In Jamaica, the recent tabling of the long-awaited Microfinance Act in parliament, has once again brought the issues in the microfinance industry there into sharp focus, and more specifically, the high interest rates being charged by institutions in the sector. This legislation not only seeks to regulate “microcredit institutions”, but it also includes a proposed cap on microcredit interest rates, pegging them to the current Treasury bill rate + 3%, which would bring down rates dramatically to around 10%, from the 1% a week currently being charged on average (reaching 75% or more in some instances on an annualized basis, including fees).
Not surprisingly, the idea of a cap has created a strong reaction from microfinance institutions and credit unions, who are lobbying to convince the Government to be more reasonable on this particular issue before the actual microfinance regulations are finalized. Their argument is that microcredit rates are high because of the credit risk involved in making these small, short-term loans, as well as the high cost of processing and servicing them. Many of these institutions have previously been granted an exemption under the Moneylending Act, which caps rates at 40%. The Government’s position is that high rates enable MFIs to make excessive profits, well over the cost of doing business, and these rates are ultimately a barrier to increasing financial inclusion. How things turn out in Jamaica, i.e. whether the government pushes through a cap, as well as the short-term impact of regulation on the sector, should be instructive, as well as a call to action for MFIs, including credit unions, in the rest of the English-speaking Caribbean.
In essence, regulation is an important necessary step in the development of the microfinance sector in the Caribbean. Many of the key microfinance players in Latin America such as BancoSol and ADOPEM, began as unregulated entities. In the case of Jamaica, regulation should bring some credibility back to the sector, which has been lost because of predatory lending practices by moneylenders and those attracted to microcredit because of the prospect of high profits. These practices have tainted the sector, and fed into the distrust of the formal financial system on the part of a significant number of potential MFI clients.
The emphasis in the Microcredit Act on client protection, particularly full transparency in terms of rates and fees, if rigorously enforced, will result in market pressures on MFIs to lower interest rates, even without a cap. These pressures could include a greater shift towards consumer loans, easier to get and at lower rates, and increasing use of informal “pardner”, or “round robin” financing schemes. Regulation essentially will bring the question of the profitability of microcredit into sharper focus, and should result in some consolidation in the sector, where the smaller microcredit players who cannot compete on rates, will have to decide either exit the sector, or find ways to merge their operations with larger institutions. Broadly speaking, in the new regulatory environment, MFIs in Jamaica will need to consider new creative strategies, beyond “business as usual”. While individual microfinance markets in the Caribbean are different, in terms of demand and supply side constraints, in our view, the industry as a whole in the region needs a “re-set”, in order to keep in step with and benefit from current and evolving global trends in microfinance. MFIs in Jamaica are now facing an immediate challenge. However, within that challenge lies an opportunity for designing new business models, which take into account the need for operational sustainability, while at the same time addressing client needs in new ways, given new financing and service delivery options being offered by fintechs and others that are quickly becoming mainstream outside the region e.g. micro-crowdfunding. We suggest that the following 4 actions ought to be considered by MFIs across the region.
1. Commit to a double-bottom line, which includes both social and financial performance, and which places clients at the center of operations. In this regard, number of MFIs – across the region (Jamaica, Belize, Dominica) have now been trained in the globally recognized universal standards of social performance management (SPM), through a collaboration between the Social Performance Management Task Force and the Caribbean Microfinance Alliance. These institutions should now assess where they are in terms of adherence to these principles and seek to fully integrate them into their operations. This should result in higher levels of client satisfaction and customer loyalty, and should also lead to a clear differentiation between MFIs and predatory lenders. In the case of Jamaica, if adherence to SPM is made a priority in the short-term, it will mean that MFIs will already be in compliance with the client protection principles of the Microfinance Act, perhaps even before the microfinance regulations come into effect. Such an approach will also support the Government’s financial inclusion strategy, and could help the sector’s lobbying efforts.
