MICROFINANCE
FUNDAMENTAL CONCEPTS
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Myths and Facts
Why Microfinance
The Goals of Microfinance
Core Principles of Microfinance
Evolution in the Field of Microfinance
Myths and Facts
1. Poor people do not repay loans
This is a myth- as long as customers’ value services; they will repay loans in order
to continue to have access to credit. In the mid-80s, MFIs in Bangladesh and Latin
America had achieved sustained repayment rate of 95%.
2. Poor people cannot pay the interest rate necessary to cover the cost of delivering
the services.
This is also a myth. The poor value access to quality services that are there when
they need them and are willing to pay for them. The challenge to MFIs is to develop
an efficient and affordable way to deliver the service. By the end of the 1990s,
successful MFIs were charging interest rates to cover the full cost of delivering
services to increasing number of clients.
3. MFIs cannot access commercial sources of funding.
This is a myth. MFIs can access commercial loans; it is just a matter of choice. By
the end of the 80s, MFIs relied less on donor funds and were relying more on
commercial sources of funds or finance.
4. MFIs cannot reach the poorest of the poor only through credit.
This is a fact: Credit is a powerful developmental tool only for people who have
economic opportunities. Debt financing is not a developmental tool for the
destitute.
5. Financial sustainability is necessary for an MFI to reach large numbers of people.
This is a Fact: Without it, MFIs are tied and dependent to just donor funding to
limited few people. Licensed MFIs who leverage their equity are able to have more
clients than those who depend on donor funding alone.
6. MFIs only extend service to the very poor
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This is a Myth: MFIs reach a range of clients just below or on or just above the
poverty line. MFIs address the problem of access to financial accessibility. It is not
only the poor who suffer from access to financial accessibility.
7. Microfinance alone does not alleviate poverty.
This is a fact: Microfinance is one developmental tool among many to alleviate
poverty; it is not a panacea for alleviating poverty. However, access to financial
services can smoothen volatility of household income for the poor; making it easier
for people to organize their financial lives and respond to opportunities and stop
them from slipping deeper into poverty (what other things can you do to alleviate
poverty?).
8. The goal of microfinance is institutional sustainability.
This is a myth. The goal of microfinance is to provide millions of people with
continued access to microcredit and savings services. Sustainability is just the
means. Sustainability helps to ensure the services are available on permanent basis,
helping people to respond to opportunities to increase their assets, to better manage
risks or loss or avoid slipping back into poverty or becoming further impoverished
9. Many microfinance operations will not become sustainable.
This is a fact: Achieving sustainability requires:
i. Focused operations
ii. Stream lined efficient services
iii. Interest rate high enough to cover the cost of delivering services.
MFIs find it easy to rely on grants or succumb to political pressure. Such behavior
erodes
assets so that making the necessary changes to achieve sustainability becomes
difficult.
Why Microfinance?
Microfinance provides financial services to poor and low-income households to have
access to economic opportunities, these services allow households and micro enterprises
to keep assets liquid and respond rapidly to changing needs or opportunities.
How Microfinance affects a local economy:
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Development of micro enterprises
Micro enterprises create jobs
Supply of goods and services to low-income populations is increased
Increase in the productive use of capital
There are two goals of microfinance:
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A.
Viability: that is long time viability through profit and not donor funding.
Donor Funding
B.
Retained Earnings
Commercial Capital Deposits
This can be sub- divided into two, viz:
i.
Financial Viability: here, the basic cost of operations is covered by MFI
revenues and not subsidy
ii.
Institutional Viability: implies organizations that are well managed and
staffed for long term success
Outreach: that is, to reach more people with quality services. Outreach can be
viewed along the qualities of
i.
Depth of outreach: Depth of outreach means MFIs with deep outreach
provide financial services to very poor or hard to reach clients including
women in certain cultures, or clients in sparsely populated places with
minimum infrastructure. Depth of outreach is highly desirable.
ii.
Scale of outreach: Scale refers to the number of people who can have access
to MFIs services. There is a large-scale outreach- roughly 500 million
potential clients for MFIs worldwide, so that unless MFIs attempt a largescale outreach, they can only reach a small number of clients.
iii.
Quality of services; Quality of Services offer:
 Liquidity
 Convenience
 Availability
 Flexibility of purpose or use
 Freedom to borrow or save so that clients can borrow without saving
or save without borrowing.
