76424 CASE STUDIES IN DONOR GOOD PRACTICES No. 9 August 2003 Donor Innovation in Financial System Development: DFID’s Design of FinMark Trust in South Africa by Sarah Barlow This case study describes how the U.K. Department for International Development (DFID) designed an innovative approach to broaden the outreach of the formal financial system in South Africa. Overview that lend to salaried employees at extremely high interest rates. Known in South Africa as microlenders, these How can donors help make financial systems work for institutions have little in common with microfinance poor people? In South Africa, DFID and the Banking institutions (MFIs) operating in the country and the rest Council of South Africa (BCSA) created an independent of the world. While most banks have invested in such local organization, FinMark Trust, and gave it the payroll-based lending businesses, none have invested decision-making authority to pursue projects that inte- seriously in uncollateralized microenterprise lending to grate microfinance into mainstream financial services. self-employed people or other financial services for poor FinMark operates primarily as a facilitating organization people —the type of services that are the foundation of that has high-level convening power with both the microfinance elsewhere in the world. government and the private sector. It also provides technic al assistance and finance for strategic projects. However, both the government and private sector have been increasingly focused on improving the reach of Launched in March 2002, FinMark is a young program South Africa’s financial system to cover small and and its results cannot yet be fairly assessed. What sets it medium enterprises and the un-banked as well as apart as a significant donor intervention is its structure, managing the payroll-based microlenders. Self-employ- flexibility, and staffing. As an independent local organi- ed entrepreneurs and poor households in the informal zation, FinMark is unrestricted by typical donor sector have not been the principal focus of their efforts pressures: it does not have to meet pre-established to date, but this is changing. disbursement targets, nor must it focus on a narrow set of activities. FinMark has the freedom to choose the Changes in Focus at DFID projects it will fund (provided they are consistent with its mission) and the agility to respond quickly to Two pivotal changes at DFID laid the groundwork for opportunities. FinMark identifies projects of mutual the FinMark project. First, the DFID private sector interest to government agencies and private financial development team in Southern Africa, led by Hugh institutions and facilitates joint support. FinMark has Scott, reassessed its approach to promoting also successfully recruited talented staff and Board microfinance.1 DFID had promoted business develop- members who are well respected in South African ment services in the region since 1994. By 2000, financial circles. however, the local DFID team recognized that limited access to financial services was one of the principal Setting the Stage constraints to enterprise development and poverty reduction. They developed a new approach to micro- Although South Africa has a sophisticated financial finance that concentrated on the systemic factors system, it serves only a minority of the population. constrain ing its growth. Microfinance has largely developed outside the formal financial system and remains limited in scope. Few NGOs have reached significant scale and most remain dependent on donor support. The public perception of microfinance has been tar- 1 DFID defines Southern Africa as the Republic of South nished by payroll-based consumer credit organizations Africa, Namibia, Swaziland, Lesotho, and Botswana. Page 2 A DIRECT Case Study Second, a shift in DFID corporate objectives called for Governance. The single most difficult task for DFID less support of individual projects and more attention to was designing a governance structure for FinMark. high-level policy engagement. The new policy seeks to Rather than fund individual microfinance projects, DFID address development problems at the sectoral level— wanted the program to work with the government and including adequate infrastructure, supportive regulation, private organizations to resolve the market failures that and local technical capacity. Local ownership of discouraged private investment in microfinance. This development initiatives became increasingly necessary approach required local ownership, technical expertise, to encourage national governments and private and operational flexibility. institutions to tackle major issues of investment, regulation, and policy. “If a donor wishes to ensure real local ownership, it must be prepared to lose some direct control.