Poverty, Development & Microfinance: Nexus, Praxis and the Internet

An Introduction to Microfinance

Guy WinshipGlobal Leadership Program, Macquarie UniversityTuesday 11th May 2010

OVERVIEWDemand side issues: who are “the poor”?;

how many of them are there?; why do poor people in developing countries need financial services? And what type of financial services do they need?

Supply-side issues: How to best provide financial services to the poor? Who is best placed to provide these services? What are the costs and risks involved in providing such services?

Use of the internet (Kiva & Good Return): how it (generally) works; does this link supply & demand? What are the costs & risks? Are there any transparency issues?

DISCUSSION & QUESTIONS

THE WORLD IS POORER THAN WE THOUGHT – THE WORLD BANK

MICROCREDIT & MICROFINANCE

Microcredit means providing poor people with very small loans. They may use these loans to help them engage in productive activities or grow their small businesses, or they may use them for their consumption needs (such as a wedding, housing improvements, school fees or food).

The term microfinance is used to cover the broader range of financial services, including savings, loans, insurance and transfers of money. “Micro” simply refers to the size of the amounts involved.

HOUSE-HOLD INCOME & EXPENDITURE PATTERNS

Typical activities in the poorest areas of Asia

Seasonality

Vulnerability to economic shocks – how to protect from these shocks?

Potential to raise income – how to promote livelihood development?

Life Cycle Events•Birth •Food and clothing•Education•Marriage•Funeral•Recurrent festivals

Emergencies

Investment Opportunities

•Small business investments

•Purchasing land and other productive assets

•Home improvement

•Sickness•Injury•Theft•Natural disasters

FINANCIAL EXPENSES

HOW DO PEOPLE PAY FOR THESE EXPENSES?

Through savings: Money in bank Money at home Rotating credit Animals Jewelry / assets

Through Insurance: of Life and health, of

livestock and crops, of home and other assets

oThrough loansFrom banksFrom relativesFrom money lender

Through Payments:Usually from relatives working ion another city or country;3 main issues are: Safety; Cost; & Speed.

Very Large

Small

Certain Highly Uncertain

Degree of Uncertainty

Relative Loss / Cost

Life Cycle Events

Death

Disability

He

alth

Pro

perty

Mass, Co-

variant

DIFFERENT FINANCIAL SERVICES FOR DIFFERENT RISKS

Source: Warren Brown and Craig F. Churchill, Insurance Provision in Low-Income Communities, Part I.Source: Warren Brown and Craig F. Churchill, Insurance Provision in Low-Income Communities, Part I.

Flexible Savings and

Credit

Flexible Savings and

Credit

InsuranceInsurance

Flexible Savings

Partial protection

Flexible Savings

Partial protection

Physical Capital

Natural Capital Financial Capital

Social Capital

Human Capital

Sustainable Livelihood

The use of microfinance as a strategy to overcome poverty

ADDRESSING FINANCIAL NEEDS: PROTECTIONAL STRATEGIES FOR THE VULNERABLE POOR

Access to safe savings services is of prime importance - this enables consumption smoothing

Savings, small loans, insurance and remittance services can provide protection against financial shocks

Solidarity group activities increase the social capital of vulnerable people

FINANCIAL NEEDS: PROMOTIONAL STRATEGIES FOR THE ECONOMICALLY ACTIVE

Access to appropriate financial services, together with training and business support, assists people in the transition from traditional subsistence or income-generating activities to more growth-oriented microenterprises

NFE approaches to financial literacy, economic awareness and social empowerment enhance the effectiveness and sustainability of MF activities

MFIs depend upon the health of their clients for their own viability

WHY ARE SAVINGS AS IMPORTANT AS CREDIT?

Credit is a useful way to save but can be expensive, inflexible and inaccessible

Saving safely provides poor people with a cushion against shocks

Saving may be more important than credit in helping raise incomes and in reducing risk

When poor people have a choice,they choose they choose

to saveto save far more often

than they choose to borrow

When poor people have a choice,they choose they choose

to saveto save far more often

than they choose to borrow

INTEGRATING MICROFINANCE AND EDUCATION

Savings and credit group meetings provide an ideal venue for promoting educational messages because they are:

Regular – usually meeting weekly, fortnightly or monthly.

Self-forming – and therefore contain elements of trust, solidarity and social cohesiveness.

Sustainable – because clients attend out of self-interest. They are not dependent upon project or government funding.

HOW DO POOR PEOPLEPROTECT THEMSELVES FROM RISK?

