by Monica Brand, MBA ’97
A new investment model seeds very small businesses at the expense of loan sharks.
In 1997, on the cusp of the dot-com mania and a lesser known revolution called social enterprise, I came across the story of Sara Hernandez on a website of a nonprofit institution called ACCION International (www.accion.org). Hernandez had married at 16. She learned to bake bread from her husband’s mother and grandmother and began selling it to help feed her family in Oaxaca, Mexico. After 30 years of daily going to work at 5 a.m., you might think she was making a good profit. But with rental fees for her wood-burning oven and the high cost of purchasing small quantities of ingredients, she saw little, if any.
As my Business School classmates would recognize readily, Hernandez needed working capital, but she said, “There was no opportunity that made sense. The prestamistas [moneylenders] wanted 20 percent each month! I was barely making ends meet as it was.”
Then in 1995 she heard about Compartamos, a Mexico City-based bank that had begun providing financial services to small entrepreneurs. One of the microfinance institutions in which ACCION has invested, Compartamos, has demonstrated that lending to the poor makes good economic—as well as social—sense. Within days of Hernandez’s first loan application, Compartamos lent her $50, which she used to lower her costs by purchasing eggs and flour in bulk. Punctually making her weekly payments over four months, she was then eligible for a larger loan.
Since then, she has borrowed as much as $500 at a time, Compartamos is reaching over 200,000 clients, and I have graduated from the Business School and gone to work for ACCION. The organization’s mission is to provide the poor with financial service tools to work their way out of poverty. Enticed not just by ACCION’s mission but also by its goal of achieving massive scale and sustainable client-friendly financial services, I launched and now manage its marketing and product development unit. We are a social enterprise using market mechanisms to advance social goals.
The Magic of Microfinance
Microfinance involves providing financial services—primarily credit and savings—to millions of self-employed poor. Many of these microentrepreneurs are involved in commercial activities that generate high returns on scarce capital. Despite good cash flows and business success, they cannot get conventional bank loans because they lack formal credit histories and credit-worthy cosigners. Moneylenders, more disparagingly known as loan sharks, have for centuries capitalized on these conditions. Present in developing economies globally, they charge in the range of 10 percent per day to 50 percent per month for credit.
Microfinance institutions, pioneered in the mid-1970s by ACCION in Brazil and by Grameen Bank in Bangladesh, provide alternatives by using an innovative business model based on sociology and financial acumen. MFIs, as we call them for short, mitigate risk and control costs like all financial service providers, but the challenges are greater in the informal economy. Their customers are geographically dispersed, often illiterate, and lacking records such as sales receipts, accounting ledgers, and inventory, which are critical in determining repayment capacity. MFIs have learned to use streamlined documentation, standardized product terms, simplified procedures, and even technological innovations like personal digital assistants to maximize efficiency. (ACCION introduced PDAs for loan officers in the field to reduce the cost of credit analysis.) They also use community-bank lending, which means that loan decisions are delegated to a group of borrowers who agree to take collective responsibility for loan repayments. In the case of Compartamos, the community bank is a group of 20 to 30 women who can vote out members who have recurring repayment problems.
Microfinance has been a revolution in economic development because it is one of few strategies that can demonstrate tangible, consistent impact at the client level while paying for itself. MFIs charge much less than informal lenders but more than conventional banks in order to become financially self-sufficient and expand their reach. Since it costs a financial institution roughly the same to make a $300 loan as it does a $3,000 one, MFIs typically charge their borrowers 3 to 6 percent a month. Since 1985, ACCION’s network of affiliates has loaned over $5 billion to nearly 4 million microentrepreneurs in Latin America, the Caribbean, Africa, and the United States, with an average repayment rate of 97 percent.
Compartamos, the largest Latin American MFI in client volume, had as of last October over 200,000 clients and an active portfolio of $63 million. More astonishingly, based on June 2003 financial statements, it had a return on assets of 18.5 percent and a return on equity of 56.5 percent. To put this performance in perspective, Citibank and Bank of America each had an ROA of 1.4 percent and an ROE of 18 percent in 2003, according to published reports. Standard & Poor’s gave Compartamos an MXA+ rating on a Mexican bond issue of $10 million in 2002 that was backed solely by the institution’s financial strength, not its loan portfolio. This vote of confidence from one of the most rigorous corporate rating agencies is astonishing when you consider that the majority of Compartamos’ assets are unsecured loans averaging $315 per borrower.
Since her first loan for her bakery, Hernandez has borrowed to purchase large mixers so that she and her two grown children can produce more with the same labor. She also has made improvements to her house with the money she has saved. “We started with the concrete floor, then walls and a ceiling, and now we have the two rooms,” she said recently. There is still no bathroom or running water, but her pride in the improvements is clear from her smile and continued aspirations. She would like to borrow enough money next for an electrical industrial oven. “There is criticism of the pollution and firewood is expensive—nearly $3,000 each year,” she said, adding, “We are thinking about opening a little store. With our experience with the bakery and a little more help from Compartamos, I know we can do it.”
Hernandez’s story illustrates the spillover effects to families and communities. Microentrepreneurs invest their growing profits in a better family diet, home improvements, and education for their children. Others in the community can see the possibility of raising their own standard of living.
Compartamos has invested its profits in expanding to reach more poor—an additional 60,000 new customers in one year alone! Although impressive, the company’s board of directors is aware that the interest rates charged invite competition and that lowering them also would benefit clients. ACCION has a seat on the board through its equity investment, and as a social enterprise it is the most vocal proponent of lowering interest rates over time. Its long-term goal is harnessing the power of capital markets to stimulate informal economies and integrate them into the formal financial system.
Applying Business Skills
I spent the second quarter of last year in Mexico City working to strengthen Compartamos as it gears up for new competition. In 2002, Citibank acquired a consumer lender in Mexico to move down market, and Elektra, the largest retailer in Latin America, purchased a banking license to leverage its database of credit histories of the low-mid-income market of Mexicans. Though both target a market niche slightly above that of Compartamos, they are a potential competitive threat. We designed a national study to evaluate customer satisfaction and determine what kinds of products and services clients prioritize. We also mined the company’s management information system, which contains client profiles and borrowing patterns that helped us target new products, including a customer loyalty (fidelización) program. Second-year student Rachel Payne, an intern from the Business School’s Stanford Management Internship Fund (SMIF), helped create our new customer service strategy, which involves streamlining credit delivery and setting up a call center for promotion and complaint management.
I am a rarity among my ’97 classmates: Commanding salaries more attractive than nonprofits can offer, most of them have rotated in and out of both startups and Fortune 500 companies. In spite of attractive opportunities, I remain at ACCION because its mission still compels me. ACCION is in the business of fighting poverty. Its commercial approach to institution building takes advantage of best corporate practice and the fact that the world’s poor are vibrant, resilient people who require quality service products. Whether re-engineering a bank to reach down market or designing new financial products, I get a thrill from figuring out how to reach still more of the millions of microentrepreneurs yet to be served.
Monica Brand is vice president of marketing and product development for ACCION International.
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