(IMF Working Paper, Prepared by Anupam Basu, Rodolphe Blavy, and Murat Yulek1, September 2004)
A. Developing Complementarities between MFIs and Banks The African experience suggests that MFIs have built on pre-existing informal sector mechanisms (among the many examples are susus and tontines) to create viable channels for capital infusions from formal sector banks, donors, and governments.7 As a result, deposittaking MFIs, informal microfinance institutions, and credit-only MFIs have all developed increasingly close ties with full-fledged commercial banks and other non-bank financial institutions in the formal sector (Box 4). Banks and MFIs complement each other well by servicing substantially different client bases. Banks lend and collect deposits mostly from a limited formal private sector and to the government, while MFIs service poor and rural households, and small entrepreneurs often in the informal sector.
With the increasingly closer linkages between commercial banks and MFIs, the prospects for enhancing financial deepening have improved. Both commercial banks and MFIs benefit from a closer relationship. MFIs may increase their effectiveness in having access to financial services that facilitate their liquidity management, while banks expand their client base by working with MFIs. We review below the nature and implications of such interactions, supported by evidence from the experience of our selected countries.
• MFIs reap benefits as clients—depositors and borrowers—of commercial banks.
First, as observed in Guinea and Benin, commercial banks typically manage MFIs’
deposit accounts, and sometimes, provide them with liquidity management services, for example emergency credit lines to cover cash shortfalls, hence reducing the risks associated with irregular cash flows. Second, extended credit facilities also allow MFIs to expand their services. In Guinea, while MFIs are currently using liquidity management services provided by commercial banks—including one of them having access to an emergency credit line—banks have been cautious in extending credit lines, given the risk that the failure of MFIs spills over to commercial banks. Conversely, these risks are to some extent mitigated by the additional benefits of interaction between MFIs and the banks, which include (a) the opportunity given to banks to expand their portfolio of clients beyond a usually highly concentrated clientele, and (b) the monitoring of MFI clients by commercial banks. The experience of Guinea supports this conclusion, although the interactions between MFIs and banks are in an early phase.
• MFIs and commercial banks work together in providing financial services. In a number of African countries, banks and MFIs have successfully cooperated in extending their outreach and achieving economies of scale. Branch network sharing is seen as effective in servicing a larger client base while containing costs. In Guinea, banks are looking at possibilities to use the network of MFIs to expand credit to large rural clients. In Tanzania, the example of the CRDB developing banking relationships with savings and credit cooperatives to channel funds for micro-lending is illustrative. Cooperation also entails channeling credit from banks and MFIs to clients with obvious business synergies. The NMB of Tanzania is developing relations between credit to its large corporate clients and credit to micro-enterprises that supply inputs and distribute the products of the former. The NMB lends to micro-enterprises to finance their purchases and inventories, and provides large corporate clients with collection and payment services to and from micro-enterprises.
• The links between MFIs and banks provide a platform for strengthening the links between the formal and informal sectors of the economy. While small entrepreneurs with no credit history are usually excluded from commercial bank credit, they constitute a profitable business segment for MFIs. Those entrepreneurs could eventually graduate from micro-credit to conventional bank loans, either by developing successfully into sizeable businesses or by building reputation through repeated borrowing and establishing a strong record of loan repayment, even though barriers to entry into the conventional banking sector for small entrepreneurs would still limit the possibilities of graduation to the conventional banking sector.
With MFIs linking up with banks, the supply of loanable funds to previously underserved areas of the economy and the number of small borrowers with access to credit are likely to increase. Some might argue that this would lend to increased competition and better terms for loans to small borrowers. Unfortunately, however, this may not necessarily happen. The expansion of credit to new borrowers may entail increases in default risk, loan administration and monitoring costs, strategic collusion among informal lenders (to avoid a costly price war), and contamination of the pool of borrowers for lenders who are poor at screening out the risky ones. All these potential risks suggest that the cost of borrowing may not fall, at least in the early stages of growth in the microfinance sector. This being said, the cost of credit provided by formal MFIs is generally much less than that provided by informal lenders (such as money lenders).
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