Introduction to Microfinance Free

The World of Microfinance

This course is made possible through the generous financial support of the Arab Gulf Program for Development (AGFUND). _For more information visit the Global Platform on Financial Inclusion _

Objectives By the end of the module, you should be able to: Define what is microfinance Explain why financial intermediation is necessary for the poor Identify in broad terms microfinance clients and financial services offered to them State historical background of microfinance and its growth Identify risks for microfinance growth

The concept of microfinance has been usually associated with provisions of small loans to the poor. Today, it is thought of in broader terms since it offers a wide range of financial services which not only include microcredit, but also savings, insurance, and money transfers.

Microfinance can be defined as the provision of financial services to those excluded from financial system due to their lack of wealth, but also due to their social, cultural, and gender backgrounds.

Microfinance plays an important role in poverty reduction, and in economic and social development. It overcomes a variety of barriers to provide financial services to the poor.

In the 2030 Agenda for Sustainable Development, financial inclusion has been placed prominently as an enabler of other development goals. It features as a target in 8 of the 17 goals, and thus the vital role of microfinance, not only as a factor of financial inclusion but also as a significant lever in the implementation of the 2030 Agenda, cannot be overlooked.

Financial intermediation facilitates the use of money. For example, transforming small individual deposits into a line of credit for different businesses. Such financial intermediation pools risk, increases liquidity, provides valuable information, and reduces transaction costs to borrowers and returns to savers.

Poverty is usually thought of in static terms, but that is not the case. It is very dynamic and any economic or other shock, such as a loss of income, damage to the workshop, or illness, can reduce the vulnerable non-poor to levels of poverty.

In order to manage such risks, individuals use financial services. Financial services are used in two ways. You can protect yourself against risk ahead of time by borrowing in order to, for example: diversify your income, grow your business, or send your children to school, or you can use financial services to cope with shocks after they have occurred.

Savings services allow for direct accumulation of capital in a safe place, so people can build up their assets in order to invest in the future or protect against a loss.

Financial Services Financial services most commonly offered by microfinance organizations include savings and credit, but insurance and payment services are provided as well by some. In addition to financial services or intermediation, many microfinance institutions provide social intermediation services such as group formation, development of self-confidence, and training in financial literacy and management capabilities. When considered in terms of financial and social intermediation, microfinance can be thought of as an important development tool. Activities performed by a typical microfinance institution include provision of small loans, typically as working capital, informal appraisal of borrowers and investments, collaterals substitutes, such as group guarantees or compulsory savings, access to larger loans based on repayment performance, streamlined loan disrobement and monitoring, and secure savings products. Some microfinance institutions also offer enterprise development services, such as skills training and marketing, and social services, such as literacy training and healthcare, but these activities are not usually included in the definition of microfinance. The services and activities performed by microfinance institutions may vary depending upon the region and maturity of microfinance institutions. For example, most of the services provides by microfinance institutions in the MENA region are credits and they don’t provide saving or deposit services as well as many other advanced services as highlighted above.

The Evolution of Microfinance

Microfinance gained prominence in the 1980s as a response to subsidized credit given by governments and international donors to poor farmers. In the 1970s, government agencies were the principal institutions providing credit to the individuals with no access to financial services. Governments believed that the poor needed cheap credit in order to promote agricultural production.

However, in 1980s, subsidized loans received a lot of criticism since programs accumulated large loan losses and required frequent recapitalization to continue operating. Market-based solutions were sought after and this led to the establishment of microfinance as an important part of financial system. Emphasis shifted from rapid distribution of subsidized loans towards building of local and sustainable institutions serving the poor.

At the same time local NGOs sought to develop a more long-term approach to community development. Dr. Muhammad Yunus of Bangladesh (pictured above) pioneered a group lending scheme for landless people.

This later became the Grameen Bank, and today it serves more than 2.4 million clients. Microenterprises spread in Latin America as well and programs such as solidarity group lending to urban workers and provision of credit and training system for individual microentrepreneurs flourished.

Changes were also occurring in the formal sector as the Bank Rakyat of Indonesia moved away from providing subsidized loans towards institutional approach operated by market principles. They developed a system of transparency where on-time loan repayments were rewarded and voluntary savings mobilization was used as a source of funds.

