Third Tier Banking:

Some ideas on building inclusive

Financial Systems through

partnerships

7 September 2006

Rural Housing Loan Fund 10th Annual Workshop

Presented by:

Dr Marius Ungerermariusu@absa.co.za

Contents

1. Macro Global perspectives: World Bank Conference – May 2006

- General trends and key principles

2. RSA context: Falkena Report

- Multi Tier banking

3. Linking different Tiers of banking

- Players

- Models

4. Partnering to leverage on strengths of current players

5. Discussion

Building inclusive Financial Systems

Macro Perspectives: General trends¹

Comments

• Creditworthiness of the informal

market customers it is not about:

•Income or wealth

•Availability of collateral

• But more about;

•History and track record of

sustainable micro economic

activity

•Household support

•Past savings patterns

• Savings is the starting point for

connecting to financial services

• There is an increasing trend of

commercial banks entering the

microfinance arena

• The value creation contribution of

microfinance is more than just

profits.

Key inputs

• Traditionally, the poor have low access to finance because of :

•Social distance: banking as unfamiliar space

•Knowledge distance: poor perceived not to be eligible and

creditworthy

•Physical distance: density of services

• Access to finance increases:

•Economic growth and development

•Social and educational development

•Market reforms

• Free enterprise economies need to reflect a free access economy

•Without access, the poor cannot utilise the benefits that are available

to the middle class - Raghu Rajan – Chief Economist, IMF

•Two types of access is relevant:

•Firms’ access to financial services: Matters because of the

impact on growth, and especially of small and new firms (entry)

•Households’ access to financial services: Matters because of

poverty reduction, risk mitigation, more voice and inclusion

•Serving poor customers need not hurt financial viability.

•Microfinance is profitable and stable enough to move into the

mainstream financial system. - Rosenberg & Gonzalez, CGAP

Guideline from ABN Amro Bank: Think Big, Start small, Act quickly

¹Access to Finance: Building inclusive Financial Systems – World Bank conference, May 2006

Access to Finance: Building inclusive Financial Systems

Macro Perspectives: General trends (2)

Comments

• The intent is that each country

should have a vision and

national strategy for building an

inclusive financial sector.

• The process to build this vision

and national strategy should

encourage open and

transparent discussion among

stakeholders.

• Policies and implementation

plans for financial inclusion

should be integrated into

financial sector development

and poverty alleviation

strategies – The South African

Financial Sector Charter and

governing mechanisms created

are acknowledged as positive

progress in this regard

Key inputs

•Vision of Inclusive Finance: “Inclusive Financial Sectors” are those

characterized by:

•“Access at a reasonable cost of all bankable households and

enterprises to the range of financial services for which they are

‘bankable’…”

•“Sound institutions, guided by appropriate internal

management systems, industry performance standards, and

performance monitoring by the market, as well as by sound

prudential regulations where required.”

•“Financial and institutional sustainability as a means of

providing access to financial services over time.”

•“Multiple providers of financial services, so as to bring cost-

effective and a wide variety of alternatives to customers.”

•“Inclusive Financial Sectors” must be “supported by a sound policy

environment.

Source: Building Inclusive Financial Sectors for Development,

UNDESA and UNCDF, 2005.

Access to Finance: Building inclusive Financial Systems

Macro Perspectives: Key Principles of Microfinance¹

1. Source: Consultative Group to Assist the Poor (CGAP)

• Poor people need a variety of financial services, not just loans. In addition to credit, they want savings, insurance, and money transfer services

• Microfinance is a powerful tool to fight poverty. Poor households use financial services to raise income, build their assets, and cushion themselves against external shocks

• Microfinance means building financial systems that serve the poor. Microfinance will reach its full potential only if it is integrated into a country’s mainstream financial system

• Microfinance can pay for itself, and must do so if it is to reach very large numbers of poor people. Unless Microfinance providers charge enough to cover their costs, they will always be limited by the scarce and uncertain supply of subsidies from governments and donors.

• Microfinance is about building permanent local financial institutions that can attract domestic deposits, recycle them into loans, and provide other financial services.

• Microcredit is not always the answer. Other kinds of support may work better for people who are so destitute that they are without income or means of repayment –role of NGO’s or micro-savings alone

• Interest rate ceilings hurt poor people by making it harder for them to get credit. Making many small loans costs more than making a few large ones. Interest rate ceilings prevent microfinance institutions from covering their costs, and thereby choke off the supply of credit for poor people.

• The job of the government is to enable financial services, not provide them directly. Governments can almost never do a good job of lending, but they can set a supporting policy environment.

• Donor funds should complement private capital, not compete with it. Donor subsides should be temporary start-up support designed to get an institution to the point where it can tap private funding sources, such as deposits.

• The key bottleneck is the shortage of strong institutions and managers. Donors should focus their support on building capacity .

