Case of Mongolia

While many of these ICT applications are highly innovative, they often cannot overcome the specific barriers that limit the provision of microfinance in rural areas. Furthermore, some ICT applications require a certain level of infrastructure, an enabling environment, institutional capacity and human resources that may not be available in a developing country. An appropriate ICT solution needs to be identified through a detailed analysis of a context in which it will be applied. This section describes the socio-economic conditions in Mongolia, and the challenges and gaps in extending microfinance services in rural areas in the country.

Mongolia is one of world's most sparsely populated countries, with an area of 1.6 million square meters and a population of 2.5 million. The country is divided into 22 aimags, the second largest administrative division in the country, and the 22 aimags are sub-divided into 321 soums. 47% of the total population of Mongolia resides in soums (equal to a village); 11% are in aimag centers (provincial centers), and 42% are in the larger cities (Ulaanbaatar, Darhan and Erdenet).

One of the biggest challenges for financial development in Mongolia is the low population density. Mongolia has a population density of only 1.6 people per square kilometer, which is one of the lowest densities in the world.8 It is much lower in rural areas. 65% of the total population lives in urban areas9, while the total area for the rural market is 86 times larger than for the urban market. Due to the low population density and poor infrastructure, rural people have difficulties accessing basic services, including financial services.

Although the Mongolian economy has begun to stabilize after severe national crises during the early and mid 1990s, the transition from a controlled economy to a free market one has perpetuated wealth disparity and created unemployment. As in other formerly socialist countries, the transition left many state employees jobless. The social safety net made up of pensions, benefits, health care and education suffered severe cutbacks. As a result, large numbers of people in both small rural towns and more urban areas have only modest, informal and sporadic income opportunities. The section of the population that falls into this category has increased significantly since a series of winter disasters, or dzuds, between 1999 and 2002, during which over one third of all livestock (the mainstay of the rural and national economy) died. Tens of thousands of herders, especially those less experienced pastoralists, who only began practicing animal husbandry after losing government jobs, were entirely or almost entirely dispossessed, and moved, jobless, to villages (bag center), towns (soum center) and cities (aimag center, capital city). Recent estimates suggest that Mongolia's rural poverty ratio has increased (from 33% to 43% over the years 1999-2003).

The Mongolian banking sector, and in particular, the micro finance sector, has grown rapidly since the late 1990s, in the aftermath of the bankruptcy of a majority of the banks. Yet most of the fast emerging financial service providers are concentrated in urban areas. Only two banks in particular, XacBank and XAAN Bank, have outreach to rural areas at the soum level. They claim to serve around 100,000 micro clients between them. However, most of these micro loans are disbursed primarily through their branch offices in the capital city or at the provincial centers (aimag), excluding those in remote rural areas (in soums and bags).¹⁰

Financial institutions in Mongolia have been wary of rural and poverty lending. One of the primary reasons, among others, is attributed to higher transaction costs due to low population density and poor infrastructure. The market size and the density of clients are important factors for successful microfinance. When clients scattered over a large geographic area and financial institutions’ local offices fully controlled and supervised by central offices in the capital, as is the case in Mongolia, transaction costs are obviously very high. Thus, MFIs must find a special delivery mechanism to provide services for people living in rural areas in a sustainable manner.

XacBank and its rural finance strategies

XacBank is a leading microfinance institution in Mongolia. It had its beginnings in the MicroStart Mongolia project funded by United Nations Development program (UNDP) in 1997. XAC, the finance company which grew out of the project, became a very dynamic and entrepreneurial MFI using a unique individual loan methodology.¹¹ In just 2 ½ years of operations, XAC demonstrated an impressive performance. The institution established a network of 13 branches, managing a loan portfolio of US$854,000 and serving over 3,600 clients. Furthermore, XAC maintained excellent portfolio quality (Portfolio at Risk of 1 day or more late is 0.3% as of April 2001) and reached operational self-sufficiency after 8 months of operation. In October 1999, XAC registered as the nation’s first non-bank financial institution. In the last quarter of 2001, XAC merged with Goviin Ehlel (Gobi Start)12 and as a result, XacBank was created. The banking license was obtained in January 2002. Now, XacBank, the banking subsidiary of XAC-GE group, is incorporated as a limited liability commercial bank with a license to conduct banking activities. Headquartered in the country’s capital Ulaanbaatar, XacBank operates branches in all of the provinces (aimags) of Mongolia.

