determinants of rural households’ participation in formal microfinance programs in malawi: an...

8/16/2019 Determinants of Rural Households’ Participation in Formal Microfinance Programs in Malawi: An Instrumental Varia…

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Academic year: 2009 – 2010

Determinants of Rural Households’ Participation in Formal

Microfinance Programs in Malawi: An Instrumental

Variables Approach

Nyoni, Abel Mauluka

Promoters:

Dr. ir. Marijke D‟Haese

and

Dr. ir. Jeroen Buysse

Thesis submitted in partial fulfilment of the requirementsfor the joint academic degree of International Master of Science in Rural Development (Agricultural

Economics) from Ghent University (Belgium), Agrocampus Rennes (France), Humboldt University of

Berlin (Germany) and University of Cordoba (Spain) in collaboration with Wageningen University (TheNetherlands), Slovak University of Agriculture in Nitra (Slovakia) and the University of Pisa (Italy).

This thesis was elaborated and defended at Ghent University (Belgium) within the framework of the

European Erasmus Mundus Programme “Erasmus Mundus International Master of Science in Rural

Development “(Course N° 2004-0018/001- FRAME MUNB123)


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Certification

This is an unpublished Master of Science thesis and is not prepared for further distribution. The

author and the promoters give the permission to use this thesis for consultation and to copy partsof it for personal use. Every other use is subject to copyright laws; more specifically the source

must be extensively specified when using results from this thesis.

Place of Defence: Ghent University, Belgium.

The Promoters,

Dr. ir. Marijke D‟Haese Dr. ir. Jeroen Buysse

The Author,

Nyoni, Mauluka Abel


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Abstract

The study aimed at investigating the major determinants of rural households‟ participation in

formal microfinance programs in Malawi. A probit model was used on secondary data on “credit

and loans” collected by the National Statistical Office (NSO) between March 2004 and April

2005 under the World Bank funded Integrated Household Surveys program to answer the study

hypotheses. To control for the effect of omitted variable bias and endogeneity, we use exogenous

age and land size as instrumental variables for credit constraint, and estimate that credit

constraint is markedly negatively related to participation in formal microfinance programs.

Further, the findings reveal that households with smaller dependency ratio, without contact with

extension agents and those residing far away from trading centers/bomas are less likely to

participate in formal microfinance programs.

The empirical model results further show that

households headed by younger and less educated heads, male headed households, households

with larger dependency ratio and smaller land size are more likely to be credit constrained.

The findings suggest important policy lessons which can help improve the participation of rural

households particularly women in formal credit programs. The binding land constraint in most

rural households suggests a change of focus in the delivery of microfinance services to include

both agricultural and non-farm loans which will give the rural poor an opportunity to make trade-

offs between the two as per their convenience. Additionally, an improvement in the delivery of

extension services on issues of credit would help create awareness about the potential sources of

credit to the rural populace.


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Acknowledgements

In the preamble, let me give special thanks to the Almighty God for His everlasting mercies and

blessings. Special thanks to my parents, brothers and sisters for their unceasing love, moral support and

encouragement in my life. God bless you all.

I owe my heartfelt appreciation to my promoters: Dr. i r. Marijke D‟Haese and Dr. ir. Jeroen Buysse, for

their constant guidance, advice and valuable inputs in every single step of my thesis execution. I say

without you this piece of work would not have been possible.

In a special way I would like to thank Ghent University for awarding me a master grant which enabled me

to pursue this MSc. program. Furthermore, I extend my gratitude to the IMRD programme coordinator,

Prof. Dr. Ir. Guido Van Huylenbroeck, the entire Management Board and all the members of staff at the

IMRD secretariat for their kind hospitality and tireless efforts to see to the needs of students. I also extend

my appreciation to Judis Renate (local coordinator) at Humboldt University of Berlin (Germany) for her

motherly support and care throughout my stay in Berlin.

My heartfelt appreciation to all the lecturers in the Departments of Agricultural Economics both at Ghent

University (Belgium) and Humboldt University of Berlin (Germany) for the valuable knowledge imparted

on me. Let me also express my sincere gratitude to the members of staff in the Faculty of European

Studies and Regional Development and the Faculty of Economics and Management at the Slovak

University of Agriculture in Nitra (Slovakia) particularly Prof. Anna Bandlerova, Jela Tvrdoňová,Barbora Milotová, Loreta, Lucia and Ivan for the wonderful organisation, guidance, support and reception

in Nitra.

I also would like to thank the entire IMRD students‟ family in Gent (Belgium) and Berlin (Germany) for

the social and moral support as well as constructive criticisms rendered to me in the course of my studies.

I would say this has helped to shape me in one way or the other and prepare me for future challenges. It

was really an experience worthy going through. Lastly but not least, I give my sincere thanks to my dear

one, Ms. Maria Chinoko Ngulube, for her patience, love and encouragement. To you, I say thank you for

being by my side through those difficult times. God bless you.

Nyoni, Abel Mauluka

Gent, Belgium


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List of Abbreviations

AIDS Acquired Immune Deficiency Syndrome

APIP Agricultural Productivity Investment Programme

CUMO Concern Universal Microfinance Organization

DEMAT Development of Malawian Enterprises Trust

ECLOF Ecumenical Church Loan Fund

EPA Extension Planning Area

EU European Union

FINCA Finance for International Community Assistance

FITSE Finance Trust for the Self Employed

GTZ Gesellschaft fur Technische Zusammenarbeit (German Technical Cooperation Agency)

HIV Human Immunodeficiency Virus

IFAD International Fund for Agricultural Development

IHS Integrated Household Survey

ILO International Labour Organization

GoM Government of Malawi

GDP Gross Domestic Product

MAMN Malawi Microfinance Network

MARDEF Malawi Rural Development Fund

MFI Microfinance Institution

MDGs Millennium Development Goals

MGDS Malawi Growth and Development Strategy

MPRSP Malawi Poverty Reduction Strategy Paper

MRFC Malawi Rural Finance Company

MSE Micro and Small Enterprise

MSB Malawi Savings Bank

http://www.ilo.org/http://www.ilo.org/


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MUSCCO Malawi Union of Savings and Credit Cooperatives

MK Malawi Kwacha

NABW National Association of Business Women

NEAP National Environmental Action Plan

NGO Non-Governmental Organisation

NSO National Statistical Office

OIBM Opportunity International Bank of Malawi

PMERW Promotion of Microenterprises for Rural Women

PRIDE Malawi Promotion of Rural Initiatives and Development Enterprises

ROSCA Rotating Savings and Credit Association

RBM Reserve Bank of Malawi

SACA Smallholder Agricultural Credit Association

SACCO Savings and Credit Cooperative

SAP Structural Adjustment Programme

SEDOM Small Enterprise Development Organization of Malawi

SPSS Statistical Package for Social Sciences

TLF Touching Lives Fund

WSBI World Savings Banks Institute

UN United Nations

USAID United States Agency for International Development

US$ United States Dollar


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Table of Contents

Abstract ........................................................................................................................................... ii

Acknowledgements ........................................................................................................................ iii

List of Abbreviations ..................................................................................................................... iv

Table of Contents ........................................................................................................................... vi

List of Tables ............................................................................................................................... viii

List of Figures ................................................................................................................................ ix

Chapter 1: Introduction ................................................................................................................... 1

1.1 Background of the Study ....................................................................................................... 1

1.2 The Genesis of the Microfinance Concept ............................................................................ 2

1.3 Motivation of the Study......................................................................................................... 41.4 Objectives of the Study ......................................................................................................... 6

1.5 Hypotheses of the Study ........................................................................................................ 7

1.6 Structure of the Report .......................................................................................................... 7

Chapter 2: Theoretical and Conceptual Framework ....................................................................... 9

