Microfinance; A selective introduction with special focus on HIV/AIDS

Transcription

1 Microfinance; A selective introduction with special focus on HIV/AIDS * Occasional Paper Number 5/03 * Special thanks to John David Kisuule at the Norwegian church Aid for valuable input on the HIV/AIDS part, and Roy Mersland for insightful comments on the overall document. 1

2 Abstract Microfinance can be defined as the provision of a variety of financial services to the poor. Main products are credit, savings and insurance. A variety of actors are involved, ranging from donor agencies, consultants and commercial banks to specialised and multipurpose NGOs. Networks exist at global as well as at regional and national levels. The industry is moving towards more professional actors, and credit rating is likely to become a precondition in order to obtain loans from private and public investors. Microcredit has proven powerful in combating poverty, but extra care is required if a microfinance institution is to establish services in areas of very disperse population or an unstable social context. Being it post-war, lack of basic social and physical infrastructure, a society seriously hit by epidemics or in high risk for future crisis. Successful microfinance can be characterised by having a focus on permanency, scale, outreach and financial sustainability. These are crucial elements in order for an MFI to tap into the financial marked, the only marked with enough recourses to serve the world demand for microfinance services. Albeit the possible trade off between financial sustainability and depth of outreach, experience show these can be combined. When it comes to the Millennium Development Goals, microfinance contributes through reducing the poor s vulnerability towards income and expense fluctuations. A stronger household economy enables poor families to meet expenses for schooling, nutrition and health in a better way. Within the variety of organisations providing financial services there are those working with microfinance only, and those having microfinance as a part of a broader work. Separation of microfinance and other activities are recommendable in order to assure the quality of both services. This can be done either internally or thorugh strategic linkages to other organisations. HIV/AIDS affects not only potential and actual clients but also the staff. Increased medical as well as funeral expenses, household size and less time available for income generating activities are the main (micro) economic consequences. Direct targeting of HIV/AIDS 2

3 infected persons has not proven fruitful. Strategic partnership with providers of health insurance and information is likely to become a win-win situation for both organisations, and thus for the poor. Microfinance differs from other development aid in the sense that its success depends fully on the target group s (clients) ability to mobilise their own resources. A successful approach will assure permanent provision of services. It is also different in the sense that a microfinance institution not operating within the frame of the market will seriously hamper the possibilities of the long-term access to financial services for the poor. Over-subsidising will drive the market oriented microfinance institution off the market, and lead to ineffectiveness. Microfinance is a field that requires skills and experience, therefore; Do it well or leave it to others. 3

4 Abstract Microfinance a brief introduction As a tool for combating poverty Products Actors in Microfinance Where does microfinance fit? Assessment of microfinance Sustainability versus Outreach Microfinance and the Millennium Development Goals Provision of additional services Microfinance and HIV/AIDS Conclusions References

5 1. Microfinance a brief introduction The purpose of this paper is to provide a basic overview and understanding of microfinance to nonpractitioners. The target group is not microfinance experts, but rather people of different skills and background working within the broader development aid sector. The hope is that this document will provide useful information and tools in dealing with the variety of settings where microfinance is present, or could (should) be. For generations, people have saved and borrowed, as income and expenses have followed different patterns. A striking example of non-monetary saving is from Egypt, where Pharaoh, with the assistance of Joseph, stored away food in order to meet the 7 bad years 1. Obviously, the King of Egypt is not representative for the poor of today, neither in wealth nor in position. Still, the same need for financial services is present. Lifecycle needs such as births, baptisms, weddings and funerals, as well as seasonal fluctuations in income and expenses are a part of life for everyone. Once in a lifetime investments like housing, and investments in productive land and machines are other important events generating a need for financial services. If we add emergencies to the list, we clearly see the need for access to lump sums of funds in specific situation. One will hardly find any community where some kind of credit or saving services is not available, either through local moneylenders, groups, family or friends. What is today known as the microfinance industry, emerged as a response to what was perceived as poor people s lack of access to adequate financial services. The basic assumption behind this is that access to financial services was a major constraint for the improvement of the livelihood. Poor families were not seen as interesting clients to the traditional banking sector, due to economic features, such as lack of collateral and low and insecure income, but also as a part of a broader marginalizing of a more social character. Although some micro entrepreneurs would meet the demand for collateral and cash flow, the costs related to provision of loans to this group were, and still are, perceived to be too high 2 and risky for normal banking. Procedures required by private banks constitute an additional barrier. Fighting the marginalisation and stigmas of the poor is an important value in development aid. Access to financial services is very often reserved for people being part of the establishment, and the poor are excluded. Offering these services to the poor does not only provide an opportunity of improving the livelihood, it also contributes in improving the self-esteem of many. By meeting the requirements put forward by a professional microfinance institution, many clients have experienced that they are capable of making a difference for themselves and their family, without any free help from benevolent donors. Instead of focusing on own poverty in order to be eligible for donations, the focus 1 The Bible, Genesis ch Small loans with high transaction costs. The latter due to lack of formal guarantees. 5

