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Strategies and Structures for Commercial Banks in Microfinance

This paper begins by pointing to the rapid rate at which banks have been entering microfinance. It notes that this has been due to the increasing competition many find in their traditional markets as well as the lure of reported high profit margins at the “bottom of the pyramid”. One of the key decisions facing any bank that wishes to downscale (i.e. to offer financial services to microenterprises) is whether to provide these services through an internal unit or through a subsidiary or other kind of external organisation. This paper argues that the degree of success of the microlending program often depends crucially on this choice.

The paper considers two questions a commercial bank may face as part of its business development strategy:

whether the bank should get into microlending? And
whether to do microlending in house or through an external organisation that the bank would own either partially or in full?

It is suggested that in order to answer the first question, the bank must begin by looking at the second question as there are many important advantages and disadvantages of doing microlending in house versus through an external organisation. The paper then analyses the different options.

The opening chapter also covers five additional topics:

It briefly examines the performance of downscaling banks, noting in particular their rapid penetration of the microlending sector and the increasing quality of their microloan portfolios.
It presents the major reasons banks have given for their rapid entry into microfinance.
It discusses the four different organizational structures that banks can use to downscale: the internal unit, service company, lightly regulated subsidiary, and heavily regulated subsidiary.
It presents a number of best practices that banks serving the microfinance market should observe.
It extends the discussion of one of these best practices by describing in greater detail how the bank’s microlender (that is, the internal unit or external organization doing the microlending) can and should utilize the bank’s infrastructure and services, and do so to best advantage.

The rest of the paper then build on the last three of these topics.