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If microfinance is to achieve increased access to financial services over a long term,
it must achieve these two desires.
What indicates that services are valued to clients? Demand alone shows that clients
value the services.
Benefits of Financial Viability
1. Services can be maintained into the future without being subject to unpredictable
fluctuations in donor funding
2. Access to commercial sources of funds
3. Operational self-sufficiency: means that depreciation, loan loss provision
expenses and cost operating expenses are covered by income from operations
Operational Self Sufficiency
Salaries
Rent
Depreciation
Cash cost of funds
Loan Loss Reserve
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Financial Self Sufficiency
Salaries
Rent
Depreciation
Cash cost of funds
Loan Loss Reserve
Value of subsidies
cost of capitalisation
Inflation on Equity
Levels of Financial Viability- Three levels of Financial Viability have been identified
Level I.
Organizations are dependent on donor subsidy
Characteristics:
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They consist of MFIs that have not achieved operational self sufficiency
They rely on outside donations for continued operations
Revenues fall short of operating expenses
Inflation erodes the loan fund
Poor performers are subject to erosion of loan fund through delinquency and
default
 Many have high operating costs, are reluctant to charge sustainable interest rates
and have high delinquency and default rates especially older organizations.
It is estimated that 90% of micro credit and microfinance institutions operate at level 1.
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Various factors contribute to this level viz: Donors, MFIs and Clients
Level II.
They have broken even on a cash basis
Characteristics:
 Operational self-sufficiency but not Financial self sufficiency
 They apply proven principles and are generally efficient, have high client- to
staff ratios, increasing scale of operations and good control of delinquency and
default.
 Increase and income cover operating expenses but inflation can erode equity
 Funds are borrowed on terms near, but still below market rates
They can vary widely from those that rely on soft money to those on the verge of
unsubsidized profitability. They use savings, bank loans and donor funds.
Level III
 They have attained financial self sufficiency
 Operation is fully financed from retained earnings, savings and or commercial
funds
 Interest rates and fees cover the full costs of service delivery and returns on
savings
 Interest rates and fees cover the real costs of funds
 MFIs can increase their equity base through profits and attract outside equity
participation. So far, only a few MFIs have reached level 111 but many are
posed to do so. These MFIs use savings, bank loans and investments to reach
this level.
Key operating principles of Microfinance
Those who apply these core principles consistently are more likely to achieve significant
outreach and financial viability
 Understanding the market and designing products that best serves its clients’.
listening to customers and understanding limitations on supply side
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 Streamlined operations which help MFIs make efficient use of resources and keep
costs low.
 Informal sector practices which help MFIs manage risk, motivate repayment and
lower administrative costs e.g. finding substitutes for formal collateral, operating
in convenient location, using simple loan application and disbursing procedures.
(What are some of these practices?).
 Repayment incentives- if a client knows he will get another loan when it is needed,
he gets a high incentive to repay.
 Savings Services: Quality savings services are liquid, secure, and convenient and
offer competitive returns and are not to be limited to borrowers alone. Many poor
households are interested in savings than in incurring debt.
 Viability and Growth- Staff should be focused on achieving efficiency, financial
productivity and financial viability
 No delinquency – tolerated; clients who do not repay add to cost and stress
operations, erode capital
 Sustainable interest rates- Interest rates and fees must be set high enough to cover
all costs. If delivery services such as cost of funds, desired capitalization, salary
and administrative, reserve to cover loan loss.
 Linkage to financial markets: Leveraging resources from commercial market is
essential to achieving significant outreach.
Evolution of Microfinance- i.e. the then and now:
i.
Directed credit vs. marketing approach
ii.
Evolving programs vs. evolving institution
iii. Standardization vs. Diversification
iv.
Donor reliant vs. Local capital markets
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DIRECTED CREDIT VERSUS MARKET APPROACH
THEN
NOW
 Directed credit operations,
directed priority groups with
subsidized loans. E.g. farmers
 Too small- did not achieve selfsufficiency, did not reach the
poor,
distorted
financial
markets
 Most suffered high rates of
delinquency and default.
 Model organizations designing
products to meet customers’ needs
 Successful operations seek to
attract clients with useful
borrowing or savings products
EVOLVING PRORGAMS VERSUS EVOLVING INSTITUTION
THEN
NOW
 Small microfinance programmed
evolved by moving from one
market to another and ends when
programmed ends.