2.1 The Potential Role of Microfinance in Poverty Alleviation ................................................. 9

2.2 Group Lending Theory ........................................................................................................ 16

2.3 The Microfinance Sector in Malawi.................................................................................... 21

2.3.1 The Structure of the Financial Sector in Malawi .......................................................... 212.3.2 Microfinance Institutions in Malawi ............................................................................ 24

2.4 Demand and Supply of Microfinance Services in Malawi ................................................. 26

2.5 Participation in Formal Microfinance Programs ................................................................. 272.5.1 Malawi Rural Finance Company (MRFC) ................................................................... 272.5.2 Conceptual Framework................................................................................................. 29

Chapter 3: Methodology ............................................................................................................... 31

3.1 Facts and Figures about Malawi.......................................................................................... 313.1.1 Geographic and Climatic Information .......................................................................... 313.1.2 General Economic Indicators ....................................................................................... 32

3.2 Study Area ........................................................................................................................... 34

3.3 Data for the Study ............................................................................................................... 35

3.4 Data Analysis ...................................................................................................................... 36

3.5 Analytical Model ................................................................................................................. 373.5.1 Theoretical Description of Credit Constraint ............................................................... 373.5.2 Empirical Model Specification ..................................................................................... 38


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3.5.3 Variables and Hypothesized Effects ............................................................................. 39

Chapter 4: Descriptive Analysis of the Socio-economic Characteristics According toParticipation and Credit Constraint Status .................................................................. 42

4.1 General Socio-Economic Characteristics of the Respondents ............................................ 42

4.2 Household Loan Characteristics.......................................................................................... 474.2.1 Loan Size and Repayment Period ................................................................................. 474.2.2 Reasons for Obtaining a Formal Loan .......................................................................... 494.2.3 Group Membership and Loan Purpose ......................................................................... 504.2.4 Reasons for not attempting to Borrow from Formal Sources ....................................... 51

4.3 Household Characteristics According to Participation Status............................................. 524.3.1 Household Demographic Characteristics ..................................................................... 534.3.2 Wealth Status Indicators ............................................................................................... 544.3.3 Micro-credit Related Factors ........................................................................................ 55

4.4 Effect of Main Occupation on Household Wealth Status ................................................... 57

4.5 Household Characteristics According to Credit Constraint Status ..................................... 574.5.1 Household Demographic Characteristics ..................................................................... 584.5.2 Wealth Status Indicators ............................................................................................... 584.5.3 Micro-credit Related Factors ........................................................................................ 59

4.6 Participation and Credit Constraint Status of Head According to Expenditure Deciles ..... 60

Chapter 5: Quantitative Analysis of the Determinants of Participation in Formal MicrofinancePrograms ..................................................................................................................... 62

5.1 Overview of Study Objectives and Hypotheses .................................................................. 62

5.2 Empirical Model Results ..................................................................................................... 63

5.2.1 Determinants of Credit Constraint Condition ............................................................... 635.2.2 Determinants of Participation in Formal Microfinance Programs ............................... 67

Chapter 6: Discussion, Conclusion and Policy Implications ........................................................ 70

6.1 Discussion and Conclusion ................................................................................................. 70

6.2 Policy Implications .............................................................................................................. 75

References ..................................................................................................................................... 76


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List of Tables

Table 2.1: Legal and Ownership Structures of MFIs in Malawi .................................................. 25

Table 3.1: Changes in Selected Economic Indicators (period averages): 1963- 2008 ................. 34

Table 3.2: Description of the Empirical Model Variables ............................................................ 41

Table 4.1: Distribution of Respondents According to Age ........................................................... 43

Table 4.2: Distribution of Respondents According to Educational Status ................................... 44

Table 4.3: Distribution of Respondents According to Main Occupation ..................................... 44

Table 4.4: Loan Size and Repayment Period ................................................................................ 47

Table 4.5: Pearson Correlation Results for Loan Size and Household Characteristics ................ 48

Table 4.6: Effect of Loan Purpose on Loan Size .......................................................................... 51

Table 4.7: Reasons for not obtaining a Formal Loan .................................................................... 52

Table 4.8: Household Characteristics According to Participation Status ..................................... 55

Table 4.9: Effect of Main Occupation on Wealth Status Indicators ............................................. 57

Table 4.10: Household Characteristics According to Credit Constraint Status ............................ 59

Table 5.1: Probit Model Results of Determinants of Credit Constraint ....................................... 66

Table 5.2: Probit Model Results for the Determinants of Participation ....................................... 69


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List of Figures

Figure 1.1: Growth of Microfinance Coverage: 1997-2007 ........................................................... 3

Figure 1.2: Growth of MFIs in Malawi: 1990-2010 ....................................................................... 5

Figure 2.1: Transmission Mechanism of Microfinance to Poverty Alleviation ........................... 15

Figure 2.2: A Dynamic Presentation of Problems and Solutions in a Multi-stage Joint Liability

Loan ........................................................................................................................... 20

Figure 2.3: Structure of the Financial Sector in Malawi ............................................................... 23

Figure 2.4: Conceptual Framework .............................................................................................. 30

Figure 3.1: Map of Malawi ........................................................................................................... 32

Figure 3.2: Map of Malawi Locating Kasungu District ................................................................ 35

Figure 4.1: Distribution of Respondents According to Gender (n=166) ...................................... 42Figure 4.2: Distribution of Household Income According to Source (n=166) ............................. 45

Figure 4.3: Distribution of Respondents According to Participation Status (n=166) ................... 46

Figure 4.4: Distribution of Households‟ Participation Status According to Credit Constraint

Status (n=166) ............................................................................................................. 46

Figure 4.5: Distribution of Borrowers According to Loan Size ................................................... 48

Figure 4.6: Reasons for obtaining a Formal Loan ........................................................................ 49

Figure 4.7: Group membership and Purpose of the Loan ............................................................. 50

Figure 4.8: Participation and Credit Constraint Status of Household Head According to

Expenditure Deciles (n=166)..................................................................................... 61


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Chapter 1: Introduction

1.1 Background of the Study

"The key to ending extreme poverty is to enable the poorest of the poor to get their foot on the ladder of development. The

ladder of development hovers overhead, and the poorest of the poor are stuck beneath it. They lack the minimum amount of

capital necessary to get a foothold, and therefore need a boost up to the first rung." -- Jeffrey Sachs1

The need to reduce the scale and depth of poverty among the growing population has been a

major development issue facing many developing countries for decades (Adjei et al., 2009).

Currently, about 1.4 billion people live under very precarious conditions and lack basic

necessities to sustain their livelihoods; of which over 75 per cent live in remote rural areas and

earn their living through subsistence farming (IFAD, 2009). Nonetheless, low agricultural

productivity emanating from erratic weather patterns, declining land holding sizes and

skyrocketing input prices coupled with low output prices has made it difficult for rural

households to continually depend on agriculture for survival. This has since generated so much

pressure on policy makers in the developing world to explore viable ways that would ensure that

the poor have access to the tools they need to build better lives (Clover and Eriksen, 2008).

One notable challenge the poor face in their daily struggle to raise their living standards is lack

of access to financial services which would enable them to diversify their economic activities by

undertaking investments in new agricultural activities, setting up small businesses or expanding

existing ones. Accordingly, it has been argued that improving the poor‟s access to credit and

other financial services is a positive step towards improving their livelihoods (IFAD, 2009;

Hishigsuren, 2007; Burritt, 2006; Diagne and Zeller, 2001). Microfinance has thus been singled

out as an effective tool in the fight against poverty and consequently, attaining the Millennium

Development Goal of halving the proportion of people living in extreme poverty by 2015 (IFAD,

2009).

