Q&A with Robert Vogel

Robert Vogel, Executive Director of the International Management and Communications Corp. (IMCC), is the author of several publications about savings mobilization and financial sector development. Here he answers five frequently-asked questions about the challenges that different financial intermediaries face when they start mobilizing small-balance savings.

1. In 1984, you referred to savings mobilization as the "forgotten half of rural finance," does this still remain true?

Robert Vogel in Mindanao, Philippines

First, let me give proper credit to Dale Adams for suggesting that title, which never seems to be forgotten. In one sense, deposits are no longer forgotten. That is, I think most financial institutions now recognize the importance of deposits for funding, for client service which is increasingly important to stay competitive and, perhaps most importantly, for institutional independence. (If an institution relies heavily on donors for funding, or even on large depositors, the only possible answer when they ask you to jump, is "how high.")

The incentive for donors to neglect deposit mobilization is, however, as strong as ever, if not stronger. With interest rates so low in commercial markets, donors have to try harder and harder to move their money - and credit lines are one of the best ways of moving a lot of money quickly. (Program loans are great in theory, but it is not easy to require governments to do even the things they should do but have not yet gotten around to, usually for good and sufficient political reasons). Moreover, for donor money to move, it must be more attractive than alternative sources of funds, namely deposits. However, when donor money is so attractive that it undercuts deposit mobilization and, simultaneously, institutional self-reliance, (as happened with many credit unions in Latin America in the 1970s and 1980s) disaster can quickly follow (i.e., the discipline required for good loan recovery disappears). Some financial institutions may believe that long-term funds are necessary to finance long-term loans, but large numbers from small deposits can be just as stable a source as donor loans - even if they are sight deposits, as most successful bankers clearly understand.

2. What is the biggest challenge facing financial institutions interested in mobilizing small-balance deposits on a large scale? Is this challenge different for different types of financial institutions (e.g., banks, specialized microfinance institutions, credit unions, etc.)?

Today, in spite of enormous advances in information technology, cost seems to have become a major issue, mainly because institutions - especially large commercial banks - tend to use the wrong service techniques. Specifically, it was our experience in Peru that small rural savers just wanted to get in and out the door as quickly as possible (although they also clearly liked lotteries and other promotions). This is far different from the highly solicitous service that Peruvian banks offer to their upper middle class urban depositors. Any financial institution interested in expanding deposit mobilization first needs to examine its traditional clientele to evaluate what could be the most effective and efficient techniques for mobilizing deposits from them, and then whether an expansion or redirection of efforts would be cost effective. A new clientele may appear promising for deposit mobilization, but entering this new market will require being competitive not only in deposit services but also in the provision of loans and other financial services.

Cost studies carried out by technical assistance providers often emphasize the high costs of handling large numbers of small deposits, without regard for the benefits of reciprocity (e.g., economies of scope or "relationship banking"). Specifically, establishing a relationship with a financial institution typically begins with small deposits, later leading to loans and other services that are potentially more profitable for the institution.

For bankers, deposit mobilization is a part of life. So, the issue is whether going down market to a micro-clientele makes sense given that this will inevitably involve not just deposits but a full range of financial services, including loans tailored to this clientele. For MFIs wanting to transform, deposit mobilization itself is a challenge, but successful MFIs have a strong position with this large clientele, most of whom will have a serious demand for deposit services notwithstanding their low incomes. To look elsewhere for depositors, before dominating this segment of the deposit market, would seem an ill-advised strategy, although one that is often followed - perhaps without realizing that the market for large deposits is already highly competitive.

For credit unions, after some unfortunate experiences with excessive dependence on donor funding, successful deposit mobilization has become virtually synonymous with overall success. Indeed, controversies in many countries surrounding an appropriate regulatory framework for credit unions appears to be a greater barrier to deposit mobilization than any lack of understanding of the clientele (the members themselves) or effective deposit mobilization techniques.

3. What is special about risk-based supervision? Does it apply equally to all deposit-taking institutions (including small credit unions)?

Nowadays, since risk-based supervision has become part of the Basel Standards of the Bank for International Settlements (BIS) and part of International Monetary Fund (IMF) country reviews, virtually any bank regulatory agency will state that it is doing risk-based supervision. Although it is undoubtedly true that virtually every regulatory agency looks at risks in one way or another, few seem to have adopted the rigorous approach originally developed by the U.S. Office of the Comptroller of the Currency (OCC). This approach provides a standardized methodology for analyzing risk with a commonly understood vocabulary that allows examiners to communicate effectively; and at the same time, it is highly flexible, especially in that it focuses regulatory resources where risks are greatest. In particular, risk-based supervision does not focus primarily on the risks themselves but rather on an institution's ability to identify, monitor and manage risks.

