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Microfinance is supposed to be small, but Mongolia's microfinance specialist Xacbank has grown so fast it's now taking on the big banks at their own game.

Hutagt Ganhuyag is the founder and CEO of Xacbank and knows what it takes to lift yourself up by the bootstraps. His introduction to business was as a "shuttle trader" while still a teenager. Following the fall of the Soviet Union, Mongolians were the only people in the world who didn't need a visa to travel to either China or Russia; never good friends, the Chinese had to have visas to visit Russia and vice versa. These were the days when you could fly half way round the world for less than $50 and a few Mongol traders started buying cheap consumer goods in China and selling them in Russia. "The planes were empty and as the [Russian] state wasn't making consumer goods, we used to make a lot of money flying back and forth," says Hutagt.

After a few years buying and selling in markets, Hutagt took his first proper job as a junior floor supervisor on UlaanBaatar's newly opened stock exchange. The 17-year-old Hutagt had a ringside seat to the voucher privatisation of the entire economy in 1992. "Everyone got a voucher worth about $100, and 420 major factories and service companies were privatized in one day via the stock exchange," says Hutagt. "The advisors were a bunch of Harvard graduate students who used this as a nice laboratory experiment - but it was a big mess. There was lots of insider trading and corruption."

Hyperinflation hit in 2003, so Hutagt took his shuttle trade money and went to Hungary to finish his education. By the time he returned in 1998, half the banks in the country had gone bankrupt. However, liberal reforms introduced by the first democratically elected parliament in 1996 were beginning to bear fruit so Hutagt decided to set up a bank.

Small is beautiful

Still in his 20s, Hutagt launched Xacbank (pronounced "khas-bank" - the name is a play on how the transliteration of the old Cyrillic name appears in the Latin script) with less than $1m in donor-aid from the likes of the EBRD, IFC and OPIC, and started lending $50 to $5,000 to would-be small business people. "The loans are there for people that want to help themselves. You can't make a loan to someone who doesn't want to work," Hutagt says pointing to his bag that was produced by a collective of 120 handicapped women that set up a firm with a Xacbank loan. The bank grew at an astounding rate, with assets trebling every year for the first eight years. More recently, this heady rate of growth has tailed off and now the assets are "only" rising by 60-70% a year.

Microfinance is the provision of tiny loans to the poor that are supposed to enable them to make a living for themselves and escape the poverty trap. The Bangladeshi professor, Muhammad Yunus, made the concept famous with his Grameen Bank and won the Nobel peace prize in 2006 for his efforts. However, Hutagt says that the success of his bank is a testament to the fundamental differences between Mongolia and Bangladesh. "The majority of the population in Bangladesh can't read and most of the customers of Grameen Bank are still poor. Theirs is a chronic poverty," says Hutagt. "The poverty in Mongolia is a transitional poverty that was cause by the collapse of the system. However, the Mongolians are well-educated and able to work. We have an urban poor who want to do something with their lives, but lack the access to finance. This is why Xacbank is the '3G' of microfinance."

Hutagt lists three phases to the development of microfinance: access to funding; building a sustainable and profitable business; and competing with the mainstream banks. It is the last stage that makes his bank different from those on the Indian Subcontinent.

The difference is important. Hutagt wears expensive suits, drives a fancy car and the bank's office is on Prime Minister Amar's Street, one of the best locations in Ulaanbaatar. He looks like any other successful banker, but all these signs of success make his donors uncomfortable; microfinance is seen by many as a form of charity, not a business. "They say, 'you look too much like a banker.' But that is what I am. I had a customer come to me to take out a $200 loan. Five years later she came bank and borrowed $100,000 as her business had grown and she was now employing 40 people. This is not microfinance any more; it is already SME lending. But why should I not lend to her? Why do I have to put a limit on what we do? This is the difference between chronic poverty and transitional poverty," says Hutagt. "We can take the business all the way and that is why I say Xacbank is the '3G' of microfinance."

The bank is making 10,000 loans a month and turned over $120m in 2007, but only had to write off a total of $40,000 - mostly because the borrower had died unexpectedly. When Hutagt set out, the effective interest rates on loans was 98% - par for the course in most microfinance banks. By the end of 2007, these rates have fallen to 22% per year, while those in Bangladesh remain in the nineties.

The growing credit volumes and falling interest rates means that Hutagt is now in a position to take on the more traditional banks at their own game, offering access to capital for SMEs at competitive market rates. Indeed, the bank has done so well that many of the other banks have launched microfinance schemes to cut into Hutagt's lead.

Xacbank has had a big impact on the banking sector. While banks in places like Russia, Ukraine and Kazakhstan woke up to the benefits of lending to SMEs several years ago, the banks in Mongolia have been following Hutagt into microfinance and are ready to export this skill-set elsewhere in the CIS where the market remains largely untouched. Xacbank has also helped make a material difference to the lives of those worst affected by the transition: per-capital incomes have climbed from $350 per month in 1998 to $3,000 today. "In 1991, Mongolia was the most backward country in the world. Not 'one of the most backward,' but 'The' most backward," says Hutagt. "Today, we have left the 'Stans and Eastern Europe behind. Mongolia is ranked number 52 in the world in terms of the ease of doing business by the World Bank - one notch above Italy."

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