| |
-
What is
microfinance?
-
What is the difference between microfinance and microcredit?
-
Who
are the clients of microfinance?
-
How does microfinance help the poor?
-
When is microfinance NOT an appropriate tool?
-
Why do MFIs charge such high interest rates to poor people?
-
Aren't the poor too poor to save?
-
What is a Microfinance Institution (MFI)?
-
Can microfinance be profitable?
-
Are commercial banks involved in microfinance?
-
What is the government’s role in supporting microfinance?
-
What is the role of the financial regulator in supporting
the development of microfinance?
1.
What is microfinance?
Microfinance is not just limited to credit. It include a broader
range of services such credit, savings, insurance, business
development services, money transfer, etc. as the poor and the
very poor who lack access to traditional formal financial
institutions require a variety of financial products.
Microcredit came to prominence in the 1980s, although early
experiments date back 30 years in Bangladesh, Brazil and a few
other countries. The important difference of microcredit was
that it avoided the pitfalls of an earlier generation of
targeted development lending, by insisting on repayment, by
charging interest rates that could cover the costs of credit
delivery, and by focusing on client groups whose alternative
source of credit was the informal sector. Emphasis shifted from
rapid disbursement of subsidized loans to prop up targeted
sectors towards the building up of local, sustainable
institutions to serve the poor. Microcredit has largely been a
private (non-profit) sector initiative that avoided becoming
overtly political, and as a consequence, has outperformed
virtually all other forms of development lending.
Traditionally, microfinance was focused on providing a very
standardized credit product. The poor, just like anyone else,
need a diverse range of financial instruments to be able to
build assets, stabilize consumption and protect themselves
against risks
Top
2.
What is the difference between microfinance and microcredit?
Microfinance refers to loans, savings, insurance, transfer
services and other financial products targeted at low-income
clients. Microcredit refers to a small loan to a client made by
an institution. Microcredit can be offered, often without
collateral, to an individual or through group lending.
Top
3.
Who are the clients of microfinance?
The typical microfinance
clients are low-income persons that do not have access to
formal financial institutions. Microfinance clients are
typically self-employed, often household-based entrepreneurs.
In rural areas, they are usually small farmers and others who
are engaged in small income-generating activities such as
animal husbandry and petty trade. In urban areas, microfinance
activities are more diverse and include service providers,
traders and producers, artisans, etc.
Access to conventional formal financial institutions, for many
reasons, is directly related to income: the poorer you are, the
less likely that you have access. On the other hand, the
chances are that, the poorer you are, the more expensive or
tedious informal financial arrangements. Moreover, informal
arrangements may not suitably meet certain financial service
needs or may exclude poor anyway. Individuals in this excluded
and under-served market segment are the clients of
microfinance.
Top
4. How does
microfinance help the poor?
Experience shows that microfinance can help the poor to increase
income, build viable businesses, and reduce their vulnerability
to external shocks. It can also be a powerful instrument for
self-empowerment by enabling the poor, especially women, to
become economic agents of change.
Poverty is multi-dimensional. By providing access to financial
services, microfinance plays an important role in the fight
against the many aspects of poverty. For instance, income
generation from a business helps not only the business activity
expand but also contributes to household income and its
attendant benefits on food security, children's education, etc.
Moreover, for women, who, in many contexts, are secluded from
public space, transacting with formal institutions can also
build confidence and empowerment.
Recent research has revealed the extent to which individuals
around the poverty line are vulnerable to shocks such as
illness of a wage earner, weather, theft, or other such events.
These shocks produce a huge claim on the limited financial
resources of the family unit, and, absent effective financial
services, can drive a family so much deeper into poverty that
it can take years to recover.
Top
5.
When is microfinance NOT an appropriate tool?
Microfinance increasingly refers to a host of financial
services—savings, loans, insurance, remittances from abroad,
business advisory services and other products. It is hard to
imagine that there would be any family in the world today for
which some type of formal financial service couldn't be designed
and made useful. But the fact of the matter is, that in most
people's mind, "microfinance" still refers to microcredit.
Microcredit is only useful in certain situations, and with
certain types of clients. As we are finding out, a great number
of poor, and especially extremely poor, clients exclude
themselves from microcredit as it is currently designed.
