We bust the myth and bring you the truth about microfinance.
1. What is microfinance?
Microfinance refers to financial services for poor and low-income clients. Although most attention has been on the provision of small loans, microfinance in fact also includes the provision of other basic financial services such savings, money transfer and insurance for poor people. Improving access to such services allows poor and low-income people to finance income-generating activities, build assets, stabilize consumption and protect against risks. Microfinance is now widely recognized as a powerful solution to alleviating poverty among the working poor.
2. What is the difference between microfinance and microcredit?
Although often used interchangeably, microfinance and microcredit are in fact quite distinct. Microfinance is a much broader concept than microcredit and refers to loans, savings, insurance, money transfers, and other financial products targeted at poor and low-income people. Microcredit refers more specifically to making small loans available to poor people, especially those traditionally excluded from financial services, through programmes designed specifically to meet their particular needs and circumstances. The characteristic features of microcredit are that;
a) Loans are usually relatively small and short term. As borrowers regularly repay their loans and demonstrate their creditworthiness, they become eligible for larger loans.
b) The traditional lender's requirements for physical collateral such as property are usually replaced by a system of collective guarantee (or solidarity) groups whose members are mutually responsible for ensuring that their individual loans are repaid.
c) Loan application and disbursement procedures are designed to be helpful to low income borrowers - they are simple to understand, locally provided and quickly accessible with minimal paperwork.
3. Who do we target with our microfinance services?
Our microfinance services are usually aimed at economically active poor and low-income people most especially women who have limited or no access to the services provided by formal financial intermediaries such banks and other high end MFIs such as MDIs. Since there are so few salaried work opportunities, our clients are usually self-employed micro-entrepreneurs often working from home.
4. Why has microfinance become so important?
Primarily because it has been proven that microfinance is a long-term and sustainable solution to alleviating poverty. After nearly four decades of experience it has been shown that when poor people have access to financial services – loans, savings, insurance and money transfer facilities – they can lift themselves out of poverty. Poor people in general and poor women in particular, are a good credit risk. They invest their loans wisely, not only in income generating activities, but also in the welfare of their families. With access to successive loans over a longer period of time and through the cycle of further investment and increased income, poor entrepreneurs can through their own efforts gradually climb out of poverty.
6. How does micro-insurance work?
As with normal insurance, micro-insurance is a service that protects poor people against certain risks in return for a fee or premium. The service is offered to low-income individuals and businesses and is characterized by low insurance premiums, often a small fixed proportion of the loan amount, and low coverage limits.
7. What kinds of institutions provide microfinance services?
Most microfinance initiatives were started by non-governmental organizations (NGOs). These often developed into formal microfinance institutions or MFIs whose activities are regulated by the relevant national banking or microfinance authorities. An increasing number of MFIs are now organized. In addition to insurance and money transfer facilities in recent years some MFIs have also begun providing social services, such as basic healthcare and education for their clients and their families.
8. When is microfinance NOT an appropriate tool?
Microfinance can be a very powerful tool in helping poor people; however it may not always be appropriate. For example, when small loans are to be used for business purposes, microcredit is most useful for those entrepreneurs who have already identified a productive and profitable economic opportunity, can capitalize on it if they have access to credit and are capable of making the regular repayments in order to have continued access.
The very poorest people may be unable to repay even a small loan and providing them with a grant to help them build assets or start an enterprise may be more appropriate. In fact, they are generally more in need of help in meeting their basic needs such as food and shelter. Providing credit to those who cannot use it productively could push already vulnerable poor people into debt and in fact worsen their situation.
9. How does microfinance help the poor?
Microfinance can help poor people in a number of ways;
a) Firstly, it provides micro entrepreneurs with the capital needed to operate and expand their businesses. Indeed, having a reliable source of credit allows micro entrepreneurs to better plan their business activities and manage their cash flow. Although the size of the loans may seem small, sometimes just $50, it is worth remembering that for half of the world’s population who survive on less than $2 a day; this is still a significant sum.
b) Secondly, through the increased income generated by their businesses as well as the ability to save and obtain loans, microfinance allows poor people to build their assets, for example by acquiring land, constructing or improving their homes and purchasing livestock and poultry.