As part of its mission, XacBank strives to continue its strategic focus on rural markets. In 2002, the Bank piloted an agricultural lending program in six aimags and disbursed loans of USD 42.5 – 12,755 primarily for agriculture. In 2003, it opened five new branch offices, making XacBank the third banking network with a nationwide presence. At the end of 2003, 21 branches (65 percent of all branches) were located in each of the aimag centers (Figure 3 [ PDF 152.6KB | 1 page ]). The clients served through these branches comprise 62 percent of total borrowers.

In June of 2003, the Bank activated its facility under IFAD’s Rural Poverty Program in collaboration with the Government of Mongolia. This program was targeted toward Arhangay, Bulgan, Huvsgul and Hentiy aimags, which are mainly agricultural and livestock breeding regions. 2, 435 loans totaling USD 1615.64 were disbursed in the four aimags.

Compared to the banking sector as a whole, XacBank has a larger share of the market in the rural areas (see Figure 4 [ PDF 88.5KB | 1 page ]). When reviewed aimag by aimag, XacBank has gained an increasing share of the lending market. However the rural clients are currently served by branches located in the aimag centers. Yet, the majority of the rural population lives in soums outside the aimag centers. Only 1.4% of XacBank borrowers are herders, and loans for livestock account for only 0.8% of the total portfolio as of December 2003 (See Figure 5 [ PDF 92.8KB | 1 page ]).

With the increasing competition in the financial sector and rapid growth of MFIs in urban areas, XacBank is feeling the pressure to expand its outreach into rural areas, especially to small farmers and herder families beyond aimag centers. Having attracted significant social investment, XacBank also feels the pressure to demonstrate its commitment to serving communities with little or no access to financial services in rural remote areas.

Traditional branch offices are established at the aimag center level. With an exception of three large soums, there is no branch operation at the soum level primarily due to the limited economies of scale, high transaction cost, limited connection to transfer transaction data and lack of qualified human resources to serve as a bank staff.¹³ In order to break even, it is estimates that a branch needs a population of at least 10-20 thousand. Yet, a typical soum has a population of 2500 people, of whom 600 are potential borrowers. Average soum is 150 km far away from the aimag (province) center.

In order to extend its financial services to the rural remote areas, XacBank is experimenting with two innovative approaches. They are described below.

Franchise model

In order to reach clients in soums where opening a full-fledged branch office is not justified economically, XacBank believes a local savings and credit cooperative (SCC) is the most feasible option. SCCs are important partners for expanding microfinance outreach as have a base in the local community and potentially have low administrative costs. However to become an effective outreach strategy in rural areas, limitations of SCCs need to be addressed: such as weak governance, limited financial management skills, and lack of experience in demand-driven product development. To address these limitations intensive capacity building is necessary at least at the beginning. XacBank has chosen to use a franchise model to support local SCCs as a vehicle to extend its financial services to rural remote areas.

By using SCCs as its franchisees, XacBank will not need to establish fully-fledged branch offices in remote areas. Instead, the existing branch offices at the aimag (province) centers will provide monitoring and supervision, review financial statements and portfolio reports (similar to internal audit), and provide advice and guidance. On the other hand, the franchise SCC will review and approve loan applications on its own independent of XacBank branch staff. The SCC has an advantage in terms of having information on the behavior of potential clients and their capacity to absorb credit as well as enforcing loan repayment through informal mechanisms, such as peer pressure and a close follow up.

The start-up cost for establishing a franchise includes the salary and per diem for three staff persons for 5 days in the field: after this first time, the visits will be for two days once a quarter. Four days are spent on training and a local SCC, which is interested in becoming a XacBank franchise, is expected to start with a total asset of US$2,000. In order to increase the loan capital of the franchise, XacBank provides a wholesale loan (initially US$3,000). Usually, SCCs want to take more wholesale loans. To give an incentive, XacBank commits to lend 80% of the total equity. There are other incentives to increase the equity capital and expand the number of members.¹⁴

XacBank experience with the franchise model has demonstrated two key difficulties:

• Start up cost is high due to intensive capacity building, including promotion, training and technical assistance in establishing and strengthening the local Savings and Credit Cooperative who will become the franchise of XacBank. In Mongolia, the cooperative model is just emerging as a rural development strategy and it requires a national level effort to provide extensive support. The franchise model does not break-even in the short run, so there is a need for a subsidy to cover the capacity building costs.
• Commitment and buy-in from the local community members and key stakeholders is crucial. The final outcomes do not depend on XacBank alone, but also on the commitment and interest of local stakeholders and community members. There are also issues of politics, which can influence the running of the co-operative.

