Bold reforms for equitable access to finance by promoting microfinance

By Donald Lambert - Principal Private Sector Development Specialist Asian Development Bank

Vietnam’s capital markets are on a positive trajectory. Its corporate bond market is growing much faster than neighbouring markets. The banking sector is healthy, reflected in a positive outlook from Moody’s earlier this year. Moreover, fintech is accelerating, with the State Bank of Vietnam currently licensing over 40 companies as payment intermediaries.

It is surprising, then, that microfinance institutions (MFIs) are not enjoying similar dynamism. Less than 1 per cent of the population are clients of MFIs, and despite this low base, growth is slow.

Meanwhile, MFIs are booming in neighbouring countries. The Philippines and Cambodia, for example, each have three times as many microfinance clients and four times as many microfinance loans outstanding.

To close this gap, MFIs in Vietnam must expand their clientele. The number of microfinance clients increased on average by only 2 per cent from 2017 through 2019. Although outstanding loans increased substantially faster, 93 per cent of this portfolio growth was concentrated in the two largest MFIs. More importantly, rapid asset growth without corresponding growth in the number of clients indicates that this growth was driven by providing existing customers with larger loans. Re-lending to reliable customers is a good banking practice but will do little to improve financial inclusion.

Vietnam aims to expand credit to 70 per cent of the adult population. To help achieve that goal, the seven leading microfinance organisations would need to grow their client base by 9 per cent annually during the next five years. But client numbers are growing by only 2 per cent. To close the gap, the incumbents must not only expand their client base more quickly, but Vietnam also needs to attract new entrants.

Yes, fintech will be able to reach some of the unbanked. Yes, banks are increasingly extending services to lower-income clients, and yes, consumer finance is one of Vietnam’s fastest-growing market segments.

However, despite their low penetration, MFIs have an important role. They provide not just access to credit but also professional networks and education. They are often willing to work in rural areas where other providers would find the operating costs too high, and they are particularly important for women, many of whom find MFIs the most inviting entry point into the formal financial system.

The disconnect between MFIs’ slow growth and the dynamism elsewhere in the Vietnamese economy is the product of MFIs’ orientation. Despite becoming a middle-income country, most MFIs tend to operate like nongovernmental organisations (NGOs).

NGOs birthed the microfinance movement. But as microfinance has matured, many MFIs outside of Vietnam have recognised that they can reach more clients by adopting a commercial orientation. Although this can mean higher interest rates for clients, more clients are better served because commercially-oriented MFIs can attract the leadership to drive growth and the capital to fund that growth.

For MFIs in Vietnam to flourish and grow their client base, regulatory changes are needed beginning with their ownership, as argued in a recent ADB publication. Currently, a political or sociopolitical organisation must be an MFI’s largest shareholder. But such organisations are unlikely to have the business or financial acumen to drive growth. Additionally, they have limited financial capacity to inject capital, effectively limiting an MFI’s growth to what it can retain from its profits.

Ownership restrictions deter foreign investment. Presently, there is no possibility of a dynamic MFI from another country entering Vietnam’s market. The only foreign investors allowed are foreign banks, which have traditionally shunned investing in MFIs. Moreover, their shareholding must not be larger than that of political or sociopolitical organisations – a further deterrent.

Regulatory changes are also required on how MFIs operate. Loans are capped at VND50 million ($2,170). As microbusinesses grow, MFIs cannot retain them, and small businesses that have slightly larger borrowing needs must look elsewhere.

There are strict limits on adding branches and operating across provinces. These rules prevent MFIs from expanding geographically, which diminishes both their operational efficiency and attractiveness to capital providers.

Speaking of capital, few if any lenders will bank an unlicensed MFI. To get around this, many countries have introduced tiered licensing frameworks. The broadest licence may allow an MFI to accept deposits whereas a narrower licence confers fewer liberties but concurrently entails less regulatory compliance.

In Vietnam, there is only one category of licence. And out of the over 180 microfinance organisations in Vietnam, only four have obtained it.

There is a perception that MFIs in Vietnam have been held back because they cannot access finance. I disagree. Although there may be scope to designate Vietnam’s Cooperative Bank or other state-owned financial institutions with a mandate to lend to MFIs, regulatory changes that broaden ownership and operations will do more to empower their growth.

As they grow revenues and profits, investors will take notice. International microfinance investment vehicles will expand their limited presence. As has happened in other middle-income markets, MFIs will eventually access wholesale loans from international and domestic banks. In some markets, MFIs are even able to issue bonds.

None of this means that all MFIs must abandon their nongovernmental orientation. The exigencies of expanding access to finance are such that both commercial and nongovernmental operating models should coexist.

A lower-middle-income country should not have 10 times as many licensed payment intermediaries as licensed MFIs. Vietnam needs to take regulatory action to empower microfinance so it can do its job ensuring everyone benefits from economic growth.