Perhaps most importantly, from the perspective of microfinance, risk-based supervision does not take the traditional approach of searching large numbers of loan files for documented financial statements and evidence of guarantees. Rather, it looks to see if the systems actually in place (not just in the manuals) are adequate to handle the major risks being faced. From the perspective of rural finance, in contrast to the compliance-oriented approach of traditional supervision, risk-based supervision¹ does not impede the opening of new small branches in isolated rural areas with arbitrary rules about security, hours of operation, etc., but rather focuses on the solvency of the institution and its capacity to identify and manage the risks involved. In short, a main premise of risk-based supervision is that the basic task of regulators is to analyze an institution's risk management capabilities and not to attempt to manage an institution's risk-taking, which inevitably leads to imposing rules that favor risk avoidance and thereby reduce access to financial services.

In the case of a small credit union, the regulatory resources applied would be similarly small for two reasons: (1) the members of a small credit union should be able to monitor each other effectively enough to handle most risks; and (2) the risks to the overall financial system are likely to be exceedingly small. Nonetheless, primarily through off-site surveillance, risk-based supervision would want to be sure that certain elements were in place, e.g., standardized transparent accounting systems with adequate audit policies and with clear identification of the difference between member shares and institutional capital, and clarity about the liquidity of member shares (i.e., rights to automatic loans against shares, and rights to withdrawal shares without resignation).

4. Why have transformed MFIs often had only limited success in capturing savings from their traditional clientele?

One would suppose that transformed MFIs, which are typically quite successful in their lending operations, would thoroughly understand the diversified cash flow patterns of their clients; and, consequently, understand that these clients also need liquid assets -- best of all deposits that can be withdrawn quickly in small increments to protect against the risks of sudden emergencies or to not lose the benefits from unexpected opportunities that must be acted upon immediately. However, it appears that many transformed MFIs are convinced that large deposits from NGOs and similar types of "friendly" institutions are likely to be cheaper sources of funding than small deposits from traditional clients. In addition to neglecting traditional clients, this focus can also underestimate interest rate sensitivity and especially the strong bargaining position of large depositors as compared to traditional micro-clients with their small deposits.

In addition to ignoring the risks of being captive to relatively few large depositors, MFIs may take the contractual nature of time deposits too literally and fail to understand that requests for premature withdrawals of time deposits must be honored to maintain institutional credibility (although interest penalties can be imposed if stated clearly in the original contract). Furthermore, MFIs with policies of required deposits against loans ("compensating balances," in banker language) may have difficulty disentangling these and voluntary deposits, both in terms of internal policies and in the eyes of their clients. Moreover, being unfamiliar with voluntary deposits, it is not surprising that transforming MFIs would hire traditional bankers to help get started with deposit mobilization. However, these bankers are likely to bring with them techniques used to mobilize deposits from typical middle and upper class bank clients - techniques that may not be appropriate for traditional micro-clients, as well as being excessively expensive.

If it is true that MFIs must look beyond their traditional clientele for adequate and cost-effective funding, in order to be competitive in new markets, these transforming MFIs are likely to need to offer an attractive range of financial services, including loans. The decision to be confronted may thus involve not just moving up-scale in deposit mobilization, but also the costs and benefits of entering an entirely new market niche.

5. What are the risks and potential advantages of leveraging the extensive branch networks of state-owned retail banks to offer high quality deposit services to the rural poor?

The main points are, first, whether the bank and its employees have incentives to offer high quality deposit services; second, whether the bank presents an image of security to the rural poor; and third, linked to the first, whether the bank is willing and able to provide good service. Certainly the Unit Desas of Indonesia's BRI and more recently Mongolia's Agricultural Bank have given ample evidence that it is possible. One might think that an image of security is guaranteed by the fact that the bank is state-owned. However, one can find many examples where governments offer little credibility in such cases, having previously denied their responsibility to depositors at a failed state-owned bank or delayed payment so long that the guarantee was largely worthless. To utilize such state-owned banks by trying to create an image of security is probably not worthwhile if it is even possible.

If an extensive branch network means many locations where there are no competing banks or other deposit-taking institutions, this can be a major advantage. Given the right preconditions, the challenge, then, is to create an environment of good service (e.g., deposits are liquid, with no delays in line, convenient locations and hours of operation, etc.). However, government bureaucracies are often governed by an ethic of poor service, so that transformation can require major attention to employee incentives, including carefully designed programs of performance payments to employees. Such incentive systems are typical of successful microfinance institutions, but are often strongly resisted (even in private banks) and can sometimes be against the law in government bureaucracies.

Suggested readings

¹For a more complete discussion of risk-based supervision, especially as it applies to microfinance, see Vogel, Robert C. and Fitzgerald, Tom 'Moving Towards Risk-Based Supervision in Developing Economies,' Harvard Institute for International Development, CAER II Discussion Paper No. 66, May 2000