Improving Access To Banking Without Sacrificing Profits

Even a bank serving the poorest communities can make big profits while making a difference in peoples’ lives and doing good for society, confirms new research from the University of Maryland’s Robert H. Smith School of Business. The research, published in the Review of Finance, explores a successful bank making an impact in poor, rural areas in Africa and is the work of Lemma W. Senbet.

Senbet, the William E. Mayer Chair Professor Finance and founding director of Smith’s Center for Financial Policy, for five years (2013-2018) headed the Africa Economic Research Consortium (AERC), the oldest economic research and training network in Africa. That prompted Senbet to expand his research work to Africa’s financial sector. He helped organize a team including five other leading finance researchers to work on African finance: Franklin Allen of Imperial College London, Elena Carletti of Bocconi University, Robert Cull of the World Bank, Jun “QJ” Qian of Fudan University and Patricio Valenzuela of the University of Chile.

In previous research, the group studied how countries on the continent stacked up against developing countries in other regions. They came up with a benchmark financial development line and saw that most African countries’ financial sectors are below that line. One country was close to the indicator line – Kenya. That prompted the researchers to take a closer look to understand why.

Senbet said the researchers looked to a very active Kenyan bank making a splash in the country’s financial sector: Equity Bank.

Equity Bank’s founders, Peter Munga and James Mwangi, saw an opportunity in rural areas that larger banks were ignoring. They took the startup bank into remote areas, adhering to local cultures, and reduced the requirements banks traditionally impose for customers to open and maintain accounts. They also made sure employees working in their community banks spoke the local language.

“We asked one basic question: ‘Is this bank making any difference?’ Has this bank enhanced access and inclusion for finance in Kenya?,” says Senbet. The researchers' analysis showed, undoubtedly, yes.

They looked at the number of people who had bank accounts and access to credit in Kenya and the demographics of those people and found that Equity Bank had made a big impact in increasing access to banking. The researchers found its presence increased financial inclusion by 31 percent of the adult population between 2006 and 2015, especially for Kenyans who were less educated, did not own their own home, and lived in less developed areas.

But was the bank making money? Senbet and his co-authors needed access to the bank’s private data to confirm the success of its business model.

“Something lucky happened,” says Senbet. He was invited to a 50th-anniversary event celebrating the Central Bank of Kenya, where he was serendipitously seated next to Mwangi, the CEO of Equity Bank. He helped Senbet and his co-authors get the data they needed to finish the research.

The research shows that the bank’s business model is highly effective, with branch-level profits rising in areas with a smaller number of operating banks. Equity Bank’s success was built on formalizing microfinance, the practice of giving very small loans to poor individuals and entrepreneurs who lack credit.

“Microfinance is not a panacea,” says Senbet. “It’s a high-cost proposition. Your objective should be to formalize that finance and integrate it within formal financial systems.”

Equity Bank became one of the largest banks in Kenya, listed on the Nairobi stock exchange. It expanded into countries outside Kenya -- Rwanda, Uganda, Democratic Republic of Congo, South Sudan.

“Now if you want to invest in very local areas in Africa, you don’t have to go there and lend money. You just buy shares of Equity Bank stock,” says Senbet. “The bank has a branching strategy -- they go after low salary, low income, underserved populations. If you look at their strategy, it stands out from other banks. But they don’t sacrifice profits.”

Read the full research, “Improving Access to Banking: Evidence from Kenya,” in the Review of Finance.