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Financing African SMEs: can more of the same help bridge the gap?

24.10.2017Rodrigo Deiana, Junior Policy Analyst & Arthur Minsat, Head of Unit, OCDE

This post was originally published on the OECD Development Matters website.

African firms don’t have it easy. Among the many constraints faced by formal companies, access to finance consistently ranks as a top issue. Almost 20% of formal African companies cite access to finance as a constraint to their business.[i] Overall, African micro, small and medium enterprises (SMEs) face a financing shortfall of about USD 190 billion from the traditional banking sector.[ii] African firms are 19% less likely to have a bank loan, compared to other regions of the world. Within Africa, small enterprises are 30% less likely to obtain bank loans than large ones and medium-sized enterprises are 13% less likely.[iii]

To bridge this gap, governments and market players need to strengthen existing credit channels as well as expand new financing mechanisms.

Various innovative financing instruments are currently expanding or present strong growth potential across Africa. Private equity funds invested a total of USD 22.7 billion in Africa across 919 deals between 2011 and 2016, although less transactions took place in the last months. Most took place in capital-intensive sectors such as telecommunications and energy.[iv] Asset-based lending can ease some stringent conditions associated with traditional credit. Experiences in Burkina Faso (with Burkina Bail) and South Africa suggest that commercial banks and other financial operators can engage in factoring and leasing services, without the need for additional legislation.[v]

At the same time, many entrepreneurs can directly harness new financing mechanisms such as crowd-funding or venture capital within and outside Africa. Togolese entrepreneur Afate Gnikou successfully used crowdfunding to raise the capital for a prototype 3D printer from recycled electronic waste selling at an affordable price of less than USD 100. Nigeria’s online movie entrepreneur Jason Njoku, for one, raised USD 8 million in venture capital from African and global investors. Andela, a pan-African start-up launched in 2014 that pairs coders with global companies, recently obtained USD 40 million in funding from an African venture capital fund.[vi] This opens the door for African entrepreneurs to look for funding within the continent rather than in Europe or North America. Return migrants are using remittances, expatriate savings or loans to fund their businesses. More international equity funds are providing seed or venture capital to African SMEs, often by specialising in African markets with a mix of private and public funds.[vii]

Many other instruments can help fill SMEs’ financing gap: microfinance for SMEs, direct support from development partners (e.g. the African Development Bank’s Souk At-Tanmia initiative, providing financing and mentoring services to entrepreneurs), and philanthropic finance (the Tony Elumelu Foundation’s support to start-ups in Africa regularly makes the headlines; other initiatives are also growing such as the think tank Land of African Business).

However, these innovative financing solutions are out of reach for the majority of small businesses operating in the informal economy. To bridge the financing gap, we must also improve traditional credit channels by expanding best practices in the financial sector.

Some emphasise the role of traditional instruments, such as credit guarantee schemes (CGSs). CGSs are guarantees by third parties -- governments or development partners -- that can cover a portion of the lenders’ losses from loans to SMEs, significantly reducing default risk for banks. CGSs can benefit small businesses that have little collateral, no credit history or are perceived as too risky. Policy experiences outside Africa (from Turkey and Malaysia) have shown that CGSs can avoid creating market distortions.[viii] A set of key principles can guide the design of effective guarantee schemes without incentivising lending to high-risk borrowers. They can also contribute to reducing poverty. In Tanzania, for instance, several of these guarantees effectively channelled funds to the more vulnerable groups otherwise unable to access credit, such as smallholder farmers as well as micro and small entrepreneurs.[ix] CGSs can also work on a larger scale, as shown by the African Guarantee Fund’s experience. Commercial banks leveraged the Fund’s USD 230 million in guarantees to lend out double that amount to 1 300 SMEs, generating 11 000 jobs. The Fund reached break-even point and started turning profits in just three years, quadrupling its revenue.[x] 