Microfinance is basically understood as the provision of small-scale financial services to low

income segments of the population (WSBI, 2008; Burritt, 2006). It is undoubtedly the most

visible innovation in anti-poverty policy in the last half century. Microfinance is unique among

1 American economist and Director of the United Nations Millennium Project Millennium Development Goals

http://www.betterworldheroes.com/sachs.htmhttp://www.betterworldheroes.com/sachs.htmhttp://en.wikipedia.org/wiki/United_Stateshttp://en.wikipedia.org/wiki/Economisthttp://en.wikipedia.org/wiki/United_Nationshttp://en.wikipedia.org/wiki/Millennium_Projecthttp://en.wikipedia.org/wiki/Millennium_Development_Goalshttp://en.wikipedia.org/wiki/Millennium_Development_Goalshttp://en.wikipedia.org/wiki/Millennium_Development_Goalshttp://en.wikipedia.org/wiki/Millennium_Projecthttp://en.wikipedia.org/wiki/United_Nationshttp://en.wikipedia.org/wiki/Economisthttp://en.wikipedia.org/wiki/United_Stateshttp://www.betterworldheroes.com/sachs.htm


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economic development initiatives because it has the ability to contribute directly to people‟s

economic and social progress, by allowing them to invest and multiply their scarce assets

(Schreiner, 2003). The UN General Assembly has recognized the positive impact of

microfinance on poverty reduction and has since pledged its full support for programs that aim at

bringing financial services to the rural poor. This was af firmed by the Assembly‟s decision to

dedicate 2005 for the commemoration of the International Year of Microcredit which served as

an opportunity to highlight and support microfinance programs throughout the world (IFAD,

2009). Furthermore, the Nobel Peace Prize awarded to the microcredit “icon”, Professor

Mohammad Yunus in 2006 brought microfinance into the spotlight in developing countries but

also in the developed world as a major tool for empowering vulnerable people, addressing social

and economic exclusion, and alleviating poverty (Dworkin and Blankenship, 2009 and WSBI,

2008).

1.2 The Genesis of the Microfinance Concept

Informal savings and credit groups have operated in different forms around the world for

centuries, but the field of microfinance took-off in the early 1970s in Bangladesh when

Mohammed Yunus lent $0.64 to a bamboo weaver (Schreiner, 2003). Thereafter a number of

experimental development programs began lending tiny amounts of money to groups of poor

women and by 1976 the Grameen (village) bank of Bangladesh was born. Grameen had only36,000 members when it was formalized as a bank in 1983, but by 2003, the bank had 3.1

million members, most of them rural poor women. Today, Microfinance has become a global

institution and the concept of Grameen has been replicated both in low and high income

countries (IFAD, 2009; Armendàriz and Morduch, 2005; Schreiner, 2003).

As shown by Figure 1.1 below, it is estimated that between 1997 and 2007, the total number of

microfinance clients worldwide grew from 13.5 million to 155 million while the number of MFIs

went up from 618 to 3,552, respectively. Similarly, the number of the world‟s poorest families

accessing microfinance services increased from 7.6 million in 1997 to 107 million by end of

2007, representing an average growth rate of about 40 per cent per year (Microcredit Summit

Campaign Report, 2009). Of the 107 million poorest clients, 83.4 per cent were women. This


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demonstrates the pace at which the microfinance phenomenon is gaining ground as a potential

tool for poverty reduction and social change (Microcredit Campaign Summit Report, 2009).

Figure 1.1: Growth of Microfinance Coverage: 1997-2007(Source: Microcredit Summit Campaign Report, 2009)

During the early years after the “ birth” of the microfinance concept, most microfinance programs

focused on the provision of credit to the poor. However, in the past few decades, the

microfinance sector has undergone several transformations and has moved beyond credit to

include savings, business development services, money transfers and a variety of insurance

products that cover life, health and agriculture. Currently, a wide range of institutions ranging

from grass-roots savings and credit associations, financial cooperatives, microfinance

institutions, rural banks, specialized NGOs, agricultural development banks and government

sponsored programs are all involved in the delivery of microfinance services in rural

communities all over the world. Notwithstanding, the major challenge still remains to extend

microfinance coverage to the poorest families in the developing world where millions lack

access to even basic savings and credit services (IFAD, 2009; Microcredit Campaign Summit

Report, 2009; WSBI, 2008). IFAD (2009) reported that only about 10 per cent of the world‟s 1.4

billion poorest people have access to the most basic financial services. This just illustrates the

magnitude of the task the world is faced with not only in extending financial services to the

poorest but also in eradicating abject poverty and consequently attaining the MDGs.

020406080

100120140160180200220240260280

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

N u m b e r o f c l i e n t s ( m i l l i o n s )

Year

Total clients reached Total poorest clients reached


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1.3 Motivation of the Study

In Malawi, studies have shown that lack of access to credit is impacting negatively on various

aggregate and household-level outcomes, including technology adoption, agricultural

productivity, food security, nutrition, health, MSE development, and overall household welfare(USAID, 2006: 2004; Diagne and Zeller, 2001). Recognizing this challenge, the government and

its development partners have undertaken numerous initiatives to ensure that the poor have

access to basic financial services. This has resulted into the proliferation of the microfinance

sector in recent years. The microfinance concept is thus increasingly gaining importance in

Malawi as an effective tool in the fight against HIV/AIDS, social mobilization and poverty

alleviation (Burritt, 2006; GOM, 2002).

Malawi embraced the microfinance concept around mid-1990s, following the introduction of the

Structural Adjustment Programs (SAPs) which resulted into the gradual liberalization of the

financial sector (USAID, 2004). This facilitated the entry of new players into both the formal and

semi-formal financial systems, which has fostered competition and innovation in the sector.

Since then the microfinance sector has received tremendous political and financial support from

the government. To underscore its commitments towards supporting the microfinance sector, in

2002, the government developed the microfinance policy and action plan to create an enabling

legal and regulatory environment for the operation of MFIs (Burritt, 2006; GOM, 2002). This

was augmented by the formulation of the national development strategy; the Malawi Growth and

Development Strategy (MGDS) in 2005 which is the government‟s medium term operational

strategy (2006/07 – 2010/2011) for the attainment of the nation‟s Vision 2020. The overriding

philosophy of the MGDS is poverty reduction through sustainable economic growth and

infrastructure development. The MGDS recognizes the role of economic empowerment in

poverty alleviation and has since placed emphasis on programs that support the development of

enterprises in rural areas; of which microfinance is one of them (GOM, 2006a).

Currently, several government, private sector and NGO sponsored programs and schemes are

involved in the provision of financial services to rural households. Most of the microfinance

programs target a wide range of clientele ranging from smallholder farmers and micro-

entrepreneurs to large-scale farmers and entrepreneurs (USAID, 2008; Burritt, 2006). As

presented by Figure 1.2 below, the number of formally registered MFIs has significantly


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increased over the past two decades from about 6 at the beginning of the 1990s to around 10 in

early 2000. Presently, there are over 20 MFIs registered by the Malawi Microfinance Network

(MAMN) representing a period average growth of about 37 per cent (AFMIN, 2010; MAMN,

2008; Burritt, 2006; USAID, 2004; Diagne and Zeller, 2001).

Figure 1.2: Growth of MFIs in Malawi: 1990-2010 (Source: Various2)

According to the Malawi National Gemini MSE Baseline Study 2000, about 19.8 per cent of

rural households and 10.5 per cent of urban households reported acquiring a loan from somesource, both formal and informal (NSO, 2001). Surprisingly, despite a remarkable increase in the

number of MFIs in the past decade, Simtowe and Phiri (2010) observes that the proportion of

households with access to any form of credit still remains less than 20 and 10 per cent for rural

and urban households, respectively. Burritt (2006) further estimates that only about 3 per cent of

the population in Malawi has access to deposit services. This suggests that the majority of the

population in Malawi still do not have access even to basic financial services despite a

proliferation in the number of MFIs operating in the country.