 Multi service organizations began
to consolidate and offer more
specialized financial services
 Now formed at the outset as
specialized finance.
 Goals of large-scale outreach and
viability.
 Commercial banks are moving
into microfinance markets and
services
STANDARDIZATION VERSUS DIVERSIFICATION
THEN
NOW
 Micro financial intermediations
offered only micro credit products
almost exclusively
 Clients were assured to graduate to
formal institution this did not
prove to be true
 Varied products and services are
offered
 Focus on keeping best customer
in the system.
 Attention given to attracting new
customers who have confidence
that the institution can assist over
time
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DONOR RELIANT VERSUS LOCAL CAPITAL MARKET
THEN
NOW
 Donor agencies were the primary
source of funds
 Service was dependent on
unpredictable donor funding and
was therefore not re
 Donor restriction limited the
breadth of product and customer
 Funding for services and products
comes more from local and
international capital markets
including savings department that
is commercial sources of funding.
 Products can be diversified to suit
the market
State of the Industry
Most institutions are still operating at level 1
Leading MFIs have proven that goals of deep outreach, scale and financial viability are
achievable.
Donors still play a significant role. They continue to provide equity base that allows
committed MFIs to emerge and grow in extending financial services to poor and lowincome people who do not have access to formal sources of finance.
Term paper: Microfinance in Sierra Leone
- Past, Present and Future
PRACTICE QUESTIONS
1. Labor Bank, a commercial bank with a nationwide presence in the country, is
expanding its services to better fulfill its mission of “providing financial services
to all”. In doing so, it has set up a separate micro credit operation within its existing
banking structure. It plans to offer a single working capital loan product to its
clients nationwide, through its existing banking structure. The loan will require
collateral. The bank is launching the programmed in all its branches all at once, in
both rural and urban markets. Which principles of microfinance do you think that
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undertaking this micro credit operation might violate? Give reasons for your
answers.
2. My aged mother taught me that microfinance is the granting of small loans to poor
people. My friend who has just been newly appointed as a Minister of Parliament
in Sierra Leone believes that over the years, politicians in the Sub Saharan have
used it to canvass for votes during the elections. The students of microfinance
totally disagree with these two views. They say that even though these two views
fall within the purview of microfinance, they are more of its origins than its present
or future. Who is right?
3. Over the years, the dual goal of sustainability and outreach has generated
considerable debate within the field of microfinance. Some argue that the two goals
are not complementary, but rather that the pursuit of sustainability undermines the
institutions’ ability to serve the poor. Do you agree?
4. There are two underpinning philosophies of microfinance. On one side of the
spectrum is a philosophy that views microfinance as the commercialization of
social welfare. On the other side of the spectrum is a market- oriented philosophy
that sees microfinance as deepening the financial system. Expatiate on these two
views bringing out all key issues that explain the present state of microfinance.
5. There are countless myths and facts surrounding microfinance, identify some of
these misconceptions and present a case to demystify microfinance to newly
recruited credit officers in your microfinance institution.
CLIENTS AND SERVICES
SECTION A
TEST YOURSELF (MYTHS OR FACTS)
1. Only people with economic opportunities can benefit from credit.
This is a fact; some form of current or potential economic opportunity MUST exist
in order for people to benefit from borrowing money. This is true regardless of
whether the borrowed funds are used to finance or create a micro enterprise or
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business or used to increase liquidity, invest in the future, smooth cash flow or
diversify household income streams.
2. Micro credit creates economic opportunity.
This is a myth. The financial service itself does not create economic opportunity.
The borrower or the saver or the entrepreneur creates economic opportunity. The
availability of micro finance or micro credit financial services can translate the
economic opportunity to reality. It will help those with economic opportunities to
manage finance more effectively, manage cash flow or manage household and
increase income.
3. MFIs perform best when they mirror many of the practices of the money lenders.
This is a fact. MFIs can learn a lot from informal sources of finance e.g. the money
lenders, in spite of their weaknesses. Such practices include
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Simple procedure
Timely loans
Clear terms
Timely and convenient services
Loans backed by borrower’s character rather than collateral. In fact, they are
best when combined with more formal financial services practice
4. Saving is more important than borrowing for the very poor
This is a fact. The very poor may not have an economic opportunity that will benefit
from debt financing. Erratic and uncertainty of incomes motivates informal sector
households to save. Wealth is held in cash or illiquid assets such as animal or gold.