Many solutions exist to bridge the financing gap faced by Africa’s SMEs. Finding a balance between traditional and innovative financing depends on each country’s context. While the 54 African countries are very diverse, three main issues stand out. First: developing regulations and policies (e.g. on tax compliance, contract enforcement) that are flexible enough for innovation by African entrepreneurs. Second, broadening and widening financial solutions that are accessible to the most vulnerable groups. For example, Rwanda’s financial sector has been able to diversify despite its small size, with banks, savings cooperatives, microfinance institutions all tailoring their products to different target social groups. Finally, governments must aim to ensure macro-economic stability by avoiding market distortions and excessive risk taking. In this sense, the establishment of SME Authorities may help reduce information asymmetries and reduce lending risks. To achieve these objectives and increase the financial sources available to small African businesses expanded co-operation between governments, development partners and the private sector will remain vital.


[i] AfDB/OECD/UNDP (2017) African Economic Outlook 2017: Entrepreneurship and Industrialisation: 210, calculations based on The World Bank Enterprise Surveys. World Bank Enterprise Surveys cover firms in the formal sector with at least 5 employees.

[ii] Based on data from IFC’s Enterprise Finance Gap Database

[iii] AfDB/OECD/UNDP (2017): 225, based on Beck and Cull (2014), “SME finance in Africa”, Journal of African Economies, Vol. 23 (5), pp. 583-613

[iv] AVCA (2017), 2016 Annual African Private Equity Data Tracker

[v] Based on evidence from factoring and leasing services in Burkina Faso (through the financial company Burkina Bail) and South Africa (through the commercial banking sector), the Bank of Namibia argued for the possibility of successfully replicating such services in Namibia. See AfDB/OECD/UNDP (2017): 226 for further information.

[vii] Severino, J.-M. and J. Hajdenberg (2016), Entreprenante Afrique, Odile Jacob, Paris.

[viii] IFC (2010), Scaling-Up SME Access to Financial Services in the Developing World

[x] AfDB/OECD/UNDP (2017): 226, based on African Guarantee Fund, 2015 Annual Report

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About the Authors

Rodrigo Deiana is a Junior Policy Analyst in the OECD Development Centre's Africa Unit as part of the UN's JPO Programme financed by Italy. He contributed to the 2017 edition of the African Economic Outlook (AEO), and among other topics works on policy aspects of international trade and financial sector development in Africa. Before joining the OECD, Rodrigo was an economist in the Government of Rwanda as part of the ODI Fellowship, advising on regional integration, trade policy, and private sector development. He also worked as consultant to the World Bank Group in Kigali on matters of agricultural policy. Prior to that, he worked at the European Central bank in Frankfurt and at the World Trade Organization in Geneva. Rodrigo holds a Master's degree from the Barcelona Graduate School of Economics and a BA in International Economics from the University of Nottingham.

Arthur Minsat leads the OECD Development Centre's Africa Unit. He is responsible for the African Economic Outlook (AEO), a partnership with the African Development Bank and UNDP, and the Revenue Statistics in Africa, a joint publication by OECD, the African Union Commission and the African Tax Administration Forum. As lead economist, Arthur drafted the thematic chapters of the AEO 2017 on Entrepreneurship and Industrialisation, AEO 2016 on Sustainable Cities, AEO 2015 on Regional Development. Before joining the OECD, Arthur contributed to the UNDP's flagship Human Development Reports. He worked in Abidjan during the electoral crisis in 2010 and 2011, monitoring West Africa's economic outlook for the United Nations Operations in Côte d'Ivoire (ONUCI). Prior to that, he taught economics and international relations in several British universities and gained private sector experience with Wolters Kluwer Transport Services. Arthur holds a PhD from the London School of Economics (LSE) and a Franco-German double diploma from Sciences-Po Lille and the University of Münster.

Capital requirement, bank competition and stability in Africa- Q&A Session

05.09.2017Jacob Oduor, Principal Research Economist, African Development Bank

This Q&A session highlights key insights of a study co-authored by Dr. Jacob Oduor, economist with African Development Bank. The research shows that increased capital beef-up significantly increases financial instability in Africa (except in big banks) implying that higher capital requirements did not make African banks safer.