This may prompt one to wonder as to why most rural households do not participate in formal

microfinance programs in an environment of the booming rural microfinance sector. Is the

problem with program targeting, transaction costs, interest rates charged or there are some

2 AFMIN, 2010; MAMN, 2008; Burritt, 2006; USAID, 2004 and Diagne and Zeller, 2001

0

5

10

15

20

25

1990 1995 2000 2005 2010

N u m b e r o f M F I s

Year


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household or community level factors that hinder rural households from utilizing such credit

schemes or programs to alleviate their capital problems? It is under this motivation that this

study attempts to empirically determine the factors that influence rural households to participate

in formal microfinance programs.

A number of studies have been carried out in the field of microfinance in Malawi with the

majority of them focusing on the impact of credit on technology adoption (Giné and Yang, 2009;

Simtowe et al, 2008); impact of credit on general household welfare (Diagne and Zeller, 2001);

impact of credit program participation on child schooling (Shimamura and Cornhiel, 2009);

effectiveness of group lending approaches (Simtowe and Zeller, 2006); and credit demand and

supply (USAID, 2006). However, none of these studies has attempted to (holistically) understand

the determinants of rural households‟ participation in formal microfinance programs. This isimportant as it will help one to understand why the majority of rural households still do not

participate in formal credit markets despite the proliferation of the rural microfinance sector.

1.4 Objectives of the Study

The underlying objective of the study was to analyze the determinants of rural households‟

participation in formal microfinance programs. Specifically, the study aimed to look at the

following:

1. To examine if there are any differences in socio-economic characteristics between

participants and non-participants; and credit constrained and unconstrained households;

2. To establish the factors that influence households‟ credit constraint condition;

3. To find out if credit constraint has an influence on households‟ decisions to participate in

formal microfinance programs; and

4. To ascertain the major determinants of rural households‟ participation in formal

microfinance programs.


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1.5 Hypotheses of the Study

Basing on the above objectives, the following were the major study hypotheses:

H0: There are no significant differences in socio-economic characteristics between

participants and non-participants; and credit constrained and unconstrained households;

H0: There are no factors that influence households‟ credit constraint condition;

H0: Credit constraint has no influence on participation in formal microfinance programs; and

H0: No factors influence rural households to participate in formal microfinance programs.

1.6 Structure of the Report

The rest of the report is organised as follows: Chapter 2 reviews the theoretical and empirical

literature on microfinance. The chapter begins by giving an insight on the role of microfinance in

economic development and poverty alleviation, followed by an overview of the group lending

theory and the microfinance sector in Malawi. The final section of the chapter provides a

description of Malawi Rural Finance Company (MRFC), the focus MFI for the study, as well as

a conceptual framework of the determinant of participation in formal microfinance programs.

Chapter 3 provides a methodological framework which was used to answer the above statedstudy hypotheses. It starts by giving a brief background of Malawi‟s geographic, climatic and

economic situations followed by a description of the selected study district, the data used in the

study and the methods used for analysis. The chapter concludes by providing the analytical

framework of the empirical model used to analyse the determinants of participation in formal

microfinance programs.

Chapter 4 presents the descriptive analysis results of the study. The chapter begins by giving a

general overview of the socio-economic characteristics of the respondents followed by adiscussion on household loan characteristics in section two. The third section focuses on the

comparison of socio-economic and micro-credit related characteristics between participants and

non-participants while the final part of the chapter draws a comparison between credit

constrained and unconstrained households with respect to household socio-economic and micro-

credit related characteristics.


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Chapter 5 presents the empirical model results in line with objectives 2, 3 and 4 of the study. The

chapter begins by giving an overview of the study hypotheses followed by the empirical model

results in sections two and three.

Chapter 6 provides a discussion of the results, conclusion and draws some recommendations

basing on the findings. Additionally, the chapter also provides some suggestions for further

research.


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Chapter 2: Theoretical and Conceptual Framework

Since the birth of the microfinance concept in the 1970s much has been documented about its

potential role in economic development and poverty alleviation. Over time a diversity of models

under which microfinance programs are implemented have emerged responding to the changing

economic, social, political, cultural and technological environments. This has necessitated some

improvements to the existing products as well as the development of new products that serve the

poor better while satisfying the triangle of microfinance vis-à-vis: financial sustainability,

outreach and welfare impact (Armendàriz and Morduch, 2005).

In recent years, much of the economic development literature on microfinance has been centered

on the group lending theory pioneered by, among other, Stiglitz (1990), Besley and Coate

(1995), Ghatak (1999), and Van Tassel (1999). Group lending with joint liability is celebrated as

a major breakthrough in microfinance as it defeats the popular notion by traditional commercial

banks that believe that the poor are not trusted borrowers. In his pioneer work on group lending

theory, Stiglitz (1990) argues that joint liability in groups can help to mitigate adverse selection

and moral hazard which are common problems experienced in credit and insurance markets.

This chapter gives an overview of the economic development literature on microfinance. It

begins by giving an insight on the role of microfinance in economic development and poverty

alleviation, followed by an overview of the group lending theory and the microfinance sector in

Malawi. At the end, a conceptual framework of the determinants of participation in formal

microfinance programs is developed.

2.1 The Potential Role of Microfinance in Poverty Alleviation

It is argued that, if targeted at the poorest segments of the society, microfinance has the potential

to significantly contribute towards the fight against poverty as it makes available the financial

services to the poor who often lack access to or are neglected by commercial banks and other

formal financial institutions (IFAD, 2009; Todaro and Smith, 2009; Burritt, 2006; Armendàriz

and Morduch, 2005; State Bank of Pakistan, 2005). Most formal lenders require collateral such

as land or houses as a prerequisite to issue out loans but often times poor people lack such

physical assets. As a result, they are denied the opportunity to access credit and other financial


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services that they need to best manage their assets and generate income to improve their

livelihoods (Adjei et al., 2009). This constrain them from improving productivity from their

small landholdings and diversifying into other food and cash crops as well as non-farm activities

which are key to poverty alleviation (Diagne and Zeller, 2001). However, the growth in the rural

microfinance sector, which offer relatively flexible lending terms, has reduced the credit

constraint among the poor (Armendàriz and Morduch, 2005; Schreiner, 2003).

Microfinance offers a wide range of benefits to the poor and the notable ones include; increase in

savings and effects in production, increase and diversification of incomes, changes in

consumption patterns, promotion of new non-agricultural activities, and improvement of

methods of production (Hidalgo-Celarié et al., 2005). Thus, it has multiplier effects on people's

standards of living through enhancing basic household welfare, such as food security, nutrition,

shelter, sanitation, health and education services (IFAD, 2009; UN, undated). Apart from

addressing material poverty, at individual level, microfinance can effectively address issues

associated with non-material poverty, which include social and psychological effects that prevent

people from realizing their potential. It can help to build individual self-esteem and confidence

which eventually empowers the poor to actively participate in the decision making process of the

society. Additionally, when properly guided, the material benefits of microfinance can extend

beyond the household into the community (UN, undated).

It is argued that microfinance plays a crucial role in household food security either through own

production or market access. Access to credit enables farmers to purchase inputs such as

fertilizer, seeds, tools and machinery and hire extra labour which ultimately increases the

productivity of their small plots. This is essential in ensuring household food security and better

nutrition (IFAD, 2009; Todaro and Smith, 2009; Armendàriz and Morduch, 2005; Diagne and

Zeller, 2001). Further, the small loans the poor obtain from MFIs enable them to engage in a

variety of income generating activities that continually generate income for them which help to

reduce their income variability and increase their spending power. Ultimately, this enables them

to meet their basic needs and smooth consumption throughout the year. Microfinance programs

thus have the potential to provide a fallback position for the households in case of production

failure or other adverse shocks as it may help them to avoid distress through sales of assets while


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at the same time enable them to replace productive assets destroyed in natural disasters (Burritt,

2006; Martin et al., 2002; Vonderlack and Schreiner, 2002; Zeller, 1999).

