Financial Inclusiveness in Our Hemisphere

Over the last 20 years, microfinance services have expanded tremendously throughout Latin America and the Caribbean, providing small loans to lower income beneficiaries and small businesses. As this success has grown, the need for greater integration of the region’s lower economic strata into the formal financial sector has become an important and urgent issue for policymakers and supportive financial regulators.

 

Microfinance institutions (MFIs) can play an important role. Increasingly, many non-governmental MFIs have been pressed to provide savings as well as credit services. But, to do so, they must accept regulation and supervision of national banking authorities. MFIs must also begin to attract savings deposits from the current credit client base, expand their investment capital and reduce dependence on international donor funds.

 

Sustainable financial services systems that can offer the working poor and informal sector entrepreneurs access to savings and savings-based credit must continue to reduce both the costs and the risks of serving this population. Latin America’s microfinance sector has begun to address these low levels of access and the resulting supply problem. In Colombia, Mexico, Ecuador, Peru, and Brazil, two types of financial institutions are leading the charge: banks specialized in microfinance and leading commercial banking institutions increasingly implementing downscaling strategies.

 

A group of microfinance-focused banks has created sustainable and profitable business models that serve populations with low access to finance. These banks use tactics such as the creation of products specifically designed for the target population (Banco Caja Social Colmena in Colombia), highly efficient electronic payment methods (Lemon Bank in Brazil and Mibanco in Peru), best practices in credit risk analysis (Banco Solidario in Ecuador and Compartamos in Mexico), better use of remittances (Banco Azteca in Mexico), and a focus on synergies and economies of scale (ProCredit Group).

 

Now, however, a second type of banking institution is fast emerging as the new microfinance leaders in Latin America. These are the leading domestic commercial banks that have begun to leverage existing infrastructures to distribute low cost financial services. The size and scale of these banks allows for the creation of infrastructures that facilitate the use of electronic banking products, innovative credit risk analysis, alternative distribution channels, and optimization of remittance impact. Across Latin America, banks such as Caixa Econômica Federal (Brazil), Banco del Pichincha-Credife (Ecuador), Bancolombia (Colombia), Banco de Crédito (Peru), and Banorte (Mexico) are implementing downscaling strategies that seek to address deficiencies in access.

 

Research from Florida International University (FIU), largely focusing on the experiences of these and other financial organizations, strongly suggests that the lack of financial services access in Latin America is primarily due to business models not adapted to present-day realities. In tandem with our research, FIU has begun a new Financial Inclusiveness Program to promote banking services access via electronic banking platforms. Based on nearly three years of research, it targets lower income populations and remittance and microfinance recipients. Our work has led to the conclusion that the region’s less than optimal banking access can be attributed to low efficiency ratios, low distribution network density, inadequate risk analysis methods, and a lack of economies of scale. The challenge for the region’s financial services providers is to create viable and profitable business models that set the stage for greater financial deepening. For this, cost effective and affordable banking products should be offered to microcredit clients and remittance recipients.

 

To address these issues, we propose technical solutions using a business model of microfinance services. This model intends to resolve the problems of efficiency, outreach, delinquency, unbanked remittances, and optimal scale. Its core components include an essential focus on electronic banking products, alternative networks, innovative credit risk analysis methods, incorporation of migrant remittances, and the creation of nodal technical networks.

 

First, the model highlights the importance of electronic payments—a type of low cost financial product that can increase access to a payments system. This is a basic function of a financial intermediary. E-products also meet a consumer’s liquidity needs, which are reinforced with the inclusion of migrant remittances. These monies function as both payment methods and savings vehicles.

 

Next, non-bank branch distribution networks, including remittances distribution networks and retail shopping center alliances, are needed to take advantage of economies of scale to reduce transaction costs. This is a necessary departure from expensive bank branches. In the model, significant operational synergies emerge between remittance distribution networks and banking networks. Both require locations in low economic development areas, along with technological infrastructure access and commercial management instruments.

 

Third, the incorporation of socio-demographic variables into risk analysis methods strengthens a bank’s ability to analyze potential borrowers and allows for the use of income from the informal economy. This is a departure from traditional models that generally take into account only a borrower’s economic variables. However, it does require a more robust ability to process and analyze information. Credit risk tracking is also facilitated by the incorporation of methods such as behavioral scoring and credit information centers (credit bureaus). Hard to apply in conventional financial distribution models, these systems allow for better customer tracking and decrease the risk of dishonesty (moral hazard) inherit in the financial asset transformation process.

 

The incorporation of migrant remittances into the formal financial system helps to maximize potential systemic synergies between the banking and remittance industries. By chanelling remittances into bank accounts, the system is able to boost its liquidity while taking advantage of economies of scale and reducing transaction costs. On top of that, the remittance recipient can build creditworthiness.

 

Finally, the model incorporates a nodal technological network system that allows small microfinance institutions to access expensive infrastructures. Like many of the other elements, this aspect of the model exploits economies of scale to lower transaction costs. In this case, reduced costs are achieved with shared access to technological platforms. It is also supported by modern banking practices that seek to create efficient multi-agency financial delivery systems. Such systems help to solve cost problems and stimulate a free and competitive market.

 

However, both microeconomic theory and actual market experience tell us that competitive financial institutions will not share all of their technological infrastructures, despite the potential savings and the public benefits to be generated. For that reason, public sector intervention will be fundamental to fostering nodal network systems and ensuring cost efficiencies. Such public intervention could come either from the creation of a publicly owned node or through adoption of public incentives that favor private entities joining a network.

 

The FIU researchers believe the proposed model can be an important step for increasing access to financial services in Latin America. Taken together, our recommendations can serve as an important stepping stone for disseminating and adopting current best practices in banking and promoting the economic well-being of the region’s poor. As microfinance methodologies continue to rapidly mature, now is the time for new thinking for all financial services groups on how to best capitalize on recent advancements to serve this enormous market.