What Microfinance Institutions Can Learn from the German Savings and Cooperative Banks of the 19th Century

By Reinhard H. Schmidt

The German savings and cooperative banks of the 19th century were precursors of modern microfinance. They provided access to financial services for the majority of the German population, which was formerly excluded from bank funding. Furthermore, they did this at low costs for themselves and affordable prices for their clients. By creating networks of financially viable and stable financial institutions covering the entire country, they contributed significantly to building a sound and “inclusive” financial infrastructure in Germany. Looking back at the history of German savings and cooperative banks and combining these experiences with the lessons learned from modern microfinance can guide current policy and be valuable for present and future models of microfinance business.

Microfinance in Germany in the 19th century

The economic, social and political situation in Germany in the early and again towards the middle of the 19th century was largely similar to that in most developing countries in the 1970s when modern microfinance was first implemented by Muhammad Yunus. The few existing banks were neither willing nor able to offer financial services to the general public. Funding for poor people and small businesses in agriculture, trade or handicraft could only be obtained from money lenders or friends and family.

The first savings banks in the late 18th century and the first cooperative banks in the mid-19th century specialized in a dual sense: At the time they started their respective operations, the savings banks only took deposits whereas cooperatives only granted small loans. Both offered their services to really poor people or really small businesses in the region of their operation and not to the general public. They did not intend to generate profit but to provide social support and public education instead.

In the early to mid-19th century the institutional form of savings banks has been changed from private non-profit to community-based or municipal. Subsequently, savings banks were assigned the additional roles of building a stock of capital that could be used locally and of granting loans to the entire local community, including local businesses. Until today, serving their respective region, its economy and the entire population is the overarching purpose of savings banks. A profitable business is of course a precondition for being able to fulfill this mandate. Thus, profitability is in a certain sense also an objective, but, at least in principle, one that ranks behind the mandate to support people and region.

The first German cooperatives were funded by charitable institutions or local dignitaries. When this funding turned out to be insufficient to meet the clients’ credit demand, the cooperatives started to also mobilize savings from their clients and used them to lend the money to other clients. They also opened up to a more general local clientele. Thus, in an even shorter span of time the cooperatives undertook a similar strategic reorientation as the savings banks: From at first being highly specialized financial service providers, they soon turned into genuine financial intermediaries that would today be called “inclusive” providers of financial services; and this was most likely the reason for the stunning success of both groups of popular banks in Germany in the 19th century.

Modern microfinance

The first microfinance institutions that came into existence in the late 1970s and early 1980s, at first pursued a poverty-oriented development finance policy and were also highly specialized in a dual sense: They only offered and granted loans to really poor people and very small businesses. This was extremely inefficient. They had annual costs for administration and loan losses that came close to the outstanding volume of their loans. Neither could microfinance in this style reach a significant number of people nor could any appreciable impact be expected because of the small available credit volume. Having an impact on social and economic conditions presupposes operations of at least some scale as well as a “sustainable” business model that does not depend on a permanent stream of subsidies and possibly even generates a moderate profit.

Rather soon, some microfinance institutions tried to overcome this deficiency and adopted what has come to be called a “commercial approach”. Those that followed this approach around 1990 have grown rapidly since. The growth alone lowered the unit costs of small loans considerably and enabled them to have substantial economic and developmental impact. Only ten years later, this development led to a real microfinance boom.

The boom did also have its downsides which cumulated to a microfinance crisis shortly after the outbreak of the general financial crisis in 2008. The initial public offerings of the Mexican microfinance institution Compartamos and its Indian peer SKS-Microfinance for instance attracted hedge funds, private equity and other investors who were only interested in making as much profit as possible and did not care about social and developmental effects. Further, the merit of creating and supporting thousands of extremely small “enterprises” has at best a limited developmental impact. There is also a risk of over-indebtedness and increasing default rates if too many credit facilities are offered and people can easily take out several loans from different lenders. Hence, a more “inclusive” approach, where institutions provide their services to the entire local community including small and even some mid-sized enterprises, proved to be more successful. This idea of “inclusive finance” which benefits the entire population has now been widely accepted.

What can we learn from history?

All microfinance institutions which are considered successful have chosen a path similar to the German savings and cooperative banks of the 19th century. Even though most of them had started to operate as dually specialized institutions, they all changed their strategy to become true financial intermediaries, which grant loans and also mobilize clients’ deposits, as well as “inclusive” local banks, serving a more broadly defined local clientele to increase the scale of operations and to stabilize the banks’ revenue base.

Hence, important conditions of success are that relevant institutions do not specialize, neither in terms of services or clientele. Instead, they should be set up as true financial intermediaries that offer loans, take local deposits and provide additional elementary financial services such as payment services. Both the history of savings and cooperative banks in Germany and the history of modern microfinance clearly support these general conclusions, which may provide a guidance for current development finance policy and practice.

 

Literature

Schmidt, R. H. (2017), "Microfinance – Once and Today", SAFE White Paper No. 48.

Schmidt, R. H., Seibel, H.-D. and P. Thomes (2016), “From Microfinance to Inclusive Banking: Why Local Banking Works”, Wiley-VHC, Weinheim.

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