microfinance and the poor - imf · elizabeth littlefield and richard rosenberg bolivian women wait...

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Page 1: Microfinance and the Poor - IMF · Elizabeth Littlefield and Richard Rosenberg Bolivian women wait in line at an automatic teller machine. Finance & Development June 2004 39

ONTRARY TO a common impression, poor peo-ple need and use a variety of financial services,including deposits, loans, and other services.They use financial services for the same reasons

as anyone else: to seize business opportunities, improve theirhomes, deal with other large expenses, and cope with emer-gencies. For centuries, the poor have used a wide range ofproviders to meet their financial needs. While most poorpeople lack access to banks and other formal financial insti-tutions, informal systems like moneylenders, savings andcredit clubs, and mutual insurance societies are pervasive innearly every developing country. The poor can also tap intotheir other assets, such as animals, building materials, andcash under the mattress, when the need arises. Or, for exam-ple, a poor farmer may pledge a future season’s crops to buyfertilizer on credit from commercial vendors.

However, the financial services usually available to thepoor are limited in terms of cost, risk, and convenience. Cashunder the mattress can be stolen and can lose value as aresult of inflation. A cow cannot be divided and sold inparcels to meet small cash needs. Certain types of credit,especially from moneylenders, are extremely expensive.Rotating savings and credit clubs are risky and usually don’tallow much flexibility in amount or in the timing of depositsand loans. Deposit accounts require minimum amounts andmay have inflexible withdrawal rules. Loans from formalinstitutions usually have collateral requirements that excludemost of the poor.

Microfinance institutions (MFIs) have emerged over thepast three decades to address this market failure and provide

financial services to low-income clients. Most of the early pio-neer organizations in the modern microfinance movementoperated as nonprofit, socially motivated nongovernmentalorganizations. They developed new credit techniques: insteadof requiring collateral, they reduced risk through group guar-antees, appraisal of household cash flow, and small initialloans to test clients. Experience since then has shown that thepoor repay uncollateralized loans reliably and are willing topay the full cost of providing them: access is more importantto them than cost.

The poor need and use a broad range of financial services,including deposit accounts, insurance, and the ability totransfer money to relatives living elsewhere. Experience hasshown that the poor can be served profitably, on a long-termbasis, and in some cases on a large scale. Indeed, well-runMFIs can outperform mainstream commercial banks inportfolio quality. The top-performing MFIs in some coun-tries are more profitable than the top-performing local com-mercial bank.

In turbulent times, microfinance has been shown to be amore stable business than commercial banking. DuringIndonesia’s 1997 crisis, for example, commercial bank portfo-lios deteriorated, but loan repayment among Bank RakyatIndonesia’s 26 million microclients barely declined. And, dur-ing the recent Bolivian banking crisis, MFIs’ portfolios suf-fered but remained substantially healthier than commercialbank portfolios.

Today, microfinance is reaching only a small fraction ofthe estimated demand for financial services by poor house-holds. While a few hundred institutions have proved the

Finance & Development June 200438

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Microfinance and the PoorMicrofinance and the PoorBreaking down walls between microfinance and formal finance

Elizabeth Littlefield and Richard RosenbergBolivian women wait in line at an automatic teller machine.

Page 2: Microfinance and the Poor - IMF · Elizabeth Littlefield and Richard Rosenberg Bolivian women wait in line at an automatic teller machine. Finance & Development June 2004 39

Finance & Development June 2004 39

poor can be served sustainably and on a large scale, most ofthe institutions are weak, heavily donor-dependent, andunlikely to ever reach scale or independence. Only financiallysound, professional organizations have a chance to competeeffectively, access commercial loans, become licensed to col-lect deposits, and grow to reach significant scale and impact.To achieve its full potential, microfinance must become afully integrated part of a developing country’s mainstreamfinancial system rather than being confined to a niche of thedevelopment community.

Encouraging signs of integration are beginning to emerge.In some countries, the walls between microfinance and theformal financial sector are coming down. The commercialsuccess of some MFIs has begun to attract new, mainstreamactors. Partnerships are forming, andpublic and private sector infrastruc-ture and knowledge are being sharedand leveraged. New technologies arealso driving costs and risks down toprovide services to poorer clientsmore cost effectively. The quality andcomparability of financial reporting,ratings, and audits are improving,and domestic and international com-mercial investors are investing in thesector.