In recent years, economic development literature on microfinance has also given much attention

on micro-savings and micro-insurance which are equally important to the poor as microcredit but

often times not provided to them (Burritt, 2006; Armendàriz and Morduch, 2005). It is argued

that if the small loans the poor get from MFIs are to make any significant impact, then they

should be given an opportunity to access micro-savings facilities which they need in order for

them to deposit the surplus income they generate from their farms or non-farm activities. Later

on they can withdraw it in times of need or use it as collateral for new loans. Such basic micro-

saving facilities play a crucial role in income and consumption smoothing over the year besides

making the poor less vulnerable to unexpected events. Further, a deposit account can help therural poor to take out a loan when they need it or obtain a life or health insurance which can

provide them with security from unexpected events and income shocks (IFAD, 2009; Martin et

al., 2002; Zeller, 1999).

It is also argued that extending micro-savings services to the poor would help the countries in the

mobilization of the much needed savings which play a significant role in generating investments

required for accelerating economic growth. This is on the assumption that the middle class and

even the poor generally save and invest a significant proportion of their income compared to the

rich who spend much of their incomes on imported luxuries or they invest it in foreign banks

which offer relatively higher returns which leads to capital flight (Todaro and Smith, 2009;

Morduch, 2000; Tinker, 2000). Nevertheless, it is also observed that most of the loans obtained

by the poor are mainly used for consumption other than for investment purposes as highlighted

by most development agencies (Hidalgo-Celarié et al., 2005; NSO, 2001).

Microfinance is also argued to be the major source of employment for the majority of the

unemployed rural and urban residents that dominate the informal sector in the developing world.

With the increasing failure of the rural and urban formal sectors to absorb the additions to the

labour force emanating from high population growth, the informal sector is seen as a panacea for

the growing unemployment problem (Todaro and Smith, 2009; Burritt, 2006; Woller and

Woodworth, 2001). It is estimated that over 500 million of the world‟s poor people are


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economically active and are either self-employed or are working in microenterprises.

Consequently, the informal non-farm sector, in developing countries, is argued to provide refuge

to the extremely poor who are either landless or near landless (Haggblade, 2005; World Bank,

2000; Ellis, 1999).

It is observed that a highly heterogeneous collection of microenterprises, supported by both

formal and informal MFIs, operate in the rural areas of the developing world. These provide the

backbone of the rural economy and their contribution to aggregate household income has been

increasing over time. For instance, non-farm activities currently account for over 40 per cent of

average household incomes in Africa; a continent whose rural population is believed to be

predominantly subsistence (Bandiera, 2007; Haggblade, 2005; and Barrett et al., 2001). Halder

(2003) points out that the expansion of microfinance has thus been rooted in the expectation thatit can help generate income and self-employment, which can eventually solve both the problems

of unemployment and poverty.

Besides increased employment and income, microfinance has also been commended as a

powerful weapon in the fight against gender inequality and its role in ensuring women

empowerment (Dworkin and Blankenship, 2009; Kim et al., 2007; Armendàriz and Morduch,

2005; Hidalgo-Celarié et al., 2005; Schreiner, 2003). Most microfinance programs target rural

women who are often excluded from educational opportunities, highly valued job skills, and

traditional financial institutions and services. Women are perceived to be a better credit-risk than

men and more responsible managers of meager resources. They are more committed to using

their loans for the benefit of their households rather than self-gratifying consumption as most

men do (Dworkin and Blankenship, 2009; Corsi, 2006; Tinker, 2000; Goetz and Gufta, 1996). It

has been argued that the multiplier effects from microfinance programs are higher when the

recipients are women compared to men. A small loan obtained by a woman is said to have far-

reaching impacts for the household as it is invested in child health and education apart from

improving the general household welfare (IFAD, 2009; Shimamura and Cornhiel, 2009; Todaro

and Smith, 2009; Hidalgo-Celarié et al., 2005; UN, undated).

The advocates of credit programs targeting women point out that microfinance increases

women‟s participation in the labour force through the creation of self-employment opportunities


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and this promotes their economic empowerment. Ultimately, this promotes gender-equality,

increases women‟s intra-household bargaining power, authority, autonomy and participation in

household decision making (Pronyk et al., 2007; Halder, 2003; Vonderlack and Schreiner, 2002;

Goetz and Gufta, 1996). Studies have shown that women‟s participation in microfinance

programs leads to increased reproductive health decision making power which in turn plays a

great role in reducing fertility rates (Kim et al., 2007; Pronyk et al., 2008: 2007; Hidalgo-Celarié

et al., 2005). Further, the status of women, in their homes and in their communities, improves

when they are responsible for loans and manage their household savings (IFAD, 2009).

Microfinance has therefore been recognized as a powerful instrument of social change,

institution-building at the grassroots level and a step towards achieving the MDGs on gender

equality and women empowerment (Kim et al., 2007; Goetz and Gufta, 1996).

Nonetheless, empirical studies on the role of microfinance in women empowerment and gender

equality have shown mixed results. While some studies have confirmed women‟s economic and

social empowerment others have argued that despite that making credit available to women is a

positive contribution towards efforts to challenge gendered terms of access to productive

resources and opportunities, a significant proportion of women‟s loans are directly invested by

their male relatives, while women borrowers bear the liability for repayment. It is observed that a

significant proportion of women transfer the power and control over the loans to men within

their households who eventually play a pivotal role in making investment decisions, general

management of the loans, controlling accounts and marketing of products apart from providing

labour inputs and deciding on any use of income generated (Corsi et al., 2006; Hunt and

Kasynathan, 2001; Goetz and Gufta, 1996).

This eventually leaves women with very limited or no direct control over credit defeating the

whole objective of women empowerment and gender equality in terms of control and use of

productive resources. Consequently, development literature argue that the link between targeted

access to credit for women and the transformation in gender relations required for empowerment

and equality is not as automatic as depicted by most development agencies committed to the

empowerment of women and gender equality (Corsi et al., 2006; Hunt and Kasynathan, 2001;

Morduch, 2000).


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In recent years, microfinance has also gained so much attention as an important instrument in the

fight against HIV/AIDS. The number of microfinance programs that are currently integrating

poverty reduction and HIV/AIDS prevention in their initiatives is increasing globally (Dworkin

and Blankenship, 2009; Kim et al., 2007). Studies have shown that poverty and gender inequality

are the two main structural determinants of HIV/AIDS. Economic empowerment can thus greatly

assist in the prevention and mitigation of the disease, particularly for women (Dworkin and

Blankenship, 2009; Pronyk et al., 2008; Kim et al., 2007).

Generally, poverty affects women and girls more negatively than men and boys (Todaro and

Smith, 2009). As a result, women and girls are more likely to be constrained into sexually risky

situations which increase their risk of contracting HIV (Hallman, 2004). Tan Minh et al. (2004)

as cited by Dworkin and Blankenship (2009) argue that many women who do sex work are firstinduced and partly trapped into it for economic reasons. Consequently, it has been argued that

microfinance programs that target women do not only help to empower them economically by

providing alternative sources of income but to a greater extent promote HIV/AIDS prevention.

Thus, by combining HIV/AIDS prevention and microfinance, important synergies may be

produced that extend beyond the economic realm to provide more enduring „„structural

protection‟‟ from HIV/AIDS risks than HIV/AIDS prevention can do alone (Dworkin and

Blankenship, 2009).