� Designing FinMark Trust Hugh Scott, Senior Private Sector Development Advisor, DFID Mission. The mission of FinMark is to “make financial markets work for poor people ,� that is, to ensure that The agency sought a structure that would maximize the financial markets in South Africa provide demand- impact of FinMark activities, minimize direct DFID driven financial services to poor people on a sustainable involvement, safeguard the DFID investment, and avoid basis. The Trust concentrates on attracting private-sector unnecessary bureaucracy. After extensive consultations investment into microfinance by strengthening the with stakeholders, DFID and the BCSA created FinMark infrastructure of the financial sector, which it divides as an independent trust. into three levels: a) Institutional infrastructure—polic ies, laws, and The trust structure allows DFID to provide strategic regulations oversight rather than direct management. Led by CEO Porteous, FinMark operations are overseen by a Board b) Organizational infrastructure—the institutional of Trustees. The Board establishes strategic direction, capacity of retail financial institutions approves significant investments, and provides financial c) Support infrastructure—service providers, such as oversight. It is comprised of four recognized financial consultants, auditors, information providers, etc. leaders in Southern Africa, plus Porteous. Two s enior international microfinance figures (from CGAP and the What distinguishes FinMark’s approach is its ability to United Nations Development Programme) and DFID work at all three levels simultaneously and build on their representative Hugh Scott serve as advisors to the Board. interdependence. FinMark was originally established as a joint venture Funding. The FinMark Trust was established wit h an with the Banking Council of South Africa. It became initial DFID grant of £5 million (approximately US$ 7.5 independent in 2003 to emphasize its role as an million) to be disbursed over five years. Other donors independent, “honest broker� among private-sector and work with FinMark on a project basis, with most government stakeholders in the financial services projects funded in part by a private-sector partner. The market. Trust itself is not intended to become self-sufficient, but aims to help establish a sustainable financial services market which services the majority of the population. “It is impossible to underestimate the importance of getting the governance and structure of the FinMark Trust right.� David Porteous, CEO, FinMark Trust Staffing. The ability of DFID to recruit superior local staff for FinMark has been crucial to its success. The What Exactly Does FinMark Do? Trust is managed by a well-respected CEO, David Porteous, who has an extensive background in FinMark can do almost anything it wants in the pursuit promoting financial services for the poor. Established of its mission. To date it has convened high level financial leaders were also recruited to the Board of meetings between financial services institutions and Trustees, which greatly enhanced the credibility and government agencies, promoted industrywide communi- effectiveness of the organization. cation, and supported regulation and supervision of microfinance. It also funds a range of relatively small A DIRECT Case Study Page 3 projects and research initiatives. FinMark looks for opportunities to partner with government and private organizations on projects that will increase the provision of sustainable financial services to poor people in South Africa. FinMark’s full-time staff of three (including the CEO) works out of an office in Johannesburg. External consultants are engaged on an as-needed basis. Two of its initiatives are summarized below. Gauteng Partnership Fund (GPF). Created in 2002, the GPF seeks to attract private investment into the low- income housing sector in the province of Gauteng, South Africa. A technical assistance grant from FinMark of Low-income housing project in South Africa. (Photo: US$ 21,000 was essential to its establishment and helped Copyright Guy Stubbs, www.guystubbs.co.za). cover the cost of an initial market assessment. Micro-Finance Regulatory Council (MFRC). MFRC To date, the GPF has attracted investment from two is a not-for-profit regulatory organization approved by commercial banks into two low-income housing projects the Ministry of Trade and Industry (DTI) of South by co-investing in the form of equity and/or partial loan Africa. Its mandate is to protect consumers against guarantees. These investments have facilitated the unfair practices by microlenders while encouraging the construction of 1,200 low-income housing units. GPF is development and growth of the microfinance market. presently planning to develop a database to track the real FinMark supports a range of projects with the MFRC, level of financial risk involved in such housing including: investments. • Funding the cost of consumer focus groups as part of a recent MFRC review of consumer credit legislation. In addition to this funding, FinMark Advice for Donors 1. Put the right people in place on the ground. The reputations, expertise, and commitment of the FinMark CEO and Board of Trustees give the organization credibility in the South African financial sector and are thus critical to its success. 2. Be willing to cede control in appropriate circumstances, but only if donor and local program staff include individuals with sound technical expertise. 