Financial aid has long been a staple of the developing world, but hand-outs do little to kick-start economic growth. Instead, the countries of Asia, Africa and South America want a hand-up so that they can fuel their own development, which is why more and more microfinance institutions are moving into these areas.
Microfinance institutions are organisations that lend relatively small sums of cash to people in the hope that they can sustain their own lifestyles and provide for their own families rather than relying on aid. Underlying the scheme is a hope that these loans may be able to stimulate entrepreneurship and industry at a grass-roots level.
Furthermore, such schemes hope that access to small loans will stop usury, alleviate poverty, diminish dependence on aid, and empower communities – particularly women, who make up around 85 percent of total clients.
Pioneered by economics lecturer (and now Nobel laureate) Mohammed Yunus in the 1970s when he first loaned a Bangladeshi village $27 to develop its farming capabilities, supporters say that microfinance has improved the lives of millions of people by lending them tiny sums that enable them to set up their own businesses and improve their lifestyles. For banks, which have also woken up to the opportunities the phenomenon throws up and are among the key donors to such initiatives, microfinance facilitates the first steps for billions of people to open a bank account and potentially become aware of a wider range of financial products.
As the majority of the world is still classed as “developing” (at least in economic terms), there is plenty of scope for microfinance institutions and their backers – banks, charities, NGOs, and international development organisations like the World Bank – to target areas they think will benefit from their input. In January Boston-based microfinance specialist Accion International announced that it will launch a micro-financing operation in the Amazon offering small loans to as many as 1.9m entrepreneurs who have trouble securing loans through traditional channels. At the same time, the Bill & Melinda Gates Foundation announced that it is providing funds worth $38m to 18 microfinance institutions in 12 countries across Latin America, Africa and Asia, following a year-long review by the organisation to expand its innovative development work into “micro-savings”.
In the Philippines Standard Chartered Bank (SCB) and the International Finance Corp. (IFC), the private investment arm of the World Bank, have entered into an agreement for a $1bn unfunded risk participation arrangement that will help increase the availability of trade finance in emerging markets. Standard Chartered will originate a portfolio of up to $1bn in trade finance transactions from banks in emerging markets, with a special focus on the world’s poorest countries. These local banks, in turn, will extend trade financing to their importer and exporter clients. IFC will guarantee a mezzanine tranche of this portfolio providing credit protection and capital relief on the portfolio over three and a half years.
This April Barclays and international development organisations CARE International and Plan launched Banking on Change in Kenya, a three-year £10m microfinance initiative that aims to reach half a million people in ten countries across Africa, Asia and South America. The project will predominantly be based on the Group Savings and Loans model (GS&L), a savings-led community finance initiative whereby individuals in a community join together in groups to save regularly and access small loans from a group fund.
Moving assets
Even the EU has set up a facility to stave off unemployment in Member States. On February 11, the European Parliament cleared the way for the adoption of the new European Microfinance Facility which, according to László Andor, EU Commissioner for Employment, Social Affairs and Inclusion, will offer “a lifeline to people suffering from the [global banking] crisis and help create new jobs”.
Operating accounts, however, swings wildly from the very low tech, such as a man on a bicycle handing out money and checking names in a book – to cutting edge technology. Opportunity International Bank of Malawi (OIBM), for example, which now also offers savings accounts and weather-indexed insurance products, uses biometric technology. No formal identification documents are needed to open a savings account and, for those who are illiterate, no forms need to be filled out. In Brazil, on the other hand, Banco Bradesco’s Banco Postal service operates in post office branches and now has more than six million clients. Elsewhere, Citigroup has developed a system for a large construction company in the Middle East where workers can have payments deducted and remitted home automatically, saving them having to queue for hours at a money transfer bureau – and saving them transfer costs.
The mobile phone has become a major tool in microfinance banking schemes as it is the most widespread piece of technology in use in most of the developing world. In Nigeria, where eight out of ten people do not have a bank account, customers can add money to their mobile phone Sim card by buying credits at mobile phone shops. This enables them to then have the ability to buy goods, pay bills or transfer money to someone else. Vodafone’s M-Pesa mobile money transfer service, launched in Kenya in 2007, allows people to open an account and deposit cash through mobile phones. Account holders can send money to other mobile users by text message. The service now has more than two million subscribers. Another innovative model comes from South Africa, where Wizzit offers services using mobile phones as the channel through which clients sign up and access accounts. The bank has developed technology that can handle large transaction volumes and can be used by other institutions.