What’s at stakeReliable measurement of the impact of financial services onhousehold welfare is expensive and methodologically diffi-cult. However, an increasing number of serious studies aresuggesting that microfinance can produce improvements in arange of welfare measures, including income stability andgrowth, school attendance, nutrition, and health.Microfinance has been widely credited with empoweringwomen by increasing their contribution to householdincome and assets and, thus, their control over decisionsaffecting their lives. Of course, microfinance has generatedconsiderable enthusiasm—not just in the development com-munity but also politically—with the predictable result thatsome of its merits have been oversold.

Microfinance alone is not a magic solution that will propelall of the poor—particularly the very poorest people—out ofpoverty. But there is no doubt that poor clients themselvesvalue microfinance very highly, as evidenced by their strongdemand for such services, their willingness to pay the fullcost of those services, and high loan repayment rates that aremotivated mainly by a desire to have access to future loans.Moreover, because microfinance can be delivered sustain-ably, its benefits can be made available for the long term—well beyond the duration of donor or government subsidies.

MFIs form one part of a much broader spectrum ofsocially oriented financial institutions (SOFIs) that includesstate-owned development, postal, agricultural, and savingsbanks, as well as smaller entities like savings and loan coop-eratives. These institutions are considered socially orientedbecause, for the most part, they were created not to be profit-

maximizers but, rather, to reach clients who were not beingwell served by the commercial banking system. SOFIs repre-sent a vast infrastructure and clientele: a recent, far fromexhaustive survey identified well over 600 million accountsin these institutions. Although no concrete data are availableon the proportion of SOFI clients who are poor, averageaccount sizes suggest that this proportion is substantial.

Despite their extensive outreach and infrastructure, SOFIsalso have significant limitations. Some of them—especiallythe state-owned ones—provide inferior services, are highlyinefficient, and generate large, continuing losses. In manycountries, financial authorities do not consider SOFIs part ofthe mainstream financial system and do not supervise themas seriously as commercial banks. Except in a few countries,

SOFIs account for a small percentageof financial system assets and may notpose systemic risk. But in many coun-tries, a large proportion—sometimesthe majority—of households usingfinancial services access themthrough SOFIs. The SOFI share oftotal financial system accounts is, forexample, 50 percent in Bolivia and65 percent in Côte d’Ivoire.

When large SOFIs can be turnedaround and run on a commercialbasis, the results can be dramatic. InMongolia, for example, the state agri-

cultural bank restructured, moved into microfinance, andhas been privatized. The bank, which serves half of all ruralhouseholds in Mongolia through 375 points of sale, is nowprofitable. Bank Rakyat Indonesia is another restructuredSOFI that now provides high-quality services to massivenumbers of poor people and generates very healthy profits.

Increasingly commercial orientationMost leading MFIs operate today on a commercial basisusing the techniques and disciplines of commercial finance.They are investing in more sophisticated management andinformation systems, applying international accountingstandards, contracting annual audits from mainstreamauditing firms, and seeking ratings from commercial ratingagencies. Last year, rating agencies, including industry lead-ers Standard & Poor’s and Moody’s Investors Service, carriedout over 100 credit ratings of MFIs.

There is growing awareness that building financial systemsfor the poor means building sound domestic financial inter-mediaries that can mobilize and recycle domestic savings.Foreign donor and social investor capital diminishes as indi-vidual institutions and entire markets mature. For this reason,increasing numbers of MFIs are getting licensed as banks orspecialized finance companies, allowing them to financethemselves by accessing capital markets and mobilizingdeposits from large institutional investors as well as poorclients. Several MFIs, mainly in Latin America, have tappedlocal debt markets, largely by issuing private placements takenup by local financial institutions.

“To achieve its full potential,microfinance must become

a fully integrated part of a developing

country’s mainstream financial system.”

Page 3: Microfinance and the Poor - IMF · Elizabeth Littlefield and Richard Rosenberg Bolivian women wait in line at an automatic teller machine. Finance & Development June 2004 39

Finance & Development June 200440

Dozens of countries are con-sidering legislation to create newtypes of financial licenses, usuallywith lower minimum capitalrequirements, designed for spe-cialized microfinance intermedi-aries. Although generally positive,this trend does pose risks.Supervisory authorities who arealready stretched thin trying tomonitor commercial banks canfind it difficult to take on respon-sibility for a new group of smallinstitutions. Moreover, a movetoward specialized MFIs some-times overlooks opportunities toinvolve mainstream commercialbanks in microfinance.

