Deutsche Bank, one of the first financial institutions to engage in the microfinance sector and one of the leaders in the industry today, spoke with Shafiq Choudhury, the founder and President of ASA, which is one of the largest non-governmental organizations (NGO) in the world. ASA serves more than seven million clients in 72,000 villages throughout Bangladesh. Although a non-profit organization, it generates between US$ 10 and 12 million in profit, which goes right back into the company, and has assets of more than US$ 450 million.

ASA operates not only in Bangladesh but is also replicating the ASA model worldwide through a commercial fund of about US$ 125 million. Through the ASA Foundation, in which Deutsche Bank is one of the founding partners, Choudhury has established an aid program whose aim is to increase the efficiency of the least developed microfinance institutions (MFI). He has also launched the ASA University, which enables young people to obtain a quality education at low cost and also offers subsidized education to the children of ASA staff and its borrowers.

Deutsche Bank cooperates with more than 100 microfinance institutions in 41 countries today. Asad Mahmood, Managing Director Global Social Investment Funds of Deutsche Bank in New York, interviewed Shafiq Choudhury in Dhaka, the capital of Bangladesh.

Mr. Choudhury, you started doing microfinance through ASA in 1992, and within a short period of time, you matched or exceeded some of the microfinance institutions that have been operating for much longer. What makes ASA so successful?
The main reasons behind the exponential growth of ASA are our simple operations and products. When we started microfinance in 1992, we focused on minimizing the time it takes to deliver our product, the workload of our loan officers, and our paperwork, and on making our operations as simple as possible. We try to be innovative across all processes, from delivering loan products and managing our books right up to purchasing and maintaining our office equipment. In short, our entire approach to microfinance differs from the traditional model.

So standardization is a priority?
Definitely. Everything is standardized: the size of our loans, their installments, even the goals for our loan officers. Standardized operation gives us the ability to move freely and quickly. It’s like photocopying – very swift and efficient. And it’s fundamental to our low-cost structure and ability to generate a profit.

You embody both the commercial and social element of microfinance. You have an astute eye for making your institution profitable and efficient. At the same time, you are focused on the social mission. How do you balance the profitability needs of your commercial investors with the social objectives of ASA?
I think microfinance is both commercial and social; the two are intertwined – like DNA. When we started, our focus was on efficient microfinance. At that time, we did not think a lot about commercialization. Our basic objective was to make our operation very lean to cover our costs and generate a profit. This profit could be used to grow our loan fund and reduce the interest to our clients. That was our objective. In the beginning, we did not fully understand the commercialization principles, as our roots were in an NGO. But we managed our operation like a business. I believed that if ASA followed a commercial approach, we could gain access to far more capital and thus be able to serve more poor people.

Do economies of scale play a role?
Yes, with scale we can reduce interest rates and still generate bigger profits that flow back to ASA. The benefit is that we not only lower interest rates but also reach considerably more poor people. In our mind, that was the benefit of commercialization. At the same time, we learned that we had to be careful about commercialization, which also has a different meaning: maximizing profit. Because we do not agree with this approach, we choose investors who are not totally commercially oriented.

But these investors still expect dividends, don’t they?
Their main objective is to help the poor. We provide a dividend in the form of efficiency. We don’t charge the poor more interest. Rather, we want to ensure that more and more poor are reached and the scale of the business grows. We believe that if we go for more scale, we can generate more profit. With that, we can enhance returns to our investors. The question is, what type of investors are we seeking as partners? If they are too commercially oriented, we could have a problem.

Have you had any problems to achieve this balance?
So far, we are maintaining a good balance between both commercial and social goals. The for-profit entity ASA International is benefiting from an estimated US$ 125 million commercial equity fund that we raised.

Do you think that a focus on pure commerce and profit can achieve scale faster than a hybrid approach that combines commerce with a social mission?
While interest rates matter to poor people, access to money is far more important to them. Because so many poor need money, it is true that they will accept higher interest rates. At the same time, I can’t agree that you can grow fast only with a purely commercial approach that allows you to charge whatever interest you can. I don’t think this will yield good results.

ASA generates annual profits of between US$ 10 and 12 million. Your rates are reasonable. In fact, you’ve reduced your rates twice. But is there room to reduce to the point where you’re breaking even and not generating profits?
We can’t pursue a break-even strategy because we have many poor people in Bangladesh. First of all, if we don’t generate any profits, we can’t increase our client base. Second of all, we need some loan-loss reserves for protection against future risk. That is the reason why we also need to make a profit.

Don’t you think that development agencies should have a role in providing the kind of capital you need for expansion and risk mitigation?
No. Instead, I propose that we use savings deposits to reduce the funding cost and to lower interest rates. Our funding cost from banks is 12 percent to 13 percent. We can raise deposits at half the cost and then lend it to the poor at cheaper rates while still maintaining our profit.