Finally, empirical studies have also established a strong link between microfinance and child

labour as fewer cases of child labour and school absenteeism have been reported in households

which participate in microfinance programs. It has been argued that access to credit expands a

household‟s income earning opportunities thereby reducing its reliance on casual labour as a

major source of livelihood. In turn, this reduces children‟s participation in the labour market and

in the process improves their school attendance (Shimamura and Cornhiel, 2009). However,

another line of literature argue that microcredit has the potential to decrease the schooling levels

of children as it increases the labour demand on children either for household production or

chores as the working-age adults get more involved in income generating activities financed by

the loans (Morduch, 1999; Wydick, 1999).


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The flow chart in Figure 2.1 below shows the transmission mechanism of microfinance to

poverty alleviation. The chart illustrates that microfinance, if targeted at the poorest segment of

the society, leads to increased employment and women participation in economic activities

which translate into increased household income. Eventually, this results into an increase in per

capita income, increased consumption of goods and services and better standards of living. This

ignites an increase in aggregate demand and supply of goods and services which eventually spur

a growth in the economy and results into a reduction in poverty levels (State Bank of Pakistan,

2005).

Figure 2.1: Transmission Mechanism of Microfinance to Poverty Alleviation(Source: Adopted with some modification from The State Bank of Pakistan, 2005)

Microfinance

Target poorestSegment of society

Women

em owermen Increase inemployment

Increased women participation ineconomic activities

Gender equality Increased role of women in

family decision making

Rise in income level

Reduced fertility rates Improved family well being

Reduced risk of contractingHIV/AIDS

Small population size

Better provision of health &education services

Improved food security & nutrition Increased health opportunities Access to education improved Reduced child labour

Increase in productivity Increase in per capita income

Improved standards of living

Increase in consumption of goods& services

Aggregate demand increased

Increase in investment &employment opportunities

Aggregate supply increased

The economy grows

& poverty declines


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2.2 Group Lending Theory

This section provides an overview of the merits and demerits of group lending theory which

MRFC, the target MFI for the study, uses when providing loans to rural households which do not

have physical collateral. The discovery of group lending in microfinance is seen as the major

breakthrough in the delivery of financial services to the poor and ultimately in the fight against

poverty. Empirical evidence suggests that the success of most microfinance programs

implemented across the globe, as reflected by high repayment rates, is to a greater extent

attributed to the group lending approaches used by most MFIs. It is argued that group lending

has shown how unconventional contracts can work where true banking practices failed to

achieve tangible results. Accordingly, the discovery of group lending contracts has opened up

new possibilities for microfinance and it is by far the most celebrated microfinance innovation

(Guttman, 2008; Cassar et al., 2007; Armendàriz and Morduch, 2005; Chowdhury, 2005;

Kritikos and Vigenina, 2005; Schreiner 2003).

Basically group lending relies on “joint liability” or “group responsibility” contracts in which,

instead of collateral, poor borrowers act as guarantors for each other (Besley and Coate, 1995;

Ghatak, 1999). The group forms voluntarily and while loans are made to individuals within

groups, all members are expected to support each other when difficulties arise. Unlike

commercial banks which demand physical collateral as a precondition for lending, most MFIsimplement group-based lending programs with joint liability contracts and peer pressure as

substitutes for collateral, along with community-based delivery systems that seek to exploit the

social capital and information advantages of local communities in screening and monitoring

borrowers (Cassar et al., 2007; Armendàriz and Morduch, 2005; Kritikos and Vigenina, 2005;

Rankin, 2002). Nevertheless, Schreiner (2003) argues that joint liability by itself cannot result

into higher repayment rates but a combination of a set of incentives, such as progressive lending,

targeting of women, weekly or monthly repayment schedules, public repayments, routine

monitoring by loan officers from MFIs and other dynamic incentives also come into play.

Credit theorists argue that joint liability contracts in group lending can help to circumvent the

principal-agent (agency) problems that arise in credit and insurance markets due to information

asymmetry such as adverse selection, moral hazard, and lack of enforcement (Ghatak, 1999;


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Besley and Coate, 1995; Stiglitz, 1990). Firstly, joint liability contracts are argued to help in

overcoming the problem of adverse selection which arises due to lack of information about

borrowers on the part of the principal (lender). This makes it costly and difficult for MFIs to

determine the creditworthiness of borrowers and the process of screening prospective borrowers

has the potential to escalate their transaction costs. As such they are unable to discriminate

against risky borrowers and in the process they charge high interest rates to compensate for the

possibility of having very risky borrowers. However, potential borrowers are able to easily

screen each other and through assortative matching they are able to choose amongst themselves

best partners and for them this is a sunk cost. The screening is based on the knowledge they have

about each other from informal relationships. It is argued that the voluntary formation of groups

induces borrowers to self-select into homogenous groups of low risks before the loan contract is

concluded and it induces several peer measures within the group of borrowers if anybody

defaults (Cassar et al., 2007; Armendàriz and Morduch, 2005; Kritikos and Vigenina, 2005).

Secondly, when loans are issued out, most outside financial institutions encounter moral hazard

problems which emanate from difficulties in monitoring the actions of borrowers which

eventually raises the monitoring costs for the banks. However, the advocates of group lending

argue that joint liability contracts can help to mitigate this problem (Armendàriz and Morduch,

2005; Ghatak and Guinnane, 1999; Stiglitz, 1990). Stiglitz (1990) argues that joint liability helps

to circumvent ex-ante moral hazard by inducing members to monitor each other‟s choice of

investments and to inflict penalties upon borrowers who have chosen excessively risky projects.

In this regard, group members faced with the joint responsibility for the loans are induced to

monitor each other‟s investment decisions and this ensures that members do not squander their

loans or invest in projects that are not viable. Thus borrowers are given tasks of both managing

their loans and monitoring peers to ensure that they take safe decisions that would protect them

from falling into repayment problems (Simtowe and Zeller, 2006). Nonetheless, empirical

studies elsewhere have shown that members in credit groups rarely experience any form of

excessive monitoring and borrowers do not receive any pressure from peers regarding the types

of projects to invest in (see for example Kritikos and Vigenina, 2005; Diagne et al., 2000 as cited

by Simtowe and Zeller, 2006).


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Thirdly, after undertaking an investment, the project might fail due to some external factors

beyond the control of the borrower, thereby making it difficult for the member to repay the loan.

The proponents of joint liability lending argue that such circumstances are taken care of by peer

support as other members without repayment problems can come in and repay the loan on behalf

of the defaulters. This provides a form of intra-group insurance which is argued to help reduce

default rates in joint liability lending (Simtowe and Zeller, 2006; Ghatak, 1999). But under

certain circumstances, borrowers may be unwilling to repay their loans even when their

investments have been able to yield higher returns. This results into the ex-post moral hazard

problem which is argued to raise enforcement costs for the banks as they try to recover their

money. On the contrary, under joint liability contracts peer monitoring and enforcement as well

as peer pressure and social sanctions if needed, ensures that members abide by the agreed

contracts and repay their loans (Armendàriz and Morduch, 2005; Ghatak, 1999; Besley and

Coate, 1995).

Conversely, Diagne et al. (2000) as cited by Simtowe and Zeller (2006) point out that peer

monitoring rarely occurs in credit groups in Malawi and when it occurs it does not lead to

improvements in repayment rates as unwillingness to repay (moral hazard) and not the inability

to repay was reported to be the main reason behind high default rates in Malawi Rural Finance

Company (MRFC) credit programs. Additionally, Che (2002) argues that in certain cases joint

liability contracts create a free-riding problem as some group members may deliberately decide

not to repay their loans knowing that it is the responsibility of the group to take care of such

situations thereby increasing the burden for other members. As a result, this makes group lending

unattractive. Wydick (1999) also observes that while peer monitoring appears to have a positive

effect on group loan repayment, strong social ties within the group make it difficult to pressure

fellow members to repay their loans. This demonstrates that much as joint liability contracts have

produced positive results elsewhere, the model has failed to achieve high repayment rates in

other programs. At times, joint liability has yielded mix results even for groups under the same

MFIs.