Savings services offer the very poor a safer way of accumulating assets for future
consumption or investment.
5. Access to financial services is more important than price
This is a fact. As with saving services, easy accessibility, minimum administrative
requirements and low transaction costs are priorities for borrowers. Hidden
transaction costs e.g. the timing cost of attending meetings are often higher than
the financial cost of the loan. Interest rate as not as important a factor as access to
services and convenience for people who need to attend to their businesses.
Compared to many informal sector finances, interest rates charged by MFIs are
normally very competitive.
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6. Credit for consumption should never be provided
This is a myth. Economic shocks to microfinance client’s household are frequent
and diverse. Often people cope with loss by borrowing for consumption purposes.
This strategy allows them to avoid selling an income producing assets and thus
preserve the household economic base and prevent further impoverishment.
7. Longer term loans are more beneficial to borrower than short term loans.
This is a myth. The cash flow of the household or entrepreneur will determine the
duration of the loan. The cash flow will determine the house hold ability to repay
without experiencing undue hardship.
8. The greatest incentives to people to repay their loans are to repeat loans.
This is a fact. The key reason for low delinquency in microfinance program is the
implicit contract between client and MFIs. The implicit contract is based on the
belief that if client repays promptly, they will continue to access additional or larger
loans. Households are quick to realize that having an affordable, permanent source
of financial services is important to maintaining their economic security.
NB: All the eight (8) statements above only go to show the importance of a understanding
of MF customers which is very critical to designing successful services.
SECTION B
How Financial Services are used.
Access to credit or savings increases household liquidity. Credit and savings services help
households to increase their liquidity in both near and far terms. Through access to lump
sums of cash from investment or savings, household can increase their purchasing power.
This allows them to better diversify their economic activities, pursue opportunities, better
manage risk and avoid loss, such activities increase their economic security.
Micro finance clients use financial services to:
1. Respond to economic opportunities-i) by buying in bulk at better rate ii) buying
supplies when prices are most favorable which will all lead to increase in income.
2. Protect against bad times- such as job loss, accident or other disability by building
savings or borrowing. This way, risk can be better managed, losses can be better
absorbed and assets can be protected.
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3. Invest in the future e.g. children’s education for -Economic expansion, by
obtaining capital, households can expand enterprises
-Education of children
-Housing improvement
How do Households Manage Their Financial Resources?
1. Multiple activities- that is; by investing in diverse economic activities, households can
increase economic security.
2. Loan use –financial resources are fungible, that is they are used interchangeably for
the house hold and various micro enterprises. That is, for consumption and investment.
Households do not really stick to the reason for which loan is given.
3. Illiquid assets (i.e. without losing value) - to take the best advantage of opportunities,
households need a combination of saving assets. When institutional savings programmers
are unavailable, households hold assets as illiquid assets, such as animals (which can die),
gold (which can be stolen) and not really to respond to economic opportunities,
4. Access to funds: to take advantage of positive opportunities, households need a
combination of savings and debt.
5. Concurrent debt and savings: debt and savings are the tools used by households increase
economic security by reducing risk and managing loss.
6. Credit sources- Households use informal sources of credit or short-term cash needs and
will continue to borrow from a variety of them.
7. Save: erratic and uncertain incomes motivate savings. Savings are used for a variety of
purposes- educational, emergencies, consumption during loss of income, social and
religious obligations
8. Cash savings: households tend to save cash and even engage in-kind savings (what
are the advantages and disadvantages of each?)
9. Emergencies: informal sector households are subject to frequent economic shocks and
often must rely on emergency funds to deal with them.
SECTION C
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EFFECTIVE CREDIT & SAVINGS
MFIs perform best when their services combine successful practices from both formal
and informal finance providers.
EFFECTIVE SAVINGS SERVICES
Efficient and effective savings should offer
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Security
Liquidity
Convenience
Offer competitive returns
SECURITY: Protecting savings from theft and from claims from families and friends is
of great importance to low-income savers
LIQUIDITY: That is savings must be made available when needed.
CONVIENENCE: Low transaction costs especially easy accessibility and minimum
requirements are important for clients who may not be literate and for whom travel may
be costly
COMPETITIVE: So that the value of the funds can be maintained.