c) Thirdly, it can reduce poor people’s vulnerability. Access to credit, savings and insurance can help them to smooth cash flows and avoid periods when access to food, clothing, shelter, or education is lost. Microfinance can make it easier to manage shocks such as sickness to the family breadwinner or theft.
d) Fourthly, it instills a culture of hard work and regular saving among the poor
10. How do savings services help poor people?
Secure and accessible savings facilities provide a means for poor people to reduce their vulnerability by allowing them to better manage risk and cash flow - poor people do not just have to cope with low incomes, but also with irregular and uncertain incomes. Savings are also used to accumulate money that can be used for investment or to meet the costs associated with expected commitments such as their children’s education and weddings or unexpected events such as ill health and funerals. In fact, very poor people tend to be much more comfortable investing what they already have than increasing their level of liability by taking out a loan. For this reason, for the very poorest people, savings facilities are often more important than access to loans. In fact, all poor people already save but tend to use informal methods because they lack access to good formal banking deposit services that suit their circumstances.
They may hide cash under the mattress or buy animals or other assets that can be sold when the need arises. However, these savings methods are fraught with risk - for example cash can be stolen and animals can become ill and even die. What poor people want is secure, convenient deposit services that allow them to frequently withdraw and deposit relatively small amounts of money. The difficulty with the savings facilities already offered by banks is that they may require savers to open an account with a large initial deposit or maintain a high minimum balance thereby excluding small savers or it may simply be that their nearest branch is located too far away.
13. Why can't poor people just go to a bank for financial services?
There are many reasons why poor people find it difficult to deal with banks. These include:
a) They may live too far from the nearest bank branch and it may take too long or be too expensive for them to travel each time they wish to apply for a loan, make a repayment or access their savings.
b) They may not have enough money to open a savings account or the minimum balance that the bank requires them to maintain may be too high.
c) They may not have sufficient traditional collateral (such as the deeds to the house where they live or the land they farm) to secure their loan.
d) They may be self-employed without regular or verifiable sources of income.
e) They may have no existing history of receiving loans with the bank.
f) They may be illiterate and be unable to complete all the necessary paperwork required for applying for a loan or opening a savings account.
g) They may feel intimidated by a bank’s premises and staff who are used to dealing with well dressed wealthy customers in salaried jobs rather than poor micro entrepreneurs who work in agriculture or markets.
h) Some banks think it will be uneconomic for them to deal with poor people and they deliberately exclude poor people from their services. They may consider that it is too costly for them to analyze and process the large number of loan applications made for the relatively small amounts of money required by poor people and instead prefer to make a few large loans to richer borrowers.
As a consequence poor people frequently rely on friends or family or private moneylenders as their principal sources of credit. Private moneylenders can offer several advantages that make their service convenient. They are often personally familiar with the borrower and therefore offer credit without collateral; they are generally located locally and can both disburse loans immediately with minimal paperwork as well as receive repayment without the need to travel great distances. Nevertheless, it is almost always the case that private moneylenders charge relatively high rates of interest and they may not be able to provide more than limited short-term capital.
However, the successful provision of microfinance by institutions such as Grameen Bank in Bangladesh who specifically target micro entrepreneurs, meant that lending to poor people can be profitable and that poor people in fact also make very good clients.
14. Why do we mostly target women?
The main reason is because women are usually one of the most vulnerable and poorest segments of society – indeed most of the world’s poor are women. Furthermore, it has become apparent that in many instances microfinance can significantly contribute to women’s empowerment by generating additional income earning opportunities either for the women themselves or for the household. Once women start making more visible economic contributions to the household, this can lead to growth in women’s self-esteem, self-confidence and their status both within the household as well as the wider community. Eventually, this provides women with more choices and a greater voice in family and community matters.
We also target women micro entrepreneurs because studies have shown that women are the ‘change’ agents of the family since women spend a greater percentage of their income on the welfare of their households than do men. As a consequence increases in women’s incomes improve the health, nutritional and educational status of other household members, particularly children. Moreover, as women have become organized, it has formed a basis for addressing a range of other issues such as domestic violence and male alcohol abuse and in regions where women’s mobility is limited; women have become more visible and are better able to negotiate in the public sphere. Finally and equally significant is that we target women because they have proved to be more reliable borrowers and are more likely to repay promptly than men.