Finally, apart from the advantages of group lending highlighted above, it is also argued that

offering loans through groups helps MFIs to cut on operational costs as they are able to reach out


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to many clients at a cheaper cost than when targeting individual lenders. MFIs also utilize these

groups to provide various forms of trainings to the clients at a lower cost (Armendàriz and

Morduch, 2005).

Figure 2.2 illustrates the different stages of a loan transaction; problems encountered at each

stage and corresponding theoretical solutions as suggested by credit theorists. At the beginning

of the process there is a pool of potential borrowers unknown by the lender (safe and risky)

trying to access loans. But for them to qualify for a loan they need to be affiliated to a group and

bearing in mind that each group will need to sign a joint liability contract with the principal

(lender). Each borrower, through peer selection tries to match with members of similar risk type.

It is this self-selection process among the peers that is argued to reduce incidences of adverse

selection (Cassar et al., 2007; Simtowe and Zeller, 2006).

Thereafter each group member undertakes an investment. At this stage the lender is faced with

the ex-ante moral hazard problem which occur because the borrower either misuses the loan;

invests in a risky project or does not apply enough effort to manage the project. However, credit

theory argues that peer monitoring can help circumvent this problem. The third stage is about

investment outcomes. Under this stage, there are two possible outcomes: the project may fail due

to factors beyond the borrower‟s control which results into a limited liability problem or the

borrower‟s project may succeed but the borrower might be unwilling to repay the loan which

results into the ex-post moral hazard problem. As a remedy, group lending theory argues that

peer support can help address the former case as other members may repay for the defaulters

while peer pressure and social sanctions can help to address the latter situation (Simtowe and

Zeller, 2006).


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Figure 2.2: A Dynamic Presentation of Problems and Solutions in a Multi-stage Joint Liability Loan

(Source: Adopted from Simtowe and Zeller (2006); modified after Sadoulet (2004))

A number of distinctive group lending models with joint liability contracts exist reflecting the

fact that microfinance has evolved differently in different environments and the types of models

used differ widely across countries. Some of the popular and widely used group lending models

relying on joint liability include: the Grameen model (see: Armendàriz and Morduch, 2005;

Schreiner, 2003; Zeller, 2003); cooperatives and credit union model (see: Armendàriz and

Morduch, 2005; Zeller, 2003); the village bank model (see: Zeller, 2003; Buckley, 1997);

Rotating Savings and Credit Association (ROSCA) and Self-Help Groups models (see:

Armendàriz and Morduch, 2005; Zeller, 2003; Vonderlack and Schreiner, 2002).

In recent years, new lending models which do not necessarily rely on joint liability are emerging.

These models basically target individuals with relatively flexible lending terms as opposed to

traditional commercial banks. Currently, a wide range of MFIs worldwide also offer individual

loans to the poor with flexible collateral terms. It has been noted that these new forms of lendingcontracts are very helpful in areas with low population densities or highly diverse populations

and in situations where more established clients seek greater flexibility. In such circumstances,

peer monitoring costs are high and the social punishments for non-compliance are more difficult

to implement (Armendàriz and Morduch, 2005).

Potential

borrowers

Loan

Investment

FailureUnwillingness to repay

Repay

Tim

Problems

Theoretical

solutions

Peerselection

Monitoring(Peer monitoring)

Intra-group insurance

(Peer support)

Enforcement throughsanctions

(Peer pressure)

Ex-ante moral hazard

(project choice)

Limited

liability

Ex-post moral hazard

(limited enforcement)Adverseselection


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2.3 The Microfinance Sector in Malawi

Malawi, just like other developing countries, has not been spared by the microfinance revolution

and the concept is gaining importance as an effective tool for social mobilization and poverty

alleviation. Initially, microfinance was seen as a “development tool” and its activities were oftenisolated from the wider financial system. However, over time with the success of credit-led

NGOs in many countries, their transformation into licensed banking institutions, and the entry of

mainstream and specialized commercial banks into the business of micro-lending and savings

collection, the microfinance industry has evolved into a powerful sub-sector of the formal

financial system (Burritt, 2006; USAID, 2004).

2.3.1 The Structure of the Financial Sector in Malawi

The formal financial sector in Malawi is fairly small and limited in scope. The sector is regulated

by the Reserve Bank of Malawi (RBM) which was established in 1965 under an Act of

Parliament. Through the Banking Act of 1989, the RBM is mandated to regulate and supervise

the activities of most financial institutions. The bank is also responsible for licensing and

registering banks and financial institutions (USAID, 2004).

The central bank basically categorizes formal financial institutions under two broad headings and

these are: commercial banks (providing all types of savings, lending and investment products)and other financial institutions (non-banks). Currently, there are about 11 commercial banks in

the formal financial sector. Other financial institutions include discount houses, leasing

companies, a building society, a finance company, development finance institutions, savings

institutions and an insurance industry made up of several insurance companies. There are also

many semi-formal actors providing financial services in Malawi. These include NGOs,

parastatals, Savings and Credit Cooperatives (SACCOs), private companies, and projects of

international development agencies and donors. It is to this category that most microfinance

institutions operating in Malawi belong. Generally, the regulations do not allow most of these

actors to mobilize savings for on-lending with the exception of SACCOs. Their focus is mainly

to provide credit, both in-kind and cash. As such, none of these semi-formal institutions is

subject to any kind of prudential regulation from the central bank as is the case with formal

financial institutions (Burritt; 2006; USAID, 2004).


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Malawi also has a vibrant informal financial sector which caters for lower-income clients and is

operated through Katapila (moneylenders), Rotating Savings and Credit Associations

(ROSCAs), and networks of families or friends. These informal credit providers operate beyond

any regulatory or supervisory framework. It is estimated that informal sources account for over

26 per cent of the money used to start-up micro and small businesses compared to 2 per cent

from formal sources (USAID, 2004). Figure 2.3 shows the structure of the financial sector in

Malawi.


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Figure 2.3: Structure of the Financial Sector in Malawi (Source: Author)

Financial Sector in Malawi

Semi-formalSector

Commercial

banks

Otherfinancialinstitutions(Non-banks)

Government

owned

(Parastatals)

NGOs Private

sector

owned

Traditional

moneylenders

, relatives,

friends, etc

Formal Sector Informal Sector

Rotating

Savings and

Credit

Associations

(ROSCAs)

Examples:

SEDOM, DEMAT, MRFC, MSBand MARDEF

Examples:

ECLOF, FITSE,Microloan, CUMO, NABW and TLF

Examples:

FINCA, PRIDE Malawi,MUSCCO and OIBM

2 2


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2.3.2 Microfinance Institutions in Malawi

The MFIs operating in Malawi are basically defined as semi-formal financial institutions and can

operate under several legal forms and ownership structures (USAID, 2004). In terms of bothlegal form and ownership structure the institutions are categorized into three groups as described

below:

a. Cooperative Associations.

These include both financial and non-financial cooperatives registered under the Cooperative

Societies Act of 1946. Examples of institutions registered under this act are the Savings and

Credit Cooperatives (SACCOs) and Malawi Union of Savings and Credit Cooperatives(MUSCCO). MUSCCO is an affiliated network of 66 SACCOs dispersed throughout the country

but both MUSCCO and its member SACCOs are registered independently as cooperative

associations. SACCOs can mobilize and on-lend savings of members (USAID, 2008: 2004).

b. Non-Profit Institutions

All NGO microcredit institutions without a profit-making motive registered under the Trustees

Incorporation Act of 1962 belong to this category. NGOs are generally engaged in multi-sector

development activities with microcredit being one of many. Ownership structure is not always

clear. Microcredit operations are usually started as donor projects or initiated by the government.