6 is shifted to own resources necessary to meet the requirements from the microfinance institution. Improved self-esteem comes as a result of being taken seriously and treated with respect. The Consultative Group to Assist the Poor (CGAP) provides a good and brief overview of this and other aspects of microfinance on In spite of attempts to focus on redistribution of wealth as the way forward, it is (still) a global consensus that economic growth is a key element in improving the livelihood of the poor. It is hard to define who was the origin of modern microcredit. Publicly run agricultural credit programmes were common in the 1950 s; some attempts were done also prior to this. However, more attention has been given to Grameen Bank, which in 1976 initiated what became the first large-scale operation in group based lending. Since then, a variety of approaches, organisational forms, products and methodologies have seen the light of day. In this paper, the concept of microfinance is a rather broad one. Initially, microfinance was often defined as microcredit, focusing on credits to micro entrepreneurs. Later, a variety of products, such as saving, micro insurance, leasing and transfer facilities, have been introduced 3 within the microfinance industry. Here, we refer to microfinance as the provision of a broad range of financial services to the poor (See for instance Helms 2002). 2. As a tool for combating poverty A decade or two ago, the expectations for microfinance as the decisive tool in combating poverty were high. Empowerment of marginalized groups in general, with special focus on women, was among the non-monetary impacts one hoped microfinance would bring about. By providing access to credit at reasonable conditions, it was believed that poor people would increase their income, create more jobs and gradually lift themselves away from poverty. After the first love had drift away, there has been a gradual shift towards building sustainable institutions that, through a strong focus on financial sustainability, would assure the permanency of these services to the poor. As mentioned in the general report from the Microcredit Summit +5 Campaign 4, in the latter half of the 90 s, financial performance was by many seen as the single most important criteria for judging success of a microfinance program. Once financial services have become a natural part of the society, it is hard to imagine these go away without having adverse effects on the clients. It is hard to imagine a society like the Norwegian working properly without a broad range of financial services. A second argument is basically about the big gap between supply and demand. The world demand is so high that it is unrealistic to think that this can be met by donor capital. The only way the demand can be served is if the microfinance 3 One might argue that they have always been present through traditional solidarity mechanisms (e.g. the Pasanaku in Bolivia) 4 State of the Microcredit Summit Campaign Report 2002, available on 6

7 institutions (MFI) manage to tap into the financial market, financial sustainability is a must in order to do so. The push for financial viability might challenge the wish to reach the poor. Basic economics tells us that lending a small amount of money to a person with no collateral, an unsure income flow and unknown to the institution is far riskier and more costly then giving a loan based on collateral and long term relationship. Considering recent development in the field, data from Microcredit Summit +5 held in Washington in November 2002, suggests that the number of clients reached with microfinance products have increased considerably over the last years. Considering the fact that the industry has matured, and that more funds have been made available also through commercial channels, this should not come as a surprise. The interesting thing mentioned in this report is the increase in the number of poor people reached through microfinance activities. The discussion goes on about how many clients actually are being served and how big the world demand actually is. Robinson (2001) suggests that 360 million poor families are, not only, in demand for credit for their businesses; they are also capable of meeting the down payment requirements. According to FINCA, 500 million people run micro and small businesses and need access to financial services. Finally, figures from the MicroCredit Summit as of indicates that of the approximately 55 million people benefiting from a credit, 27 million were considered as poor at the time of receiving the loan. We see that figures for total demand are uncertain, still there can be no doubt that financial services for the vast majority of poor still continues to be nothing more than a dream. Many consider the retail capacity to be the single largest constraint (see for instance Nancy Barry, summary from June 24 debate on "Poverty vs. Commercialisation" organized by the Microfinance Club of New York). This is a quite a paradox, considering the fact that there are more than institutions, most of these NGOs, working within microfinance. Institutional development and scale should continue to be the single most important issue to attack during the years to come. One important feature that distinguishes microfinance from most other aid forms is that it requires full payment for the services involved. Healthy and sustainable MFI have interest levels that fully cover all the costs (operational, financial and provisional). This might seem obvious, but has important implications when it comes to targeting. There is a debate on whether people with no resources at all (i.e. the poorest of the poor ) will be better off after entering a credit/microfinance program, or if it only adds burden to an already difficult situation. Actual experience reflects both cases. This illustrates 7