1. Why did you choose a topic on the banking sector, precisely on regulation? Is there any subdued risk with African banking system that justifies your research?

The banking sector is important in driving economic growth through intermediation of investment resources. Its effectiveness in achieving this role can however be undermined by one-size-fit-all regulations. In Africa, where financial inclusion is still low, any regulation that increases the cost of financial services may be counterproductive in achieving the broader economic growth objectives. If increased capital requirements can achieve its core objective of financial stability without adversely affecting the cost of financial services, then it is welcome. That tradeoff is important but sometimes difficult to strike.

2. Basel I, Basel II and now Basel III have called for capital build-up over time. In your view, how will the latest reform affect African banks?

Capital build up has the consequence of creating bigger banks. There are two main problems with this. First, emerging evidence show that bigger banks are not necessarily safe. They perceive themselves to be "too big to fail" and therefore engage in more risky investments and are more vulnerable to shocks that smaller banks (Berger and Mester, 1997[1]) and such regulation may just as well increase banking sector instability in Africa. The second and more important consequence for Africa is that capital build-up concentrates the banking industry, reduces competition, has the potential to drive up costs of financial services and stifle financial inclusion. The high initial capital stringency requirements can impose entry barriers for new entrants and this would restrict competition and allow existing banks to accumulate market power (Berger et al; 1993[2]). In a continent where financial inclusion is pathetically low, such regulation may have more negative consequences than benefits.

3. Your research was centered on the impact of regulatory build-up on first financial sector stability and second competition. What did your research reveal?

The results show that increased capital beef-up significantly increases financial instability in Africa (except in big banks) implying that higher capital requirements did not make African banks safer. We also find that increased regulatory capital improves competitive pricing for foreign banks while it makes domestic banks less competitive. This is mainly attributed to the high cost of sourcing and holding extra capital for domestic banks compared to foreign banks who can source cheaper capital from parent companies. The results put to question the effectiveness of higher regulatory capital on stability and competitiveness of the African financial system.

4. Did you find in your literature review similar conclusions?

While other studies including Furlong and Keeley (1989)[3] and Keeley (1990)[4] found stabilizing effects of increased capital requirements, other studies have come to similar conclusions as our study. Boot and Greenbaum (1993)[5] for instance find that capital requirements reduce monitoring incentives, which reduces the quality of banks' portfolios increasing the risk of instability. Hakenes and Schnabel (2010)[6] on the other hand show that tighter capital requirements increases the risk of individual loans and may also increase a bank's probability of default because they relax the competition for loans and thus destabilizing the banking sector.

On increased capital requirements and competition, similar findings as ours were obtained by Bikker & Groeneveld (1998)[7] who assessed competitive structure in the banking industry in the EU and finds that concentration impairs competitiveness. Similar findings were also obtained by and Claessens and Laeven, 2004[8] among others.

5. In your research, you also test your model for reserve causality. What was the idea behind the test and what did the test show?

The potential for reverse causality emanates from the fact that banks that are viewed by the regulators to be less stable are likely to be asked to keep higher capital ratios compared to more stable banks. Instability may therefore be a cause of higher capital requirements for banks as much as higher capital requirements may be a source of instability. The results using instrumental variables approach, confirm the findings that increased capital ratio increases instability in the banking sector.

6. You mentioned that some critics argue that Basel III is too complex and allows banks to use in-house creative models to hold less capital than they should. Can you talk more about some of these techniques and how can regulators address the shortcoming? How will/should this be addressed in the context of the African continent?

Amendments to the Basel Accord in 1996 permitted regulators to accept assessments from banks' internal risk-management models in setting capital requirements for the market risk in banks' trading portfolios. Consequently, trading-book models have become increasingly common in banks. These models generally estimate value at risk (VaR). Because of the large number of traded securities, trading-book VaR models inevitably use a large number of simplifying assumptions resulting in different estimates of value at risk. It is therefore not inconceivable that some banks use these internal models to understate their risks in order to maintain less regulatory capital which exposes the whole sector to risks. To remedy such situation, regulators must ensure banks calculate their risk weightings and capital requirements on the basis of a common standardized approach. In-house models could be used to supplement but not substitute standard models. To reduce the ability of banks to hide risky assets there is need for reduced discretion of banks in calculating their risk weightings by narrowing the range of modeling choices for banks and improving public disclosure by banks. There is also need to explore regulation with varying standards based on complexity and risk.

