76428 CASE STUDIES IN DONOR GOOD PRACTICES No. 20 March 2005 Experienced Consortium Deepens Bulgarian Financial System by Creating ProCredit Bank, a Commercial Bank for Microenterprises by Ann Duval and Ruth Goodwin-Groen This case study describes how a consortium of international development organizations, a commercial bank, and a micro- finance technical-service company worked closely to establish ProCredit Bank Bulgaria, a highly successful, full-service commercial bank for micro and small enterprises. Overview €46.5 million in loans for onlending, plus significant technical assistance. Over a three-month period in Summer 2001, ProCredit Bank Bulgaria (PCBB) went from an idea to a function- ing full-service bank for micro and small enterprises (MSEs). The five donor-investors that created PCBB, together with the Bulgarian government and Bulgarian National Bank, worked with unprecedented efficiency to launch the bank. Three years later, PCBB had become the fastest growing bank in Central Europe.1 Its success can be attributed to the common vision and diverse experience of its investors; influential champions in donor agencies; dynamic Bulgarian counterparts; skilled staff; and significant equity, loans, and technical services from international financial institutions and donors. “Elux� manufactures fluorescent lighting to European standards in Four members of the consortiumInternational Finance Sofia. (Photo: Valentin Mechkanov Feb. 2004). Corporation (IFC), European Bank for Reconstruction and Development (EBRD), KfW Bankengruppe,2 and As of December 2004, PCBB had 26,532 savers with deposits of €74.9 million, and €139 million in out- ProCredit Holding AG3have been investing together standing loans to 26,852 clients. Loans of less than in best-practice microfinance institutions since 1997. €10,000 (i.e., microloans in the Bulgarian context) Commerzbank AG, a commercial German bank, joined accounted for 92 percent of the total number and 33 them in 2000. To achieve their shared goal of financial percent of the total value of outstanding loans. (Loans of deepening in Eastern Europe, these partners had already less than €1,000 comprised 40 percent of total out- financed nine ProCredit Banks in the region, all of which standing loans.) Only 0.35 percent of the outstanding were managed by IPC. To date, the consortium has made loan portfolio was late by more than 30 days, and the more than €21 million in equity investments in PCBB bank’s credit clients represented over 25 percent of all and continues to provide ongoing governance of the private enterprises accessing credit in Bulgaria. As of 31 bank through a supervisory board. In addition, the Dec. 2004, PCBB’s adjusted return on equity4 (AROE) partners have collectively provided PCBB more than was 15.57 percent; unadjusted ROE was 19.22 percent. 1 PCBB’s success has encouraged other banks to enter the The Banker, Financial Times, January 2005, 58. 2 Kreditanstalt für Wiederaufbau Bankengruppe includes KfW small enterprise market, expanding services for micro- Entwicklungsbank and its subsidary Deutsche Investitions und entrepreneurs and creating tough competition. Entwicklungsgesellschaft GmbH (DEG). 3 ProCredit Holding AG was formerly Internationale Micro Setting the Stage Investitionen Aktiengesellschaft (IMI). Shareholders include Internationale Projekt Consult GmbH (IPC), KfW Bankengruppe, Bulgaria has made a reasonably successful transition to a and IFC, owning 21.8 percent, 10.6 percent, and 9.3 percent of its 4 shares, respectively. Adjusted for inflation, in-kind donations, cost of funds by PCBB. Page 2 A DIRECT Case Study market-led economy. GDP growth has been strong, micro and small businesses and depositors. Within a inflation and budget deficits are under control, and month, it had disbursed 360 loans. exports have continued to perform well. Because of its strong economic performance and fiscal discipline, Contributions of Consortium Members Bulgaria is a candidate for European Union (EU) mem- Commerzbank AG. A German retail bank, Commerz- bership in 2007. In spite of these positive indicators, bank brought in-depth knowledge of international bank- Bulgaria’s GDP per capita remains among the lowest in ing relationships to the project. It serves as PCBB’s Europe (€1,900 in 2001). Official unemployment is 12 correspondent bank. In 2004, Commerzbank helped percent, and a recent World Bank survey demonstrated PCBB staff set up “ProPay,� an international money that 24 percent of the population lives in poverty. transfer service between ProCredit Banks. The service offers transfers