In countries as different asHaiti, Georgia, and Mexico, part-nerships between commercialbanks and MFIs are an alternativeto MFIs seeking their own finan-cial licenses. These partnershipsenable MFIs to cut costs and extend their reach, while bankscan benefit from the opportunity to tap new markets, diversifyassets, and increase revenues. Partnerships vary in their degreeof engagement and risk sharing, ranging from sharing or rent-ing front offices to banks making actual portfolio and directequity investments in MFIs (see figure).

In Africa, Asia, and Latin America, some local financialinstitutions are pursuing lower-end retail banking directly, asfinancial globalization heightens the competition posed byinternational banks for larger corporate customers. Banquedu Caire in Egypt, for example, entered the market two yearsago and now delivers microfinance alongside traditionalproducts through its 230 branches. It is still too early to tellwhether large numbers of commercial banks will move intomicrofinance. Well-run MFIs have proved to be profitable,but serving this market requires changes in systems, staffing,and culture that are not easy for traditional banks.

Lower-income customers have smaller account and trans-action sizes, which underscores the importance of reducingtransaction costs. Credit scoring and computerization haveunderpinned many of the important new down-marketopportunities, with the result that the boundary betweenmicrofinance and consumer finance is now blurring in manyplaces. Retailers, consumer finance institutions, and buildingsocieties in some developing countries are adapting micro-finance methodologies so they can use their infrastructure totap the new market of uncollateralized, character-based lend-ing to the self-employed or to households, more generally.

MFIs are beginning to tap into mainstream creditbureaus—an important strategy to increase productivity,improve portfolio quality, and reduce spreads betweenborrowing and saving rates. This not only reduces risk for theMFIs but also allows their clients to build a public credit

history that makes them moreattractive to mainstream banksand retailers. For example, morethan 80 MFIs in Peru are regis-tered to use Infocorp, a privatecredit bureau. In Turkey, MayaEnterprise for Microfinance nego-tiated with Garanti Bankasi, aleading private bank, to gainaccess to the national creditbureau to screen loan applicantsfor credit card and other debt.New regulations on microfinanceissued by Rwanda’s central bankrequire that MFIs communicateinformation about their borrow-ers to a credit bureau.

Creative new delivery channelsand new information technologyalso hold promise for reducingrisk and cutting delivery costs.Microfinance providers are nowexploring ways to piggybackfinancial services delivery onto

existing infrastructure, such as retail shops, Internet kiosks,post offices, and even lottery outlets. Existing distributionsystems may make it possible to provide financial servicesmore cost effectively and, thus, to poorer and more sparselypopulated areas. On the technology side, companies insouthern Africa are developing low-cost, cell phone–basedbanking services for poor clients. MFIs in Bolivia, Mexico,India, and South Africa are also making use of smart cards,fingerprint readers, and personal digital assistants toimprove efficiency and expand into rural areas. Not surpris-ingly, the actual performance of such new technologies andstrategies does not always match the initial level of enthusi-asm generated. But some of these new approaches haveproved themselves already, and others will no doubt con-tinue to emerge.

Twenty years ago, the main challenge in microfinance wasmethodological: finding techniques to deliver and collectuncollateralized loans to “microentrepreneurs” and poorhouseholds. After notable successes on that front, the chal-lenge today is a more systemic one: finding ways to betterintegrate a full range of microfinance services with main-stream financial systems and markets. While it is not yet clearhow far that integration will go, the early signs are encourag-ing. Advances taking place around the world would havebeen dismissed as unthinkable just a decade or two ago. ■

Elizabeth Littlefield is the Chief Executive Officer of theConsultative Group to Assist the Poor (CGAP), a multidonororganization created to help build a large-scale microfinanceindustry providing flexible, high-quality financial services tothe poor on a sustainable basis. Richard Rosenberg is a SeniorAdvisor on policy issues at CGAP.

Forging new linksCommercial banks and microfinance institutions (MFIs) are forming partnerships.

Bank buys MFI portfolio and/or contracts MFI

operations

Wholesale lending

Sharing/renting facilities

Bank creates loan service company

Bank invests equity in an MFI

Higher level of engagement

Lower level of engagement

ICICI Bank (India) contracts microfinance operations with self-help groups and MFIs.

Sogebank (Haiti) created Sogesol, a microloan service company, in 2000.

Jammal Trust Bank and Credit Libanais (Lebanon) have equity stakes in Ameen, a microfinance program.

Microfinance Bank (Georgia) rents space in its offices to Constanta, a local nongovernmental organization.

Raffeissen Bank (Bosnia) lends to multiple MFIs in Bosnia.

Source: Consultative Group to Assist the Poor.