CONCLUSION: Because users of savings vary, a variety of savings instruments are
needed. Some may offer more liquidity and lower returns while some may offer less
liquidity and higher returns.
EFFECTIVE CREDIT SERVICES
Effective credit services should offer
 Flexibility –that is, use of borrowed funds should not be restricted to specific
purposes. Effective credit services do not place unnecessary restrictions on how
borrowed funds can be used.
 Ready access: rapid loans approval and disbursement are crucial to MFI client
 Collateral substitutes: Effective credit services rely on collateral substitutes; since
most household clients lack property to use as traditional collaterals, so
nontraditional collaterals should be used (think of such nontraditional collaterals)
Non- traditional collaterals may include: equipment, jewellery, personal property
that is not generally accepted as collateral by traditional banking institutions,
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bicycle etc. Collateral substitutes may include; community relations, social
sanctions, reputations, group responsibilities, continued access to services etc.
Beating the competition: To be successful and to compete with informal
alternatives, MFIs must offer advantages. This does not mean that interest rate must
be low compared with other sectors but such low transaction cost and fast access
to funds are important to take good advantage of economic opportunity and avoid
loss.
Appropriate product: loan terms should be suited to client situations, when
approving loans, many MFIs consider the repayment capacity of their client
household, as well as his or her personal, social and business relationship. The
practice of keeping loan sizes small and terms short enables many people to repay
their debt without undue hardship. It will be highly impractical for MFIs to base
loan approvals on loan use due to the fungibility of funds in household economy
and high cost of analyzing individual project.
Easy process: client burdens and transaction cost throughout the life of the loan
must be kept small. Low transaction cost, minimum administration expenses are all
necessary.
Permanence: In order for clients to continue using service, the institution must be
stable and reliable.
REVIEW QUESTIONS
1. Identify at least five informal financial service providers and discuss the
weaknesses of such service providers.
2. A number of traditional sources of finance exist outside the banking system;
identify 5 of these traditional sources of finance and discuss their strengths and
weaknesses. How can these weaknesses be turned to strengths?
3. MFIs typically have two types of savings accounts: voluntary and forced; outline
and discuss the usefulness of the two to the sustainability of an MFI.
4. Why do you think that people value the liquidity of savings? What costs and/or
problems do you associate with illiquid savings?
5. Chi Yuan, a carpenter, has a loan from his savings and credit cooperative. The loan
has a term of six months, repayable in installments every two weeks. He travelled
by bus from his village to the market town where the cooperative is located once
for an initial interview, once to fill out loan applications and deposit money, and
once more to pick up the disbursement. The round trip takes about 30 hours. The
cooperative required that Yuan place 10% of the value of the loan in savings with
the institution for the duration of the loan. What financial and other transaction
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costs does Mr. Yuan incur for this loan? Which ones benefit the cooperative?
Which ones do not?
6. In your neighbourhood, you know of two different financial services available to
you. The first one, a ROSCA set up in your local village, offers a simple financial
service for its 10 members. Each person pays in $10 per week at a weekly meeting
held in a public market place. Each week one person, selected on a rotating basis,
receives $100, the total of these lump sum pays ins. The members have agreed to
limit the ROSCA to 3 rounds. The second financial service, a subsidized credit
programmed from a local NGO, offers loans at subsidized rates to finance the
working capital needs of already established micro business. The NGO has limited
specialized credit staff. As the NGO also runs a community health programmed,
all borrowers are required to attend twice weekly training sessions. The NGO’s
portfolio and credit operations are currently funded through a mix of donor funding.
Given your understanding of effective financial services, in what ways does each
scheme provide effective services? In what ways are its services less effective?
MODEL SOLUTIONS-Questions 4- 6
4. Liquidity is the ease with which one asset can be traded for money to purchase
other goods and services. A physical asset, such as a cow, though it stores value,
cannot be easily traded in for the purchase of goods and services as a financial asset,
such as a savings account (and the money therein) When time constraints are
important, as in an emergency, the owner of a cow might have to forgo a fair value
for her asset in order to quickly access cash to use, for example, in buying medical
supplies. Likewise, if the time constraints were an economic opportunity, like a low
bulk price for goods, she may have to forgo the opportunity altogether. Further, she
cannot sell only a portion of a cow, if her need for cash if her need for cash is less
than the full value of the cow.