PreparationPreparation

CopingCoping

Prevention and AvoidancePrevention and Avoidance

• Careful sanitation, for example• Identifying business opportunities• Careful sanitation, for example• Identifying business opportunities

• Saving• Accumulating assets (e.g. livestock)• Buying insurance• Educating children

• Saving• Accumulating assets (e.g. livestock)• Buying insurance• Educating children

• Taking emergency loans • Depleting savings• Selling productive assets• Defaulting on loans• Reducing spending

• Taking emergency loans • Depleting savings• Selling productive assets• Defaulting on loans• Reducing spending

OTHER MICROFINANCE SERVICES

Insurance - direct provision of viable services is complex. May be better to link poor clients with existing providers.

Transfer payments / remittances – fast and cheap remittance services are particularly valuable for those whose family members engage in migrant labour

Health Insurance For FINCA’s ClientsFINCA, an NGO operating in Uganda, acts asan agent for a formal healthcare plan to bring health insurance to its clients.

WHAT FINANCIAL SERVICES POOR PEOPLE WANT (IN ORDER OF PRIORITY)

1. Security of savings

2. “Good” access to savings and loansConvenient location

Convenient times

Minimal paperwork

3. Appropriate design

Regular, small deposits / payments

Small variable amounts

Quick access

4. “Good” interest rates (more on this later)

So, what are the Problems and risks in accessing financial services for poor households?

Traditional financial institutions not aimed at the poor – why not?

Savings: Money in bank – may be difficult to access Money at home – risk of theft, easy to spend Rotating credit – rigid amounts and timing Animals – risk of death, sickness, have to convert to

cash , change in value Jewelry/assets – risk of theft or loss, have to convert to

cash, change in value

PROBLEMS AND RISKS FOR POOR HOUSEHOLDS CONT’D

Loans From banks – can be difficult to access, difficult

procedures, collateral requirements, credit history

From relatives – not always available From money lender – expensive, not always

available

Insurance Limited availability and access

SUPPLY-SIDE ISSUES

Why use of microfinance institutions is best: sustainability & outreach

Three main costs / risks faced by financial institutions:

1. Cost of delinquency – losses arising from loans not being repaid

2. Transaction costs – the expenses incurred in providing products & services

3. Cost of capital – costs associated with funding (e.g. savings, wholesale finance, equity, securitisation etc)

Each of these has implications in the microfinance context

INTEREST RATES Sustainability in the provision of services to large

numbers of poor only possible if income covers costs

Equity in access also an issue Costs for microfinance institutions are based on

same three legs as other financial institutions, but MFIs costs differ from those of commercial banks, especially with regard transaction costs

Access main issue, so usually need to compare with rates of village money-lenders

Affordability & rates of return on SMMEs Institutional efficiencies and interest rates

Liabilities Capital

Savings

Debt

USING ITS CAPITAL, A BANKING INSTITUTION CAN BORROW TO ACQUIRE ASSETS, INCLUDING LOANS TO CLIENTS. THE BALANCE SHEET SHOWS HOW THIS IS DONE…

Other people’s money

“Our” money

Assets

Performing assets

Other Assets

Assets = Liabilities + Net worth(Capital)

EXAMPLE OF INTEREST SENSITIVITY

Gross Income 100,000based on 10% interest rateFinancial costs 42,000interest on savings at 7%Operational costs 40,000cost of staff, rent etcNet Income (loss): 18,000

Balance Sheet:ASSETS

Loans $1,000,000LIABILITIES

Savings $ 600,000EQUITY

Owners/members shares $ 400,000

EXAMPLE OF INTEREST SENSITIVITY CONT’D

Balance sheet:Prior period interest rate

New period interest rate

10.0% 5.0% Margin = 5% (i.e. 10% - 5%)

Interest earned: New interest earned:

Loans outstanding 1,000,000 100,000 50,000 Gross Income falls by 50,000

7.0% 2.0% Margin = 5% (i.e. 7% - 2%)

Cost of funding: New funding costs:

Debt / Savings 600,000 42,000 12,000 Financial costs fall by 30,000

Equity 400,000 n/a n/a

EXAMPLE OF INTEREST SENSITIVITY CONT’D

Income statementPrior period interest rate

New period interest rate

Gross Income 100,000 50,000

Financial costs 42,000 12,000

Operational costs 40,000 40,000

Net Income (loss): 18,000 -2,000

SUPPLY-SIDE ISSUES: INSTITUTIONAL ASPECTS

Understanding the country context:Legal: mainly interest rate restrictions, government support,

and contractual enforcementFinancial sector regulation and supervision:

Need for regulation Costs of supervision & being supervised

Economic and social environment: Economic stability Poverty levels Government policies