15. How can we measure whether we are successful or not?
Since we have a social mission we are judged firstly, on whether we are reaching the poor, and secondly, on whether we are helping them move out of poverty. How can we measure this? To begin with, financial criteria such as repayment rates are useful indicators of the performance. We can generally assume that the purposes for which the loans are being used are in fact generating returns because the loans are being regularly repaid and borrowers are seeking repeat loans. This is one indication that we are in fact successful.
Other criteria, such as number of loans to female-headed households, loan size, the purposes for which the loan is ostensibly used, average loan size, number of loans per employee, etc, are also useful indicators of relative success. These indicators allow us to draw up a profile of borrowers in terms of gender, age, location, martial status and type of financed activity, which can be compared with the target group of borrowers for example as well as our organizational efficiency.
However, the above are not sufficient indicators as they tend to focus on the institutional health of the organization rather than the health or well-being of the borrower. High repayment rates can be misleading, for example, when borrowers seeks funds from third party sources so that they can repay on time but in the process become further indebted. The numbers of loans given to women may hide the fact that husbands or other male relatives on occasions appropriate loans and invest badly or misuse the money altogether leaving women borrowers with heavy repayment burdens.
We cannot, therefore, rely solely on such financial indicators to measure our work. There is a need, therefore, to complement the information gathered through monitoring financial criteria with more in-depth qualitative social performance analysis that examines the changes in the lives and businesses of borrowers. This information is also useful because it helps us understand the ways in which borrowers utilize loans, the constraints they face, reasons for success or failure, etc. This information is directly relevant to operational design issues, and can assist in improving the services offered in a way that not only increases impact on borrowers but also improves the organizations’ performance.
16. What can governments do to promote microfinance?
Many governments have tried implementing microfinance directly and although there are some highly successful governments MFIs, such as the Bank Rakyat in Indonesia, most microfinance programmes promoted by governments have performed poorly mainly because they have been subject to political influence. Therefore, in recent years instead of providing financial services directly governments now prefer to focus on;
a) Providing a stable macroeconomic environment with low inflation.
b) Providing whole sale funds to MFIs such as MSCL
c) Promoting the microfinance industry in general through, for example, providing payments or credit information systems, and providing prudent regulation and supervision of MFIs in order to protect customers and prevent risks to the financial system in particular.
All these are important in promoting greater access to financial services to low income people, improving the quality of those services, and providing a favourable environment in which MFIs can develop.
17. Should MFIs provide entrepreneurs with training as well as loans?
This is an area of some debate and while many MFIs focus solely on providing financial services, they are often referred to as minimalist MFIs; others often labeled ‘credit-plus’ MFIs do provide additional components such as training or education to borrowers as well because they believe that poor people face more than just financial constraints. For example, entrepreneurs who would like to expand their enterprises or enter newer more dynamic fields may face lack of access to markets, low technology levels, be illiterate or semi-literate, and may lack training in business and related skills. Some MFIs believe that additional support such as training and technical assistance is a pre-requisite to enhance poor people’s enterprises and productivity.
Indeed the addition of training components has been justified as a means of guaranteeing effective use of credit and improvements in productivity and income for entrepreneurs, as well as being necessary to overcome a variety of non-financial barriers that they may encounter.
Usually training is provided in small business administration, basic accountancy, bookkeeping, and marketing. Although training may be ongoing it is generally only given once before the entrepreneur receives his or her first loan. In addition, there is also a concern that too many of the same types of business may be established – for example, too many dressmakers or too many small grocery stores, thereby flooding the local market. Therefore, some MFIs are concerned with encouraging entrepreneurs to diversify into new business opportunities.
However, despite these concerns most MFIs tend to focus quite narrowly on providing financial services because the provision of training can be costly and add significantly to the MFIs operational costs. The underlying philosophy of these MFIs is that they do not know what is best for entrepreneurs, rather that entrepreneurs must decide for themselves how best to use their own money. As ENCOT we believe in the former; we embark on a journey together with our clients to see that they don’t only access finance, but they access knowledge and expertise needed to propel them to higher heights in their business endeavors.