8 the responsibility of providers (as well as donors) of making sure that the provision of financial services does not push targeted groups into debt problems 5. The same applies for savings. Savings might be more adequate for the very poorest, since income is normally very low and unstable. Good savings routines will assure access to lump sums when needed, and getting used to setting aside occasional funds can provide a good basis for accessing credits at a later stage. Managing funds from poor people is a huge responsibility and requires prudence, commitment and long-term presence from the MFI. After focusing more on reaching the poorest, it seems now that many actors are spending less effort on distinguishing between the poor and the poorest. Among Norwegian actors 6 the question have been raised whether a microcredit scheme is more apt for the second poorest, and that one through fomenting micro entrepreneurs can generate a certain trickle-down effect benefiting the very poorest. The debate is linked to what many would call a more realistic approach to what microfinance can and cannot do. MicroCREDIT should probably not reach everybody, but saving products are for everyone and there should be no doubt about the fact that microfinance remains a very powerful tool in improving the livelihood for many poor. Another interesting impact of microfinance is that it contributes in reducing the inequality between the poor and the rich. In his study "Can the financial politics reduce the inequality of income" Glenn Westley (Westley 2001) demonstrates the empiric relationship that exists between the little access to credit for the poor (not very deep financial systems) and big inequality in the society. 3. Products Microcredit is for many the most well known product. Many institutions work only with credits, and there are many experiences showing its power. A credit can take many forms, the most common are purely individual loans, individual loans with group collateral and group loans. A typical credit is small with a relatively short payback period. Savings is the other main product. A variety of studies 7 show that the demand for adequate saving products often exceeds the demand for credit. This highlights the fact that the demand for credit and saving basically stem from the same need, the need of access to larger lump sums of money. Coping 5 Like, for instance, the crisis in the Norwegian housing market in the early nineties. In Bolivia, one of the most advanced MF markets, the notion of bicicleteros de crédito, credit bikers, have emerged, referring to clients taking on one loan to finance the down payments in another institution. Both examples demonstrate the potential consequence of a too eager supply side. 6 As reflected through the discussions in the Norwegian Development Networks microfinance group, where all key actors are represented (NGOs as well as NORAD, MFA and Norfund) 7 See for extensive information from one of the industry leaders in this field. 8

9 with lifecycle events, seasonality in income and expenses, smoothen consumption and investment opportunities can be done through saving small amounts prior to (=savings) or after (=credit) the lump sum is needed. The demand for savings is also closely linked to security. In many urban settings, criminality is high, and demand for safe savings is increasing among the poor. Micro insurance is a more recent development that aims at reducing poor peoples vulnerability towards unforeseen events like major illness, death of main income generator, loss of crop etc. The main trend seems to be that insurance of outstanding loan balances in case of death or permanent disability of loan taker is included in the interest charged. In addition, an increasing number of MFI are entering into partnership with health insurance providers. In the latter case the client will pay the premium, the role of the MFI will often be to facilitate the linkage between the two other parties and through an already existing system of cash collection provide a cheap way of collecting the premium. Other products For millions of poor families, transfers from family members abroad is their main source of income. Thus, reliable and effective ways of transfer is important. In Bolivia, PRODEM provides both transfer and smart card facilities for microfinance clients. In addition to the purely economic benefits of this, the access to automatic teller machines with information in the clients mother tongue (Spanish, Aymara or Quechua) also is an important element in lifting the social status of marginalized groups, and thus increasing the level of participation and respect. Micro leasing is another example of an innovative product. The demand for payment services is an area in growth. Many of the poor live in large cities and are to an increasing extent involved with the formal economy. Paying water, electricity and telephone bills, taxes and public fees are becoming more and more common also for the poor. On the income side we find public benefits like pensions and subsidies. Thus, adequate and accessible transfer services are becoming more important also for the poor. In most of the poorer countries, the public service does not have infrastructure to handle these transactions with the poor, and the MFI are often the best option for managing these services. Bolivia is an example where the MFI have been given the task to handle these transactions. There is a trend towards focusing on the MFI as a delivery channel for all kinds of financial services, either by passively passing on products and services provided by others or as active partners in selling new products/services. However, in what follows the main focus will be on microcredit. 9