INSTITUTIONAL ASPECTS CONT’D

Client tracking and Impact assessment:Quantitative & qualitative approachesNeed to ensure positive change in lives of beneficiariesEnsure targeting poorest – danger of “Mission drift”“Double” & “triple” bottom line reporting

Risks facing MFIs:Delinquency risksManagement / governance & operational risksLiquidity risks Interest rate & foreign exchange risksEnvironmental risks, some common with clients

WHAT CAN MICROFINANCE OFFER? Sustainable services Products that are appropriate to the needs of

clients Flexible responses Local ownership and/or control of resourcesHow? Usually through mobilization of savings and credit

groups whose members guarantee each other’s loans. This reduces costs and risk to the lender.

A range of models exist

MICROFINANCE MODELS Main distinction in approaches is between

minimalist versus integrated models; should the agency provide financial services only, or should these provided together with other services?

Minimalist models:Main advantages are:

Increased efficiencies (viz lower cost to income ratio) Improved effectiveness (greater & longer-lasting impacts on client

beneficiaries) Better risk management Often a requirement by regulatory authority

Main disadvantages: Ignores other needs of clients

Integrated models:Main advantages:

More holistic developmental approach, recognises diverse needs of clients

Main disadvantages:Often has negative affects on delinquency

Which approach works better depends on context & situation

Within minimalist approach there are various models that are typical…

TYPICAL MICROFINANCE MODELS

Microfinance institution model A credit officer from the institution visits a

village, collects individual’s savings and distributes their loans through solidarity groups, mutual guarantees apply.

+ good management systems

+ can leverage external resources- requires suitable regulatory environment- not usually owned by clients

TYPICAL MICROFINANCE MODELSVillage bank model A microfinance institution lends to a village

bank. The village bank on-lends to individuals in the village according to its own rules and regulations.

+ lower costs than MFI model

+ can leverage external resources

+ local ownership and control (with support)

- Requires regulatory framework for MFI and village bank regulation

TYPICAL MICROFINANCE MODELS

Cooperative or self-help group model A local organisation is formed around savings

and credit, it collects savings from its members and on-lends to its members. It may or may not have solidarity groups and mutual guarantees.

+ local ownership and control+ all profits stay in the group- management capacity a big problem- May not be able to access external resources

CLIENT EMPOWERMENT & DISCIPLINE & RELATIONSHIP WITH NGO

Whichever model is used Client discipline is important…simply in that poor people must take responsibility for their decisions, agreeing to and making on-time payment of principal and interest sufficient to cover the full cost of service. Without client discipline no microfinance program will be sustainable.

In practice this also means that clients are treated with respect, and often changes the relationship between the development agency and the client different from that in other developmental sectors: “client” versus “beneficiary”

5 PRINCIPLES OF SUSTAINABLE MICROFINANCE

1. Products and services must fit the needs and preferences of the clients

2. Streamline operations to reduce costs

3. Interest rates and fees must be able to cover all of your costs

4. Structure the program so that clients are motivated to repay loans

5. Promote institutional sustainability through capacity building

SELECTED ISSUES IN MICROFINANCE

Funding: use of the internet in providing capital for micro-credit – examples of www.Kiva.org and www.GoodReturn.org.What do you think of these programs?What do lenders think of these programs? Why?What do borrowers think of these programs? Why?

If time, can also discuss: Over-indebtedness: what level of indebtedness is

appropriate? How much debt is too much? Why? Interest rates: what level of interest rates is appropriate

for low income borrowers? Why? Savings: do you agree poor people can save? Should

they? Why?

SUMMARY Everyone needs access to financial services

– even the very poor. Savings are the most important service for

most low income people. Credit is not for everyone. People must be

able to repay. There are a range of MF models that can be

used to provide these services, but need a supportive regulatory environment

Microfinance alone is not enough, the poor need a range of support services.

Internet provides opportunities to raise capital and to educate people on poverty issues

READINGS & REFERENCES:

The Poor And Their Money by Stuart Rutherford, Oxford University Press, 2000A good introduction to microfinance & an easy read.

Sustainable Banking With The Poor: Microfinance Handbook by Joanna Ledgerwood, The World Bank, 1999A more detailed overview of the operation, methodologies, costs, risks

and issues in providing microfinance services and products.

The Challenges of Market–led Microfinance by Guy Winship, Practical Action Publishing, 2007Written as a conversation with practitioners, this book discusses the issues facing microfinance institutions from an organisational and practitioner perspective.

Various websites: list at www.cgap.org and www.worlded.org.au

THANK YOU!DISCUSSION – Q & A