicate that commercial banks can play a giant role if they properly positioned downscaling operations in this microfinance industry. Therefore, this research study aims to explore the intervention of commercial banks into Sri Lankan microfinance industry so as to ensure whether they would add value to this industry by way of reaching down the poor. In fact, this study would raise the most controversial matters; can commercial microfinance reach and serve the poor? Do they possess a right business approach to reach the poor as compared to the existing microfinance players? 3. OBJECTIVE OF THE STUDY

The main objectives of this research study are, 1. To identify the commercial microfinance experience of commercial banks in Sri Lanka. 2. To recognize the gap between the microfinance services offered by commercial banks and conventional microfinance institutions in trems of debatable areas in commercial microfinance.

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3. To recognize the extent to which the commercial banks have been able to achieve the objective of reaching down the poor in comparison to conventional microfinance institutions.

4.

LITERATURE REVIEW

Some relevant literature was reviewed by the researcher specially in the areas relating to the intervention of commercial banks into the field of microfinance. Accordingly, Baydas, Graham & Valenzuela, (1997) have concluded in their study; (1) microfinance within commercial banks is largely attributed to the efforts of a single person or to a small group of people to promote these activities, (2) Most commercial banks largely use their own deposit base for microloans. Donor funds and government rediscount lines represent cheaper sources of funds for a number of organizations, but some conditions and limitations restrict use of these resources, (3) The current outreach of commercial banks in microfinance is at best modest in scope. Further, Bell, Harper and Mandivenga (2002), by a case study done on two different commercial banks in Zimbabwe and Kenya, has concluded that there are still very few cases of privately owned commercial banks downscaling to microfinance for purely business reasons. One of the most important reasons they have identified is the effect of liberalizing markets; as local banks face increasing competition from new, start-up local banks, and foreign banks entering the market, they are obliged to seek alternative markets to survive. Segrado (2005) has identified that in many countries, MFIs are losing their monopolistic control over the market, and emerging reality of increasing competition necessitates a different approach to microfinance both from MFIs and from commercial banks. 5. RESEARCH METHODOLOGY

experience in microfinance was compared with, Sarvodaya Economic Enterprise Development Services Ltd. (SEEDS) a well established MFI currently doing successful operations in microfinance industry. Today, SEEDS has emergerd as the largets and the oldest indigenous NGO in Sri Lanka with linkages at a global level. Therefore, the researcher believes that the two institutions selected for this study would suggest the requisite outcome of the research issue. As depicted in the research design, commercial banks capability in catering the poor population and MFIs ability in successful survival while catering the poor were measured and compared with identified variables. The study was based on primary and secondary data gathered from these two institutions.

5.1. CONCEPTUAL FRAMEWORK As indicated in section 1.2 of this report, the researcher will focus on the commercial microfinance model of downscaling, which specifies that funding and infrastructure in particular would provide a wide space for commercial bank to operate successfully in the microfinance field. Back by this theoretical model, the researcher conceptualized a framework which addresses the objectives and the research issues of this study. Accordingly, it was assumed that the commercial banks would be at a great advantage in terms of their organizational structure and the capacity to offer a wide range products and services in comparison to the conventional MFIs. Further, the performances; both financial and nonfinancial were also identified so as to compare and identify the gap between these two microfinance approaches. Figure 01: The Conceptual framework Commercial Banks

This research study was based by two case studies in a qualitative research approach. The commercial banks intervention into microfinance was measured through Village Awakening (Gami Pubuduwa) programme (GP) of Hatton National Bank (HNB) PLC, a well established commercial bank in Sri Lanka. Today, GP programme is considered as the largest player in commercial microfinance in Sri Lanka. Their

Organizational Structure

Products & Services

GAP

Performances MFIs 127

As depicted in the Figure 01, the services offered by GP and MFI and their performances are measured and compared between each other. The researcher idetifies indicators such as business goals, regulatory environment and infrstructure system of these instutions for evaluating the organizational structure. Products and services offered are measured through methodoloy by which they offer the products and the variety of products offered by these two institutions are also identified and compared. Finally, the performances will be measured and comapred through main financial indicators (to measure the sustainability); Operational Self-Sufficiency (OSS) and Financial Self-Sufficieny (FSS), and a non-financial indicator; the Outreach. The main objective of this study is to identify the approach in which commercial banks have recognized the concept of microfinance and their approach in catering the poor. The researcher intends to compare their performances with an MFI so as to see whether there is any gap between these two approaches; commercial microfinance and microfinance through MFIs. 6. KEY FINDINGS AND DISCUSSION

the draft level. The GP programme operated by the HNB is therefore governed by the Banking Act No.30 of 1988 and the Monetary Law Act No.58 of 1949 under the prudential regulations, which belongs to the category of Licensed Commercial Banks. SEEDS on other hand is registered under Companies Act No. 17 of 1982 (Amended No.07 of 2007) Limited by Guarantee. The Gami Pubuduwa programme is integrated into HNBs operations as an additional product line offered by the bank. SEEDS is currently running under seven separate divisions, where as microfinance is major among them.