10 4. Actors in Microfinance Service providers The institutions providing financial services for the poor show a great variety. A typology of Microfinance institutions (MFI) is found in Gulli (2003): Table 1. Types of MFI Strategy and goals Clients Legal form Methodology Sustainability Capital Sources Commercial FFIs Specialized FFIs Specialized NGOs Multipurpose NGOs Expansion into new Profitability Social impact Social impact markets Social impact Cost coverage Initial cost Institutional image Graduation coverage Various, micro enterprises Micro and small Microentreprises Microentreprises in minority enterprises Banks Finance Companies Credit Unions Individual lending Instruments vary according to segment The FFIs as a whole is sustainable Capital Certificates Inter-bank loans Savings Donor funds Banks Finance Companies Credit Unions Individual and/or solidarity group lending Leasing Striving towards profitability and efficiency Capital Certificates Inter-bank loans Savings Donor funds NGOs Individual and/or solidarity group lending Striving towards operational efficiency Bank loans Subsidized loans from private organizations Social funds Donor funds NGOs Individual and/or solidarity group lending Difficult to isolate micro enterprise activities Few bank loans Subsidized loans from private organizations Social funds The number of organisations increases from left to right, where the multipurpose NGOs by far outnumber the other groups. Donors Donor Agencies - provide funds for capital through donations and soft loans, investigations, product- and institutional development and technical assistance. Donor NGOs their role is often similar to the one of donor agencies, funding of pilot projects including new products. These would often work more closely with the microfinance institutions (MFI) than the agencies. Professional investors - motivated by social responsibility or pure economics. Will typically be looking for existing MFI with a proven record of financial viability. Provide capital at (semi-) commercial conditions. Examples of such organisations are La CIF Latin America; AfriCap Africa; Blue Orchard Belgium; and OikoCredit in Holland. 10

11 Entities providing technical assistance, guidelines and practical tools - promotion and development of industry standards, sharing of best practices and innovations are some of the important contribution from these actors. In addition to donor-funded entities like CGAP and UNCDF, there is a growing industry of consultants and rating institutions (e.g. MicroRate). It seems clear that a rating from one of the latter will become close to a prerequisite for attracting professional investors in the future. Networks Microcredit Summit - the largest network of MFI. Had its first summit in 1997, a +5 meeting was held in November Focus on promoting microfinance as an important tool in development, encouraging innovations and learning from experience. See INAFI - International Network for Alternative Finance Institutions, with regional networks in Latin America, Africa and Asia. Regional and National Networks. See AFMIN the Africa Microfinance Network, with 380 MFI from 13 countries as members. See Retailer networks aiming at strengthening their members and developing the industry in general: ACCION, IPC, FINCA, Opportunity International, Women s World Banking, This is by no means an extensive list of actors, but provides some examples of important players. Norwegian actors in microfinance The involvement of Norwegian organisations in microfinance is presented in a recent survey conducted by Norwegian Consulting Group on behalf of NORAD /MFA (NCG 2002). This was a follow-up of a similar survey carried out in 1999, and we see that the top three organisations when it 11

12 comes to number of projects remain the same: Table 2: Number of microfinance projects supported by Norwegian actors Organisation Strømme Foundation Norwegian Church Aid Norwegian People s Aid NORAD FORUT Other (10 NGOs) Total Using the number of projects does not give the complete picture of the actual involvement. Important indicators like number of clients and total capital should have been included, but the data reported back to the survey team did not provide enough information to present comparative figures in a reasonable way. This survey is done only twice, thus one should be careful to draw conclusions regarding trends, but there is a tendency that some organisations leave microfinance, the ones staying seems to have a somewhat stronger engagement. 5. Where does microfinance fit? Microfinance is but one of the tools in development. Some years ago one could get the feeling that microfinance was perceived as the solution, and everyone wanted to get involved with it, regardless of experience, context and target group. As of today, the belief in microfinance as an important tool remains firm, but there is a trend of rethinking and redefining the ambitions of what microfinance is and can do. The survey of microfinance involvement by Norwegian organisations shows that while some organisations are leaving microfinance, those that remain seem to get more involved. We believe that this trend will continue as one learns that even if microfinance is an effective tool to combat poverty, it is also difficult and those who want to be involved will need to be profesionalized with a lot of financial expertise. One important question to ask before entering into microfinance is whether or not this is the most adequate tool to achieve the specific development goals in a given context. CGAP (20/2001) suggests some situations where the involvement in microfinance (credit) require careful analysis: In an immediate post-emergency situation For chronicle destitute and illness keeping people from working In areas lacking basic infrastructure, services and market access (rural) In a population so dispersed that the cost of reaching clients on a regular basis are too high When depending on a single economic activity (e.g. single crop) In economies with a strong component of barter transactions, i.e. in a non-monetary society 12