5. Yuan incurs several costs for this loan, including interest payments, the cost of
keeping 10%of the value of the loan in a savings account, and the bus fare from his
village to the market town. Moreover, he incurs other transaction costs such as the
two hours he must spend away from his workshop for every repayment meeting.
Of these costs, only the interest payments and required savings benefit the
cooperative. The first is a direct financial gain, while the second offers risk
reduction and can be on lent for further revenues. The bus fare and opportunity cost
of the lost earnings benefit neither Yuan nor the cooperative.
6. The ROSCA offers many aspects of financial services. In terms of savings, it
increases the security of cash savings by reducing possible claims on them from
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within the household. It is relatively liquid, though time bound and depending on
your place in the rotation, it may not be desirable for your current needs. The
obligation
MICRO CREDIT METHODOLOGIES
 Self-assessment
 Credit products and methodologies
 Effective methodologies
 Tailoring delivery
 Why adaptation is important
A. SELF ASSESSMENT
Question: What constitutes an effective micro credit methodology?
An MFI may offer different products and different methodologies. Some may offer just
one product and just one methodology.
The PRODUCT OR SERVICE
is what is delivered and the SERVICE
METHODOLOGY OR CREDIT TECHNOLOGY is how it is delivered. Both the
product and the methodology are equally important.
An effective micro credit methodology (service delivery) is the one that
 Maximizes value to the borrower
 Minimizes risk to the lender.
B. (1) Credit products: Are what is delivered and are characterized by
o Loan size (which are generally smaller than a conventional bank loan)
o Price (this is the interest rate plus other fees)
o Repayment intervals (which may be standard for all clients or structured to meet
client’s needs) and cash flows of enterprise.
o Term (the length of time over which the loan must be repaid)
o Purpose (is it for working capital, emergencies, consumption etc.)
(II) Credit Methodologies: Are also characterized by the following three key
elements. These are,
o Target market
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o Loans to groups or individuals (who receives the loan)
o Loan process
One important element in developing methodology is the target market. Some microfinance
institutions (MFIs) in developing their methodologies focus on their institutional objectives
or developmental objectives, that is why the microfinance institution was set up rather than
the market or even cost considerations, it is important to know what motivates the potential
customer
Successful MFIs combine elements of these three that is their institutional objectives, market
preference and cost considerations. Thus,
Target Market
Developmental objectives
+ Market preference= (What motivates potential clients and
decides whether the market can be reached in a way that will lead
to customer satisfaction and financial sustainability)
+ Cost considerations
= Successful MFI
Institutional objectives are important in determining whether methodologies are exclusive
or inclusive.
EXCLUSIVE METHODOLOGY: Focuses on a particular business sector of the
market. E.g. Market vendor or small manufacturers.
INCLUSIVE METHODOLOGY: Has more expansive eligibility requirements and
make these services widely available.
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Methodology is also determined by who the recipients of the loan are- individual or group
lending. Individual lending methodologies basically involves conventional banking
methods rescaled to reach micro credit customer. Group lendings are the breakthroughs
that allow organizations to deal with lack of collateral and increased cost of making small
loans.
These are as many methodologies as there are microfinance operations for example; the
size of a customer group, type of guarantee or collateral and savings policies can vary
depending on the organizational policy.
Thus,
TARGET MARKET
PROCESS
GROUP SIZE
POLICIES
LOAN TO GROUPS OR INDIVIDUALS
LOAN
TYPE OF GUARANTEE/COLLATERAL
-usually 3-10 members
SAVINGS
-serves as collateral
-large enough to make payments
loans
-required to receive
-also small enough for trust
contributions
-initial
&
regular
-self selected
Compulsory savings
substitute
alternative collateral
-inventory
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collateral
-borrowers character
-equipment
-group guarantee
-jewellery
-guarantee of co-signers
-something of value
(even when not considered as legal under the banking regulation)
All micro credit methodologies can be distinguished by the way the loan is guaranteed as
shown above. Depending on the methodology, clients may also be required to maintain a
savings account. These savings accounts are collateral for borrowers with no assets and
may be accessed by the group in case of any default.
(III). Loan Process
The choice of a product and methodology are often determined by developmental
objectives, capacity of microfinance institution’s system and skill of its staff rather than
a systematic analysis of cost and what the market prefers.