Extremely poor people who do not have any stable income—such as
the very destitute and the homeless—should not be microfinance
clients, as they will only be pushed further into debt and
poverty by loans that they cannot repay. As currently designed,
microcredit requires sustained, regular, and often significant
payments from poor families. At some level, the very cause of
poverty is the lack of a sustained, regular, and significant
income. Even though a family may have a significant income for
extended periods, it may also face months of no income, thereby
reducing its ability to enter into the type of commitment
demanded today by most MFIs. Some people are just too poor, or
have incomes that are too undependable to enter into today's
loan products. These extremely poor people at the bottom
percentiles of those living below the poverty line need safety
net programs that can help them with basic needs; some of these
are working to incorporate plans to help “graduate” recipients
to microfinance programs.
Often times governments and aid agencies wish to use
microfinance as a tool to compensate for some other social
problem such as flooding, relocation of refugees from civil
conflict. Since microcredit has been sold as a poverty
reduction tool, it is often expected to respond to these
situations where whole classes of individuals have been “made
poor”. Microcredit programs directed at these types of
situations rarely work. Credit requires a 98% “hit” rate to be
successful. Repayment rates have to be high enough to allow for
a program's overall sustainability. This is simply unrealistic.
Running a program with substantial default rates undermines the
very notion of credit and destroys credit discipline among
those who could repay promptly but who look foolish given that
many do not.
Microcredit serves best those who have identified an economic
opportunity and who are in a position to capitalize on that
opportunity if they are provided with a small amount of ready
cash. Thus, those poor who work in stable or growing economies,
who have demonstrated an ability to undertake the proposed
activities in an entrepreneurial manner, and who have
demonstrated a commitment to repay their debts (instead of
feeling that the credit represents some form of social
re-vindication), are the best candidates for microcredit. The
universe of potential clients expands exponentially however,
once we take into account the broader concept of
“microfinance”.
Top
6. Why do MFIs charge such high interest rates to poor people?
Providing financial services to poor people is quite expensive,
especially in relation to the size of the transactions
involved. This is one of the most important reasons why banks
don't make small loans. A Rs. 4,000.00 loan, for example,
requires the same personnel and resources as a Rs. 100,000 one
thus increasing per unit transaction costs. Loan officers must
visit the client's home or place of work, evaluate
creditworthiness on the basis of interviews with the client's
family and references, and in many cases, follow through with
visits to reinforce the repayment culture. This makes the
institution to charge a high rate of interest to cover its cost
of loan administration.
The microfinance institution could subsidize the loans to make
the credit more "affordable" to the poor. Many do. However,
the institution then depends on permanent subsidy.
Subsidy-dependent programs are always fighting to maintain
their levels of activity against budget cuts, and seldom grow
significantly. They simply aren't sustainable, especially if
other microcredit operations have shown that they can provide
credit and grow on the basis of “high” rates of interest—and
along the way serve far greater numbers of clients.
Evidence shows that clients willingly pay the higher interest
rates necessary to assure long term access to credit. They
recognize that their alternatives—even higher interest rates in
the informal finance sector (moneylenders, etc.) or simply no
access to credit—are much less attractive for them. Interest
rates in the informal sector can be as high as 20 percent per
day among some urban market vendors. Many of the economic
activities in which the poor engage are relatively low return
on labor, and access to liquidity and capital can enable the
poor to obtain higher returns, or to take advantage of economic
opportunities. The return received on such investments may well
be many times greater than the interest rate charged.
Moreover, the interest rate is only a small part of their
overall transaction cost of credit, and if MFI offer credit on
a more accessible basis, substantial costs in terms of time,
travel, paperwork, etc. can be reduced, thus benefiting the
poor. A long series of studies has shown that many programs
that charge subsidized interest rates end up using rationing
mechanisms to distribute credit in response to excess demand.
These mechanisms cause the borrower to have to “jump through
hoops”, increasing the time and money s/he must put out to get
the loan. In fact, these transactions costs are frequently
higher than the interest costs, which take away the advantage
to the borrower of the interest rate subsidy. However, while
increased access to credit for the poor on a long term and
sustainable basis can bring significant benefits, MFIs must
continue to work to improve efficiency levels, and to increase
scale. This will bring down the cost of providing loans, and
the benefits transferred to the poor in terms improving loan
products, better access to loans, and lower borrowing costs.