7. In the US, the concept of "too big to fail" has emerged as a hot contentious topic between regulators, policy makers and banks. A debate between breaking up large banks or at the very least the reinstatement of some Glass-Steagall-like legislation and the status quo. You cite the example of Nigeria as evidence that consolidation is not the answer to the banking system stability. Do you see any systemic risk associated with the size of the banks operating in our continent? Have some of them reached that critical level?

While this study did not go into establishing the specific threshold beyond which inefficiency sets in, experience has shown that big banks can fail and there is a threshold size beyond which decreasing marginal returns sets in. Attempting to build resilience through indefinite increase in capital requirements may be counterproductive. In addition, capital buffers on their own without accompanying regulations are at best, inadequate. Regulation must therefore look beyond the size of the banks. Market concentration in the banking industry in Africa is high compared to the developed world and therefore the potential for systemic risk exists, but whether some African banks have reached that threshold is an area for further research. What is clear from our results is that prescriptive blanket regulations on capital buffers has not helped reduce that risk. Dealing with systemic risk should not therefore overemphasize on size, but accompanying regulations to ensure good governance and prudent risk taking irrespective of the size.

8. If capital build-up is not the answer to increase financial sector stability, what types of policy should regulators and policy makers pursue/explore in their quest for a strong, deep and liquid financial sector?

Capital build up is still important in building resilience, but it is not the only way to build resilience, not in all contexts and on its own it is inadequate. Regulators must be able to identify the sources of systemic risks and develop regulatory instruments that are able to deal with different kinds of risks. Internal governance weaknesses is turning out to be a major source of instability in the banking sector in many countries both in Africa and in more developed markets. This kind of risk cannot be cured by increasing capital buffers. Improvements in monitoring and supervision of banks may as well give the same financial stability outcome without jeopardizing financing inclusion objectives.

9. What is your opinion on the emerging rivalry between fintechs and banks and do you see this as an inevitable event to improve efficiency and increase inclusion? From the regulatory stand-point, what if need be, can be improved?

Without a doubt, fintechs have disrupted the business-as-usual way of traditional banks and helped improve financial access and efficiency beyond the boundaries that traditional banks were willing to go. From mobile money payment and transfer services, to savings and credit services through the mobile phone platforms, fintechs have proved to the banks that your can reach the low-income unbanked and still make profits. Banks are increasingly adopting the same approaches to delivery financial services in order to stay in business. However, in some instances, the pace of adoption of new technologies in the financial sector is faster than regulations. A number of regulators have not developed tools and infrastructure including state of the art reporting and analytics infrastructure to support and sufficiently regulate the fintech innovations. In most cases, fintech companies are discouraged by the time and cost of registering and complying with regulations. This is a particular problematic in the financial services sector in Africa where political interests are still intense and where intruders coming to share the profits are not welcome. In addition, regulations should be flexible and fintech companies should not be forced into the same costly regulatory mold as traditional banks, which may stifle innovative capacity of start-ups.

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[1] Berger, A. N. & L. J. Mester. 1997. Inside the black box: What Explains Differences in The Efficiencies of Financial Institutions? Journal of Banking & Finance, Vol. 21, pp. 895-947

[2] Berger A. N., W. Hunter, and S. Timme. 1993. The Efficiency of Financial Institutions: A Review and Preview of Research Past, Present, and Future, Journal of Banking and Finance, Vol.17 pp. 221-249

[3] Furlong, F. T. and M. C. Keeley. 1989. Capital Regulation and Bank Risk-Taking: A Note, Journal of Banking and Finance 13, 883-891.