13 High risk of future crisis Absence of law and order Lack of social network, undermining the use of non-collateral methodologies (i.e. group collateral) These conditions do not necessarily exclude the success of a microfinance project, but history shows that even capable and experienced MFI face serious challenges under these conditions. So, what is needed for successful microcredit? There are four basic characteristics of high-quality microcredit (op.cit.): 1. Long-time perspective - permanency 2. Reaching large numbers of clients - scale 3. Depth of outreach 4. Financial sustainability Permanency There is an increasing focus on building viable local financial systems that work for the poor, in other words a long-term perspective on the provision of financial services. A short-term program might have an immediate impact, but in the long run, this kind of programmes might have negative impact for their clients. Clients get used to living with financial services and organize their businesses and lives thereafter. If these services are taken away the impact for this type of clients can be severe. In addition, short-term programmes will almost always have repayment problems. Poor people as all people take advantages of the situation, cashing out their loans without paying back. It is hard to imagine a well functioning society as of today without access to financial services for the majority of the people as an intrinsic part. It is also hard to imagine an economic growth that really benefits the poor without including financial systems that works for the majority. Scale The notion of small is beautiful is well known in many contexts; Does this also apply to microfinance? Without underestimating the good work done by many small organisations, it remains clear that in order to make an impact beyond the individual level, quantity matters. The relation between size, competence and operational costs indicates that smaller institutions have a bigger challenge in providing quality services at a reasonable cost in the long run. The Millennium Development Goals (MDG) 8, where reaching a large proportion of the poor is one of the goals, support this view. 8 See box 1 below for specification of the MDG.. 13

14 Outreach Being an alternative to the formal sector and with an overall perspective of inducing growth for the poor, depth of outreach is unquestionable as a criterion for success. Having said this, there is a debate on the targeting of the poor versus the poorest, how to identify them and to what extent microfinance institutions should specifically target the poorest. One can argue that the very poorest often will not be eligible for credit, due to lack of stable income and assets. On the other hand, as is further discussed below, experience shows that important shares of the clients of many successful MFI live below the absolute poverty line 9. In any case, we are convinced that targeting the poor without necessarily identifying the poorest provides more than enough argument for this basic tenet. When it comes to savings, another way of getting access to lump sums, even the poorest are eligible clients and should be targeted by the MFI Financial sustainability For some, this is a more controversial issue. Is it in line with principles of aid and ethical values to expect that poor people shall finance this kind of operations? Should we not provide these services free of charge and cover operational costs through other mechanisms? We believe that the answer is a clear no. The main argument is linked to the notion of permanency as indicated above. We believe that in order to assure a long-term commitment in providing financial services for the poor, we need to build viable institutions. In a world with limited donor funds, the only way to assure this is to cut the dependency on donors and help the MFI to enter the financial market. Another strong argument is that aiming at financial sustainability also gives a strong incentive to cost-effectiveness. The presence of effective institutions is a cornerstone of the society. A as part of developing the society at large, the (financial) independency of these institutions has a value beyond the mere operational ones. However, aiming at financial sustainability does not exclude the need for grants and technical assistance in an initial face. However, this must be handled with wisdom. There is a growing concern in many microfinance markets on the role of donor funds. For instance, in two of the more mature microfinance markets, Uganda and Bolivia, established MFI have raised the question if continued subsidized donor funding have adverse effects on the industry at large. Through providing free, or cheap funding of capital, the wrong incentives 10 are given to the market, and thus hampering the creation of viable and sustainable financial systems for the poor. Maybe what some markets need is a close down of the non-professional institutions? 9 Less than one dollar (US) per day. 10 By facilitating on-lending at rates below market rates and not encouraging cost effectiveness. 14

15 CGAP has developed specific donor guidelines to assist donors in defining and implementing appropriate policies, see As stated in CGAP 20/2001, successful microcredit rests on two basic principles, institutional and client discipline. As Mohamad Yunus, the founder of Grameen Bank put it (Yunus 1998): Credit without strict discipline is nothing but charity. Charity does not help overcome poverty. Poverty is a disease that has a paralysing effect on mind and body. A meaningful poverty alleviation program is one that helps people gather will and strength to make cracks in the walls around them Conclusion Microfinance has proven powerful. The long-term concept should be that of a viable institution and not a project. If you do it, do it right. Else, leave it to others. 6. Assessment of microfinance Assuming that a need assessment process concludes that there is excess demand for microfinance products and services, and that the situation is such that setting up a microfinance institution is adequate, what are the main steps forward? Considering the fact that a wrong set-up might do more harm than good, there are several considerations to be done. A variety of tools are developed for this purpose, ranging from more simplistic methods to be used at an early stage, to more elaborate ones covering planning, implementation and monitoring. CGAP (1999), IADB (1994) and USAID 11 have elaborated extensive tools for this purpose designed for more mature MFI. See for instance for best practices in this field. After a basic need assessment, the business plan for a MFI should include (at least) the following points: 1. Market analysis; competition and products 2. Institutional capacity and competence 3. Plan for reaching financial sustainability 4. Funding 5. Monitoring system 6. Reporting, audit and rating 7. Structure and ownership 11 See 15

