Why linking to savings groups may be key to increased bank value

by 11th Aug 2015
Unlocking the potential of savings groups: A member of the Yesu Amala VSLA group locks the group's shared safe during a meeting of the group's members in Busia District, Eastern Uganda Unlocking the potential of savings groups: A member of the Yesu Amala VSLA group locks the group's shared safe during a meeting of the group's members in Busia District, Eastern Uganda

We at CARE International are excited by some recent research by McKinsey, the leading global strategy consultancy, which highlights that “a bigger deposit base routinely results in a higher valuation [of a bank]. The data show that this is a very reliable driver of an improved market-to-book ratio.” We think that the research adds considerable weight to the business case for banks in developing countries to add large amounts of new savers who are currently in informal savings and loan groups.

CARE International has been working in financial inclusion for more than 20 years, focusing on our Village Savings and Loan Associations, which now have more than four million members in sub-Saharan Africa alone. Some years ago we started work on linking these groups with banks as group members need greater security for their savings, and also need more sophisticated credit products as their financial literacy and financial needs develop. However, many banks are sceptical about the attractiveness of this market – the currently unbanked are seen as being hard to reach, expensive to serve and of low value.

However, the McKinsey research presents evidence that a key consideration in the minds of bank senior executives (and indeed, the minds of shareholders) – the market valuation of the bank, particularly in comparison to its accounting valuation – is significantly improved by accessing new deposits: “we found improving the size of the deposit base relative to assets to be a uniformly powerful metric; a bigger deposit base routinely results in a higher valuation”(emphasis added). This seems to point to the idea that bringing new savers into the bank, such as by linking with savings groups and accessing their deposits, can significantly influence how the bank is perceived by the market and improve its value – surely a key objective for bank executives.

Now there are some caveats on this view. Firstly, the McKinsey researched is based on 80 European and North American banks, but our savings groups are in developing countries. Secondly, the McKinsey claim is based on an empirical review of these banks and does not provide an analysis of how increased deposits causes market valuations to rise. Thirdly, McKinsey classify “increasing deposits” as being of “high difficulty”.

Our belief however is that these caveats do not undermine the argument that banks in developing countries who link to savings groups and thereby tap into new deposits are likely to improve their position in the minds of investors and so see their valuations rise.

On the first point, one can only say that there’s nothing to suggest that developing market bank shares would be valued in any fundamental way that is different from their peers quoted in Europe and North America. But let’s go through the second and third points in some more detail.

Why would increased deposits cause bank valuations to rise?

McKinsey do not explain the link between deposits and valuations. However, it seems reasonable to believe that increased deposits are valuable to a bank because they provide a relatively cheap and low risk source of funds. Retail customers generally get paid little, if anything, for the money they leave in the bank, thus allowing banks to lend it out at higher margins than funds obtained elsewhere, such as in the wholesale financial markets.

Further, although money on short-term consumer deposit may initially look potentially volatile – after all, everyone can just turn up and withdraw when they want to – the reality of course is that, unless there is a run on the bank caused by a widespread loss of confidence in the bank, aggregating relatively small savings from a large number of customers smooths out the peaks and troughs, or at least shapes them into highly predictable phasing such as a peak at the end of the month when incomes are paid in.

Also of course, we could assume that a well-run bank will make money on providing its basic services to account holders; so increased deposits may well point to increased opportunities for service charges, thus defraying operational costs against higher volume of activity.

Therefore increased access to deposits points toward higher and more stable margins, and reduced risk – very attractive to investors.

McKinsey classify “increasing deposits” as being of “high difficulty”

So if you are a bank in sub-Saharan Africa and you are convinced by the previous points, how difficult is it to find these new deposits?

Remember that the McKinsey research was based on Europe and North America – very mature retail banking markets, where over 90% of the population already has a bank account. However, in developing countries the picture is very different: in sub-Saharan Africa, on average only 34% of the population has a bank account – and that number can be much lower in some countries.

So there is plenty of opportunity in developing countries. Yet aren’t these low-income countries where many people never have enough money available to open a bank account?

The ability of people with low incomes to save tends to be underestimated. Research for the Banking on Change partnership between CARE, Barclays and Plan revealed that members of savings and loan groups – once the group reached maturity (usually after about three years) and became linked to a bank – each had savings on average of $58 per year. There are around 10 million members of these savings and loan groups in sub-Saharan Africa. So that’s a lot of savings waiting to be deposited. And linking groups is more cost-effective than linking individuals, and is becoming more so with improved use of mobile banking products and increasing insight into the products and channels that work.

We therefore believe that banks in developing countries should be looking intently at linking to savings groups: not only can this provide attractive new sources of deposits, but tapping into those deposits is also likely to be highly valued by investors.

This blog was co-authored by Marco Bartholdy, who is an intern with CARE’s advocacy team.

Gerry Boyle

I lead CARE International UK’s policy analysis and advocacy around value chains and dignified work. I originally joined CARE as the Senior Policy Adviser on Private Sector Engagement. With the advent of our new Global Programme Strategy which put a particular emphasis on women’s economic empowerment, my focus changed a little, although I still work extensively with issues in the private sector and with CARE’s corporate partners.

Until recently I spent a lot of my time on financial inclusion, now looked after by my colleague Fiona Jarden. I also co-chair the Bond Private Sector Working Group.  Immediately before I joined CARE I worked for Oxfam as Head of Business Relations for about three years, but the vast majority of my career was spent as a management consultant including being a consulting Partner at Deloitte, where for a time I led Deloitte UK’s Consumer Business consulting practice, serving many major multinationals. My original degree was in Law from Oxford University, and in 2008 when I left Deloitte I did an MSc in Philosophy and Public Policy at LSE.

One good thing I've read

Amartya Sen’s Development as Freedom. It provides a framework for many people’s modern understanding of what is development, based on a profoundly human-centred approach rather than anything instrumental. And to check whether one personally is doing enough to fight poverty, I recommend Peter Singer’s The life you can save: Acting now to end world poverty – it’s very clear and easy to read but very challenging! Finally, Ha-Joon Chang’s Bad Samaritans: Rich nations, poor policies, and the threat to the developing world is a very readable guide to economic development which argues strongly against many of the prevailing orthodoxies.

Email: boyle@careinternational.org

Twitter: @gerryboyle10