Microfinance, views from the field: Challenges for a critical service for entrepreneurs having no access to traditional financial services
Interview by Ignace R. Combes, Chairman, Vlerick Centre for Financial Services
Microfinance refers to a movement that envisions a world in which low-income households have access to a range of affordable financial services, including credit, insurances, remittances, payments, savings and other. It is a business that is developing also in Belgium and, in this contribution, the focus is more on the narrow definition of loans to micro-entrepreneurs. In Belgium, we have several types of players including banks and non-financial institutions who see this activity as part of their social responsibility or in the case of BNPParibasFortis see this business as a strategic contribution to their core goal of supporting entrepreneurs and this also at group level of BNPParibas.
To give insights, the article is based on an interview with Mr Luc Haegemans responsible for their corporate social responsibilities and Mr Patrick Sapy head of MicroStart head of their lending arm in partnership with others to micro-entrepreneurs.
Before zooming in on MicroFinance, let’s first describe some of the main characteristics of this business. Most information is drawn from presentations given at a Vlerick Alumni event with representatives from IncoFin, microStart, BNPParibasFortis… The business has developed rapidly in the last few years, going from worldwide about 13 million clients in 1997 to 205 million in 2010. Size of the microfinance business is estimated at more than USD 50 billion with the majority of loans smaller than 1,000 USD and loans extended for more than 80% to women. The lending business is originated by banks, non-bank financial institutions, NGO’s and credit unions. Lending is generally done through specialised dedicated organisations such as microStart, lending directly or through specialised vehicles such as mutual funds, structured vehicles, equity funds...
Given the fact that the business is targeted to low-skilled and low-income entrepreneurs, an uninformed assumption might be that this business is purely a social contribution as the default rate on loans must be high. However, the business experiences a default rate of not worse, even better than the default rate for traditional loans. While lending itself given the support to be provided is generally not profitable, return-on-equity in case of specialised funds can be quite attractive with sometimes generating a return of more than 10%. It is true that the family and neighbours to these micro-entrepreneurs play a social pressure not to fail. Nevertheless, an important main reason is that lenders support the entrepreneurs with basic financial and business management often through volunteers.
Interview with Mr Patrick Sapy from microStart
In 2010, Adie and BNP Paribas Fortis together created microStart SCRL-FS in the form of a pilot program aiming to provide an innovative answer to founders of companies in Brussels. MicroStart Group is actually composed of 2 organizations: a cooperative company for social purposes which distributes microcredit, and a not-for-profit organisation that supports the cooperative company with administrative, consulting, education and non-financial services. So one organization gives microcredits to entrepreneurs, the other one helps these entrepreneurs with administration, setting-up their business, passing the necessary exams etc. Clearly, it takes more than just money to get started as a micro-entrepreneur.
Why does a financial group like BNPP Fortis support an organisation like microStart?
There are many reasons why our activities are interesting for banks. First of all, and this is I think the main raison, because we create future clients for them. We are not just supplying credit. We are also giving all these people a financial track record which they can later take to the bank. This way we create transparency on potential future clients for banks. Clients with a successful microStart track record are clients they are much more likely to trust when they come to the branch for new credit. This is very valuable for them. Next, we perform an activity which banks, at this moment, do not have the know-how and expertise to do themselves. Bank branch employees are not trained to assess the potential and risks of micro-initiatives of people who are unemployed or living on social welfare. Next to the financial assessment do not forget that we are also coaching, training, guiding these micro-entrepreneurs to make their projects a success. This is something a normal bank does not do. Furthermore, I am sure BNPP Fortis understands the potential of this market. There is really a strong demand for micro-credits at this moment, and not only in Belgium. Our volumes are growing year after year. Finally, next to the engagement and belief of the bank in our model, this is also part of their corporate social responsibility to invest capital in an organisation that activates people and stimulates entrepreneurship.
Is the microStart model a financially viable model at this moment?