[4] Keeley, M. C. 1990. Deposit Insurance, Risk and Market Power in Banking, American Economic Review, Vol. 80(5), pp. 1183-1200

[5] Boot, A.W., and S. Greenbaum. 1993. Bank Regulation, Reputation, and Rents: Theory and Policy Implications. In: Mayer, C., and Vives, X. (eds), Capital Markets andFinancial Intermediation. Cambridge, UK: Cambridge University Press, 292-318.

[6] Hakenes, H. and I. Schnabel. 2010. Capital Regulation, Bank Competition, and Financial Stability, Leibniz University of Hannover, MPI Bonn, and CEPR

[7] Bikker J.A. and J.M. Groeneveld. 1998. Competition and Concentration in the EU Banking Industry Research Series Supervision 8, Netherlands Central Bank, Directorate Supervision

[8] Claessens, Stijn, and Luc Laeven. 2004. What Drives Bank Competition? Some International Evidence. Journal of Money, Credit, and BankingVol. 36, pp. 563-583

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About the Author

Dr. Jacob Oduor is Principal Research Economist at African Development Bank (AfDB). He is a holder of Ph.D in Economics from Bielefeld University, Germany. He is also a holder of MA (Economics) and BA (Economics)- First Class Honours from Kenyatta University, Nairobi, Kenya. Prior to joining AfDB, Dr. Oduor lectured in the School of Economics at Kenyatta University and he worked with the Cooperative Bank of Kenya and the Kenya Institute for Public Policy Research and Analysis (KIPPRA). Dr. Oduor is an accomplished time series econometrician specialized in: time series, cointegration, general macroeconomic theory and policy, monetary policy and growth theory.

Message from the MFW4A Partnership Coordinator

30.01.2017David Ashiagbor

Dear Readers,

Let me begin by wishing you all a very happy and prosperous 2017, on behalf of all of us at the MFW4A Secretariat.

2016 was a rewarding year for MFW4A. We were proud to host the first Regional Conference on Financial Sector Development in African States Facing Fragile Situations (FCAS) in Abidjan, Cote d'Ivoire, jointly with the African Development Bank, FSD Africa, and FIRST Initiative. The conference attracted some 140 policy makers, business leaders, academics and development partners from over 30 countries, to discuss the role of the financial sector in addressing fragility. The conference has already led to several initiatives by MFW4A and our partners in the Democratic Republic of Congo, Liberia, Sierra Leone and Somalia. We expect to build on this work in 2017.

Our support to the Conférence Interafricaine des Marchés d'Assurances (CIMA), the insurance regulator for francophone Africa, helped them to secure financing of EUR 2.5 million from the Agence Française de Développement. The funding will help to expand access to insurance in a region where penetration rates are less than 2% - well below the average for the continent. We worked closely with a number of our funding partners to help define their strategies in Digital Finance and Long Term Finance. These results are a clear demonstration of how the Partnership can directly support the operations of its membership.

With the support of our Supervisory Committee, we took steps to ensure the long term sustainability of the Partnership. The approval of a revised governance structure which fully integrates African financial sector stakeholders, public and private, was a first critical step. The ultimate objective is to expand membership and build a true partnership of all stakeholders in Africa's financial sector.

2017 will be a year of transition for the Partnership. It marks the end of MFW4A's third phase, and the beginning of its transformation into a new, more inclusive partnership, with an expanded membership. We will focus on revamping our value proposition to provide more focused, needs based services with the potential to directly impact our current and potential membership. In so doing, we hope to consolidate MFW4A's position as the leading platform for knowledge, advocacy and networking on financial sector development in Africa.

In closing, I must, on behalf of all of us at the MFW4A Secretariat, thank all our funding partners, stakeholders and supporters, for your constant support and encouragement over the years. We look forward to working together to strengthen our Partnership.

