The microfinance revolution has only just begun

Microcredits have proven to be powerful instruments in the fight against poverty. However, they will reach their full impact only if they manage to limit their reliance on the charitable sector.

“The genocide brought the destruction of my parents’ retail shop“, Nsengiyma Gilbert from Rwanda explains. “It ended in ruins and in the brutal killing of my father. After the war, I dropped out of school, crisscrossed Kigali in search for a job to no avail. Then the idea of selling milk to a nearby kindergarten school near my home came to me. However, the earnings from this business were not enough to buy me a refrigerator and enable me rent a bigger place to start a restaurant,” Gilbert says. “I tried to get a loan from other banking institutions, but the conditions were a little too harsh and couldn’t provide an immediate solution to my desperate situation. That’s when a friend of mine told me about RML quick loans,” he explains.

RML is the abbreviation of Rwanda Microfinance Limited, a company founded in 2004 in order to provide loans to low-income salary earners and micro-entrepreneurs. RML provided Gilbert with a business loan of about $500, and things improved. He bought a refrigerator for his dairy products and moved to a bigger place that he turned into a restaurant. The income generated from his restaurant business helped him build a decent home for his mother. “This business has served as a lifeline for me and my family‘s financial and social livelihood. Now my aged mother will no more spend sleepless nights when it rains,” he affirms. With additional support from RML, Gilbert plans to expand his business.

RML is part of Micro Africa, an East African microfinance group based in Nairobi, Kenya. In mid-2006, RML had not yet reached operational self-sufficiency and had a total loan portfolio of half a million dollars. But then the Deutsche Bank Start-up Fund provided a letter of credit in the amount of $100,000, which secured a Rwandan franc loan from a local lender. Since receiving the loan, RML has become profitable and now serves over 1,400 clients with a portfolio of over $1.4 million.

The Deutsche Bank Start-up Fund, which is supported by the Deutsche Bank Americas Foundation and CORDAID, a Dutch NGO, seeks to identify start-up microfinance institutions (MFI) in underserved markets with strong management. Capitalized through grants and soft funding, it provides flexible financing to support portfolio growth and works to build governance and financing capacity. Like all the other microfinance instruments developed and used by Deutsche Bank, the Start-up Fund does not lend to the final borrowers, but gives financial and logistics support to microfinancing institutions. By transferring capital and know-how, it strengthens regional economic structures and networks in order to stabilise developing countries.

Microfinance, the extension of very small loans to those who lack collateral or a credit history, is proving to be a revolutionary model in enabling people to rise from poverty. It is based on the recognition that the working poor can act in an entrepreneurial manner and are, in principle, creditworthy. As a study by Deutsche Bank think tank db research illustrates, for these micro-borrowers, microcredit is often the only alternative to paying excessive interest rates charged by unofficial moneylenders or pawnshops in developing countries. For instance, in the Philippines loan sharks often charge an annualised interest rate of up to 1000% for a monthly loan. In contrast, interest rates charged by MFIs are in the range of 15% to 70% p.a. Seen from the perspective of a developed country, this may still seem high, but these rates result from the small size of loans and the high administrative costs as loan officers need to travel to remote places and intensively advise clients. It is estimated that administrative costs amount to up to two thirds of the interest paid by clients. In addition, there is a need for risk provisioning.

According to db research, women make up the vast majority of borrowers, especially in Asia. This reflects the fact that women are more reliable debtors because, due to stronger social and family ties, they often follow a more conservative investment strategy, which in turn results in lower default rates for MFIs. This lower credit risk is further supported by a relatively low degree of labour mobility of female clients (due to strong family ties, women tend to work from home), which decreases the cost of monitoring debtors for an MFI.

In order to influence borrower behaviour, many MFIs apply the principle of group lending. This entails an MFI making a small loan to an individual who belongs to a group of 5 to 20 people. As soon as the individual borrower proves reliable, credit is extended to additional people within the group. This procedure creates an incentive for the group to monitor each other’s behaviour and ensure borrower discipline, as the group is jointly liable for the failure of any single member to repay her microloan. The average loan size starts from USD 100 and can reach several hundred dollars, depending on the debtor’s repayment history. Interest rates vary significantly according to the geographic regions, e.g. in India microloans are usually granted at 15% to 30%.