No, it is not. There are different reasons why this is the case. The first reason is that most western countries have created a system in which it is much easier to become an employee than to become self-employed. Everything is focussed on people finding a job, not on creating a job. In most developing countries it is the other way around: starting a business is much easier than becoming an employee. Especially in Belgium, it has become very complex to start your own business. Think about all the administration, legal and fiscal aspects, etc. So it makes no sense to offer micro-credits without offering coaching and support to our clients. They would never even be able to start their activities without the coaching. And the coaching and support is a very costly and labour-intensive part of our model. Next, do not forget that we continuously have to look for new clients. After a successful micro-loan our clients go to a normal bank. Constantly finding and starting a relationship with new clients is very costly. Finally, we have to keep the price for our services socially acceptable. If we would apply risk-pricing correctly we would in many projects have to ask for interest rates of 20% or more which we do not do. Our micro-credit amounts vary between 500 and 15 000 euro with a maximum interest rate of 10% a year and a flat fee of 5% of the amount borrowed. Asking higher interest rates would be socially unacceptable. So at best, we could get break-even in our lending activities (excluding the coaching and consulting activities) but only when we increase our volumes and efficiency. But when you add the coaching and consulting, it is nearly impossible to make this a financially viable model under the current circumstances.
How have you been impacted by the economic and financial crisis?
From a regulation point of view, something many banks are facing now, we are not impacted as a micro-credit institution. For us, the main effect of the crisis was the rise in demand of micro-credits. As unemployment rises, especially for our client segment, more people became interested in creating their own job. So yes, demand has risen, but so has risk, meaning we had to be more prudent in our risk-assessments. As was the case for other micro-finance institutions (more than 10 000 worldwide) who follow the international standards on micro-credits.
Is it a deliberate choice to focus on entrepreneurs? What is the importance of micro-entrepreneurs?
We do not see ourselves as an organisation focussing on micro-entrepreneurs. Rather, we consider ourselves an organisation who is fighting poverty and who believes that creating your own job is the best way to do this. Most of our clients are people with no degree, who do not speak English or Dutch and are currently in unemployment. So it is very difficult for them to find a job. We really believe they have the best chance to succeed if they create their own job, do what they love and, as an entrepreneur, contribute to their local community. In the areas in which operate with our branches (St. Gilles, Schaerbeek) there is in some parts over 40% unemployment rate. For most, starting their own small business seems the best way to break out of poverty. Since 2012 we have 100 000 jobs less in the industry but every year in Belgium we create around 70 000 new businesses of which 30% are being created by unemployed people.
What does the future bring for microStart?
The first thing we have to do is continue to answer the growing demand for micro-credit. We have opened new branches in Gent and Liège and will open new branches in Charleroi and Antwerp. Branches are important in our business as we have to be close to the local community. But once our new branches are operational we will cover the main Belgian cities and can serve the rest by organizing permanencies in other cities. Next, we have the ambition to reach a break-even position at financial level (excluding advise and consulting) by increasing our volumes to 1000-1500 micro-credits per year. This year we expect a volume of about 650 loans. But we do not only focus on loans. We are currently looking at new products f.e. the idea of micro-insurance and will further explore that idea. Finally, we want to have an impact on regulation on business creation. This is a huge problem for our clients. In Belgium there is no transition between unemployment and business creation. So when you create your new business you immediately lose your unemployment payment when you receive your VAT number. In other European countries they have gradual transition systems for micro-entrepreneurs. The day they start their new business they have no clients, they lose their unemployment payments and they have to pay social contributions. This scares of a lot of people. Not having a transition system is driving people towards the informal sector. We argue for a transition system of 6 months. Finally, Belgium is the only country in the European Union where for entrepreneurs it is compulsory to have a high-level degree or pass a central exam. Almost all of our clients have to take the exam and that’s why we need to coach them. At this moment 80% of the people we coach pass the exam. Our proposal would be that entrepreneurs who are being coached by an organisation like microStart for a certain period of time do not need to take this exam as for many it is still an extra hurdle to take. I truly believe that as a micro-finance institution we have and important role to play in influencing legislation to help people create their own business.