Notable examples include microcredit providers that operate as donor-funded projects within

international NGOs such as Ecumenical Church Loan Fund (ECLOF), Microloan, TLF and

Finance Trust for the Self Employed (FITSE). This category also include parastatals such as

Small Enterprise Development Organization of Malawi (SEDOM) and Development of

Malawian Enterprises Trust (DEMAT). The National Association of Business Women (NABW)

is also a microcredit institution registered under this act (MAMN, 2008; Burritt, 2006; USAID,

2004).


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c. Profit-Oriented Institutions

This category includes all profit-making institutions limited by guarantee or shares that are

registered under the Companies Act of 1986. Institutions like Finance for International

Community Assistance (FINCA), Concern Universal Microfinance Organization (CUMO),PRIDE Malawi and the government owned Malawi Rural Finance Company (MRFC) are all

registered under this Act. The government owned Malawi Savings Bank (MSB) and the

Opportunity International Bank of Malawi (OIBM) registered under the banking act also belong

to this group. MSB is mainly responsible for the disbursement of funds under the Malawi Rural

Development Fund (MARDEF) which was created by the government to provide small loans to

rural people mainly targeting non-farm activities (MANM, 2008; Burritt, 2006; USAID, 2004).

The table below summarizes all the MFIs discussed above in terms of their legal forms and

ownership structures.

Table 2.1: Legal and Ownership Structures of MFIs in Malawi

MFIs Registering Act

Trust Banking Companies Cooperative

Government ownedDEMAT *MRFC *MSB *SEDOM *

Non-Governmental OrganizationsECLOF *FITSE *Microloan * NABW *

Private sector ownedCUMO *FINCA *OIBM *MUSCCO *PRIDE Malawi *SACCO *

Source: Adopted with some Modification from USAID (2004)


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2.4 Demand and Supply of Microfinance Services in Malawi

The demand for microfinance services both by households and microenterprises is quite large in

Malawi and the larger part of it is still unmet despite the ever increasing number of players in the

sector. It is estimated that the sector has the potential clientele base of around 622,000; mostlycomprising of microenterprises, of which over 80 per cent are located in rural areas. The demand

for loans is highly seasonal as MSEs mostly depend on agriculture (Burritt, 2006). The supply of

microfinance services is basically a mixture of agricultural credit and small loans for the

microenterprises which account for 91 per cent of all the MSEs (USAID, 2004; GOM, 2002;

NSO, 2001). Generally, agricultural-related credit dominates the sector and is mostly issued out

as in-kind inputs of fertilizer and seed to smallholder farmers in groups (USAID, 2004).

The number of players in the microfinance sector has been increasing over time but the

government still remains the major actor; controlling a higher share of the market. By 2004,

Government owned parastatals (MRFC and MSB) controlled over 80 percent of the micro-

savings market and around 63 per cent of the micro-credit market. APIP, a bilateral agricultural

credit project funded by the EU accounted for about 18 per cent of the credit market (USAID,

2004). Private sector institutions and NGOs control a small share of the market and most of them

target urban and semi-urban residents with few penetrating into the remote areas of the country

(MAMN, 2008; USAID, 2004). However, between 2004 and 2008, the sector experienced a

dramatic shift in MFI market share among previous players as well as the entry of new entities

that has led to an enormous deepening and broadening of the microfinance sector (USAID,

2008).

In terms of national coverage, MRFC, MARDEF and MUSCCO are the main actors reaching out

to rural areas in almost all the 28 districts of the country (MAMN, 2008). With regard to micro-

savings, a few MFIs are licensed to accept savings in Malawi, thus this service is very limited.

The only formal savings institutions broadly available to rural residents are the MSB and MRFC.

These are also the major providers of microcredit used for agricultural production and non-farm

microenterprises. Additionally, credit cooperatives, such as SACCO and MUSCCO, service both

rural and urban areas and can mobilize and on-lend savings of members (USAID, 2004; Diagne

and Zeller, 2001).


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2.5 Participation in Formal Microfinance Programs

Participation in formal microfinance programs in Malawi is still very low despite the increase in

the number of players in the microfinance sector. Just like in other developing countries, the

majority of households in Malawi rely on a combination of both formal and informal sources offinance and they make trade-offs as per their convenience. It is argued that much as informal

sources tend to be better positioned in the rural areas and offer relatively flexible lending terms,

the formal sector still remains the major and stable provider of a wide variety of services to the

rural poor. Just like elsewhere, in Malawi the informal sector (especially moneylenders) charge

extremely high interest rates but the absence of formal intermediaries leaves the poor with no

choice but to access deposit, credit and transfer services from informal sources at higher costs

(USAID, 2004; Zeller, 2003).

In this study, the focus will be on households that participated in credit programs under Malawi

Rural Finance Company (MRFC) which is a good representative of the spectrum of formal

microfinance programs as it is the major provider of both credit and savings services in the rural

areas of Malawi. As such, the following section will give a brief description of the institution.

2.5.1 Malawi Rural Finance Company (MRFC)

MRFC is wholly owned by the government and is registered under the companies Act. Apart

from issuing out loans, the company is also given a special exemption by the RBM to accept

deposits from the public. It is the largest provider of both micro-savings and microcredit services

in rural areas and operates nationwide. It provides agricultural loans, group loans, individual

loans and consumer loans in cash or in-kind. Its client base is mainly composed of small and

medium scale farmers, women and employees (MAMN, 2008; Burritt, 2006; USAID, 2004).

MRFC was created with financial and technical assistance from the World Bank, to replace the

bankrupt Smallholder Agriculture Credit Administration (SACA) which was disbanded in 1993.

It begun its operation in 1994 and inherited much of SACA‟s infrastructure consisting of rural

extension service offices in the Extension Planning Areas (EPAs). SACA was a department of

the Ministry of Agriculture established in 1987 and was mandated to provide seasonal

agricultural loans to smallholder farmers (Diagne and Zeller, 2001). Since 1995, MRFC has


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absorbed other rural financial projects such as the Promotion of Microenterprises for Rural

Women (PMERW supported by GTZ), a microcredit program targeted at women in support of

non-farm income-generating activities; and the Malawi Mudzi project, a Food Security Program

(Shimamura and Cornhiel, 2009; Diagne and Zeller, 2001). The Mudzi project is one of the

earliest microfinance programs in Malawi introduced in the late 1980s with funding from IFAD

and was based on the Grameen model (Chirwa, 1998 and Hulme, 1991 as cited by Shimamura

and Cornhiel, 2009).

The company has 7 branch offices, 23 satellite offices, and 122 field offices throughout the

country. MRFC is the major provider of agricultural credit with 80 per cent of its loan portfolio

being agricultural in nature. According to the MRFC annual report for 2004 as cited by

Shimamura and Cornhiel (2009), the company‟s loans for agricultural production totaled MK1,001.7 million (US$ 9, 668, 918.9) while the loans for microenterprise activities were pegged at

MK 328.2 million (US$ 3, 167, 953.7); with an average loan size of Mk 7,252 (US$70). Burritt

(2006) observes that while MRFC accepts savings deposits, about 70 per cent of these are forced

savings to collateralize the loans.

According to the MRFC annual report for 2006 as cited by MAMN (2008), the company has

over 200,000 clients countrywide, of which the majority are smallholder farmers. Women

account for about 40 per cent of the total clients and are the major borrowers of small loans for

microenterprises while men dominate in the agricultural credit category. Agricultural loans are

provided mostly in-kind, in form of seeds and fertilizer, while microenterprise loans are

distributed in cash. After its establishment in the mid-1990s, MRFC was mainly providing

agricultural credit for the production of hybrid maize; however, of late the focus has changed as

it is mainly targeting smallholder farmers who produce cash crops such as tobacco, g

determinants of rural households’ participation in formal microfinance programs in malawi: an...

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