It’s a new year. 2016. Maybe you’re an expat living in the Philippines considering ways to bring in some extra cash. Should you start a micro-financing business in the Philippines?
Micro-financing, or micro-lending, is the lending out of small amounts of cash, usually without collateral.
Despite all the boasting about economic growth in the Philippines, over 11 million Filipino families still remain poor. Almost 8 million Filipinos rate themselves “food poor.”
Many Pinoys and Pinays from a lower economic class have little chance of finding a job because he or she is under-educated and barely literate. Starting a micro business, such as street vending or driving a tricycle, is usually his or her only (legal) option for earning a living.
Due to the massive size of the lower income segment, nearly 90% of businesses registered with the Department of Trade and Industry are microenterprises.
But why, despite their popularity, do microenterprises remain tiny and inefficient, unable to pull their owners out of poverty?
Traditional banks do not lend to people who have no collateral and can only afford to borrow a few thousand pesos at a time.
Poor people thus turn to loan sharks, such as “Bombays,” Five-Six Moneylenders from India, to borrow the money that they need to survive, paying interest rates of as much as 200% a year.
“Bombay’s,” Five-Six Moneylenders
So-called because of the manner in which they lend, five-six (5-6) moneylenders charge a nominal interest rate of 20 percent over an agreed period of time.
A person who borrows 5 pesos from a 5-6 moneylender over a period of one week repays 6 pesos, including 1 peso interest.
Neither Filipino nor Indian 5-6 moneylenders require collateral or documents from their borrowers. The success of a borrower’s business and loan repayment history provide a gauge of the borrower’s credibility.
5-6 moneylenders undertake daily collection of payments in the morning, afternoon, or both. A client’s daily payment is determined by the sum of the principal borrowed plus its 20 percent nominal interest divided by the credit term.
The loan arrangement is flexible; if the client fails to pay one day, it is understood that he or she will pay for the day missed the next time around.
Renewal of loans depends on the moneylender’s policy. Some 5-6 moneylenders will renew clients’ loans only after the previous loan is paid in full. More accommodating lenders will renew a client’s loan earlier, subtracting the outstanding balance of the old loan from the new loan and issuing the client the remainder.
Although they operate illegally as usurers, Bombays, have actually mastered the technique of marketing and collecting, so much so that they have flourished and grew and their simple “5-6” operation have been passed through generations.
Note that Bombays limit their operations in one specific area where they can easily manage the collection process and keep a very strict watch on the businesses that they lent their money. For example, one person will concentrate only at Libertad St in Pasay City, another one will concentrate only at Paco Market and its vicinity, another at Pasong Tamo, Makati, Guadalupe, Caloocan, Malabon, etc.
The main purpose of these concentrations is to be able to collect 100% of the calculated and agreed interest of the principal, every day.
The significant difference in a Filipino or “Bombay” is the fact that Filipino 5-6s are resident “insiders” in the community, while the Indians, as immigrants, are clearly identified as “outsiders.”
As an expat, foreigner, whether Indian or not, you too, are an “outsider,”‘ of course. If you are interested in starting your own micro-financing business in the Philippines, you might consider becoming a “silent partner” and back a Filipino, such as your spouse.
Why are traditional banks unable to lend to the poor?
Traditional banks have higher overhead costs compared to MFIs. Therefore, they require a minimum size for loans or deposits to justify the cost of servicing such accounts. These minimum requirements are too large for poor people to meet (the average size of a micro loan in the Philippines is only P5,000).
Traditional banks support the cause of microfinance by making funding available to MFIs, who then repackage these funds into smaller amounts that the poor can access.
MFIs charge higher interest rates than traditional banks to reflect the higher administrative costs of processing micro loans.
Can the poor be trusted to pay back their loans and handle money responsibly?
Yes. Actual repayment rates of micro loans are consistently above 90%. An MFI borrower is at least as good a credit risk as a traditional bank borrower.
MFIs in the Philippines report a number of success stories of microentrepreneurs who started with as little as P5,000, but in less than five years were generating as much as P500,000 in annual profit.
The microinsurance and savings products offered by MFIs have also enjoyed wide acceptance, proving that the poor do understand the value of managing risk and providing for the future.
In the Philippines, microfinancing is an activity dominated by rural banks, non-government organizations (NGO) and people organizations (PO), with support from international donor organizations. It is a strategy used to combat poverty particularly in the rural areas.
There are several approaches to engaging in microfinancing. You can get accreditation from the NGOs like Grameen Bank, CARE Philippines and government institutions like Small Business Guarantee and Finance Corporation (SBGCF). Partnering with these organizations will provide you logistics, knowledge and support in pursuing this endeavor.
Can you go it alone?
However, you can also decide to go at it alone – but with a lot more work, more risks and more resources.
One of your primary concerns will be to establish a system or mechanism that would allow your micro-loan clients to repay their loans on time. Two key microloan policy strategies recommended by experts (including USAID) are cash flow-based client analysis and “zero tolerance” for overdue repayments.
With cash flow-based lending, you should get a clear picture of revenue streams of your potential clients. You can determine their actual and potential income, and, with this information in hand, determine how much of a loan the potential clients can afford to handle. You can also devise a loan repayment schedulethat fits the clients’ cash flow.
Select your clients carefully.
Given this, it is imperative that you select your clients very carefully. Your client must have the ability to pay you back with cash, not with chickens or vegetables harvested from their gardens. Like the “Bombays,” they offer their money to legitimate small businesses or to someone who wants to make an honest living through a means of livelihood, like sidewalk vendors, small carinderias, and stalls in the public markets.
Regarding the “zero tolerance” policy, you must view micro-loans in the same way the banks view the loans that they provide. It is not a social service. You must be “zero tolerant” of any late payment, or non-payment of loans regardless of any contributing circumstances. With this approach, it can be very profitable for you. Interest rates on micro-loans must be market-driven, and must be high enough to allow you to cover all costs associated with the loan. Here in the US, many micro-lenders even charges the same kind of interest rates charged by credit cards.
Providing microfinancing, however, is a big undertaking. You must have enough support and logistics to allow you to seek out clients (which would be very easy to find in the Philippines), however to ensure repayment and pursue laggard clients is another story. Seek out specialized training in operating a successful microfinance operation (the Asian Institute of Management in Makati offers such courses). Remember, you must learn not only to run a financing operation, but how to provide excellent client service and nurture long-term relationships with your microfinance clients.
Your capability to collect repayments will depend on your ability to establish a presence among your clientele. If you have a wide clientele located in Metro Manila, Laguna, Iloilo or Baguio, it may be difficult to collect back on your loans.
Monitor and Track Repayments
- An important part of your logistics is software that will allow you to keep track and monitor repayments. Your software must instantly flag any instance of late repayment, or non-repayment.
- Given that microfinance loans are typically of short duration (usually some where between 30 days and six months), and frequently call for daily,weekly or bi-weekly repayments.
- Keeping track of payment due dates for hundreds of clients is a demanding task, and can only be achieved if you have a good IT infrastructure.
- If you cannot acquire this kind of software, a very tight record keeping is necessary to allow you to monitor payments and repayment schedules. The “Bombays” keep a small notebook to record the accounts of all their clients.
Another more secure example of Microlending is the pawnshop. If your money is sufficient to capitalize one, this is the safest way to go because you don’t lend any money without collateral. This business require accreditation from the Central Bank as a financial institution, you may check the rules and regulations from there.