However, not all MFIs apply the group lending principle; instead, some MFIs prefer to lend to individuals without any shared liability aspect. This reflects, inter alia, the argument that group lending has some shortcomings, e.g. that it only fully works in rural settings where social control is higher. In addition, opponents of group lending argue individual lending is superior, as it judges people on their own merits rather than on the group’s. In some countries, individual lending exhibits higher average loan amounts and often primarily serves the self-employed rather than the very poor seeking to start a business. As db research sums up, both approaches have their advantages and respond to different circumstances; hence, it can be expected that individual and group lending techniques will continue to coexist over the long term.

Among commercial banks, Deutsche Bank is a pioneer in the field of microfinance. As early as 1997, the company established the Deutsche Bank Microcredit Development Fund (DBMDF) in order to help established microfinance institutions reach scale and long-term sustainability by encouraging relationships with local financial institutions. The DBMDF is a registered 501 (c) 3 non-profit. It provides catalytic funds as collateral for leverage loans, typically 2:1, and is supported by social investors, private clients of Deutsche Bank, and the Deutsche Bank Americas Foundation.

The Global Commercial Microfinance Consortium, established at the end of 2005, is an $80.6 million fund that serves as a platform to combine high risk catalytic development agency resources with the scale and execution efficiency of the private sector. Deutsche Bank created the Consortium in recognition of the pivotal roles that the private sector can play in the development arena in partnership with development agencies. In so doing, the Consortium harnesses resources available through the growing corporate social responsibility sector as an investment rather than as an expense.

db Microfinance-Invest No. 1 – the next step in microfinancing: However, the microfinancing instrument will reach its full impact only if it manages to limit its reliance on the charitable sector and turn into a regular business highly attractive to the private sector. Against this backdrop, three branches of Deutsche Bank – Private Wealth Management (PWM), Corporate Social Responsibility (CSR) und Asset Finance & Leasing (AFL) – have developed a product which addresses economic and philanthropic customer interest at the same time: db Microfinance-Invest No.1, the first securitization of subordinated microcredits with an external rating worldwide. The securitization transaction, which has a total volume of EUR 60 million, was completed in 2007 and is the first German investment product which gives retail and institutional investors access to the ever-growing asset class ”microfinance“. The securities were purchased not only by Deutsche Bank but also by KfW-Entwicklungsbank (the largest institutional investors) as well as retail clients, foundations and church institutions. Deutsche Bank and its partners agreed upon a fee structure that is attractive for investors; for example, 99.6% of the total investment volume is used to support microcredits.

Senior notes in db Microfinance-Invest No.1 were assigned a BBB rating by Fitch Ratings. The portfolio comprises 21 microfinance institutions and banks in 15 countries in Africa, Latin America, the Caucuses, Central Asia and Southeast Asia. The diversification of the MFI-Portfolio was compiled by Deutsche Bank’s New York Center of Competence and the Community Development Finance Group in Africa, Asia, Latin America, eastern Europe and central Asia. The fund’s goals include the provision of reasonably priced debt that garners full or partial equity credit without increasing clients’ weighted average cost of capital. This enables MFI clients to present a fairer picture of their financial strength to investors. The subordination layer should also enable clients to attract senior debt through strengthened equity ratios. Many microfinance institutions are also in the process of transforming themselves from unregulated into regulated financial entities, and db Microfinance-Invest’s subordinated debt provides quasi-equity that helps MFIs to meet their regulatory requirements in the transformation process.

Throughout the world, Deutsche Bank seeks opportunities to play a positive role in addressing local needs by making available financial resources, the talents of its personnel and the leadership of its management. All of these efforts are geared toward forming lasting partnerships with community-based organizations to achieve durable and lasting benefits for local citizens. A combined Deutsche Bank Americas Foundation and Community Development Group carry out the firm's corporate citizenship commitments in the Americas. The microcredit initiatives are an integral part of Deutsche Bank’s CSR activities and a recognized best-practice project in the framework of the Global Compact.