3. Be clear about program goals. FinMark’s mission of “making markets work for poor people� informs its decision making on all activities. 4. Be realistic about donor capacity. DFID created an independent local entity because it wanted to an organization that could both quickly respond to opportunities and credibly influence local government and financial actors as a local player. 5. Focus on objectives, not expenditure levels. DFID assesses FinMark primarily on the how well it achieves agreed outcomes, not on its speed of disbursement. Be prepared to adapt the program over time. 6. Mitigate the risks of local program management by, for example, naming the lead donor representative an advisor to the Board of Trustees and using standard management procedures (e.g., quarterly disbursements, regular reviews, annual independent audit) to monitor the donor’s investment. Page 4 A DIRECT Case Study CEO Porteous sits on the review panel. The study 5. Streamline bureaucracy. FinMark’s funding will be used by DTI to develop a policy paper on application process is simple, transparent, and quick, “making credit markets work.� making it an ideal private-sector partner. • Providing technical assistance (US$180,000) to the 6. Innovate. FinMark aims to kick-start change and National Loans Register, a credit bureau managed by innovation within the sector by supporting MFRC, to facilitate the register’s expansion to cover unorthodox projects. micro, small and medium enterprise (MSEs) 7. Leverage impact. FinMark understands that large lending. As a result of FinMark technical assistance, amounts of money are not always required to the National Loans Register will soon be able to address market failures, and can in fact be counter- provide credit information on MSE borrowers to productive. Many FinMark interventions have been registered financial institutions, thereby mitigating low cost but high impact. The ability to undertake some of the perceived risks of lending to this target very small projects is an enormous source of its market. strength. Initial Conclusions 8. Tap microfinance expertise. FinMark has made optimal use of local and international technical FinMark is a new program, so it is premature to judge its expertise, developing strategic links with such ultimate success in building financial services for poor international microfinance partners as CGAP (a people in South Africa. However, several principles have consortium of 28 donors and private foundations that contributed to its emergence as a credible player in the support financial services for the poor worldwide) financial sector, giving it an operational flexibility rare and MicroSave-Africa (a donor-funded service among donor programs: provider specializing in microfinance product 1. Partner with local institutions. FinMark is development). designed to facilitate change in the formal financial system by partnering with government and private References sector organizations on projects that encourage both CGAP Staff. Microfinance Means Financial Services for the parties to take action. Poor. CGAP Donor Brief, no. 11. Washington, DC: CGAP, 2. Focus on good microfinance practice. DFID staff, March 2003. FinMark management, and other stakeholders agree FinMark Annual Report 2003. www.finmark.org.za. that a market-based approach to financial services FinMark. “Business Plan 2003− 2004.� Draft, n.d. for poor people is the best way to reach scale on a U.K. Department for International Development (DFID). sustainable basis. “Project Memorandum: Making Financial Markets Work for 3. Institute local decision-making. DFID relinquished the Poor in Southern Africa (FINMARK).� Internal paper, direct program management to build local credibility October 2001. and attract private-sector investment into U.K. DFID. “Output to Purpose Review.� Draft, May 2003. microfinance. The FinMark Board has the authority to approve projects, allowing the organization to Contacts and Web Sites rapidly respond to opportunities as they arise. DFID contact: Hugh Scott, Senior Private Sector Development 4. Create flexible funding mechanisms. FinMark can Advisor, South Africa, h-scott@dfid.gov.za choose from a range of funding mechanisms (grants, FinMark contact: David Porteous, CEO, loans, equity), but anticipates that the bulk of its david@finmark.org.za financial support will be in the form of technical FinMark Trust web site: www.finmark.org.za services. Photograph on page 3 reprinted with permission of Guy Stubbs. “Donors tend to underestimate the time it takes to develop Sarah Barlow is a private sector development consultant on leave of proposals, and this, combined with often lengthy approval absence from DFID. This case history is based on the cited times, makes many project ideas too costly to pursue. In references as well as input from David Porteus (FinMark), Hugh addition, the window of opportunity for an initiative may Scott (DFID), Gabriel Davel (MFRC), and Elize Stroebel (GPF). close if funds cannot be sourced fairly quickly.� Gabriel Davel, CEO, MFRC