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Workshop 3: "Are Small Business Loans Another Form of Social Lending?" Workshop outline and paper by Leo Verhoef
QUESTIONS TO BE ANSWERED WITHIN THIS WORKSHOP SESSION:

1. Can business micro credit lending be a commercial activity or is financial support always necessary?

2. How to improve the situation for micro credit lending in Europe?

3. Which are good examples within or outside the EU?

4. Is there a specific role for main stream banks in micro credit lending?

5. If so, how to involve banks more intensively in micro credit lending?

6. What about the role of the EU in micro credit lending?

7. Should the EU play a bigger or different role in micro credit lending?



ARE SMALL BUSINESS LOANS ANOTHER FORM OF SOCIAL LENDING (by Leo Verhoef, Professor in Entrepreneurship at Eindhoven University of Technology)

Banks and SMEs share the same goal: the optimal functioning of their own organisation. In order to achieve this, they are relegated to each other. However, their insights, methods and means all differ, as well as the expectations they have of each other, especially if the entrepreneur belongs to the category of micro credit lenders. In that case, (main stream) banks are even more than just cautious when dealing with applicants for finance. To be able to improve the situation it is important to know what lies at the bottom of the tension between banks and micro lenders.


MISCONCEPTIONS

• MICRO CREDIT IS A RISKY AFFAIR, BECAUSE MICRO LENDERS HAVE A LOW DEVELOPED SENSE OF RESPONSIBILITY IN RESPECT TO LOANS.
The actual practice is different. Figures from well organized micro credit organizations, show poor credit risks which are the same or even lower than from main stream banks dealing with SMEs. Results from social surveys show that persons who received a micro loan (after several intensive talks) enjoy the organizations confidence and will do everything not to harm it.

• MICRO CREDIT LENDERS IN THE EU IS JUST A MARGINAL GROUP
Compared with the total number of SMEs their size is (negligible) small. However, the volume differs considerably from country to country, but also from region to region. Moreover the number increases due to changes in the composition of the population (immigrants) and due to social-economic developments. More and more (young) people with no or little work experience decide in favour of self-employment in stead of a life time appointment.

• MICRO CREDIT LENDERS ENTIRELY CONSIST OF PROSPECTLESS PEOPLE
Business micro credit lenders are not identical to private micro lenders. Several researches show that the background of micro lenders is rather wide, ranging from illiterates to academic educated people. Moreover a considerable number of micro lenders are able to work its way up to the regular SME sector. The micro credit lending sector partly can be regarded as an incubator for the common business world.

• MAIN STREAM BANKS ARE NOT INVOLVED IN MICRO CREDITS.
Also not massive, several banks participate in micro credit programmers, such as the German Kredit Anstalt für die Wiederaufbau in some Central European countries, the Dutch ING Bank in Fundusz Mikro in Poland, The German Commerzbank in ProCredit Banks in the Balkan states and the Dutch Rabobank in Amsterdam.


VALID CONCEPTIONS

• MICRO CREDIT LENDING IS EXPENSIVE FOR THE PROVIDER
This allegation is correct. The low credit amounts do not justify the high processing and administration fees. Besides that micro credit lenders make a strong appeal to additional (more tailor made) services provided by financial institutions such as, advice.

• BANKS ARE NOT WELL EQUIPPED TO SUPPLY TAILOR MADE SERVICES AND PRODUCTS TO MICRO CREDIT LENDERS. Although some of the most successful main stream banks in Europe once started as micro credit lending bank, such as Rabobank (one of the few banks in the world with a Triple-A status) set up 100 years ago by poor farmers or the Deutsche Ausgleichsbank, set up after the World War II in order to support refugees to start a small business, regular banks need the support of specialist organisations to fulfil the needs of micro credit lenders.

• THE SUCCESS OF MICRO CREDIT INSTITUTIONS IS STRONGLY DETERMINED BY THE MOTIVATION AND DRIVE OF THE KEY STAFF. As a result, it is very difficult to roll out successful credit lending initiatives nationwide and therefore often locally limited. There are only a few successful network institutions on micro credit with national coverage. A good example is Fundusz Mikro with 34 local branches and 6 sales points.


There is no denying that European main stream banks in general do not play an important role in the granting of micro credit. At the contrary, the present situation creates the impression that traditional banks incline to give a non-committal reaction if others are more active in this field.

In order to improve the situation it is essential to have a good understanding of the conduct of banks towards (potential) business clients. The model presented below and based on the so-called Kraljik-model can throw light on this issue.

Banks, just like all companies, classify all products and services to be provided in terms of their profit impact and supply risk. Following this approach, they sort out all products and services into the categories shown in following figure: strategic, bottleneck, leverage and non-critical. Each of these four categories requires a distinctive approach, the complexity of which is in proportion to the implications.


• NON-CRITICAL FINANCE
If returns and risks on the supply of finance to SMEs in general are estimated as being low, banks have various relatively cost reducing and yield raising options that also fulfil the needs of SME clients, such as use of overdrafts and business credit cards. Although also attractive for micro credit lenders, due to the flexibility and quick processing time, banks consider the supply risk with this specific target group as too high. Therefore these products are mostly inaccessible to micro credit lenders.

• LEVERAGE FINANCE
To banks, this type of finance products, such as mortgages, lease and factoring have a low supply risk profile (even in respect to micro credit lenders) and a relatively high profit impact. However, these very situation oriented products are not suitable for micro credit lenders due to their very specific requirements.

• BOTTLENECK FINANCE
Not only to micro credit lenders, but also in respect to SMEs in general, banks consider bottleneck finance, such as longer term and subordinated loans, as being risky. Therefore banks are quite often reluctant and attach severe conditions to the supply of bottleneck finance products to all SMEs. With the introduction of Basle II, the demands are becoming even more rigorous. In many cases, external support instruments, such as (mutual) loan guarantee schemes, have to be called on in order to bridge the gap between bank and lender. It goes without saying that bottleneck finance products from main stream banks are beyond the reach of micro credit lenders.

• STRATEGIC FINANCE
In cases of high risk, but also (in potential) high returns, banks are willing to offer a helping hand to SMEs with seed capital and advice and other types of support. With these favourable SMEs, banks have an intensive, but expensive relationship. Although in principle, the best alternative for micro credit, strategic finance by main stream banks is the farthest away from this target group


The solution to the problem is sought in various directions. First of all in persuading main stream banks to engage themselves extensively with micro credit lending. In general, the results of these efforts are very disappointing. Banks are not equipped to meet the needs and requirements of this target group. To them micro credit lending will be a very loss-making activity and impossible to keep on its feet in confrontation with their shareholders and regular SMEs. Another solution is broadening the setting of tasks of existing financial institutions at arm's lengths of the (local) government. Quite often, also this answer proves to be rather unsuccessful. Lack of knowhow and experience in business financing within these organisations lead to very convential credit granting procedures and thus to risk avoiding behaviour by the staff members. The most extreme chosen option is the development of new micro credit institutions. But, as mentioned before, also to this solution has certain shortcomings, such as limited regional coverage and the tendency of main stream banks to stand severely aloof from micro credit lending.

ID: 37218
Author(s): iff
Publication date: 29/04/06
   
 

Created: 13/04/06. Last changed: 20/04/06.
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