Top
7. Aren't the
poor too poor to save?
The poor already save in ways that we may not consider as
"normal" savings--- investing in assets, for example, that can
be easily exchanged to cash in the future (gold jewelry,
domestic animals, building materials, etc.). After all, they
face the same series of sudden demands for cash we all face:
illness, school fees, need to expand the dwelling, burial,
weddings.
These informal ways that people save are not without their
problems. It is hard to cut off one leg of a goat that
represents a family's savings mechanism when the sudden need
for a small amount of cash arises. Or, if a poor woman has
loaned her "saved" funds to a family member in order to keep
them safe from theft (since the alternative would be to keep
the funds stored in jowar container or under her mattress),
these may not be readily available when the woman needs them.
The poor need savings that are both safe and liquid.
They care less about the interest rates that they can earn on
the savings, since they are not used to saving in financial
instruments and they place such a high premium on having savings
readily available to meet emergency needs and accumulate
assets.
These savings services must be adapted to meet the poor’s
particular demand and their cash flow cycle. Most often, the
poor not only have low income, but also irregular income flows.
Thus, to maximize the savings tendency of the poor,
institutions must provide flexible opportunities--- both in
terms of amounts deposited and the frequency of pay ins and pay
outs. This represents an important challenge for the
microfinance industry that has not yet made a concerted attempt
to profitably capture tiny deposits.
However, Nirantara Community Services is not accepting
savings and deposits from its members considering legal
bindings.
Top
8.
What is a Microfinance Institution (MFI)?
Quite simply, a microfinance institution is an organization that
offers financial services to low income populations. Almost all
of these offer microcredit and only take back small amounts of
savings from their own borrowers, not from the general public
(only in some countries). Within the microfinance industry, the
term microfinance institution has come to refer to a wide range
of organizations dedicated to providing these services: NGOs,
credit unions, cooperatives, private commercial banks and
non-bank financial institutions (some that have transformed
from NGOs into regulated institutions) and parts of state-owned
banks, for example.
The image most of us have when we refer to MFIs is of a
“financial NGO”, an NGO that is fully and virtually exclusively
dedicated to offering financial services; in most cases
microcredit NGOs are not allowed to capture savings deposits
from the general public. This group of a few hundred NGOs have
led the development of microcredit, and subsequently
microfinance, the world over. Most of these constitute a group
that is commonly referred to as "best practice" organizations,
ones that employ the newest lending techniques to generate
efficient outreach that permit them to reach down far into poor
sectors of the economy on a sustainable basis.
A great many NGOs that offer microcredit, perhaps even a
majority, do many other non-financial development activities
and would bristle at the suggestion that they are essentially
financial institutions. Yet, from an industry perspective, since
they are engaged in supplying financial services to the poor,
we call them MFIs. The same sort of situation exists with a
small number of commercial banks that offer microfinance
services. For our purposes, we refer to them as MFIs, even
though only a small portion of their assets may actually be
tied up in financial services for the poor. In both cases, when
people in the industry refer to MFIs, they are referring only
to that part of the institution that offers microfinance.
There are other institutions, however, that consider themselves
to be in the business of microfinance and that will certainly
play a role in a reshaped and deepened financial sector. These
are community-based financial intermediaries. Some are
membership based such as credit unions and cooperative housing
societies. Others are owned and managed by local entrepreneurs
or municipalities. These institutions tend to have a broader
client base than the financial NGOs and already consider
themselves to be part of the formal financial sector. It varies
from country to country, but many poor people do have some
access to these types of institutions, although they tend not
to reach down market as far as the financial NGOs.
Top
9.
Can microfinance be profitable?
Yes it can. Data from the MicroBanking Bulletin reports that 63
of the world's top MFIs had an average rate of return, after
adjusting for inflation and after taking out subsidies programs
might have received, of about 2.5% of total assets. This
compares favorably with returns in the commercial banking
sector and gives credence to the hope of many that microfinance
can be sufficiently attractive to mainstream into the retail
banking sector. Many feel that once microfinance becomes
mainstreamed, massive growth in the numbers of clients can be
achieved.
