Recently in Unbanked Category

I am midway through reading Gary Rivlin's new book, Broke, USA. As CNN Money contributor Dan Okrent puts it in his review, Rivlin's book is about the industry of "vulture finance." It exposes large and small financial services companies that prey on financially vulnerable people because they can and because they find it lucrative.

So I was understandably skeptical when I flew out to Miami a few weeks ago to attend the Underbanked Forum, a conference organized by the Center for Financial Services Innovation.

Was I about to jump into a pool infested with loan sharks?

The conference turned out to be quite good. Several presentations and topics were true eye-openers. Here's the bottom line: for the broke, there's still hope for fair financial services that support flexible modern life and encourage financial responsibility.

Not just the fringes of the economy
Who cares? A lot of people should. The FDIC puts the number of under-banked and un-banked households - i.e. people who can't access the kind of credit and banking services that support mainstream life in the U.S. -- at about 30 percent in its December 2009 survey.

Add in younger people who are just starting to build their financial lives but have a world-weary cynicism of big banks. Also add more experienced adults who've been wronged by their banks lately, and there's a potential pool of 100 million people who demand better financial services.

With numbers like that, it's not surprising that a segment of the financial services industry is mobilizing to do a better job of being inclusive, understanding and creative about addressing customers needs without gouging them at every turn.

Too much downside, not enough upside
At the conference, design firm Ideo and non-for-profit D2D Fund reported on their analysis of people banking and non-banking behaviors.

Most striking among their findings: the upside of having a bank account often is perceived as being less than the downside of hidden fees and other practices that filch money. What's the point of hoping to earn roughly one percent interest on a few hundred dollars in your savings account while taking the risk of being hit with a $29 overdraft fee on your checking account?

Speakers highlighted two emerging alternatives to traditional savings accounts that offer a bigger potential upside for people who are starting from scratch:

• Starter savings accounts offered at an eye-popping five percent interest rate from established players such as US Bank and start-ups such as Mango Money.
• A "Save to Win" pilot conducted at a Michigan credit union offered prize drawings, including a grand prize of150,000, for people who saved.

According to the speakers, financial service providers tend to fund these programs out of marketing budgets rather than operational profits. It makes all kinds of sense to channel money directly into the pockets of first-time customers from the TV ad budget spent hawking big banks during Wheel of Fortune.

A nicer kind of access
Rivlin's book says that check-cashing and payday lending outlets have expanded so much in the past few years that they now outnumber McDonald's and Burger Kings combined.

In spite of the poverty industry's survival skills, as mentioned in a recent post by Rivlin, I believe that this trend will start reversing, fortunately.

Here's why. First, a very large percentage of the under-banked are connected and using the Internet several times a week. (Migrant workers not born in the US are the exception.) So creative minds can rapidly deploy new financial services at the very low costs made possible by not having to deploy physical outlets.

Second, the government will mandate that federal benefits be distributed electronically by 2013, avoiding the need for recipients to cash paper checks at a significant cost.

And even in the brick-and-mortar world, companies such as Mango Money are piloting new kinds of stores that are a lot more welcoming than check cashing parlors and less intimidating than bank branches.

Innovation, innovation, innovation
It's the word I heard the most often at the conference. There were plenty of sessions showcasing new ideads in credit, savings and payments. While Twitter's co-founder Jack Dorsey displayed showmanship with the "Square" credit card reader for iPhones and iPads, my pick for most intriguing initiative goes to GoalMine, a company intent on selling investments off of j-hooks at your nearest convenience store. When GoalMine deploys its service, people will be able to buy $50 worth of investment in a mutual fund as easily as they pick a $50 gift card today.

Overall, the good news is that there are many of us who care about serving the un-banked, under-banked and ill-banked. While I did not hear the word "affordability" very often, competitive spirits seemed to be high and will bring more just pricing quickly.

It is almost 40 years since "modern" microfinance was born. Money has always been lent to the poor but in the Indian subcontinent in the 1970s Grameen and BRAC made it big. Providing tiny loans to the poor (usually women) to help grow tiny businesses, the top-down, Bretton Woods development world watched as the borrowers repaid fastidiously, cross-insured their loans and used the working capital to grow.