16 Market analysis Various tools for market analysis have been developed; see for instance for different methods and experiences in the field. The main challenge is to capture the demand form potential clients and address actual and potential competition. Institutional capacity Seen from a donor s point of view, the first step would be to consider the potential in working with already existing organizations. Do they have the capacity of providing what the market asks for in a professional way, or is setting up a new institution a better way? As indicated above, most of the organizations involved in microfinance are multipurpose and have microfinance as one of their activities. We then need to verify how they are organised, and if necessary challenge them to separate microfinance from other activities. It is of crucial importance to identify real costs and income on microfinance activities, regardless of the level of financial sustainability. Some argue that due to the nature of target groups, local economies etc., financial sustainability is merely a dream, indicating the need for subsidizing operations also in the longer run. Regardless of this argument, it is necessary to separate flow of capital due to loan activities from other transactions. In any case, if sustainability is not perceived as a possible end goal, reengineering of the institution and/or abandoning microfinance activities should be considered. Another strong argument for dividing microfinance from other activities is related to the funding side. Potential donors for non-financial activities might be reluctant in releasing funds if they see that the NGO is holding a large sum of capital. Although these might be designated for microcredits, the NGO might risk that the donor see this as accumulation of funds and require that these be spent before additional funding is provided. Other donors might consider microfinance as being outside their area of work, and will thus reject an application for NGOs involved in microfinance. Thus, there are strong arguments for having a clear division between microfinance and other activities. The institutional competence is another important area to address when getting involved in microfinance. Do they have or can they get the necessary skills to handle large-scale operations that include complex data systems, liability management, human resources etc.? It is important to bear in mind that managing a professional microfinance institution takes much more than just handling a microcredit portfolio. It is worthwhile underlining that what matters is the provision of accessible financial services at reasonable costs, rather than who is providing it. As a donor it is easy to "fall in love" with some 16

17 partners, but this feeling for a partner should be dealt with in a very objective and professional way when it comes to microfinance. Former good partners from other projects can end up being bad partners if they get into microfinance without having the skills and the internal culture it takes to handle the challenges involved. Financial sustainability Financial sustainability is / must be a long-term goal for a MFI. In order to address this issue, a checklist for budget for microfinance activities is useful: Identify operational costs Projection on financial costs (interests, losses) Projections on income (donor funding, operations) Define horizon for break even Calculate interest rate Professional partners must be willing to charge interest rates that in the long run can make the institution sustainable. Microcredit services are expensive because of the costs involved of handling a large amount of small clients. A sustainable interest level is therefore likely to be above the local interest level in the formal market Funding In the initial face, most MFI have received donor funding for setting up the organisation. The long-run goal must be financial self-sufficiency, but in order to reach a large number of clients it would generally be necessary to access loans from capital providers on commercial terms. Thus, the analysis of funding includes both potential donors as well as financing partners. Monitoring system In Norway, in a joint effort by the Norwegian Development Network (Bistandstorget), NORAD and the Ministry of Foreign Affairs (MFA), guidelines for appraisal and monitoring of microfinance projects have been elaborated (Clausen 2002). These build among other on the more elaborate CGAP tools, and aim at combining the need for specific information with the necessity of a tool that is not too complicated nor costly to use. The development was based on three basic criteria; we quote: The formats should be simple with information strictly on a need to know basis. The information required should be easily available by microfinance projects to limit the transaction cost for them in meeting donor appraisal and monitoring requirements. 17

18 The performance indicators should be simple and easy to interpret but at the same time provide a comprehensive overview of overall performance of the microfinance project. Three sets of indicators must be considered; Outreach indicators, efficiency, number of clients and poverty bracket (using average loan in percent of GDP per capita). Savings can be added when pertinent Institutional indicators focus on effectiveness; defined as productivity of staff (loans per staff), financial productivity (administrative costs per loan) and efficiency (administrative costs over portfolio). Financial performance / portfolio risk, that is sustainability, looks at operational sustainability (income versus expenditure), portfolio yield and portfolio quality (arrears). All of the above indicators do provide important information regarding the different aspects of an MFI. Due to the variety of contexts in which MFI operate, there are no global standards for most of the indicators to compare whether a microfinance project is performing well or not. However, the Micro Banking Bulletin 12 presents at regular intervals some of these indicators for a sample of MFI. When it comes to outreach, a project with a strong poverty focus should have a low number for average loan in percent of GDP per capita. Regarding financial sustainability, based on many empirical studies, it is becoming a common understanding that an arrear, or default rate above 5 % will make a long run sustainability of the MFI very unlikely. When assessing indicators one should bear in mind that statistics and numbers are not often easy to compare and can easily be manipulated. For example when comparing portfolio at risk on must know how many days the portfolio is due before being classified as being at risk. A technical guide has been developed for assessing MFI; this can be downloaded from Reporting and audit procedures Proper reporting is an intrinsic part of a well-designed monitoring system. In addition to this, external audits are necessary to establish institutional credibility. In many cases this will be a legal requirement, it is also becoming more and more a pre-condition for potentially new financing partners. 12 See 18

