Part 1 ("The Economics of Microsavings") of this brief exploration into the economics of savings-driven microfinance looked at the role of microsavings at microfinance institutions. In one large study, poor borrowers, despite accounting for 75% of active accounts, only contributed 3% of total deposits mobilized, mainly because they maintain low balances. However, poor savings clients carry out frequent transactions, for which they have well-demonstrated willingness to pay relatively large fees. These and other fees can be a major source of revenue on its own. However, many savings clients are also borrowers, and it is through the combination of fees, high yield microcredit loans, and other services (insurance, transfers, etc.) that microsavings clients can be truly profitable.
That raises a question: if small savers are indeed profitable without providing significant funding, then where does the funding of deposit-driven MFIs come from? The answer takes us back to the IADB study from Part I, which found that the bulk of deposit funding came not from savings accounts, but from time deposits, which sport a far higher average balance. Among Bolivian MFIs, half of all deposits mobilized came from accounts greater than $50,000 (both savings and time deposits), even though such accounts comprised just 0.4% of all deposit accounts. Clearly, deposit-driven MFIs are raising their money from a very different customer segment than the one targeted by microsavings.
For such accounts, operating costs are essentially negligible. Instead, the cost driver in their case is interest expense. And it is here that we see the other side of the deposit-driven model. Consider for a moment who is depositing $100,000 sums in a country like Bolivia. At a minimum, it has to be an upper middle class household or business. Now, why should such a client go to an institution associated with the poor? With rare exceptions, it is not out of a sense of social solidarity. It could be better service, since at an MFI, clients don’t need to bring in a million dollars to be treated like the “big fish.” Anecdotes from the field suggest that this is indeed part of the motivation, though if it were only that, surely smart banks could find a way to improve their customer service to retain such clients.
Unfortunately for the banks, the MFIs have an advantage that they cannot match: a high-yield portfolio. Even in the most competitive markets, microcredit portfolio yields remain substantially above those of banks. And this allows MFIs to offer significantly higher rates on large deposits. A recent look at MiBanco’s website shows an interesting advertisement: a 7.1% rate on 3-year time deposits. The closest bank competitor offers 5%; most are below 3%.
Apparently, such rate differentials are high enough to attract wealthy customers away from banks. Yet for MFIs, even a 7.1% rate (in local currency) is an excellent deal, and it is cheaper than nearly all foreign loans. The fact that these customers are attracted by high rates is also useful for another reason: it makes funding easy to adjust as needed. Thus, an MFI seeking to slow down its funding inflows can simply decrease the interest rate on deposits to see a near-immediate effect. Indeed, large deposits allow significantly more precision and sensitivity to funding needs than working with large-ticket debt, such as from MIVs, local capital markets, and the like. The ability to control funding also extends to maturity – for example, a shift into shorter-term funding only requires increasing the rate offered for short-term deposits and decreasing for longer-term deposits.
With a good regulatory regime and a high-yield portfolio, a deposit-funded MFI can find itself quite comfortably situated, compared to those that don’t collect deposits.
Concluding thoughts
As I had confessed in the beginning of this series, I began researching this blog with a hypothesis that a shift into microsavings could cause excessive liquidity, which would bring us back to the saturated microcredit markets we’re trying to avoid. So what is it about the economics of microsavings that proves the notion wrong?
First, because it generates minimal funding, microsavings alone cannot result in over-liquidity. Second, the ability to adjust interest rates charged to the actual funders – wealthy local households – allows MFIs to closely tailor funding to the needs of their portfolio growth. Funding by large deposits allows greater flexibility for MFIs seeking to better attune their funding to changing loan portfolio needs.
This is a significant departure from the push-factor of institutional funders trying to place their funds – whether needed or not – with high-performing MFIs. After all, the majority of crisis-affected microfinance markets (India, Pakistan, Bosnia, Morocco, and Nicaragua) featured excessive inflows of institutional funding, whether from local banks or foreign lenders. While deposit-driven MFIs are not immune from credit bubbles (see Nigeria for a notable exception), their funding model is less likely to generate the kind of excess liquidity that we have seen elsewhere.
Daniel Rozas is a microfinance consultant based in Brussels. Previously he worked at the U.S. mortgage investment company, Fannie Mae.