at half the price and twice the speed of MSEs together account for 54 percent of total employ- standard international transfers. ment in Bulgaria’s private sector. Of the country’s 226,586 registered businesses, 81 percent are micro- EBRD. EBRD brought specialized knowledge of enterprises that employ fewer than ten people. In the late Bulgaria and Eastern Europe to the project. The develop- 1990s and early 2000s, these crucial businesses were ment bank has been a major catalyst for investment in starved for cash because banks were reluctant to lend to the country, having directly invested €784 million itself “risky� clients. At the end of 2001, for example, banks in various infrastructure and development initiatives. As had collectively extended only 16,336 loans under a result, EBRD carries tremendous political clout in €100,000 to private enterprises in Bulgaria. Bulgaria. Responding to the Market: Creating a Full- IFC. IFC, with its AAA rating and deep pockets, Service Commercial Bank brought leadership, credibility and experience in struc- Each consortium member had experienced staff with a turing commercial transactions. Together with IPC, it deep knowledge of both the Bulgarian market and the designed the original financing model, and it was the region. These staff served as champions for the PCBB “lender of record.� project. Aftab Ahmed at the IFC; Elizabeth Wallace, “A key aspect of the model is for the management team to Jana Sivcova, Elvira Lefting, and Stephan Boven at invest cash up front equivalent to 10 percent of the new EBRD; Dr. Klaus Glaubitt at KfW; and Dr. Claus-Pieter bank’s equity (at a minimum).� Zeitinger and Cristoph Freytag at IPC, all knew there Aftab Ahmed, senior manager, IFC was huge demand for a bank that focused on MSEs, which could deepen the financial system. Loan applica- KfW Bankengruppe. KfW has banking and capital mar- tions to local banks required microentrepreneurs to com- ket expertise, together with a broad range of financial plete mountains of paperwork, and then wait up to three instruments (e.g., equity, mezzanine and debt instru- monthswith most applications subsequently rejected. ments, as well as grants). KfW played a leading role in the consortium, providing debt, equity, and technical To provide MSEs with a range of financial services, the assistance, and in 2003, helping PCBB place its first consortium had two options: (A) buy an existing com- mortgage bond issue in the local-currency market. mercial bank, or (B) create a new microfinance bank. In 2001, KfW and IPC helped a local commercial bank EBRD and KfW-Entwicklungsbank. These investors downscale. Although they generated little management both have “preferred creditor status,� which permits interest, the two partners trained 56 young, motivated them to assume credit risk for development-oriented loan officers in microenterprise lending. The consortium investments beyond the scope permitted private sought to purchase this bank, but decided against it when commercial banks. This ability proved important for questions arose in the later stages of due diligence. PCBB while it was establishing credibility with inter- national bankers. Unwilling to give up, the consortium team immediately went to plan B: create a new bank. Consortium staff, ProCredit Holding AG and IPC. It takes hard skills and local loan officers, and Central Bank officials worked real experience to run a full-service bank. IPC (founder day and night from June to September 2001, when the of ProCredit Holding AG, which now owns 19 banks team was granted a full banking license for a new insti- globally) brought deep experience in financial institution tution. ProCredit Bank Bulgaria opened its doors on management, staff training, product and branch design, October 15, 2001, positioning itself as an institution for and a commitment to transparency to the PCBB project. A DIRECT Case Study Page 3 PCBB’s Rapid Expansion “We did not wish to become solely a lending institution; rather, we aimed to develop a stable client base consisting PCBB quickly expanded its size, services and financial of both business loan customers and depositors.