19 Due to the nature of microfinance, the audit procedures required are different form those of a regular NGO. Handbooks for this purpose are elaborated by a.o. CGAP 13. Credit rating is gradually becoming a part also of the microfinance industry. A proper rating, carried out by professional rating institutions, is likely to become a prerequisite in order for a MFI to attract professional investors in the future. A list of qualified raters by IADB and CGAP is found at Electronic Information Systems and internal control routines are two crucial points in professional microfinance and should therefore be included in all kinds of business planning for MFI. Structure and Ownership When a MFI grow, the question of structure and ownership becomes more important. As in any business or organisation, the main stakeholders will determine the long-run strategy, and the way the organisation is structured and managed will be determinate for the long-run performance. Thus, these are key factors in assuring the permanent provision of financial services. 7. Sustainability versus Outreach There is little doubt that there is a trade off between financial sustainability and depth of outreach. Lending to people with no formal guarantees, no stable income or valuable assets does imply a rather considerable amount of risk. This is reflected in the interest rates charged by local moneylenders, often way above 100% annually. On the other hand, the very fundamentals of microfinance is closely linked to the wish of reaching the poor and enabling them to improve their livelihood. Thus, outreach must always be an important consideration when dealing with microfinance. Fortunately, there are good examples of MFI reaching out to the very poor while making profit. In a study related to the MicroCredit Summit +5, the authors present two organisations (CRECER in Bolivia and SHARE from India) that have managed to combine these two criteria (Simanowits et.al. 2002). Based on these case studies, some critical factors for combining outreach and profitability are; An internal culture of poverty focus, understanding the costs and benefits of working with the very poor Design appropriate products Focus on cost effectiveness Access to credit must always be based on the ability to repay. If not, indebtedness may leave the poor in an even worse situation after receiving a loan. 13 See 19

20 The issue of outreach is further discussed below, when we analyse microfinance in light of the MDG. 8. Microfinance and the Millennium Development Goals The goals as defined by the UN are the leading star for the development community in the years to come. Donor agencies are relating their policy and programming to the achievement of these goals, the question of how microfinance relate to this is highly relevant. Before addressing the issue specifically, we Box 1: The Millennium Development Goals: would like to remind of the fact that (1) eradicate extreme poverty and hunger microfinance, and the impact it produces, goes (2) achieve universal primary education far beyond business loans. The poor use (3) promote gender equality and empower women financial services to provide for emergencies, (4) reduce child mortality invest in health and education, improve housing (5) improve maternal health conditions and smoothen consumption. (6) combat HIV/AIDS, malaria and other diseases Although not without exceptions, the majority of (7) ensure environmental sustainability impact studies show that access to microfinance (8) develop a global partnership for development. services have improved the economical situation of poor clients. Through increased income and accumulation of assets, the vulnerability in facing the crisis has been reduced. Evidence also shows that a better financial situation leads to better nutrition, and thus better health conditions in general. The targeting of women is a well-known feature of many MFI, and the positive effect on women s position and situations is beyond question. Without disqualifying this, it is worth mentioning that there are groups claiming that giving credits to women have increased their already heavy burden and responsibility. Within a broader development perspective, the impact of one tool is hard to measure. This goes for microfinance as well. There are methodological problems of self-selection, and we know that a strong correlation does not automatically imply causality. The following part is to a large extent based on a discussion from CGAP (24/2003) 14, which provide a good reflection on the role of microfinance related to the MDG. MDG1: Eradicate extreme poverty The demand for financial services can roughly be grouped in three categories: Take advantage of business opportunities 14 Includes references to a number of background studies. 20