• Microfinance works best when it measures - and - discloses - its performance. Reporting not only helps stakeholders judge costs and benefits, but it also improves performance. MFI’s need to produce accurate and comparable reporting on financial performance (e.g., loan repayment cost and recovery) as well as social performance (e.g., number and poverty level of clients being served)

- 6 -Group Strategy Development • Proprietary and Confidential Falkena Report for Board 6/20/2014 11:28 AM

Background, Purpose and Scope of the Falkena Report

Background

• In May 2003, the National Treasury requested a study on the competitiveness of South African banking, along the lines of similar studies done abroad in the UK and Australia

• The SARB wholeheartedly supported the National Treasury’s proposal and seconded staff to the project

Purpose

Scope

• To build on the UK and Australia studies and see to what extent competition in the banking sector in South Africa differs from industrialised countries

Included Excluded

• Small Business (SME)

• Retail Banking

• Central Banking, Corporate and Merchant Banking and Bancassurance

- 7 -Group Strategy Development • Proprietary and Confidential Falkena Report for Board 6/20/2014 11:28 AM

Key contrasting characteristics of Tier 2 and Tier 3 banks as outlined by Falkena

Bank Tier Key Differentiation Key Attributes

Tier 2 Banks*

• Two types of Tier 2 Banks

Narrow Banks

• Will be prohibited from using deposits

for (illiquid) lending to private sector

• Will invest all deposits liabilities in

approved highly-liquid money market

instruments

• Will not be allowed to engage in credit

business

Core Banks

• Will be prohibited from using deposits

for (illiquid) lending to private sector

• Will be allowed to lend to the private

sector provided such loans are funded

from their second-tier capital (i.e.

subordinated debt)

• Must have deposit insurance

Tier 3 Banks* • Ring-fenced to a specific geographic

region (area)

• Relatively smallish operations such as

village banks, stokvels, community

banks, cooperative banks, small local

mutual building societies

• Can use deposit liabilities for lending to

private sector but only if their deposits

and lenders are from the same

community

• Must have deposit insurance

• Key issue is that the possible

bankruptcy of the Tier 3 banks should

have NO systemic risks for the financial

sector at largeAn important difference between Tier 1 and Tier 2 and 3 banks is the philosophy of the legislation supporting their daily operations. In case of Tier 1, everything is allowed unless prohibited by law while for Tiers 2 and 3 banks everything is prohibited unless specifically permitted in terms of legislation

*Definitions as applied in Falkena report, thus not from legal point of view

Dedicated Banks Bill applies

Cooperatives Banks Bill applies

1. The Department of Trade and Industry (the dti) presented the new microfinance apex institution, South African Microfinance Apex

Fund (SAMAF) to Parliament on 17 May 2006. SAMAF aims to provide seed capital, wholesale finance and institutional development

support to micro-credit programmes (read NGOs) that focus on the poor, financial service cooperatives, credit cooperatives and

burial societies.

¹

Overview of service providers: The RSA context on Funding

Access to Finance: Building inclusive Financial Systems

Source: Marie Kirsten, Development Bank, SA

The options for Banks entering microfinance and Success Factors

Access to Finance: Building inclusive Financial Systems

MFI Alliance

opportunity

Absa intends to partner with MFI’s that have the following core

capabilities:

• A sustainable business model:

– Customers:

• Clear targeted customer grouping

• # of clients

• Historical growth rate

– Processes:

• Loan origination and delivery process

• Loan administration system

• Default rates

– Infrastructure:

• Working arrangements

• Security

– Financials:

• Audited financial history

• Donor involvement

• # of years to reach break-even

– People:

• Commitment

• Skills

Nature of Relationship and Possible

Product Mix

• Facilitating Direct Access to banking

products and/or Distribution/

Origination of banking products:

– Transactional

– Credit

– Insurance

– Savings

– Remittances

• Retail Funding through Partnership

• Wholesale Funding

Partnership opportunities to leverage the core capacities of player

in the 3rd Tier Banking space

• MFI’s can increase their services to their current customers by partnering

with a Bank to supply the following:

– Insurance solutions e.g. funeral cover

– Individual loans up to R15000 for “loan graduates” of MFI

– Saving/Investment solutions:

• Group Saving scheme/product

• Individual saving

– A basic transactional bank card – Debit card

• Mzansi

• Grant recipients card

• MFI’s can increase their income streams through origination fees for:

– Insurance: R5 per funeral cover policy

– Individual loan based on full record of MFI graduate: R100 per loan

– Valid cellphone number of current customer to educate customers on saving

solutions: R0.20 per valid cellphone number

• Wholesale funding for qualifying MFI’s

• Mortgage Loans for buying homes e.g Absa’s MYHOME solution

Thank you

Any Comments and/or Questions?