www.ifc.org/thoughtleadership NOTE 58 • OCT 2018 Competition Works: Driving Microfinance Institutions to Reach Lower-Income People and the Unbanked in Peru Competition from commercial banks is prompting microfinance institutions in urban areas of Peru and other Latin American nations to provide more service to lower-income groups. Where higher-income clients are already served by commercial banks, microfinance institutions compete by attending to a new demographic, while continuing to serve higher-income clients where commercial banking services are scarce. Microfinance Institutions industries compete for the same clients or customers in Microfinance seeks to remedy credit market failures and a market, the result can be a fundamental change in the the poverty they can engender. Providing modest amounts dynamics of that market. of capital to both small entrepreneurs and households can Moreover, intense competition can also create or expand result in additional business income as well as liquidity for a a market. The market for financial services is not immune wide range of needs. The rapid growth of the microfinance to this process. This critical market can be altered industry over the past 15 years has served approximately fundamentally by the introduction of new competitors, 130 million clients, according to recent estimates, yet it still and more generally through the spillover of ideas and the reaches less than 20 percent of its potential market—the creation of new networks. world’s three billion or more lower-income people.1 Such alterations can drive financial services providers The main microfinance lenders are nongovernmental to cater to additional groups, and often marginalized organizations, non-bank financial intermediaries, and ones. These groups include lower-income individuals, microfinance banks. As the industry has expanded and women, rural populations, and others that were previously matured, it has allowed the private sector to become increasingly active in providing financial products and services to low-income populations in emerging economies, demonstrating that the sector can be commercially sustainable. The question, then, is, can the development community use market-altering mechanisms to shift the strategic focus of microfinance institutions (MFIs) to serve these communities? Also, could this ultimately trigger an increase in microfinance lending to lower-income and other unbanked populations? “Competition is the act of endeavoring to gain what another endeavors to gain at the same time,” wrote English An MFI client engaged in the bakery business. essayist Samuel Johnson. 2 And when multiple firms or Source: Grameen Foundation 1 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. unbanked or underbanked. This alteration and expansion The study found two interlinked factors driving the market of markets has been observed in Latin American countries, focus of MFIs across these countries: competition and where it has contributed to enhanced economic opportunity overly high levels of debt. and increased inclusiveness in the region. MFIs reached more lower-income clients in regions where Affirmative responses to these questions would be there was higher commercial banking saturation, despite helpful for development finance institutions such as the the fact that the MFIs may not have targeted these groups International Finance Corporation,* as well as impact initially. Commercial banks in these typically urban areas investors, whose challenge is to infuse operational business tended to serve higher-income clients, so market forces—in models with a larger focus on markets, rather than a the form of new competition for customers—encouraged traditional and narrower focus on individual investments. the MFIs to expand their service offerings to individuals Doing so could potentially produce a bigger impact lower on the income ladder. on lower-income and marginalized groups, as well as In addition, MFI leaders who were interviewed said that contribute to inclusiveness and sustainability. high debt levels among higher-income clients in urban areas A recent IFC study investigated the poverty outreach efforts precluded those clients from additional borrowing, and so of fourteen MFIs across six countries in Latin America, forced the MFIs to expand their service offerings to lower- including Peru, Colombia, Bolivia, Ecuador, Guatemala, income clients with less debt. and Nicaragua.3 The study leveraged information collected Robust competition from commercial banks in urban by these MFIs on poverty likelihood using the Poverty areas also led MFIs to shift the geographic focus of their Probability Index (PPI), which is a statistically sound yet operations, from cities to suburbs and rural areas. In these easy to use country-specific tool4 used to measure poverty non-urban areas, the MFIs tended