A short pilot of the franchise model has demonstrated that in Mongolia the franchise model would not be able to break-even within a year. Therefore currently mobile banking is being used as a transition strategy with a view to eventually introducing franchising after mobile banking breaks-even in a given soum.¹⁵

Mobile banking model

XacBank introduced mobile banking as a transition strategy before the franchise model becomes sustainable. There are mobile banking services in 120-130 soums as of September 2005.¹⁶ Most of them are operating profitably. Only those who have started recently (about 2 months ago) have not yet made a profit. On average, after 5-6 months, a mobile bank breaks even. A portfolio of $40,000 in a given soum is a sufficient scale to break even. XacBank is currently giving priority to introduce mobile banking in soums with a population of more than 3,000 with an initial portfolio of $20,000.

A typical mobile banking crew consists of a driver and two credit officers (one for micro credit and one for SME loans). They travel by a Russian jeep from a branch in an aymag center to soums, usually 50-100 km in distance, once or twice a month. During their visit, the mobile banking crew meets the Loan Approval Committee (LAC) members, reviews the loan applications (which are received by the LAC members between the visits), evaluates the collateral, makes a final approval of the loans together with the LAC, and disburses the loans. Since the loan repayment is scheduled once a month, the mobile bank collects the repayment during their visit. Each visit takes about 1-2 days in each soum.

A loan approval committee (LAC) is formed at the soum level. It consists of three members. Criteria for selecting LAC members are:

• Age: 40 years or older
• Residency: many years of stable residency in the community
• Work experience: representatives from government agencies (such as school teachers and local officials) and representatives of the community
• Knowledge of and well-respected in the community.

LAC members are responsible for:

• Product promotion
• Distributing loan applications
• Distributing repayment schedule
• Monitoring loan performance
• Collecting late repayments and transfering to the branch through the Agriculture bank branch in the soum (Repayment, if paid on schedule, is collected by the mobile bank.)
• Receiving loan applications
• Calling and informing the branch about loan applications
• Reviewing loan applications and approving together with the mobile bank crew.

LAC members are paid based on their portfolio. Below is the current incentive chart:

See Table 3 [ PDF 115KB | 1 page ]

The total cost for running a mobile banking crew (assuming two visits per month per soum) and hiring LAC members (3 members per soum, assuming anaverage portfolio of USD5652) is estimated to be USD 208 (approximately). It is estimated that using this approach XacBank, on average, generates revenue of approximately USD 479 per month (assuming two visits, each approving 20 loans or USD 5,952 in loan portfolio, at an interest rate of 3.1-3.5% per month, charging 0.5% of the loan amount for loan fee, and a fee of 66 cents per loan application form).

While the mobile banking approach appears to be an effective transition strategy, it poses a serious challenge regarding the security of the cash carried by the mobile banking unit, as the portfolio grows. Also, it is only a temporary strategy because the mobile bank visits any given soum only once a month, hence offers a limited access to clients. This limited presence in the local areas does not allow XacBank to mobilize savings. As concluded by Hirschland (2003) easy access and proximity are considered as one of the most important factors that poor people consider in making decisions on savings. Therefore, XacBank needs to find a solution that will allow them to have closer and more convenient access to financial services for the poor at the soum level and beyond, so as to increase its savings mobilization. Furthermore, in order to exit the mobile banking and transition to the franchise model, XacBank has to find solutions to cut down cost, improve efficiency of staff, and reduce cash transactions.

The next section explores some promising ICT solutions that may enable XacBank to extend its microfinance services to rural remote areas on a sustainable basis.

Download this Discussion Paper [ PDF 626KB| 34 pages ].

Comment(s)

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1. Pratyush Agarwal
   (posted 12 June 2009 / 03:20:06 PM)
   
   A very good paper! It recognizes and abridges the technological usage for the bank. But, It has not dealt on the possibilities of using land-line phones, a prevalent technology in rural areas.