Recent surveys have pinpointed where microfinance is likely to flourish. For example, the commitment to it has been particularly strong in Latin America, according to the Economist Intelligence Unit’s (EIU) first annual global microfinance index, Global microscope on the microfinance business environment, where six of the top ten countries (Ecuador, Nicaragua, Colombia, El Salvador, Peru and Bolivia) are from the region. Asia boasts two strong finishers (India, along with the Philippines), and two hail from Sub-Saharan Africa (Ghana and Uganda).
However, no country has a perfect environment for microfinance. Indeed, only two of the 55 countries scored above 70 on a scale of 0 to 100. The EIU report found that those countries that perform best have a favourable legal and regulatory framework, a moderately conducive investment climate and a strong level of institutional development.
But microfinance initiatives are being used in the unlikeliest of places. Going hand in hand with the US-led coalition’s aim of empowering local people in Afghanistan to become more independent – particularly women – microfinance is gaining popularity. The villagers of Bamiyan – about 15km from the provincial centre – have a long history of forced migration to other areas due to a history of armed conflict. This has resulted in the need for economic recovery upon return. In the past villagers relied on credit from local lenders, often taken with high interest. But this practice has changed with the entry of microcredit.
There are at least three microfinance institutions operating in the village, but one offers both group and individual loans, which are designed according to its use. Loan products offered are solidarity group loans for the poorer clients as well as agricultural, livestock and business loans. Loan amounts start at $300 and reach a maximum of $3,000. Characteristic to all of this lender’s loan products is a substantial grace period, which enables the borrowers to repay the loans according to the natural cash flow of their livelihoods. The loans are repaid either in one or two instalments after harvest or livestock maturation. During the grace period, the borrowers pay the interest fee, which is 1. 5 percent of the loan amount per month.
However, not all microfinance institutions in Afghanistan have met with such success. In the village of Kabul, 20km north of the capital, men have often taken the loans made out to women, preventing the aim of the system.
Sliding problems
Gender inequality, conflict and political uncertainty may not be the only barriers to the success of microcredit. In a report issued last year by the Centre for the Study of Financial Innovation, a think-tank, called Microfinance Banana Skins 2009 – Confronting crisis and change, the authors claim that, as a result of the financial crisis, the pressures of cost and deteriorating loan portfolios will prompt microfinance institutions to turn their attention to more lucrative markets, which could mean that the poorest people who may benefit from such schemes may be denied their help. They also say that funding difficulties will drive more NGO-led microfinance institutions to become shareholder-owned authorised banks to attract investment, while some smaller institutions will need to merge to avoid collapse, reducing their number and regional coverage.
One expert, who declined to be named, says that of the ten thousand or so microfinance institutions worldwide, there are only around 300 of the necessary size to survive on their own. And even they are at risk. Last year, three well-established microfinance institutions collapsed: two defaulted on their loans, and one folded due to political pressure. However, the same source says that “this does not suggest that the industry is particularly risky or that such institutions are not well managed. Such a failure rate is nothing compared to what happened to large banks in the US and Europe as a result of the recent financial crisis.” Prof Yunus also made the same argument last year when he noted that “it is particularly remarkable when big banks – lots of collateral, lots of lawyers around them – are collapsing, and microcredit, the programme we built, is working everywhere without any collateral, without any lawyers. Their repayment has remained as high as ever.”
Richard Wilcox, head of the social banking unit at Co-Operative Financial Services, says that there are broadly two strands of microfinance institutions – a “top slice” of around five percent that are moving away from working with non-governmental organisations and are largely able to function as banks, and the remaining majority of institutions that are small and need further development.
“There are only a small proportion of microfinance institutions that have grown to such an extent that they can function largely as banks,” says Williams. “These institutions have developed a solid understanding of financial management, corporate governance and risk awareness and so are able to function more independently and can prepare to take steps towards becoming banks. It is important that commercial banks help them to prepare for this transformation, while organisations like the World Bank focus on helping other microfinance institutions to acquire the same levels of expertise so that the number of self-sufficient micro-credit organisations grows quickly,” he adds.
Wilcox says that it is easy to measure the success of microfinance. “In financial terms, it is relatively simple to measure the success of microfinance initiatives, such as taking account of the number of customers taking loans, how many defaults there are, and how many of these customers are coming back for larger loans,” he says. “In Bosnia, I have seen people now on their seventh cycle of lending in just a couple of years, borrowing upwards of $1.500 as opposed to the original loans of around $100.”