6.1.3. INFRASTRUCTURE AND SYSTEMS The Gami Pubuduwa programme is integrated into HNBs operations as an additional product line offered by the bank. Therefore, GP does not perform as a separate banking division, however, it is a part of the Development Banking Unit, established under the Personal Banking Division. The bank today has 110 micro financing units disbursing funds to micro entrepreneurs. They currently possess 37 agricultural professionals and 87 micro finance field officers. SEEDS currently operates its businesses through different divisions with 25 offices and 1032 personnel.

6.1. ORGANIZATIONAL STRUCTURE 6.1.1 BUSINESS GOALS Hatton National Bank being an indigenous financial institution in Sri Lanka has been involved in rural development almost from the inception of the Bank in year 1972. HNB, having realized the importance of this social & economic upheaval, has been initiated Gami Pubuduwa (Village Awakening) programme in May 1989 with a view of extending banks assistance to the rural youth in exploring self employment activities. The core objective of Gami Pubuduwa (GP) programme includes developing a sustainable programme which will provide a new orientation to the village folks, contributing to uplift their lifestyles (HNB Annual Report 2008). SEEDS main objective is to alleviate poverty by promoting economic empowerment of rural people for a sustainable livelihood (SEEDS Web Site)

6.2. PRODUCTS AND SERVICES The GP programme is mainly offering credit and savings facilities to its clientele. As depicted in Figure 02, the GP loan portfolio has an extensive exposure to a wide spectrum of micro enterprises consisting of agriculture, cultivation & processing, fisheries & aquaculture, handicrafts, pottery, and food preparation etc. The GP loans are ranged from a minimum of LKR 5,000 to a maximum of LKR 1,000,000 depending on the requirements of the customers. SEEDS offers a wider range products and services from credit and savings to micro insurance and micro pawning facilities. It offers four main types of microcredit products (Shown in Figure 03); Type A loan scheme is focusing on promoting income generating projects which targets poorest among the poor members of the community, Type B loan scheme is of two categories; Non-Solar and Solar, both are commercial loans which focus on enhancing

6.1.2. REGULATORY ENVIRONMENT There is no separate microfinance regulation currently exist in Sri Lanka though the proposed Microfinance Act by the Central Bank is still at

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quality of life of households. Type C loans are given for creating new employment opportunities by initiating and expanding viable enterprises. The loan disbursement for Type A and B loans are ranging from a minimum of LKR 10,000 to a maximum of LKR 50,000, where as Type C loan disbursement ranges from LKR 50,000 to LKR 500,000. The lending methodology of GP is different to SEEDS. GP largely adopts individual based lending and SEEDS on the other hand take on group lending approach, comprising five members for each group which ensures the repayment, as the group is liable together. Figure 02: Sector wise Distribution of Loans: GP

6.3. PERFORMANCES Table 01: Measuring & comparing the performances (Year end 2008) Description GP SEEDS

Sustainability

CRR 95% NPA 5%

OSS 102.31% LLR 1.89%

Outreach Total Loan Outstanding Clientel Average Loan Size (Approx.) Per Capita GNP Depth of Outreach LRK 2.2 Bn 14,053 LKR 158,000 LKR 213,262 74% LKR 3.8 Bn 178,509 LKR 21,000 LKR213,262 10%

Source: Mix Market Research Web Site, HNB Annual Report 2008 & Reserachers Own Calculations.

6.3.1. SUSTAINABILITY
Source: HNB PLC Annual Report 2008

Figure 03: Sector wise Distribution of Loans: SEEDS

Source: SEEDS Web Site

The GP programme at HNB does not separately measure the Operational Self-Sufficiency and Financial Self-Sufficiency for their decision making purposes. Because, the branch offices only maintain their financial information separately and the cumulative income and expenditure will be accounted at the head office including all HNB operations. Therefore, the researcher would see this as a major limitation of this study. However, previous study which have been done by USAID in 2005 for the HNB Gami Pubuduwa programme identifies the OSS for the year 2003 as 121%, which indicates that HNB GP programme has been able to cover its operational expenses while achieving sustainability. Further, GP programme has been able to maintain a client repayment rate (CRR) of 95% with a Non-Performing Assets (NPA) rate of 5% (See Table 01). SEEDS has been able to maintain a continuous sustainable operations as indicated by OSS 102.31% and loan loss (LLR) and write-off ratio of 1.89% in year 2008.

