The microfinance sector is rapidly growing across the world, bringing banking and financial services to people that have been long-ignored by traditional banks. By experimenting with new technologies and channels of distribution, microfinance is changing the world of finance and banks have taken notice.

From the left, Ian Callaghan of Enclude Capital Ltd, Andrew Hilton of the Centre for the Study of Financial Innovation, and Stephen Pegge of Lloyd's Bank

On Wednesday, 30 April 2014, the UK Microfinance Club hosted Ian Callaghan and Stephen Pegge to speak about current trends in microfinance and their implications for the banking world, as well as analyse the strengths and weaknesses of this sector overall. Andrew Hilton, founder of the Centre for the Study of Financial Innovation, moderated the discussion.

Callaghan, of Enclude Captial Advisory UK Ltd., focused on two big picture topics in microfinance-intentionality and regulation. The intentions behind microfinance are client-oriented, rather than profit-oriented, so “[finance] can be used not just as a means of exchange, but as a force of good.” Highlighting wealth inequality across the globe, he showed that the top 0.1% of world’s population holds 20% of the wealth, while the botton 50% of the world’s population holds only 5%.

“[Finance] can be used not just as a means of exchange, but as a force of good.”

The structure of the financial system rewards the wealthiest with higher returns on investment, widening income inequality. He argued that “wealth actually trickles up, not down” and that the wealthiest benefit at the expense of the poor. Callaghan emphasized that this is not just a developing world issue, because the largest difference in wealth growth rates are seen in developed countries. Banks should be learning from successful models in Pakistan, with United Bank Limited, and India, with Basix Sub-K, where mobile phones are replacing traditional banks and reaching a huge portion of the population.

“Wealth trickles up, not down.”

Microfinance institutions (MFIs) have pioneered technologies and operational systems that banks have begun to follow. MFIs developed real wealth measurements that help them determine affordability of loans for their clients, and reduce lending risks, which banks are now using as well. There is more to learn from MFIs however, such as giving education in financial literacy to clients and making sure they fully understand the products they are receiving.

The proactive approach to self-regulation in MFIs, using real wealth measurements and customer feedback to constantly improve their products and efficiency based on what clients need, rather than potential profits to be gained, is a unique attitude in the world of finance and is sadly absent from traditional financial institutions.

Stephen Pegge, of Lloyds Banking Group, then brought the perspective of corporate banks on microfinance to the table. One of the strengths of  MFIs in the diversity of financial structures they provide, fostering innovation and managing risk for the financial market as whole.

Main Strengths of Microfinance

Outreach-MFIs are accessible and approachable
Affinity-There is a foundation of trust in the relationships which improves risk outcomes for the lender
Support-Mentorship and support systems in MFIs are very strong, help customer grow
Interest-By blending charitable and commercial funding, they lower costs and can lower interest rates
Social Impact– The multiplier effect

Commercial banks handle many small loans, half of Lloyd’s are under 7500£, and there are many lessons to learn from MFIs. Pegge identified the need for banks “to be in the market for people who are nearly bankable as well as clearly bankable, and help them on this journey.” Banks need to improve their relationships with customers, by urging businesses to seek financial services they can benefit from and providing more support to them. They must be adding value with their products and working on efficiency, to better serve their clients, the industry, and to help Britain prosper.

“We need to be in the market for people who are nearly bankable as well as clearly bankable, and help them on this journey.  The risk otherwise is very serious financial exclusion.”

Looking forward, we would like to see a more serious commitment to collaboration between commercial banks and MFIs in developed markets as well as developing markets. We also want to see that banks are serving the entire range of customers, and actively combatting financial exclusion, because it is ultimately in their interest to develop the people at the Bottom of the Pyramid.  Just as we have a rating system for microfinance that shows financial and social performance, we would like to see a similar ranking of commercial banks.  One of the biggest complaints people have about banks is that their products are very complex, and difficult to understand.  On top of this, they don’t look after the needs of their customers.  This is a disconnect between commercial banks and their entire customer base, and microfinance will start filling this gap as they have before.

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