Since the 1980s, the field of microfinance has grown substantially and today the focus has shifted toward providing financial services only rather than an integrated package of credit and training. The industry has emphasized the need to provide savings services to their clients and to access market funding sources rather than rely solely on the donor funds.

The Microfinance Industry Today

There are an estimated 7,000 to 10,000 microfinance institutions worldwide. However, only 200 to 500 are considered commercially sustainable.

About US $7 billion in outstanding loans has been provided to more than 13 million individuals and groups. There is an annual growth of 30 percent and repayment rates are around 97 percent.

Around 30 million individuals have access to microfinance, but 90 to 98 percent of self-employed poor still lack access to any type of financial service. It is estimated that around US $ 21.6 billion is needed to provide microfinance to 100 million of the world’s poorest families.

The growth of the microfinance sector can be attributed to several reasons: The promise to reach the poor. 2. The promise of financial sustainability. 3. The potential to build on traditional systems (microfinance activities mimic traditional systems such as rotating savings and credit associations but with greater flexibility and more affordable price). 4. The contributions of microfinance to strengthening and expanding of existing formal financial systems. 5. The growing number of success stories. 6. The availability of better financial products as a result of experimentation and innovation. Although microfinance activities have been growing in the past years and they have come to play an important role in providing the poor with access to financial services, there have been more failures than success.

Risks of Microfinance

Research suggests that favorable microeconomic conditions, managed growth, deposit mobilization, and cost control are among key factors that contribute to the success and sustainability of a microfinance institution.

Many institutions lack basic accounting capacities in terms of reporting plausible cost and debts data. This is a common shortcoming among the NGOs, and highlights the need to place a greater emphasis on financial monitoring and reporting using standardized practices.

Some of the reasons for institutional failures include: Targeting a segment of population that has no access to business opportunities because of lack of markets, inputs, and demands 2. Some institutions never reach either the minimal scale or the efficiency necessary to cover costs 3. Some face non-supportive policy frameworks and daunting physical, social, and economic challenges 4. Failure to manage funds adequately to meet future case needs and as a result confronting a liquidity problem 5. Not developing the financial management systems nor the skills required to run a successful operation 6. Replication of successful models has at times proven difficult due to differences in social contexts and lack of local adaptation

Goals of sustainability and outreach have generated considerable debate within the microfinance field.

To some, the two are not complementary and pursuit of sustainability undermines the institution’s ability to serve the poor.

The argument follows that the push for sustainability and the demands this places on the institution will decrease outreach and leave the poor unserved and abandoned as the institution is no longer subsidized by donors.

Future Growth of Microfinance

Challenges for Microfinance Growth Although growth is usually welcomed for microfinance institutions, problems can arise that might jeopardize the effectiveness of microenterprises. Problems of large micro-lenders include: Increased transaction costs Heavier reliance on commercial credit Variability of social and cultural factors Friction with traditional political climate

Some of the political and legal aspects that need to be considered in terms of microenterprise expansion are:

Negative governmental interference and obstruction Microfinance institutions have to restructure to comply with legal boundaries Limitations for marketing goods, protectionist trade policies, and heavy taxing of informal sector

Governments seeking to penalize or reward certain segments of the population Violence and political struggle that can curtail a microfinance institution’s positive influence in the region

The local political economy has a large influence on microfinance institutions. Microcredit growth can create division between those who work with the bank and those who do not. This can, as a result, foster tensions in the local environment.

What are some challenges for microfinance growth? Select all that apply

In recent years microfinance has been the subject of various innovations and experiments, which is hugely transforming the way in which low-income clients can access the products and services of microfinance institutions.

These include, for example, mobile banking (i.e. mobile credit, savings, payment and e-wallet solutions) that helps the poor to access financial services, save time, and make secure transactions anytime and anywhere.

Moreover, digital technology and data analytics has the impact of allowing microfinance institutions to serve their customers more effectively while adopting a “customer-centric” approach that is more focused on the understanding their financial needs and then offering them products and services accordingly.

This course is made possible through the generous financial support of the Arab Gulf Program for Development (AGFUND). _For more information visit the Global Platform on Financial Inclusion _

Module Review & Quiz

Which financial services are covered within the purview of microfinance?

Who are typically clients of microfinance institutions?