Regulators have a responsibility to protect the financial system. But don’t they also have a fiduciary duty to provide access to financial services to the vast majority of the population with no access to credit or a place to put their savings, even if that means allowing relatively small and unregulated microfinance institutions to collect deposits?
We tell regulators to come and do their fiduciary work, their monitoring and tracking. But they still don’t allow us to retain savings. They don’t see the situation the same as we do. To them, if there is no access to credit, so be it. Historically, the reason why the industry has charged higher rates, has been to generate capital because there was no other capital available. It’s been a pragmatic approach: either you do nothing or you do something that has a higher cost but still has many benefits for the poor. I definitely believe we should do something rather than nothing. Let me put it this way: If you are thirsty, you want water. You don’t question whether it is purified or not. Then you ask whether it is cold or bottled. We believe if you insist on bottled water from day one, you can kill the thirsty person. It’s the same in microfinance; I think there are stages. Poor people are sensitive to the level of interest rates. If you increase them by two percent or three percent, that hurts them; but their need is great and, consequently, they will borrow at higher rates.

In Ghana you are charging up to 80 percent effective interest rates. Are you ever asked to justify these rates?
If you look at the cost structure of doing business in Ghana, you will understand. In Ghana, our funding costs can be as high as 25 percent. Manpower costs are much higher, we can’t find qualified people, and our human resource costs are six times higher than in Bangladesh. Default risk and provision costs are also higher. Of all African countries, Ghana has the highest default risk.

These are complex, technical issues that are difficult to understand and thus easy issues for politicians to exploit. Are there risks?
Yes, there are. If you want a risk-free choice, then do not lend in Ghana. But I don’t want that. Gradually, repayment behavior will change. Gradually, borrowing costs will reduce and Ghana will have more educated people. If we are patient, we can reach that state. But if we are not and fear criticism, we will stop all activities and not help the poor.

Would you agree that the microfinance sector doesn’t talk openly about interest rates?
As far as interest rates are concerned, the microfinance industry has traditionally not been overly transparent. But here’s the problem: people only see how much you charge. They don’t really want to know about your funding costs, the level of inflation, human resources costs, and a host of other factors. That’s why we are reluctant to talk about interest rates.

But surely regulators and policymakers understand interest rates. Don’t they want more information?
If you make a serious effort to communicate with regulators and government officials, it’s still very difficult to satisfy them. When it comes to helping the poor, most of them consider this assistance should be done as charity or should be free of charge. There is also much mistrust. Government officials and politicians suspect we are making money to keep it for ourselves. Many don’t really understand microfinance and are not willing to think in new ways outside of charity when helping the poor. This is the situation in most countries I work in.

What steps could alleviate this tension?
I believe that we must simply continue our work because any dialog with government officials and politicians is more difficult than demonstrating our case. As long as the poor are being served, they will support us.

What do you see as the greatest emerging risk for microfinance?
The risk of client over-indebtedness poses a significant potential risk. Although this risk is still not prevalent, we are seeing early signs of it. Clients are borrowing from multiple microfinance institutions. In effect, several of them share the risk of a single client, much like syndicated loans. The borrowers who have overstretched their payment capacity are the real risk. They are the borrowers who borrowed from one microfinance institution to pay another.

Is your portfolio being affected now?
We’re not facing significant problems, and our portfolio-at-risk is less than four percent. We are taking steps to reduce our exposure either by restricting the saving withdrawals of clients we consider over-indebted or by dropping them altogether. I think it is important to raise awareness about this potential emerging risk. Establishment of a central credit bureau is also a long-term solution. Governments, development agencies, and banks such as Deutsche Bank have a critical role to play as initiators. We can certainly learn from the experience of countries such as Bolivia and Peru that have faced over-indebtedness issues in the past.

Do you think poor people are being abused by microfinance as it grows? Or is it still having a positive impact?
I believe people who intentionally abuse the poor are few. Overall, it is a positive picture, but just like anything else, microfinance also has a dark side.

Now that microfinance is in the limelight and pure commercial interest has been developing, how do you think the industry can protect itself?
There are two main components: One of them is to establish a code of conduct or principles for client protection that will spell out the major issues as an industry code. I think Deutsche Bank took the lead in organizing a meeting of microfinance leaders last year in Pocantico, New York. The Pocantico Declaration has served as a staging ground for the code of conduct. The second component: once the code of conduct is defined, we need to form a network at the national level and at the global level that will validate the code of conduct and ensure that it is being adhered to.

Why is microfinance different from traditional money lenders?
The one and only advantage of traditional money lenders is that they are available 24 hours a day. Their disadvantages are many; they charge, for instance, 300 percent to 350 percent interest in Bangladesh, and even more in other countries. But the main difference between money lenders and MFI is that the institutions are socially motivated and treat their clients with respect and dignity.

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