FinTechs, neobanks, blockchain, super platforms, artificial intelligence – with all the exciting changes in technology creating new business models for financial inclusion, it’s easy to think that older models like microfinance have been eclipsed. But have they? There’s no doubt that microfinance institutions (MFIs) are highly motivated to serve the poor. But to continue playing that role in the long run, they need to enter the digital age by embracing new technologies and rethinking their business models.
Before joining CGAP, I worked for 10 years with MFIs in Latin America and Sub-Saharan Africa, often on implementing digital strategies. I have seen a lot of attempts by MFIs to deal with the fundamental challenges posed by digital technology, and many painful lessons learned along the way. Generally, what I have learned is that the key is to have a clear objective, start small, gain experience and grow your digital business gradually. Here’s a roadmap for getting there.
Start with a business plan
First and foremost, you need a clear idea of what you’re trying to achieve with a digital solution. I’ve seen many MFIs invest in technology or agent networks without the faintest idea why they were doing it or a business plan to guide it. Digital solutions can lower operating costs, help in acquiring customers and improve the customer experience, but it’s easy to leap into a technology solution only to discover that the costs of running it are so high that you’re losing money.
I once reviewed an MFI in Latin America that provided a hugely popular bill pay service via agents. The clients loved it, but that was the problem. For every bill that was paid, the MFI lost money because it priced the service incorrectly and didn’t think about adjacencies, like deposit collection, that might have contributed to its core business. The more popular the service got, the more money the MFI lost, with no benefit whatsoever to its main microfinance business. MFIs should clearly define their business objectives before they even think about investing in technology. Develop a business plan and cost out any solution before building it.
Agents instead of branches
Agents can help MFIs operate more efficiently and increase their customer outreach, if managed well. A recent publication from the International Finance Corporation based on its work with nine MFIs in Africa, shows the cost of handling transactions via agents is about 25 percent lower than through branches. Yet managing an agent network can still be costly, so it is important to do it carefully and build slowly. GSMA estimates that mature mobile network operations run by mobile network operators (MNOs) on average pay out 54.4 percent of total revenues in agent commissions. This is an expensive business to run. The focus should be on recruiting active agents who deliver volume rather than on boosting agent numbers. It is a classic mistake to try to grab market share by opening as many agents as possible all at once. Many big players, including banks, MNOs and MFIs, have failed by making this mistake. Agents introduce new risks for MFIs, particularly operational risks, and these should be thoroughly understood before moving into agent banking.
Invest in a flexible IT solution
IT systems, not bricks and mortar, are the biggest legacy costs of banking. You can close a branch relatively easily, but as anyone who’s been through an IT system migration knows, it’s a lot harder to switch IT systems. Most MFIs have IT systems that are cobbled together, don’t speak to each other and require work-arounds. Invest in a good IT system that has the flexibility to grow with the business into the future. There are good companies out there that can provide useful services in this area, including companies that specialize in technology solutions for MFIs.
Digitize your data going forward, not backward
Many MFIs still keep paper records. They have an incredible amount of data collecting dust on their shelves. While digitizing all of that data might be useful, it can also be overwhelming. Rather than getting bogged down with digitizing old data, MFIs should prioritize investing in data management systems that will allow them to start capturing data going forward. Figuring out how to structure the data so they are useful and finding ways to efficiently and accurately collect data electronically should be the priorities. Digitizing the old data is a bonus.
Given the challenges of digitizing their own data, some MFIs have explored algorithmic scoring of unstructured third-party data, such as call records and social media feeds. I would suggest that MFIs might want to invest in using their own data well before exploring third-party data sources. MFIs’ own data are likely to be of higher quality and more predictive, and they own the data and can use the data as they wish — for credit underwriting, but also for gaining better insights into customers and understanding the impact that taking credit has on their lives. Data will be a powerful driver of financial services delivery in the future, so the sooner MFIs grasp this nettle, the better.
Really understand your customers’ needs and build your digital products and services around fulfilling them. Think of this not only in terms of what services you provide, but also how you provide them. Research shows that there is a strong link between customer satisfaction and business performance. CGAP’s Customer-Centric Guide addresses some of the core challenges and opportunities financial institutions face. Remember that one of microfinance’s comparative advantages is precisely that it is not an algorithm. MFIs are close to their customers and know their needs, and this potentially gives them a longer-term advantage over new digital rivals. Interestingly, a recent CGAP study on digital credit in Tanzania showed that two-thirds of digital credit borrowers had not reduced their use of formal loans after taking digital credit, and 60 percent of digital credit borrowers surveyed used formal loans for business purposes such as investment or payroll. Digital credit is not necessarily a substitute for microfinance.
Access digital infrastructure through partnerships
MFIs are never going to be systematically important payments players like MNOs and banks, but that does not mean they cannot leverage this digital infrastructure through partnerships. MFIs have two things that these large organizations want and need: a license and a customer base. It is worth remembering that CBA, a small corporate bank in Kenya, became the country’s largest bank by customer numbers virtually overnight thanks to its partnership with M-Pesa on M-Shwari. But it is also worth remembering that the big players are rarely going to knock down MFIs' doors to work with them. And if they do, they will be negotiating from pure self-interest. Most MFIs are ill-equipped to handle these negotiations, so it is important to stay educated about the larger ecosystem and the technological and business trends driving it.
Microfinance has a relatively good track record of serving the poor in a socially responsible way. But it must adapt to continue serving those customers in the face of new and very different competition. To be successful, MFIs will need to tackle this challenge head on.