With our best wishes for a happy and prosperous 2017,

David Ashiagbor
MFW4A Partnership Coordinator

What we learned from the Regional Conference on Financial Sector Development in African States Facing Fragile Situations? - Part 6

08.11.2016Amadou Sy, Director of Africa Growth Initiative, Brookings Institution

In June 2016, leaders from the public and private sectors and development partners gathered in Abidjan to discuss the links between fragility, resilience and financial sector development in Africa. This event, a joint initiative created by the Making Finance Work for Africa Secretariat (MFW4A), the African Development Bank (through its Transition Support Department, Financial Sector Department and the Initiative for Risk Mitigation), FSD Africa and FIRST Initiative also provided an opportunity to explore prospects for partnerships, innovative policies and private sector-led solutions to accelerate financial sector development in fragile situations in Africa.

In this last instalment of a six-part series, Amadou Sy, Senior Fellow and Director of the African Growth Initiative, Brookings Institution, looks at the different innovative solutions, instruments and other opportunities to strengthen the capacity of financial institutions operating in fragile contexts in Africa.

In case you missed it, you can read parts One, Two, Three, Four, and Five.

Strengthening Capacity

Mr. Cedric Mousset of the World Bank stressed that capacity is a big constraint in fragile countries and there are no easy solutions. Capacity building should be done when there are incentives for financial institutions to reform such as incentives to leverage market opportunities and improve markets. The supervisory and regulatory framework is key as it allows for adequate competition, restructuring, and the adoption of international standards such as the Basel standards.

Mr. Paul Musoke of FSD Africa stressed the importance of developing scale and sustainability in the financial system in Africa. To do so, his institution favours a catalytic strategy. In particular, FSD's Market Building Approach assesses the environment, looks at the core where demand is meeting supply, assesses the market failures in the supply side and builds capacity within the supply side. Such an approach requires stakeholders to look at support functions such as information, infrastructure, and skills development. It also requires a good grasp of rules such as informal norms, standards, laws, and regulations. Its goal is to build a sustainable market that continues to operate once FSD exits and that crowds-in other players.

Instruments available from development partners

Ms. Kilonzo of the African Development Bank (AfDB) noted that the landscape of African finance is dominated by small and fragmented financial systems with limited access to basic financial services. The AfDB's priorities include not only broadening access to finance but also supporting "green" growth, infrastructure development, regional financial integration, governance, entrepreneurship and innovation, and financial skills development. These priorities can be articulated in the Bank's new "High Fives" areas-Light up and power Africa, Feed Africa, Integrate Africa, Industrialize Africa, and Improve quality of life for the people of Africa.

Finance is an integral part of the Bank's strategy and is based on two pillars: access to the underserved, youth and women (Pillar I) and broadening and deepening Africa's financial systems (Pillar II). The Bank's operations and products cater to a diverse set of financing priorities, including financial institutions, trade finance, and financial markets.

Mr. Nikolaos Milianitis of the European Investment Bank (EIB) shared that the EIB has EUR1 billion per year in new activity in Africa, covering both the public and private sectors through a range of instruments such as loans, equity, guarantees, and technical assistance. The EIB brings best practices from its worldwide operations and a particularity of its operations is that they all include a sectoral expert and a banking expert.

Mr. Musoke discussed FSD's Market Systems Approach which focuses on building services that are critically missing: (i) executive coaching so as to assess environment and respond to environment; (ii) e-learning as a cost effective education tool and as a way to tap experts, working with content providers and platform deliverers, and learning for financial institutions; (iii) data analytics so as to use information that is available e.g. financial diaries in Kenya. FSD tries to develop local supply so banks can tap into these services and hopefully think differently about their markets.

Change management is critical for financial sector development and FSD Africa identifies banks that are ambitious about serving the under-banked and helps them assess existing constraints and solve them. To make the change, it offers funding, research, and technical assistance over a 4-5 years period. For instance, FSD is working on establishing a Financial Frontiers Challenge Funds to identify 23 financial institutions, including in fragile states, so as to support an analysis of the environment, help them develop proposals that can be funded for GBP 500,000.

Finally, Mr. Mousset flagged the Conflicted Affected States in Africa (CASA) initiative through which the IFC provides assistance to fragile African states to rebuild their financial sector and improve the business environment.

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You can download all presentations on the conference website.

You can view a selection of photos here.

You can watch the conference in our YouTube channel here.