21 Smoothen consumption due to e.g. seasonal fluctuations in income as well as expenses (e.g. harvest, school fees, seasonal employment, wedding expenses) Cater for emergencies (e.g. illness, death of family member, funeral costs, flood) Studies from several countries 15 show that microfinance clients have obtained diversifying, protecting and increasing their income. It seems clear that access to credit, and safe savings, have played an important role in meeting the demand in all the categories outlined above. The majority 16 of studies show that through an increase in income and assets, the vulnerability of the poor is reduced. In addition to the general effect stemming from being less vulnerable to the crisis that tend to be a part of the everyday life of the poor, a study of SHARE in India documented that half of the clients who participated in the programme for a longer period of time graduated out of poverty. Other signs of change are shift in employment patterns from irregular daily based to better and more diversified sources of income. The use of own surplus to pay for social events (funerals, feasts, weddings) instead of taking on a loan is another example of how a stronger household economy can reduce the poors' (financial) vulnerability. Findings from Zimbabwe show that participation in microfinance program has had positive impact on nutrition for very poor households in a period of rising costs of living (Barnes 2001). A common feature seems to be that the likelihood of a positive impact increases with the time the client has participated in the programme, an element to be considered in the sustainability debate. Finally, when comparing similar communities with and without accessible financial services present, one has seen positive spill over effects for non-microfinance households in communities with microfinance clients. The goal of reaching the poorest is challenged by the necessity of reaching financial sustainability. Obviously, lending to the poorest means smaller loans while requiring the same thorough analyses from the credit officer as a larger loan. Consequently, all other factors equal, the cost per dollar should be higher for smaller loans. Keeping this in mind, it is encouraging to see that a large proportion of the clients of a number of financially sustainable MFI 17 are living on less than dollar a day. New evidence from the Micro Banking Bulletin ( shows little correlation between profitability and average loan size (a rough proxy for outreach). Analyses indicate that MFI targeting the poor seem to be more cost effective, with more active clients per staff. Having said this, it is pertinent to mention that interest rates in institutions targeting the poor tend to be somewhat higher than for those lending to bigger clients. Reaching the masses has also proven possible, and it seems clear that through scaling up of successful MFI a large number of poor can be reached within the next years 18. In addition to 15 Bolivia, Ghana, Indonesia, India, Zimbabwe and Bangladesh, see CGAP (2003). 16 Some studies show none or even adverse effects. The overall picture is nevertheless on the positive side. 17 For instance BRAC, Bangladesh; SHARE, India; Nirdhan, Nepal and CRECER, Bolivia. CGAP Some examples of large MFI are BRAC (Bangladesh, 3.6 million clients), ASA (Bangladesh, 1,2 million), Banco do Nordeste (Brazil ) and Compartemos (Mexico, ). 21

22 good management, important factors are regulatory framework and access to on lending capital for the MFI. Through innovation, effective management and scaling up, experience shows that microfinance can play a significant role in poverty alleviation also for those living on less than a dollar per day. MDG 2: Achieve Universal Primary Education The studies show a clear trend; children s schooling has a high priority for poor families. Children of microfinance clients are more likely to go to school than other with similar background. This does not indicate that non-microfinance clients do not prioritise children s education as much as microfinance clients do. It is rather to be understood as a matter of feasibility. When income increases, so does the possibility of investing in primary education. MDG3: Promote Gender Equality and Empower Women Microfinance programmes have for a long time been targeting women. The issue of empowerment and gender equality is truly a complicated one, and it is prudent to remind that targeting a specific group does not automatically lead to empowerment. Nevertheless, a number of studies show that participation in microfinance programmes has had a positive impact on the role of the women. Increased participation in decision making within the family and an increased number of women acting as principal family fund managers are some indications of the empowerment of women. The findings also indicate a reduction in domestic violence in the long run, even though there are evidence of temporarily increase as a consequence of the women gaining more self confidence and self-worth. In the wider context, increased status in the community and participation in local government is found among microfinance clients. In the latter case, one should be careful to claim that this is due to participation in microfinance programmes; both self-selection mechanisms and a variety of other factors play a role here. Nevertheless, there are good reasons to believe that microfinance, through providing control and ownership of productive assets to women, has a share in promoting the role of the women at the socio-political arena. MDG 4-6: Reduce Child Mortality, Improve Maternal Health and Combat HIV/AIDS, Malaria and Other Diseases Illness and death are often the most important crisis for the poor. Loss of income, increase in medical/funeral costs and need for care taking, are frequent results of this. The extra expenses are often financed through indebtedness and sale of assets. As indicated above, microfinance clients tend to be somewhat better off economically than non-clients. Some of the extra income is spent on food, leading to better nutrition and a better health condition in general. Coupled with easier, and cheaper, access to emergency funds (credit, own savings or insurance) this makes microfinance clients less vulnerable for illness. In addition to the more general effects of an improved economic situation, some MFI offer specific products designated to meet the clients need for adequate health services. Loans 22