Microfinance institutions are failing to live up to expectations. Some have folded up, others have lost their operating license, and a lot more are bleeding within…just hanging in there till the last day they drop dead. Several reasons account for these unfortunate situations which usually leave customers (depositors especially) stranded, disgruntled and in rare cases, suicidal.
The strategic direction of microfinance institutions largely rests with the Board of Directors. The operationalization of strategies rests with the CEO who in most cases is part of the Board. The CEOs are usually sole owners or part owner of the microfinance institutions. Most decisions are made by the CEO, singularly or in consultation with some members of staff. Almost everything revolves around the owner-CEO.
A look at some microfinance institutions across the country reveals certain shortfalls and practices that largely contribute to their poor performances across different scales of measurements. There were over 400 licensed microfinance institutions in Ghana as at June 2015.
Shortfalls in banking knowledge and skills
It may surprise you to know that some of the CEOs in charge of microfinance institutions have no background or experience in banking prior to their becoming head of the financial institution. Those who happen to have some experience in banking either do not have enough experience or lack relevant banking experience. Working in a bank does not necessarily qualify one to become the head of a financial institution. It is important to distinguish between someone who has worked in a bank before and another who has relevant banking experience capable of effectively managing a financial institution. For example, in one case, the CEO was once a teller at one of the commercial banks. The mistake of thinking that because you have worked in a bank before, you can manage a financial institution has led some CEOs driving their microfinance institutions into the ditch.
As much as entrepreneurship is to be encouraged, and the need to venture into new areas is necessary for development, attention must be drawn to the fact that managing financial institutions involves protecting depositors’ money – money some have accumulated over a long period of working hard and saving the little they can afford. Being able to play that intermediation role of banks involves first, having the knowledge and skills necessary for that job.
Management of microfinance institutions are predominantly concerned with mopping funds from individuals and small scale enterprises at whatever cost and quickly handing them over to the deficit unit, disregarding all other activities in between which are necessary to operate prudently. Liquidity management is one key skill where you would find huge deficits across most microfinance institutions. This has often led to postponing withdrawal requests by depositors and in prolonged cases, a run on the institution. Asset and liability management is also a function which most of these institutions do not appreciate nor take seriously. Credit appraisal is another area where one can clearly see huge deficits both in knowledge and experience. The function is so critical to both profitability and survival, yet it has not been given the right attention and human resource investment. Risk management is another area where microfinance institutions need to do a lot more. Market risk, credit risk, operational and reputational risk are some forms of risk that they are exposed to that could lead them to their eventual collapse. It is important to put in place policies, systems, and tested mechanisms in place to mitigate these risks.
Unfortunately, most of these CEOs are not willing to pay for the service of experts who can offer them a helping hand either by way of consulting or as staff. To them, having made hundreds of thousands to be able to come up with the minimum capital for the class of financial institution they’re managing is enough evidence and guarantee for their success on the job. They therefore discount every attempt to obtain knowledge and improve their skills in managing a financial institution, especially when it comes at a fee.
High proportion of fixed assets
One noticeable thing about microfinance institutions in Accra is their heavy investment in fixed assets. It has become a common scene in the city of Accra and other major cities to see modern buildings with exquisite interior decorations occupied by some microfinance institutions. They also invest in numerous cars to help their sales executives move around the city. While this has been a common practice among the bigger-sized commercial banks in the country, it has recently been adopted by microfinance institutions as well. Perhaps, it is a way of flaunting their wealth and creating a perception of big size.
Fixed assets such as buildings, cars, furniture and computers are classified as non-earning assets by the assets and liability management function. Increasing investment in them do not yield direct revenue to the business, unlike channeling the funds into loans and advances and fixed income securities. There is absolutely nothing wrong with a financial institution operating from within plush city buildings and buying expensive brand new cars for managers and customer visits. It is however worth mentioning if these ‘assets’ are financed by customer deposits which are expected to be used to fund earning assets ahead of future withdrawals. It becomes worrying when non-earning assets exceed the value of equity.
Biting more than you can chew
One successful transaction is always an appetizer to bite the next transaction. Successive successes grow the confidence to continue with what you are doing, usually in the same manner but bigger tickets this time. Microfinance institutions tend to lend to customers who have been able to repay loans given to them in the past, just like most other financial institutions in the country. This time however, the credit appraisal process is relaxed, rushed and biased towards quick approval of loans because of past credit repayments or credit history with the institution. Based on this, microfinance firms are quick to avail the next credit and what makes it scarier is that they avail bigger amounts subsequently. They do not have the capital and balance sheet size to support the subsequent bigger loans they avail to ‘good’ clients. Committing large portions of your deposits to a customer in the form of direct exposures is quite risky as defaults on the part of the customer can drill a big hole in the books of the microfinance institution through crunched liquidity.
What most microfinance institutions fail to see is that the business environment is dynamic and things are changing pretty fast. Good loan repayments by clients in the past do not guarantee a performing loan in the future. There is therefore the need to critically appraise each credit independently and entirely. One big transaction gone wrong is capable bringing down the entire financial institution.
Diversion of funds
It is no more surprising to see CEOs and key management staff of financial institutions driving expensive cars and running other side businesses. It is however surprising when deposits are diverted to other activities and business ventures – productive or unproductive.
Funding long-term projects such as real estate with short-term funds such as current accounts, savings accounts and 91-day term deposits is not a healthy practice especially in an environment where deposit rollovers are not guaranteed and you’re not promised the next big deposit coming through the door either. While there was no admission to diverting deposits towards financing personal properties and projects of businesses unaffiliated to the business by any of the microfinance managers contacted, the suspicion looms and the flashy lifestyle of some managers, given their salaries, partly evidences that suspicion.
Deposits must be used for the business of banking. It is only right to do so. Deposits should be used to fund earning assets in order to be able to return them to depositors upon demand or maturity. Assets must be chosen carefully having considered factors such risk, returns, liquidity, tenor, among others. Safety is key when investing on behalf of customers.
Failing peer institutions
Some microfinance institutions are failing. They are collapsing. Some have folded up. A lot more are on the same path and it’s just a matter of time. Failing microfinance institutions does not help the strong ones that are healthy and operating prudently. There is a growing wave of fear that handing over your money to a microfinance institution is unsafe. Interactions with depositors revealed that they will choose safety ahead of interest receivable (returns) when handing over their funds to a financial institution. This finding appears somewhat contradictory to recent news of large numbers of people handing over their money to microfinance companies on the promise of huge and outrageous returns on their investment. What I found out is that, people would choose safety ahead of high returns which promises no security. However, as investors, they are not sophisticated enough to determine whether or not an investment is safe.
Rampant news of failing microfinance institutions is leading the healthy ones towards the path of collapse. Customers are trooping to the offices of microfinance companies to withdraw their money. This is dwindling deposits and causing liquidity problems as deposits have already been committed to loans and advances expected to be repaid between now and their maturity dates.
In addition to the issues discussed, there are a lot more that contribute to the poor performance of microfinance institutions. Weak succession plans, documentation and reporting, low investment in systems and business processes, undocumented policies and operating procedures, lax supervision, are some other factors causing microfinance companies to fail.
To restore confidence to that sector of the financial system, microfinance companies must begin to recruit experienced management, train and develop staff, implement robust policies and adhere strictly to prudential guidelines and instill a sense of discipline and integrity into the fiber of organizational culture. Earlier this year, the Bank of Ghana revoked the licenses of 70 microfinance companies in an attempt to sanitize the industry. Nevertheless, there are some, albeit few, microfinance institutions within the same operating environment that are properly run with the right level of professionalism and integrity.