The story of inclusive banking

25.10.2016Prof. Hans Dieter Seibel, Professor Emeritus, Cologne University

First published in the European Microfinance Platform Autumn 2016 Newsletter

In 1963 I went to Nigeria to seek the indigenous roots of what I expected, alas, to become the leading industrial nation of Africa. In my interviews with workers about their saving behavior, I found that many saved in a saving club, called esusu in Yoruba. I learned that the esusu dates back to the 16th century when it was carried by Yoruba slaves to the Caribbean where it is still widespread.

This was my first encounter with informal finance: savings-led! Later in Liberia I came across similar indigenous cooperatives in all 17 ethnic groups, including savings and credit groups and working groups as well as similar community-based arrangements. In towns, rotating savings groups predominated; in villages where regular incomes were rare people formed credit funds (ASCAs), with small, mostly weekly equity contributions - without a gender bias. They survived the civil war and are now, half a century later, to be included in an IFAD project.

With the ASCAs in Liberia I felt at home: Urmitz is everywhere. Urmitz is my home village where, in 1889, some 15 villagers formed a self-help group. During the same year a credit cooperative law was enacted, the group joined the Raiffeisen movement, kept growing, and eventually, in 1934, came under the banking law: as a Raiffeisen bank.

This experience inspired me, from my new base in Princeton NJ, to submit a proposal to USAID to help build a grassroots financial system on indigenous foundations. Unfortunately, the proposal, in 1969, was a few years early; it was only in 1973 that USAID sponsored the Spring Review on Small Farmer Credit, a scathing report of targeted credit and credit-driven agricultural development banks (AgDBs).

From microcredit to the microfinance revolution

I then watched with astonishment the rise of the microcredit movement, entering into the void left by declining support to AgDBs. For the new credit NGOs suffered from similar flaws as the AgDBs: donor dependency, credit bias, lack of self-reliance and profitability, and the absence of appropriate regulation and supervision. And they added a gender bias.

Recognizing these deficiencies led to a paradigm change around 1990, the "microfinance revolution", in which two of the authors were involved (also in coining the new term, microfinance). This paradigm shift spurred the reform of existing, and the creation of savings-led new, MFIs, among them inclusive (micro) finance banks.

Two centuries of inclusive savings and cooperative banking: the German experience

This paradigm change has a long prehistory. Since the 17th century, Europe experienced tremendous increases in poverty, creating new displacements and upheavals: traditional safety nets broke down, mass poverty spread. In Germany, preceded by pawnshops, widows'- and orphans' funds, a new breed of local institutions began to evolve around 1800: savings funds (Sparkassen) placing the poor at the center: foremost as savers. The Sparkassen offered special incentives to the poor: free doorstep collection services and stimulus savings interest rates. Their numbers and funds increased rapidly, enabling them to extend their outreach and offer credit to "the industrious and enterprising", such as craftsmen. From early on, they thus were inclusive, with services to the poor, non-poor, and eventually SMEs and the city or district for community investments. Two centuries later, Sparkassen serve >40 million customers (50% of all residents of Germany), with €1.2 trillion in assets (2015).

A different history of microfinance started around 1850 with the development of self-help groups (SHGs) - savings and credit associations, owned and governed by their members. The first urban SHG was initiated by Schulze-Delitzsch in 1850, the first self-reliant rural SHG by Raiffeisen in 1864, soon organized in separate federations of respectively Volksbanken and Raiffeisenkassen (merged only in 1974). After 160 years of evolution, they now serve >30 million customers (including 18 million members), and €800 billion in assets (2015).

The savings and cooperative banks are two of three pillars of the German banking system, providing inclusive universal banking services to all segments of society, including MSMEs. Self-organized federations, central funds and auditing apexes, and appropriate regulation and supervision, have played crucial roles in their development. Government has been kept at bay. Ultimately, their strength lies in the mobilization of local savings for the local economy: the foundation of their crisis resilience.

What role for government in cooperative banking?