Others worry that
an excessive concern about profit in microfinance will lead MFIs
up-market, to serve better off clients who can absorb larger
loan amounts. This is the “crowding out” effect. This may
happen; after all, there are a great number of very poor, poor,
and vulnerable non-poor who are not reached by the banking
sector.
It is interesting to note that while the programs that reach out
to the poorest clients perform less well as a group than those
who reach out to a somewhat better-off client segment, their
performance is improving rapidly and at the same pace as the
programs serving a broad-based client group did some years ago.
More and more MFI managers have come to understand that
sustainability is a precursor to reaching exponentially greater
numbers of clients. Given this, managers of leading MFIs are
seeking ways to dramatically increase operational efficiency.
In short, we have every reason to expect that programs that
reach out to the very poorest microclients can be sustainable
once they have matured, and if they commit to that path. The
evidence supports this position.
Top
10.
Are commercial banks involved in microfinance?
Yes.
Increasingly, formal financial institutions are recognizing the
benefits of serving poorer clients. For more information, see
the following documents in the Microfinance Gateway Library:
Top
11. What is the government’s role in supporting microfinance?
Governments have a complicated role when it comes to
microfinance. Until recently, governments generally felt that
it was their responsibility to generate development finance',
including credit programs for the disadvantaged. Twenty years
of insightful critique of rural credit programs revealed that
governments do a very bad job of lending to the poor. Short
term political gain is just too tempting for politically
controlled lending organizations; they disburse too quickly (and
thoughtlessly) and they collect too sporadically (unwillingness
to be tough on defaulters). In urban areas, governments never
really got into the act, and subsidized microenterprise credit
is still relatively rare when compared to its rural
counterpart.
Now that microfinance has become quite popular, governments are
tempted to use savings banks, development banks, postal savings
banks, and agricultural banks to move microcredit. This is not
generally a good idea, unless the government has a clear
acceptance of the need to avoid the pitfalls of the past and a
clear means to do so. Many governments have set up apex
facilities that channel funds from multilateral agencies to
MFIs. Apex facilities can be quite complicated and there are
few successful examples in microfinance. Successful apex
organizations in microfinance tend to be built on the backs of
successful MFIs, not the other way around. Finally, governments
can also get involved in microfinance by concerning themselves
with the regulatory framework that impinges on the ability of a
wide range of financial actors to offer financial services to
the very poor. This topic is treated below.
Top
12.
What is the role of the financial regulator in supporting the
development of microfinance?
Many feel that the most important role of a financial regulator
in supporting the development of microfinance is to create an
alternative institutional type that allows sound financial
NGOs, credit unions, and other community-based intermediaries
to obtain a license to offer deposit services to the general
public and obtain funds through apex organizations. In a few
countries, this may be an appropriate strategy. In most
countries, however, the general level of development of the
microfinance industry does not yet warrant the licensing of a
separate class of financial institutions to serve the poor.
And, in most countries, budgetary restrictions faced by bank
regulators make it very unlikely that they will be able to
supervise a whole host of small institutions; these
institutions' total assets may make up a tiny percent of the
total financial system, but the cost of adequate supervision
could eat up between 25 and 50 % of the total budget of the
agency.
Rather, regulators can work with the nascent microfinance
industries of most countries on issues such as modifying usury
limits as stated in the commercial code to allow appropriate
levels of interest, generating credit information
clearinghouses to share information on defaulting borrowers to
limit their ability to go from one MFI to another, working with
civil authorities to ensure that private loan contracts can be
recognized by courts in those transition economies that lack
even basic legislative infrastructure, and reporting
requirements that will prepare MFIs to eventually become
regulated.
Regulators can also examine the laws, executive decrees, and
internal regulations that limit the ability of traditional
banking institutions to do microfinance. These regulations
include limits on the percent of a loan portfolio that can be
lent on an unsecured basis, limits on group guarantee
mechanisms, reporting requirements, limits on branch office
operations (scheduling and security), and requirements for the
contents of loan files. Not least, banking regulators may need
to look at the way in which they would evaluate microloan
portfolios within large banks.
(Collected from
various sources)
Top |
|
