Low-income people worldwide need a full range of financial services. Banks, in turn, need new markets. Throughout most of the developing world, 70-80% of the population represents uncharted territory for providers of financial services.
It has long been assumed that poor people in developing countries are ill-equipped to make use of financial services and cannot be served sustainably or profitably. Over the past generation, pioneers in microfinance have proved such assumptions wrong, or even obsolete, as new techniques and technologies have been developed.
The first lesson for any financial service designer for the so-called base-of-the-pyramid market is that products for low-income people are not just scaled-down versions of products for the middle class. To assume that they are might be called the subprime fallacy. In the U.S. and Europe, subprime loans look a lot like prime loans, only worse. Subprime loans are scaled-down versions of standard loans, but because they are small and the clients have poor credit ratings, they are riskier. To compensate, subprime loans are priced higher and often carry stiff fees. The subprime game often boils down to a risk/cost/return calculation with little product adaptation.
Group-based microcredit, in contrast, is a product modeled on local folkways. Its inventors — from Accion International in Latin America to Grameen Bank in Bangladesh — observed poor people, especially women, forming groups to help each other save and borrow, and even covering for a member who had a short-term problem. They saw that people preferred small, frequent payments. The group loan products used today by millions of women around the world incorporate these features. The loans that result are more expensive than standard commercial bank loans (because they are small), but they are not riskier — often quite the opposite.
Housing microfinance in Andean countries demonstrates another expert tailoring of products to a local market. In Bogota, Lima, Peru, and Quito, Ecuador, migrants from the countryside squat on unoccupied land at the urban fringe. Over time, they upgrade from tin shacks to small brick huts and eventually to larger houses with improvements, all on the same plot of land, to which they gradually acquire the rights. They build the houses themselves or hire local informal builders. Traditional mortgage lenders have ignored the housing-finance needs of these millions of migrants. The lenders simply could not scale down their mortgage product to make it affordable, nor would they lend to clients with quasiformal land titles and informally built structures.
By contrast, the Peruvian microfinance bank Mibanco, an affiliate of Accion, devised Micasa, a home-improvement product aligned with the progressive building patterns of slum residents in Lima, offering loans of one year to three years, each financing a specific home-upgrade project. Rather than a scaled-down mortgage product, Micasa is an adaptation of Mibanco's standard microenterprise loan; it is based on cash flow rather than asset value. Mibanco has had excellent results with Micasa and keeps about 15% of its $320 million loan portfolio in this product.
In many regions of the world, the bank-branch model itself must be reinvented to reach poor people where they live. In Brazil, regulatory innovation opened the door for a major breakthrough in "last-mile" delivery. In 2001, Brazilian banking authorities introduced the banking-correspondent model, allowing any type of enterprise, including supermarkets, lottery kiosks, pharmacies and post offices to act as an agent for one or several banks.
The result: in Brazil today 95,000 agents are conduits for services such as account opening, deposits, withdrawals and bill payment. Before the banking-agent revolution, almost a third of Brazil's municipalities had no banking services; now they all do. At least 13 million savings accounts have been opened. The correspondent model is being adopted, with regional variations, across Latin America.
Only simple products can be delivered at affordable prices to low-income people. At the same time, simplified products must incorporate risk reduction in creative ways. Group microloans combine risk control with simplicity: they omit elaborate business analysis and reduce risk instead through peer guarantee. Mibanco's housing microfinance is simple: instead of registering formal mortgages, it ensures that borrowers have long-standing and locally accepted claims to their residence even if they lack a formal title. Brazilian-style correspondent banking enables trained retail agents and inexpensive point of service machines to cut travel time and risk from basic financial transactions for poor people in remote regions.
Other innovations — such as cell phone payment systems and microinsurance — are rapidly gaining traction in large swaths of the developing world. To participate in the vast outreach of which these innovations are part, traditional banks will have to get creative — about partnerships, product design, technology and ultimately the very nature of banking itself. The resources are out there, and the potential rewards are vast — for banks as well as their as-yet-undiscovered customers.