But microfinance is not yet global. Its centres are in the subcontinent, Central and South America, the former USSR and Yugoslavia and, slowly but surely, Africa. And with millions of people remaining outside mainstream financial services in the developed world, it is yet properly to permeate richer societies.

In the US, microlending has been growing slowly for the past 30 years and it should find a larger market as a result of the credit freeze. There are 9m US households untouched by mainstream banks and another 21m using alternative credit means such as payday loans and pawnshops. With money-lenders' interest rates in developed societies sometimes over 1,000 per cent APR, there should be a market - and arguably a moral imperative - for the provision of credit and other financial services to the unbanked poor.

But despite the attractiveness of microfinance in principle, criticisms are many: there is continued dependence on subsidies from donor organisations; few organisations reach break-even; and there is probably confusion as to its purpose. Is it a social tool for poverty alleviation or a potential mass market? It can, and perhaps should, be both. But someone will have to work out how to make it scalable.

Some organisations have made progress. Accion Texas (AT), a licensee of the US Accion network, has the largest microfinance loan portfolio in the US. It has provided more than 10,500 loans since its establishment in 1994, totalling $93.6m disbursed and $20.3m in its active portfolio as of September 2009. Loans range from $500-$100,000 and are disbursed from 14 offices to more than 2,000 active clients across Texas.

AT's relative success, according to Gustavo Lasala, AT's CFO, is due to the management services and back office support that it offers to other microfinance institutions (MFIs) - helping to reduce their costs. "Accion is now across four time zones and this brings economies of scale," Lasala says. "For the organisations we support, using our systems reduces their costs by a third to a tenth, compared with doing it themselves."

Citigroup has invested in AT. Bob Annibale, Citigroup's Global Head of Microfinance, says it joined up with Accion two years ago and was especially impressed with its data. "[The data] went back 12-14 years and was of high quality. We were also enthusiastic about how many of Accion's clients were start-ups - 50 per cent or so - and its focus on business development." AT was reaching a client segment Citigroup had previously been unable to reach.

Most AT clients use loans for working capital or equipment purchases and many have received more than one loan from AT. Although 46 per cent have been in business for less than one year, 32 per cent have been in business three years or longer. AT's market is really those who would otherwise be using credit cards for business capital.

The past two years have seen difficulties in the sector, as the poorest have been hit particularly hard by the credit crunch and the economic downturn.

"The portfolio performance for MFIs generally began deteriorating as early as April 2007," Lasala says, "and since then, there has been a gradual worsening, with a levelling off in Q4 2009." Accion, he says, has nevertheless outperformed the market. It lost 9 per cent of its portfolio in the 2008-2009 fiscal year but now delinquencies are steady at 6 per cent and restructurings at 5 per cent.

Accion's selling point is a technical platform for processing applications. This makes for more volume and efficient credit scoring - a homogenised approach that allows greater operational efficiency. So far, 12 other organisations use AT's platform to do their underwriting - freeing them up to focus on providing retail services.

In Britain, Street UK - the first MFI in the country to become sustainable, according to Rosalind Copisarow, a co-founder - also combines retail lending with providing back office support and platform design. Set up in 1998, Street UK offers services including business advice and support, enabling micro-enterprises and the self-employed to move from undeclared work into the tax-paying economy.Unlike AT, Street does not make predominantly business loans.

"Only about 14 per cent are for some form of entrepreneurship," says Martin Hockley, chief executive and co-founder. The remainder are personal consumption loans at rates of 35-37 per cent. Street UK remains a minnow, with three branches in three locations, each handling about 1,500 loans.

In addition to the retail service, however, Street UK provides a range of back office support, tailored to the needs of partner organisations, and sells bespoke software platforms.

Some MFIs have shone just for a while. Before undertaking his current role as Manager of Community Finance at Oxfam America, Jeffrey Ashe helped to set up Working Capital (WC) in 1990 - a Grameen-style MFI pioneer in New England. "We really did reach the poor," Ashe says. With a small grant from the Ford Foundation, WC spread from rural Massachusetts to Vermont, New Hampshire and Maine. "Our clients were very poor, they included illegal Hispanic immigrants and the loans were small - not the thousands of dollar loans provided by so-called 'microfinance' in America."