� base. By December 2004, the bank had 35 outlets that PCBB, Annual Report 2003 covered 23 regions (or about 85 percent) of the country. Staff grew proportionately, from a total of 71 in 2001 to Success sparks competition. One of PCBB’s great suc- 623 in December 2004, including 182 loan officers. cesses is aggressive competition from other banks, predominantly in small-scale consumer lending. “Comp- Substantial external financial investment. PCBB’s etition is cutthroat now in Bulgaria. ProCredit’s services growth was supported by substantial consortium invest- are so good because it is fighting for each customer,� ments. The bank opened with €6.15 million in equity remarks Judith Brandsma, the EBRD representative on contributed equally by IFC, EBRD, KfW Bankengruppe, the PCBB board. Competition is welcomed by PCBB Commerzbank, and ProCredit Holdings AG. The share- investors as a way to drive efficiency. However, lack of holders subsequently more than doubled their individual a national credit bureau (until recently), inadequate lend- investments so by December 2004, the bank’s equity ing technologies, and insufficient transparency also reached €18.6 million.5 Like most formal Bulgarian create a risk of over-indebtedness in Bulgaria’s market. financial institutions, the bank does not yet have Bulgarian shareholders. Keys to Investor Success In addition to equity investments, KfW, EBRD, and IFC Common investor vision. The founders and shareholders have lent €19 million, €17 million, and €10 million to of PCBB shared a clear vision of establishing a PCBB, respectively, for onlending to MSEs. (The EBRD profitable full-service bank with a core microlending loans were provided through a small-and-medium-enter- product. They sought to use the bank to demonstrate the prise financing facility cosponsored by the USA.) Loan viability of the MSE market, generate commercial conditions included six-to-seven-year terms, commercial competition, and thus deepen the financial system. They pricing (based on EURIBOR plus a margin for risk), and backed their vision and strategy with substantial funding, three-to-four-year grace periods. Commerzbank AG also enabling PCBB to keep pace with the dynamic Bulgarian lent PCBB a commercially priced bullet-loan of €3 market. Their insistence on a commercial approach also million with a maturity of three years. ensured that PCBB could augment its capital through deposits and other local debt instruments. Ability to tap local capital. PCBB has been as successful “Adopting a common formal-sector banking approach has in leveraging local sources of funding as it has in attract- been important. There is no way that sufficient capital to ing external financing. The bank’s deposit base has meet market demand could have been raised by just donors.� grown rapidly, exceeding €74.9 million in December Elizabeth Wallace, former director, Group for Small 2004. The bank successfully issued its first mortgage Business, EBRD bond in 2003 for 10 million Bulgarian leva (€5 million), and two corporate bonds in 2004 totaling €15 million. Shared aversion to competing projects. Each member of Bank profits, which reached €2.98 million in 2004, are the consortium chose to support a common project, also being reinvested. rather than create their own, to prevent competing projects that could potentially undermine the market. As Wide range of products and services for MSEs. Dr. Glaubitt, financial sector division chief of KfW Although PCBB’s core business is loans to micro and Bankengruppe, said, “We did not want to find ourselves small enterprises approved within 24 hours, the bank on an island and achieve nothing.� offers a wide range of financial products and services. It provides business development loans, agricultural loans, Qualified management from day one. The consortium overdraft facilities, credit lines, and consumer and made a conscious decision to launch PCBB with expert housing loans. It also offers six types of deposits and staff. “It is crucial to employ specialized and experi- other standard banking services (e.g., current accounts in enced consultants to provide management services at the local or foreign currency, debit cards, foreign currency beginning of such a project,� noted Jana Sivcova, EBRD exchange, internet banking, and “ProPay� transfers). operation leader for PCBB. EBRD channeled €3.75 million in technical assistance to PCBB from the United States to support the bank’s start-up and growth phase. 