Jon Williams, partner at PwC and head of the finance team within the firm’s sustainability and climate change practice, says that there is a “triple bottom line” to measure the success of microfinance. Firstly, microfinance institutions need to make a profit. “There must not be any shame in lenders making a profit from these schemes – they are operating a business just like any other financial services provider, and they need to develop effective risk management and financial management systems to cope,” he says.
He also says that microfinance institutions need to have a set of metrics in place to measure the non-financial benefits of the work that they carry out. “Micro-finance is about empowering people who would otherwise not have had the opportunity. It is about alleviating poverty and so institutions need to be able to monitor the associated effects of microfinance, such as the numbers of children in education, the rate of home ownership, and the diet and health of people living in the community.”
Changing effects
Williams also says that organisations need to measure the environmental impact that microfinance contributes to. “While individuals apply for the loans, the idea is that the business that microfinance funds will benefit the community at large as they will be the ones that buy and use the produce. Once a market for goods and services is created, local government will need to keep pace with the changes that are going on and so will look at building better roads, ensuring that there is clean water, and that there are appropriate healthcare facilities close by,” he says.
While funders’ commitments to microfinance have increased by 24 percent over the last year, the sector is also facing more scrutiny, with more questions being raised about microfinance’s impact on poor people, its contribution to economic growth, and whether all the money is going to good use. Questions also surround the governance and financial management of microfinance institutions, and how they are regulated.
In February this year the Basel Committee on Banking Supervision, which focuses on championing best practice in banking regulation, issued a consultation paper called Microfinance activities and the Core Principles for Effective Banking Supervision. The committee’s report contains supervisory guidance for the application of the Core Principles – the de facto global standard for banking supervision – to microfinance activities. The principles aim to allocate supervisory resources efficiently, and to evaluate the risks of microfinance activities, particularly microlending.
Some credit institutions have also developed their own methodologies to provide greater assurance and transparency about how effectively funders work. The Consultative Group to Assist the Poor (CGAP), a consortium of 33 public and private development agencies working together to expand access to financial services for the poor in developing countries, has developed the SmartAid for Microfinance Index. It is the first index that measures and rates how funders work in microfinance and how well equipped they are to design, implement, and monitor microfinance programmes and investments. The index focuses on the part of this chain that funders can most directly influence – their internal management systems.
“The need for independent evaluation, benchmarking, and standard-setting has never been greater in the field of development,” says CGAP expert and SmartAid technical lead Alexia Latortue. “What is unique about SmartAid is that it offers funders a rigorous external assessment and provides a framework to share lessons across a diverse group of funders. When funders can see where their peers do well, they can learn from each other and see how they can better work together.”
Five elements have emerged as key to effectiveness: strategic clarity, staff capacity, accountability for results, knowledge management, and appropriate instruments. An expert Review Board assesses documentation submitted by funders and applies scores to nine indicators, which include funders having designated microfinance specialists who are responsible for technical quality assurance throughout the project/investment cycle, regularly conducting portfolio reviews, and being able to track and report on performance indicators for microfinance programs and components. Each funder receives a SmartAid report including comments on strengths, weaknesses, and recommended improvements, as well as quantitative scores.
The results to date show some consistent patterns of strengths and weaknesses across funders. In 2009, funders tended to score best on indicators of strategic clarity and appropriate instruments. The lowest scores were in the category of accountability for results. Out of a total of 100 points, the range of scores went from 35 to 75, with no funder falling in either extreme of performance—“very good” or “inadequate.”
Other organisations have set up their own system of oversight. In addition to operating under the supervision of central banks and other regulatory bodies, microfinance charity Opportunity International UK’s partners undergo independent external audits, and follow an internal self-assessment and accreditation process using the “CAMEL” rating system which looks at capital, asset quality, management, earnings, and liquidity.
Edward Fox, the charity’s CEO, says that “good governance and better accountability for how projects are managed is becomingly increasingly important for microfinance institutions as they rely on donations for the most part to keep going. Donors – many of whom are wealthy individuals who believe that capitalism creates opportunities for all – want assurance that the money is being used appropriately and that systems are in place to check cashflow and risks in the portfolio.”
“Philanthropic enterprises need to be as transparent and well-managed as possible, otherwise they lose public trust,” says Fox. “Effective audit and assurance methods need to be deeply rooted in all aspects of microfinance, otherwise it will be the people who need these products that will suffer rather than the organisations themselves.”
