Small loans are not enough …

There are 13 million SMEs in India which accounts for 80% of all companies. They have a 40% share of industrial output and account for 45% of all exports mainly from sectors such as textiles, leather, jewellery, auto components and pharmaceuticals. They are the biggest employers in the country – second only to Agriculture. Many of them are an integral part of all sorts of supply chains that lead to formal brands on shelves or in the showroom. Without them few brands could be cost effective. And yet, according to statistics from SMERA (Small and Medium Enterprises Rating Agency) of all the investments made by SMEs in 2007 – Rs 100,000 crore or, over $20 billion – only 14% was provided by the formal banking sector!

Finance into the informal sector is not new. The Emperor Augustus created a fund for the Poor from the confiscated property of criminals and Severus offered loans to the poor without interest with repayments paid from the produce of their industry. In 1361, Michael North, the Bishop of London set up a fund that lent money in exchange for pawned objects. This was perfected in Italy over the next century and the Church promoted it as a means to reduce usuary.

Globally, there are many other examples. The Chinese used the Hui system for workers to pool their cash and, migrant workers from China to Mexico in the 19th century triggered the Tanda system which is still used throughout Latin America. Esusu funds in Nigeria; Chit funds in India; Quiniellas in Spain and Mont de Piete from Perugia to Paris – all base themselves on trust and have offered sums of money for people in the poor districts to access more funds than their daily pay for centuries. It could be for a wedding or a festival. It could be to start or grow a business.

The trouble is that for small business to flourish, more sophisticated banking services are needed. Loans are one thing; Business and Financial planning for growth quite another and, increasingly, businesses deal in global markets that demand know how on international transactions and currency exchange. This is where formal banks can play a part but, until recently they have not ventured into the informal sector.

Many people in the informal community have no experience of formal banking. For example, few banks have even moved beyond urban areas. For example, 7 out of 13 Northern Districts in Ghana do not even have a single bank outlet! This is a global pattern and what is true of retail banking is far worse for small business.

Then, along came Muhammad Yunus and the Grameen Bank. In 1976, Yunus lent less than a dollar each to 42 Bangladeshi women. The loans were repaid and several ventures were born. Grameen Bank has grown into a $3 billion collosus; Yunus has been awarded the Nobel Peace Prize and, microcredit hit the headlines. From this root, a global movement has developed with an estimated $25 billion of loans and over 130 million customers of microfinance institutions.

Yunus is keen on vocabulary. Preferring the term microcredit to microfinance, his success has triggered many formal banks to enter the fray. However, he has been highly critical of those banks that have entered the informal market to make profits. In a well publicised exchange, he has dismissed the Public Offering of the Mexican Bank Compartamos because it focusses the profit motive rather than the more philanthropic mission that Grameen has forged ahead with. This acrimonious exchange was tantamount to excommunication from the pure philosophy of the High Priest of microcredit. Is such a rigid interpretation of the scope for microfinance helpful?  

This is not the place to debate the merits of Grameen but it is important to highlight that small loans are not going to be sufficient to trigger sustainable growth in the emerging world. More sophisticated financial services than microcredit are needed. Which brings us back to SMEs and the need for financial support to grow and be sustainable.

Take a business that makes garments and starts from a network of women working from home. Fine. Low cost workers drive turnover and all is well. And yet, for some successful businesses of this type, there has to be a way to build on early success with productivity improvements that only investment in more sophisticated machinery can trigger.

It is important to acknowledge the importance of Yunus and the Grameen Bank. No doubt. However, it is high time that the debate moves up a gear. Significant investment in logistics connectivity (hardaware, software and peopleware) can generate significant transformations in any number of local economies. And yet, this cannot be acheived by small loans or, the pooling of any number of daily wages.

The informal economy needs financial services to underpin logistics improvements providing the platform for sustainable growth. In India alone it is estimated that well over 500,000 of SMEs are eminently bankable. Think of the impact on the local economy. Think of the potential on the global stage.

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2 Responses to Small loans are not enough …

  1. Ben Dunn says:

    I’m not sure what you’re arguing for here. I understand that the informal sector needs more finance but its not alone there these days. The microcredit industry has demonstrated the commercial attractiveness of developing markets to financial services organisations, but there are all sorts of risks and challenges with lending larger amounts to that sector not least basic financial skills and the kind of commercial skills that can imagine and deliver a larger business model than a sewing machine in a house.
    If you take a bank at its most basic, it intermediates between depositors and lenders in such a way as to offset the risk of the former. Zopa might be an interesting model to look at, in fact I remember one model linking developed market ‘investors’ with developing market borrowers.
    At the end of the day, the world does work on risk and return and there needs to be some form of commercial return to make it attractive to investors. We need to find a banking model that appeals to more than the charitable side of investors, and there are too many commercial issues right now to warrant anything more than microcredit solutions. I believe investment needs to be out into training first and the business ideas and investment will follow.

  2. robjbell says:

    You hit the nail on the head. First, I was trying to say that finance into the informal economy did not start with Grameen Bank. Then, I was trying to introduce the view that even micro credit is not going to be enough, as you put it so well, to deliver a larger business model than a sewing machine in a house. This is why I used the example of a guy investing in bigger and better machinery.

    However, there is a major problem brewing in this whole area. Several Banks have moved into this space to find that their efforts are dismissed by the old stagers of microcredit as little more than moneylending – with all of its negative connotations. The plain fact is that the SME sector is recording huge growth in places like India and needs help on how to manage finance. This is basic business and, with the levels of employment in this sector being way beyond what major Corporates generate – it makes sense.

    After all, as Professor Martin Christopher says – supply chains compete not companies. And, if your compnay depends on suppliers from the informal economy you had better make sure that they have access to adequate funds and don’t fail at the first monsoon. This is microfinance not microcredit and, as you emphasise, requires significant skills within the banks themsleves.

    Finally, Logistics is just as much about cash flow as physical flows and Transformational Logistics can play its part.

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