2. Seek cost-effective ways to provide a broader range of financial services beyond microcredit. MFIs in the Caribbean are operating in very small markets, which puts limits on the ability to grow the microcredit client base. One IDB Commissioned study, Open for Business, puts the potential new client base in Jamaica, the largest market, at less than 100,000 people for example. The sector in the Caribbean is also heavily dominated by credit unions, which are membership-based, which can constrain the growth of new microcredit clients. Small markets mean that MFIs have to find ways to be competitive by delivering appropriate microcredit products, services that clients need, including finding ways to effectively integrate financial literacy and business development services into the service offering, to promote responsible borrowing and improved business practices. New client segments should also be pursued e.g. micro and small businesses focusing on “green” solutions. MFIs could explore how to continue efforts already launched in the region, through programs such as the IDB’s EcoMicro program, which is financing the development of “green” loan products in 10-12 financial institutions in the Caribbean. So far, projects are underway in MFIs in Belize, Dominica, Grenada, Guyana Jamaica, and St. Lucia. Strategic partnerships with both public and private sector stakeholders in the entrepreneurship and financial markets eco-systems should be pursued to achieve new forms of diversification.
3. Increase the use of technology. MFIs are already at various stages of integrating technology into their operations – e.g. loan evaluation and credit analysis. However, the Caribbean is significantly behind other emerging markets where MFIs are providing digital financial services, not only fostering financial inclusion vis à vis the underserved, but focusing on providing convenient online loan application and banking options for customers. In these markets, traditional “brick-and-mortar” MFIs are finding themselves competing with fintechs seeking to provide microcredit and other financial services online and therefore faster, more efficiently and cheaper. This trend has begun in the Caribbean as well. Mundo Finance, and Spring Financial Services in Jamaica, and Axcel Finance in the Eastern Caribbean and Barbados come to mind.
There are hurdles to be overcome in the region to be sure, such as issues of security, minimizing fraud, and public skepticism of online banking itself. Mobile banking has not taken off as expected in Jamaica for example, due to lack of trust in this form of banking among the very population segments it could benefit the most - the unbanked and underbanked. However MFIs, with their reach at the local level, in urban, as well as rural communities, are well placed to help build appetite for and interest in mobile banking and digital financial services. Caribbean Governments have an important role to play here as well by prioritizing legislative and infrastructure changes needed to support digitalization in the sector. A Inter- American Development Bank Report on the Digital Economy in Latin America and the Caribbean released in 2017 found that none of the Caribbean countries except Jamaica and Trinidad & Tobago had an updated national digital strategy and only Trinidad had in place a national broadband strategy.
MFIs should seek to address the gaps in the provision of services to microentrepreneurs that commercial banks cannot fill efficiently. Scotiabank, for example, has been pulling out of the smaller Caribbean markets -- Bahamas, Turks and Caicos, and now the Eastern Caribbean - which they see as unprofitable because of lack of scale. This presents a significant opportunity for digital microfinance. Omni Financial Group in the Bahamas is already moving in this direction in the Family Islands. However, moving toward digital solutions should not come at the expense of interaction with clients, given the central importance of the client relationship in microfinance. The Center for Financial Inclusion suggests that MFIs seeking to provide digital financial services should develop models that combine technology with their traditional “high touch” approach.
4. Commit to Continuous Learning to support Innovation. While continuous training can be costly, nonetheless this should be a priority, not only for loan offers, but MFI management and most importantly, boards as well. Research on the sector has shown significant knowledge gaps in MFI loan officers, specifically in terms of credit methodologies, and microfinance best practices. To survive and thrive, MFIs and credit unions will need to continuously innovate, and this means training staff at all levels, line managers, and most importantly boards, on latest global microfinance trends, and how they can be applied locally to improve the customer experience while adding to the bottom line. Most importantly, training will help to build “buy-in” for new microfinance approaches at all levels of the organization. In this regard, institutions should take advantage of any subsidized learning opportunities that are available through international knowledge exchanges, donor programs and microfinance networks.
Of course, these 4 suggested actions will need to be adapted to local market conditions, and current internal and external constraints facing institutions. The Caribbean microfinance sector has the potential to significantly build the economic resilience of the region’s micro entrepreneurs, and so it is important to begin.