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6.3.2. OUTREACH Outreach refers to the ability of the Microfinance Institutions to reach large number of clients. The depth of outreach indicates whether the MFI provides microfinance services to clients belonging to the lower income segment of the country. The basic assumption is that smaller the loan size, the deeper the outreach, or the poorer the client. Thus, loan size has been consistently used as a proxy for the level of poverty. And also lower the percentage of depth, deeper the outreach of the institution. The total outstanding loan portfolio as at the year end 2008 of the GP programme is amounted to LKR 2.2 Bn. Their clientele is 14,053 and a gradual decrease in the number of borrowers has been encountered as it moves from year 2006 to 2008, though the total portfolio has been grown by around 9% in year 2008. As far as the depth of outreach is concerned, the figure remains at 74% which is considerably high compared to the microfinance norms. SEEDS on the other hand is maintaining a considerably high loan portfolio, which is LKR 3.8 Bn in year 2008. They are maintaining a continuous growth in their clientele though there is a slight drop in 2008. They are maintaining a larger client base of 178,509 which is considerably very high as compared to GP programme. Further, the depth of outreach is also very low, it is 10% approximately. Further, SEEDS average loan balance is amounted at LKR 21,000, which is very low as compared to the GPs average loan balance LKR 158,000.

programme maintains its sustainability by concentrating on a few larger loans at the deprivation of services to the entrepreneurial poorer segments as happening in certain cases where commercial banks collect small savings from village areas and use these funds to grant loans to better off customers in urban areas. However, as indicated by the OSS, SEEDS is also considered as sustainable, while catering to the poor segment as compared to GP. The most imperative objective of this study was to identify whether the microfinance of commercial bank system would pave the way for the concept of reaching down the poor. When the scale of lending in terms of loan portfolio is increasing from small to large scale, the spread of depth of service reduces. In other words, the ability of the institution to reach large number of clients is reducing. Microfinance has evolved as an economic development approach intended to benefit low-income groups. Therefore, when the depth of service is reducing with large scale loan outstandings, it ignores the theme of microfinance reaching down to the poor. The depth of outreach measured for GP and SEEDS indicates a larger gap between these two institutions in term of their outreach. The 74% depth of GP indicates that their average loan size is larger, with few clienteles. On the other hand, SEEDS depth of 10% indicates that their average loan balance is smaller with larger clientele. The industry norm of depth indicates that larger the depth, lower the outreach. Therefore, the GP programme is however catering to the category of entrepreneurial poor, as rightly indicated by their depth of outreach. This gives a good indication that SEEDS has reached to the poor segment significantly as compared to GP programme. The present population in Sri Lanka is approximately 20Mn, where 41.6% of them are at poverty, earning below USD 2 per day and 5.6% are earning below USD 1 per day (Central Bank Annual Report 2008). Further, based on household income and expenditure survey carried out in year 2006/2007, it has identified that 15.2% of people are belonging to the category of poor households. This situtaion is very depressing and therefore, instituions like GP, who seek to capture this segment should be tamper with their outreach if their ultimate objective is to contribute to eradicate poverty in Sri Lanka.

6.4. DISCUSSION Through the above analysis the researcher was able to identify several gaps between GP at HNB and SEEDS microfinance operations. As far as the funding and required infrastrucre is concerened, the GP which operates under a well established commercial bank would enjoy a greater benefits compared to MFIs such as SEEDS. Because, most of the GP projects are operated through HNB retained funds and refinancing funds. As such they do not have major difficulty in generating funds. One major advantage would also be their strong deposit base which amounts to approximately LKR 2Bn, almost closer to their total loan portfolio. Though the GP at HNB maintains a strong repayment rate of 95%, their average loan size is larger as compared to the SEEDS. Because, GP

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7.

CONCLUSION

Financial inclusion for poor would be a natural sign of growth of rural development and it paves the way for eradication of the poverty, specially in a developing country like Sri Lanka. Microcredit as a powerful tool in offering financial loans to the poor has served tremendously for their development over the past years in Sri Lanka. As compared to SEEDS, GP programme maintains its sustainability by concentrating on a few larger loans at the deprivation of services to the entrepreneurial poorer segments. The reaching down the poor concept ignores in this regard, while giving rise to a trade-off between sustainability and outreach. However, protection against prudential regulations, physical infrastructure, better knowhow, greater access to funds, and enhanced capacity, make commercial banks the most qualified to meet the untapped demand of micro entrepreneurs. Therefore, movement of commercial banks into industry needs to be proceeded by several interventions, specially need to address the reaching down the poor concept.

Microfinance Industry Report Sri Lanka (2009), GTZ ProMis. Mix Market Research, Retrieved February 2, 2010, from Web Site: http://www.mixmarket.org Segrado C., (2005), The Involvement of Commercial Banks in Microfinance: the Egyptian Experience, University of Torino. SEEDS, Retrieved February 2, 2010, from Web Site: http://www.seeds.lk USAID (2005), Case Study on Profitability of Microfinance in Commercial Banks.

REFERENCES Baydas, M., Graham, D. & Valenzuela, L., (1997). Commercial Banks in Microfinance: New Actors in the Microfinance World, USAID. Bell R., Harper A., & Mandivenga D., (2002), Can commercial banks do microfinance? Lessons from the Commercial Bank of Zimbabwe and the Co-operative Bank of Kenya, Small Enterprise Development Journal (SED), vol.13 (4). Bharti A., Bhargava H., Bellur A., (2006), Commercialization of Microfinance, The Icfai University Press. Central Bank (2008), Annual Report, Central Bank of Sri Lanka. Clerk H., (2005), Commercial Microfinance: The Right Choice for Everyone? The Icfai University Press. Country-Level Effectiveness and Accountability Review (CLEAR) Sri Lanka 2009 Hatton National Bank PLC (2008), Annual Report.

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