to serve relatively higher- in target markets. This information was supplemented with income, but still unbanked, individuals. Another study in-depth interviews with industry experts in the sector, as found that MFIs also benefitted from the additional revenue well as leaders of the MFIs. derived from cross-selling products to rural clients.5 80% NATIONAL POVERTY LEVEL Figure 1 depicts the market focus of a typical Peruvian microfinance institution. In regions with less poverty (to the left side of the horizontal axis), MFIs are being forced 60% by competition to serve poorer individuals. That is, their MFI Client Poverty Rate customers tend to be poorer on average in that region, and 40% so sit above the sloping black line. Banks in these areas are serving relatively higher income people, so MFIs seek different, lower-income customers. 20% In regions with higher poverty rates (to the right on the horizontal axis), where banks tend to be less competitive, 0% the MFI’s customers tend to be higher income (so below the 0% 20% 40% 60% black line). Regional Poverty Rate This Peruvian MFI shown in Figure 1 is an example of how FIGURE 1A Peruvian MFI serves lower-income people competition can push an institution to target underserved where competition is high, and the unbanked where competition is lower. segments of the market. Essentially, the MFI serves more Source: “Factors Influencing Poverty Outreach Among Microfinance lower-income households in geographic areas where Institutions in Latin America – A report by the Grameen Foundation and they are more scarce (that is, areas with higher-income the International Finance Corporation.” The red vertical line represents the populations). However, in geographic areas with higher percentage of lower-income households at the national poverty level in Peru, and the size of the circles the number of clients served by the MFI. The black percentages of lower-income households, the MFI is serving line represents a 45-degree angle. higher-income households. *The International Finance Corporation, or IFC—a sister organization of the World Bank and member of the World Bank Group—is the largest global development institution focused on the private sector in emerging markets. 2 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. According to interviews conducted for the study, the clients generally lower interest rates offered by those banks. Thus, served by the MFI in areas of high banking saturation they move their operations to suburban and rural areas in (where the bubbles are above the black line) were more search of underserved clients. Most of the MFIs included often lower-income and had no access to the lower interest in this study cited banking saturation as a key factor when rates offered by commercial banks. deciding which regions to enter. Microfinance lenders that do not explicitly focus on serving This is also illustrated by Figures 2 and 3. They show in lower-income people are often pushed to do so by increased green the regions where the same Peruvian MFI has a banking saturation. In-depth interviews with industry higher percentage of lower-income clients than the poverty experts and MFI leaders across the region confirmed that rate in any given region. They also show in red the regions this is due to the fact that, when commercial banks enter a where the same Peruvian MFI has a lower percentage of market, MFIs are unable to successfully compete with the lower-income clients than the poverty rate in any given Urban Cusco MADRE DE DIOS Cajamarca Arequipa JUNIN MOQUEGUA Tacna Ucayali LA LIBERTAD Lime HUANCAVELICA ICA ANCASH TUMBES Puno APURIMAC SAN MARTIN CALLAO Amazonas PASCO LAMBAYEQUE HUANUCO AYACUCHO LORETO PIURA 0% 10% 20% 0% 10% 20% 30% 40% 0% 10% 20% 30% 0K 10K 20K MFI vs. Regional Concentration MFI Concentration Regional Concentration Total Count of Clients FIGURE 2 A Peruvian MFI, with generally higher percentage of lower-income clients in urban areas Rural Tacna MADRE DE DIOS MOQUEGUA ICA Arequipa Lima TUMBES Cusco JUNIN SAN MARTIN Ucayali Puno LAMBAYEQUE Amazonas AYACUCHO LA LIBERTAD ANCASH Cajamarca PIURA APURIMAC HUANCAVELICA HUANUCO PASCO LORETO 20% 0% 20% 0% 10% 20% 30% 40% 50% 0% 20% 40% 60% 0K 2K 4K 6K MFI vs. Regional Concentration MFI Concentration Regional Concentration Total Count of Clients FIGURE 3The Same Peruvian MFI as shown in Figure 2, here shown with generally lower percentage of lower- income clients in rural areas Source for both figures: “Factors Influencing Poverty Outreach Among Microfinance Institutions in Latin America – A report by the Grameen Foundation and the International Finance Corporation”; Note: Concentration refers to percentage of lower-income people (e.g., MFI Concentration is the percentage the percentage of MFI clients who are living under the poverty line) 3 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. region. Therefore, urban