(Illustration by Adam McCauley)
In 1992, the Bolivian microfinance NGO PRODEM became BancoSol. More than 200 other microfinance institutions (MFIs) around the world have since followed its path and become banks. These transformed organizations have gained greater access to commercial funding and are able to offer their clients savings accounts and larger loans. More fully integrated into regular financial markets, these former MFIs turned banks are now often among the leaders in the regions where they operate, including XacBank in Mongolia, Opportunity Bank in Ghana, and MiBanco in Peru. But are the benefits of transformation worth the costs? MFIs seeking to become banks face a troublesome process that includes heavier regulation and structural overhaul. And what about the MFI’s originating mission of providing credit to those most in need?
Roy Mersland, professor of international business and development at the University of Agder in Norway, and colleagues studied 66 MFIs that transformed from an NGO to a shareholder-owned banking entity between 1993 and 2011. To isolate the consequences of transformation, they compared the real performance numbers of the new bank with what those numbers would have been if the MFI had continued as an NGO. The study revealed several advantages from the conversion. Annual interest rates fell 3.9 percentage points, which meant that clients could borrow more cheaply. Operational costs dropped 1.1 percent, making the businesses more efficient. Commercial debt leverage, deposits, and average loan size also spiked as the MFIs became bonafide banks. The average loan more than doubled from $566 to $1,368.
Although these results mark the greater sustainability of these enterprises, they may also suggest a more fundamental change in focus from the neediest to wealthier clientele. “This could be a sign of so-called mission drift where the MFI has moved upmarket,” Mersland says. “However, it could also be because the MFI now has access to much better funding, which allows it to serve the same customers with loan amounts better fitted to their financial needs.”
Despite the benefits of becoming a bank, microfinance NGOs should still be wary of making the move. A transformation completely alters the MFI’s business model and can take a long time to implement, Mersland says. The researchers found that MFIs normally started changing their business model three to five years beforehand and continued adapting it for at least five years after the shift.
“A transformation really stresses the organization, not only because it takes so long, but also because it involves every aspect of the business model,” Mersland says.
The new enterprise also makes new demands on those it serves. When an MFI becomes a bank, the relationship with clients grows more formal and paperwork piles up. Clients who cannot provide necessary documents such as tax cards, marriage certificates, or basic accounting information can often no longer be served, Mersland explains. Plus, credit applications may take longer to process, thanks to additional required documentation and procedures.
“There is also a risk that a transformed MFI develops a banking culture in which the clients may feel estranged,” Mersland says. Marc Labie, professor at the Warocqué School of Business and Economics at the Université de Mons in Belgium agrees: “From a mission point of view, there is a real risk of leaving some types of clients behind.”
From a management point of view, Labie explains, transformed institutions often focus attention on following regulatory requirements for capital, liquidity, and portfolio reporting but not enough on the corporate cultural changes that usually accompany this process. “Staff from top to bottom will have to face multiple challenges,” he says. What’s more, often governance receives attention too late, when organizations get into trouble. But as a preventive measure, Labie says, practitioners should make sure that they have strong enough governance mechanisms in addition to a board of directors before moving into the challenging process of transformation, rather than waiting to get into trouble to do so.
For those willing to take the risk, Mersland’s findings point to an overall positive change for the clients it can serve: Banks offer a wider scope of services, can handle more clients, and operate with lower interest rates.
“The NGO then has two choices,” Mersland says. “Transform into a for-profit player in order to attract investors and take advantages of economies of scale, or remain a niche NGO, which will probably not grow very big but makes a real difference for the clients it serves.”
Read more stories by Corey Binns.