5 Shareholders are: ProCredit Holding AG/IPC, 21.74 percent; About 70 percent of this funding covered the cost of EBRD, 19.71 percent; KfW Bankengruppe, 19.71 percent; management and branch advisors (provided by IPC) and Commerzbank AG, 19.71 percent; and IFC, 19.13 percent. Page 4 A DIRECT Case Study other start-up costs, while 30 percent was devoted to villages. Balancing the social and financial goals of the loan-officer training and stipends. IPC’s management shareholders and the bank is difficult. team then groomed their own staff, using financial and career incentives. Two of the top four PCBB managers Future ownership. A key challenge for the long-term are now Bulgarian. success of PCBB (and the other 18 banks in the network) is crafting an exit strategy that ensures continuation of Learning from the ProCredit Holding AG Network. the bank’s social mission. EBRD, KfW, and IFC have PCBB has benefited from belonging to a profitable6 given their approval, in principle, to the sale of their network of ProCredit microfinance banks, all of whose shares to ProCredit Holdings at an appropriate time. This management services are provided by IPC and are strategy will ensure PCBB’s long-term commitment to largely financed by the same shareholder group. The providing MSEs with sustainable access to finance, as PCBB Supervisory Board consists of one representative well as maintain the ProCredit network. from each shareholder. Because many individuals are on the boards of several of the network banks, board Conclusion meetings for all banks in a given region are held at the The consortium of donors and investors that established same time so lessons can be applied across the network. PCBB learned that they could achieve far more together PCBB management also participates in the regional than they could alone. Fundamentally changing a finan- network, with IPC facilitating the flow of information cial system so that it serves microentrepreneurs and low- among the staff of all banks. Consequently, PCBB was income clients requires bold decisions and a wide range able to learn from its peers and become the frontrunner of skills, experience, and instruments. But it is not with- in the region. out its challenges. PCBB’s investors, aware of the chal- lenges inherent in their approach, think they are best Commercial reporting and governance. Shareholders addressed within the context of profitable, dynamic receive monthly financial reports similar to those of a financial institutions committed to changing the lives of commercial bank, including detailed lending statistics, poor people. balance sheets, profit and loss statements, and reports on asset-liability management. The Supervisory Board References meets quarterly (initially it was monthly) to review PCBB performance; approve the bank’s strategy, budget, Helms, Brigit, and Ruth Goodwin-Groen, with input from work plans and major investments; and discuss progress CGAP staff. How Donors Can Help Build Pro-Poor Financial Systems. CGAP Donor Brief, no. 17. Washington, DC: in deepening the financial system. CGAP, 2004. www.cgap.org/docs/ DonorBrief_17.pdf. Future Consortium Challenges Matthäus-Maier, Ingrid, and J.D. von Pischke, eds. The Devel- opment of the Financial Sector in Southeast Europe: Sufficient financing for growth. PCBB has been Innovative Approaches in Volatile Environments. Berlin, successful in building a solid depositor base, but credit Heidelberg, New York: Springer Press, 2004. demand far outstrips deposit growth. The bank must ProCredit Bank Bulgaria, Annual Report. Sofia, Bulgaria: overcome a triple challenge to increase savings: a basic PCBB, 2003 and 2004. public distrust of the banking sector in Bulgaria The Banker. “Fastest Growing Banks: Europe.� Financial (following several bank failures), reaching out to a new Times (London), January 2005. type of client (not the MSEs they know well), and tough competition for deposits. Developing instruments to Contacts and Web Sites access financing from capital markets, such as securi- tization, is another big hurdle. However, it looks ProCredit Bank Bulgaria: www.procreditbank.bg EBRD: www.ebrd.com IPC: www.ipcghbh.com probable that PCBB will be able to take advantage of the ProCredit Holding AG: www.procredit-holding.com market for syndicated loans and undertake additional IFC: www.ifc.org Commerzbank: www.commerzbank.com bond issues. KfW: www.kfw-entwicklungsbank.de/EN Balancing shareholder goals. Commerzbank is facing Photo reproduced with the permission of PCBB pressure to increase ROE. KfW is facing pressure to Ruth Goodwin-Groen and Ann Duval are senior microfinance expand outreach to remote rural areas. PCBB manage- consultants. They thank Aftab Ahme, IFC; Elizabeth Wallace, Jana ment sees new client potential in small towns and Sivcova, Elvira Lefting, and Judith Brandsma, EBRD; Dr. Klauss Glaubitt, Dr. Herbert Voigt, and Hans Martin Hagen, KfW Banken- 6 gruppe; Helen Alexander, ProCredit Holding; and Petar Slavov, ProCredit Holding AG had a projected after-tax return on equity of ProCredit Bank Buglaria, for their contributions to this case study. 14 percent in December 2004.