Microfinance as a regular commercial banking product

.I 9327 Viewpoint Note No. 131 November 1997 Microfinance as a Regular Commercial Banking Product Joselito S. Hatton National Bank is the largest private com- This Note profiles Hatton National Bank's micro- Gallardo, Bikki mercial bank in Sri Lanka and one of the hand- finance operations, highlighting two questions: K Randhawa, ful of commercial banks in the world that have How does a privately owned bank downscale and OrlandoJ. initiated microfinance programs. The bank part of its operations for microfinance? Is Sacay launched its program in 1989 as an integral microfinance consistent with a profit orientation? part of its operations, motivated by two busi- ness objectives. First, the program aims to pro- Target market tect the bank's market share from state-owned rural banks and nonbank microfinance institu- Sri Lanka is a low-income economy with a per tions such as credit cooperatives, especially in capita income in 1995 of USS635. As in other rural and semiurban areas, where more than economies, the country's poor can be differ- 75 percent of the country's population lives. entiated into five categories: Second, the program is an investment in the The near poor-those at the top of the pov- future: it targets microfinance clients with the erty pyramid, who have stable wage employ- potential to grow into small enterprises in the ment but low earning power. formal sector. The entrepreneurial poor-those whose en- terprises employ five or more people. The self-employed poor-those who work for their own account and may employ others. HATTON NATIONAL BANK The laboring poor-those employed full time as unskilled labor. Romattn National Bak's principal business consists of commercial The ultra poor-those at the bottom, who banking {loan syndication, equity financing, undetwriting, and depend on others' earnings.' corporate restructuring), developmentfinance, international banking, trusts and investment, mortgage loans, and lease financing. It also fance progam on he topuhee ays ofcthe provides investment banking services&The bank has more than fifty pyramid-the near poor, the entrepreneurial branchesandassetsofmorethan$58omillion,ltsretnrnon average poor, and the self-employed poor. To this tar- tetworth was29 percent forthe period 199D-9, and aftet-tax profits get market the bank's microfinance program have grown atanaverage rate of 40permenta year. The bank is has adapted its regular credit and deposit ser- ranked anong the top 500 banks in Asia by Asiawee Magazinets vices. The program covers sectors ranging from fisheries and aquaculture to construction ma- shares are listed on the Colombo stock exchange and arewidely terials, trading, and garment-making. held. The bank's origins date back to the tea industry in the nine- feenth century. In the 1970s, it acquired National and Grindlays Bank, The portfolio followed byMercantile Bank and the Colombo branch of Emirates *International Bank.ThebankVsmicrsoansectountforabout2I In 1989-95, the microfinance program reached percent of itstotal unsecured loans outstanding. an average of 2,100 borrowers a year, financ- ing 12,654 projects with US$4.6 million in total loans. The average loan during this period was The World Bank Group . Finance, Private Sector, and Infrastructure Network  Microfinance as a Regular Commercial Banking Product US$360. More than 40 percent of loans fell in attention the products and microenterprises that the range of US$190 to US$480, and more than can be showcased for marketing purposes. 25 percent in the range of US$480 to US$960. Annual interest rates on microloans-at 19 to The microfinance operation is based on rela- 25 percent, and averaging 21.8 percent in tionship banking. Hatton National Bank has se- 1995-are not much higher than those on the lected experienced staff from its mainstream bank's regular commercial loans, which aver- banking operations to run the microfinance pro- age 21.2 percent. In 1989-95, the program's gram. Based in villages, usually in the area they loan recovery rate was 97 percent. come from, the banking officers work closely with clients. They develop an information base Loans are structured to match the revenue and about clients' asset turnover cycles, absorption cash flow patterns of microfinance borrowers. of financing, transaction costs, risk, and col- Almost half the loans are for periods in excess lection patterns. Since most loans are not se- of two years. Business expansion loans for cured by collateral, such information is equipment, machinery, or shop improvement indispensable for managing costs and achiev- have repayment periods of up to three years. ing high repayment rates. Most loans at these longer maturities go to re- peat borrowers; these loans make up 33 per- To ease microfinance borrowers' access to cent of all loans by the program. Working credit, Hatton National Bank modified its regu- capital loans of less than a year account for lar loan application and processing procedures about 20 percent of loans approved. Start-up and its collateral requirements. The micro- loans account for a third of the bank's micro- finance program's loans are well within the loan portfolio. Typical start-up loans are less limits of the amounts that branch managers can than 25,000 rupees (US$480) and are unse- approve themselves. Guarantees from two ex- cured. Program officers work closely with pro- isting clients of the bank suffice to secure loans spective start-up clients to review operating of up to Rs 100,000 (US$1,925). Loan applica- plans and develop a project loan proposal. tion forms were simplified, and the time from application to evaluation to disbursement is Savings products include savings accounts, normally only two to three days. Borrowers fixed deposits, and savings certificates. In 1989- gain access to progressively larger loans by re- 95, the microfinance program mobilized 44,500 paying existing loans on time and by main- deposit accounts, with average balances of taining profitability in their business operations, US$145, for US$8.05 million in total deposits. which are monitored by the loan officers. Downscaling operations The bank has also modified deposit services to suit the rural villages served by the micro- Microfinance units operating in remote rural ar- finance program. Depositors can open accounts eas are attached to the bank's regular branches. with small amounts and earn interest while The bank's existing branch network enables the maintaining small balances. The interest rates microfinance program to reach borrowers at a offered to the program's clients are similar to low cost and provides administrative support those offered to the bank's regular clients. But for its accounting, financial reporting, and com- while the bankwide interest expense averaged munication requirements at little additional cost. 9.1 percent in 1995, the microfinance program's These external economies have been key to the averaged 11.75 percent, because its deposits microfinance program's success. The links with are predominantly interest-bearing savings and the branches and the oversight from the bank's time deposits. head office facilitate problem resolution and pro- gram monitoring. They also enable the micro- After the fourth year of the program, deposit finance units to bring to the head office's balances exceeded outstanding loans by in-  creasingly larger amounts, and by the end of accounted for by the smaller market base and 1995, they were 4.3 times the outstanding loans. smaller transactions in the microfinance pro- These excess deposits have generated revenue gram. In 1995, assets averaged US$175,250 per opportunities for Hatton National Bank in other employee bankwide, and gross revenues areas of banking. For rural households, they US$21,150 per employee. In the microfinance have led to important deposit services that program, the productivity was 29 percent lower, would otherwise be unavailable. at US$124,000 in assets per officer, and gross revenues were 14 percent lower, at US$18,175 Profitability per officer. According to unaudited financial data from in- ternal management reports, the microfinance program broke even by the end of its third FIGURE 1 OPERATING RESULTS FOR THE MICROFINANCE year of operation, in 1992. Since that year, its .PROGRAM revenues have covered both funding costs and MllIions of rupees direct operating expenses, including loan loss [ reserves, and it has started to generate operat- Program income ing profits (figure 1). As an integral part of regular operations, the 30 microfinance program incurs virtually no addi- 20 tional costs for supporting infrastructure-for branch office overhead, data automation, or communications facilities. There has been ample