The case of India and Vietnam Since around 1900, the German credit cooperative model has spread around the world. In two of our case studies, India and Vietnam, we examine the role played by the state in that process. In 1904, the British Raj, inspired by Raiffeisen, introduced the Co-operative Credit Societies Act of India. By the mid-1920s, this had given rise to some 50,000 self-reliant credit cooperatives, backed by a network of cooperative banks. But ultimately, the Indian state governments played a destructive role: by taking over the operations of the cooperatives rather than providing a regulatory operating framework. By 2006, more than half of the 106,000 credit societies were insolvent, and more than one-quarter of the 1,112 cooperative banks reported losses. Reforms are struggling: of a sector which is too big to fail and too sick to heal.

Our contrasting story of Vietnam starts with the collapse, in the 1980s, of the socialist command economy and its cooperatives. In the early 1990s, the government launched a fresh credit cooperative initiative as part of a market economy, based on the Raiffeisen model. These People's Credit Funds (PCFs) have become one of the most impressive credit cooperative movements. PCFs are prudentially regulated and supervised by the central bank (SBV), which has not shied from enforcing compliance. They now profitably serve over four million clients (2014), having successfully weathered both the Asian financial crisis of 1997/98 and the global crisis of 2008. Most importantly, in contrast to India, the PCFs have not served as a tool of political favoritism. 

Two inclusive commercial banks: Centenary and BRI

Finally, I am presenting two full-fledged inclusive commercial banks, one from Africa and one from Asia. Both are the product of transformations. Centenary Bank in Uganda started in 1985 as a "trust fund" of the Catholic Church.

Century-old Bank Rakyat Indonesia (BRI) dates back to a member-owned Volksbank (bank rakyat) in the 1890s, later transformed into a government-owned national bank. In 1969 it was commissioned to set up a network of village units, disbursing subsidized agricultural credit, in addition to BRI's main banking business. Their performance declined rapidly, and by 1982, BRI faced a choice: reform or close the units.

Technical assistance played a crucial role in transformation of both. Centenary was assisted by the German Savings Banks Foundation (SBFIC) together with IPC. They provided a highly effective cashflow-based lending methodology and MIS, combined with incentives for staff and borrowers. As microsavings continued to grow, exceeding the lending capacity of microcredit, Centenary added SME lending. It now profitably serves 1.3 million customers (2012), calling itself "Uganda's leading Microfinance Commercial Bank".

BRI was assisted by the Harvard Institute for International Development (HIID) to transform the village units into microbanking units as of 1984. Their success has rested on two products, both with commercial rates of interest: voluntary savings with positive real returns and unlimited withdrawals; and general credit, open to all and available for any purpose. These two products have made the microbanking units the largest national microfinance network in the developing world, resilient to the crises of 1997/98 and 2008. BRI, an MSME bank, currently serves 53 million customers (2015) with by far the largest outreach of any bank across the Indonesian archipelago.

The two banks, in vastly different countries, have much in common: individual lending, opportunities for graduating to SME loans, and genuine inclusiveness, excluding no one. They may be indicative of the future of inclusive finance, pointing the way to a new stage of institutional development - similar perhaps to the evolution of savings and cooperative banking in Germany.

See From Microfinance to Inclusive Banking, by R.H. Schmidt, H.D. Seibel, and P. Thomes (Wiley-VCH 2016), http://eu.wiley.com/WileyCDA/WileyTitle/productCd-3527508023.html

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About the Author

Hans Dieter Seibel is a professor emeritus at Cologne University. He is specialized on microfinance and microbanking, linkages between informal and formal finance including digital linkages of SHGs with banks/MNOs, agricultural development bank reform, SME development, M&E, and sociocultural system research. In the 1980s, he designed the linkage banking program with GTZ, FAO and APRACA and was team leader of the first pilot project in Indonesia. In 1999-2001, he was Rural Finance Advisor at IFAD and author of its Rural Finance Policy. He also is a founding board member of the European Microfinance Platform (2006-2015).

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What do renowned economists, financial sector practitioners, academics, and activists think about current issues of financial sector development in Africa? Find out on the blog - and share your point of view with us!

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