Can you think of any industry more efficient than microfinance? Every day, lenders around the world master the challenge of lending small sums of money to otherwise disenfranchised clients, all the while tracking portfolio data, managing an array of risks, and conforming to complex banking regulations. Now that most markets have matured, the increased competition has driven them to target ever more challenging groups—all the way down to remote, off-the-grid farmers. In their quest to survive (and turn a profit), microlenders continually focus on increasing efficiency and reducing internal costs, making them champions in operational efficiency.
The only catch to this familiar, compelling narrative: It’s not true.
Photo Credit: Thanh Hai Nguyen, 2011 CGAP Photo Contest
Last year, a KfW-commissioned study examined efficiency across the industry. Experts from Business & Finance Consulting (BFC) and AdVision Finance investigated operational efficiency within microfinance institutions from a practitioner perspective, with a particular focus on credit processes. By reviewing the existing literature and using six microlenders in Africa and Asia as case studies, we discovered glaringly inefficient processes. Many microlenders – including mature and/or highly profitable ones – still have ample capacity for significant efficiency gains. Despite this, efficiency considerations are usually not among their top concerns. Why aren’t they?
- Inefficiencies often remain undetected because they tend to quietly pile up, as a natural consequence of strong institutional growth. New branches, products and services get “tacked on” to existing structures and systems that were originally designed to support smaller, simpler institutions. Over time small inefficiencies accumulate, with their costs remaining long-hidden, especially in booming markets or phases of strong institutional growth.
- A lack of clear, universally applicable metrics compounds this problem, making it very difficult to compare efficiency levels across different institutions.
- Clients often do not shop for the best offer, or they cannot accurately gauge product prices. This significantly reduces cost pressures, allowing lenders to pass high costs on to clients.
- Management often cannot identify inefficiencies or drive change, and shies away from making painful changes with uncertain outcomes.
Because of this, national market leaders are often the least efficient as strong growth and a large client base allow them to operate profitably without undertaking reforms. Such complacency, however, can end badly when booms turn to busts. Seemingly solid profits can suddenly vanish, as witnessed during the global financial crisis when many microlenders suddenly realized that they had let their operating costs climb out of control. They subsequently over-compensated by embarking on a cost-cutting frenzy far more painful than early corrective action would have been, often to the detriment of staff, clients and investors.
To contribute to sustainable development, microfinance itself must be sustainable. This means keeping operational efficiency a top priority in good times and bad. A widely cited 2013 CGAP study found that operating expenses typically account for around half of microlenders’ total costs, more than the cost of capital, loan losses and institutional profit combined. In this increasingly maturing industry, further growth will only be possible with vigilance in controlling and reducing this number one cost. Only efficient microfinance providers can achieve sustainable growth and fulfill the promise of accessible, affordable credit for even the most marginal and remote clients.
There are six areas of operation within the microfinance industry that require improvement when implementing efficiency measures: value proposition, organizational structure, processes, technology, delivery, and company culture. All these operational areas are intricately interconnected, and changes to one area can affect the other areas. For example, changes to the value proposition would necessitate a redesign of institutional structure and streamlining of procedures to eliminate redundancies and bottlenecks. When processes are changed, reporting lines or functional departments may also need to change. Similarly, the introduction of alternative delivery channels to reduce costs affects technology use in the organization.
Therefore, pursuing operational efficiency at all costs could do more harm than good. The overall aim should not be to maximize efficiency everywhere and at all costs, but rather to methodically adjust the various operational areas while still remaining faithful to the social mission and not undermine employee morale and productivity.
Improving efficiency is a challenging, never-ending task and requires continuous adaptation to ever-evolving environments. All efficiency improvements come with risks, and there are no universal solutions for improving operational efficiency. Instead, the risks specific to each microlender must be weighed and duly managed through careful planning, sequencing and coordination.
Before the global financial crisis, many microlenders dropped the ball on efficiency and paid a steep price once markets turned. Now that the crisis has passed, some lenders may be becoming complacent again. We cannot allow this to happen. Microlenders need to continuously and systematically monitor the inevitable build-up of operational inefficiencies and take corrective action, or else employees, clients and investors will once again be left to pick up the tab.