areas are predominantly green in • Microenterprises are more likely to see finance as a Figure 2, and rural areas are predominantly red in Figure 3. key constraint to their development and more likely to The study also found that those MFIs that reached the be disadvantaged in economies with underdeveloped highest percentage of lower-income clients were the financial systems. ones with a specific strategic focus in areas with higher Conclusion percentages of lower-income people. Moreover, several of Competition from commercial banks for higher-income these MFIs explained that they designed their products (for customers in several Latin American countries, and example, loan size and training) to cater to lower-income particularly Peru, encouraged microfinance institutions to clients in areas of high competition. expand their service offerings to lower-income people and This demographic shift is also motivated by the need for the unbanked. MFIs to be profitable, as the industry has changed from one in which MFIs are typically non-governmental organizations ABOUT THE AUTHORS to one in which they are for-profit institutions.6 Forests, Miguel Angel Rebolledo Dellepiane, Senior Results highlands, and mountain areas all have lower percentages Measurement Specialist, Sector Economics and Development of lower-income clients in the MFI portfolios. Given that Impact, VP Economics and Private Sector Development, IFC these are often the poorest areas, the MFIs were focusing (mrebolledo@ifc.org) their commercial strategies there on relatively higher-income Gloria Paniagua, Results Measurement Specialist, Sector clients. They were also facing little or no competition Economics and Development Impact, VP Economics and from other financial institutions in these areas. Across the Private Sector Development, IFC (gpaniagua@ifc.org) countries reviewed, the study found that MFIs reach the lowest percentages of lower-income households in regions ACKNOWLEDGMENTS with lower population density and challenging geographies. The author would like to thank the following colleagues for their review and suggestions: Martin Holtmann, Manager, The studies also found that: Digital Finance & Microfinance, Financial Institutions • The higher the income of an MFI client, the larger the Group, IFC; Terence Gallagher, Principal Industry Specialist, average loan size and the number of loans that client Microfinance, Financial Institutions Group, IFC (until March receives. However, this relationship is less significant in 2018); and Thomas Rehermann, Senior Economist, Thought areas with a higher percentage of lower-income households. Leadership, Economics and Private Sector Development, IFC. • Women tend to receive smaller loans than men, but they tend to receive loans more frequently. These women are ADDITIONAL EM COMPASS NOTE ABOUT THE PROVISION OF FINANCIAL SERVICES IN EMERGING typically the head of household. According to interviews, MARKETS as women have fewer opportunities to receive a loan, Please note the following related earlier EM Compass Notes: their opportunity cost of defaulting is higher. How Fintech is Reaching the Poor in Africa and Asia: A • The higher the number of loans received by a client, Start-Up Perspective (Note 34); Digital Financial Services: the larger the size of subsequent loans. This trend is Challenges and Opportunities for Emerging Market Banks particularly significant in Peru and Guatemala, and (Note 42; Blockchain in Financial Services in Emerging seems to be a reward for good financial behavior, but Markets - Part I: Current Trends (Note 43); Blockchain in was less significant in Ecuador and Colombia where Financial Services in Emerging Markets - Part II: Selected MFIs have greater concerns about client debt levels. Regional Developments (Note 44). 1 IFC. ”Microfinance.” Brief, no year. https://www.ifc.org/wps/wcm/connect/Industry_EXT_Content/IFC_External_Corporate_Site/Industries/ Financial+Markets/MSME+Finance/Microfinance/ 2 The Library of Economics and Liberty. www.econlib.org/library/Topics/HighSchool/CompetitionandMarketStructures.html. 3 Rebolledo, Miguel, Terence Gallagher, Sergio Correa Asmar, and Julie Peachey. 2016. “Factors Influencing Poverty Outreach Among Microfinance Institutions in Latin America – A report by the Grameen Foundation and the International Finance Corporation.” IFC, Grameen Foundation. 4 https://www.povertyindex.org/about-ppi; see also Burke, Laura, Sharada Ramanathan and Miguel Angel Rebolledo Dellepiane. 2018. “A Practical Tool to Create Economic Opportunity for Low-Income Communities”, EM Compass Note 56, IFC, July 2018. 5 Paniagua, Gloria and M. Lynch. 2015. “Systematic Review of SME Banking and Business Regulation.” IFC. 6 NGOs typically tend to measure success as poverty outreach. 4 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group.