WC expanded quickly, reaching 5,000 group members within a couple of years. In 1994, the model spread on a franchise model (Working Capital in a Box) to Delaware, Florida, Georgia and far east Russia.

WC had a 10-year run before operations ended, with the exception of some activities in New Hampshire. The Russian programme evolved into one of the largest MFIs in Russia. But why did WC ultimately not work out?

Ashe says: "When we started in 1990 the country was in a deep recession and banks had pulled out of marginal markets and moved upscale. Unemployment in the areas we were working in was upwards of 12-14 per cent - just as it is today. People were pouring into self-employment and there was no competition from other organisations." It was, he says, a perfect set of conditions, with all traditional institutions pulling out of the low end of the market.

By the time WC was no longer able to stay afloat (in 1997-1998), unemployment was close to 2 per cent, the financial sector was awash with cheap credit and many banks were providing individual loans - not just to groups. "We were killed," Ashe says, "by the twin perils of prosperity and competition."

The best-known name in global microfinance remains Grameen, begun by Muhammad Yunus, Nobel Peace laureate. He is bullish about microfinance's prospects in the US and insists that it must make money. As he told Time magazine recently: "If it's not profitable, it's not microlending. It's charity."

Since 2008, Grameen America has collected 1,700 borrowers in New York City and in June 2009 it opened a second branch in Omaha, with future branches planned for San Francisco, Boston and Charlotte. As one might expect, Grameen's model is closer to traditional, undeveloped world microfinance than Accion's. Its borrowers are mostly immigrant women and they use a group savings model - as seen in dozens of developing countries around the world. The women meet regularly with their group manager. If any of the women do not pay, credit is cut off to the entire group. So far, the results have been as positive as those seen in Bangladesh in the 1970s, achieving 99 per cent repayment.

But the shortcomings of microfinance in the developed world remain. Few MFIs are sustainable, or at break-even. Efficiency is lacking. The understanding of, and appetite for, such a sector is low. And there are continuing doubts about scalability. Jeffrey Ashe says: "In the US or UK, 10 per cent of the population is either fully or part-time self-employed. In the developing world, it's 40-60 per cent. The market is smaller."

On the other hand, Gustavo Lasala claims the market is barely tapped. "There are 25m small businesses in the US. Assume that 10 per cent of that number is our target market (10 per cent of US households are unbanked). Assume 30 per cent of these require microlending services. With an average loan size of $7,500 you get a potential market of $5bn. Now consider that the aggregated microfinance portfolio of all microlenders in US is somewhere between $200m and $300m. That's a drop in the bucket."

There may be obstacles specific to the developed world. According to economist Jonathan Morduch, of New York University, microloans have less appeal in the US because people think it is too difficult to escape poverty through private enterprise - something that is not an issue in Bangladesh. He is critical of what he says rests on a specious win-win proposition: that MFIs that follow the principles of good banking will also be those that alleviate the most poverty.

Morduch derides this vision - detailed as a set of "best practices" circulated widely by the Consultative Group to Assist the Poor (CGAP), the US Agency for International Development and the United Nations Development Programme. In an article in 2000 in the journal World Development, he argued that while some found the win-win argument to be self-evident, most practitioners were not convinced. "Despite keen awareness of best practices, nearly all programmes remain substantially subsidised. And recent surveys show that the programmes that target the poorest borrowers generate revenues sufficient to cover just 70 per cent of their full costs." Most are failing to get enough clients to become sustainable.

Successful microfinance should arguably try to lose clients anyway. "What Accion Texas and Accion USA are doing," says Bob Annibale, is "helping people to build a credit history, which they require to access mainstream banking." A successful sector, then, should be helping to lift people up to where the banks will lend to them. It is a peculiarly self-defeating thought.

For this to happen, MFIs need to reach the large potential market and to push the doorstep lenders and loan sharks away from the vulnerable poor. To do this, MFIs must demonstrate efficiency and innovation. The experiences of AT, Grameen America and Street UK show that developed-world microfinance has a challenging path ahead.