LOAN PROCESS
1. CLIENT SELECTION
2. LOAN OFFICER CONTACT
3. LOAN APLLICATION
4. REPAYMENT INTERVALS
5. MEETING REQUIREMENTS
6. REPEAT LOANS
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1. CLIENT SELECTION is the most important function of methodology, micro
credit methodologies are generally a combination of cash flow-based characterbased lending rather than asset-based lending backed by collateral. Loan approval
is often based on existing:
o Repayment capacity
o Personal, social and business relationship
o Income streams
2. Another element of methodology is frequent contact which
o Improves communication
o Builds respect
o Prevents and controls delinquency.
3. Purpose is always specified but it is generally known or recognized that small loans
support multiple activities and may be repaid for multiple sources.
Because of the high cost attached with loan use, verification, most MFIs do not vary loan
use neither do most violate the terms of the contract.
4. Repayment intervals are:
o Standard for some customers or based on cash flow
o Determined before loan agreement.
A prior agreement of this nature
o Enhance relationship between client and microfinance institutions
o Minimize delinquency
5. Meeting requirements, not all methodologies require meetings but where they are
required, they are organized to discuss businesses, collect payments or hold educational
seminars
6. Repeat loans help
o Minimized default
o Build client credit history
Question: what is the difference between repeat loans and STEPPED loans?
TEST YOURSELF- answer Yes or No.
Do these actions constitute appropriate product or methodology?
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1. MFI accepts a bicycle as collateral, even though it is not considered legal collateral
under the banking law.
2. There is frequent contact between a loan offer and the client, whether the client
comes to the microfinance institution branch or loan officer visits the client or
group
3. The assessment of repayment capacity is based on all household income stream
4. A group’s compulsory savings is used by the groups to cover one member’s default.
5. MFI does not verify loan use by the client
6. Members of solidarity group are selected by the MFI.
7. Additional loans in larger amounts are available to clients who repay on time.
SUMMARY: PRODUCT AND METHODOLOGY
To be effective, product and methodology must:
Meet client requirement
Be acceptable within culture and environment
Have sufficient low costs and risk so that MFI can continue to be financially viable and
continue to reach the poor.
C.EFFECTIVE METHODOLOGIES
Effective methodologies are designed for two main purposes
1. Enhance the value of the product to the client
2. Minimize risk to lender
Effective methodology can be seen as a building block of the credit side versus the saving
side of an MFI
Product quality is measured by:
 Customer satisfaction
 Low MFI cost
Efficient methodologies should provide.
1. ENHANCING VALUE
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1. There are a number of ways MFIs cut cost to enhance product value. Key factors are:
 Distance
 Population density
 Convenience
The closer MFI is to relatively large base of potential customers, the most customers
it should be able to serve at lower cost. Convenience is particularly important for client
who illiterate or poor or find it difficult to travel.
2.MFI’s also reduces expenses by minimizing transaction costs e.g. cost of travel,
obtaining legal documents, attending meetings increase total cost to the clients and do
not benefit MFI,
so, they must be kept low as possible so as to enhance the value of the product to the
customer.
3. Staff efficiency and productivity as in any business also minimize cost.
4. Standardized procedures and paper work throughout the entire operation will
streamline operations and reduce administrative and personal cost
5. Borrower groups can also decrease cost because screening, monitoring, and other
administrative cost can be shifted from the MFI to the group. E.g. the loan officer may
not deal with individual group members, instead the group treasurer may take the
groups entire repayment to the MFIs branch.
TEST YOURSELF
Which actions enhance value?
1. An MFI’s branch office is located in a busy market place where many customers
conduct business
2. MFI branches send cost and income data to the headquarters and receive financial
report a month later.
3. A group’s treasurer collects installment payment before meeting with loan officer.
4. In an area where there are no banking services, a mobile MFI visits a community
one day each week.
5. The total time from loan application to disbursement is 45 days
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6. Loan application must be notarized by the town council and financial statements
must be approved by an accountant.
7. Repeat borrowers with an on-time repayment history make only one visit to the MFI
to secure another loan
8. Loan officers visit clients on an established route
9. All MFI branches use the same financial reporting format.
CLIENT RETENTION VERSUS CREDIT RISK
When client find the services of MFI valuable, they would respond by referring
families and friends and they are more likely to repay full cost interest rates, repay
loans on time and continue using the MFI services. These market tests are reliable
indicators of an MFI’s products.
Sometimes client stop using services. This is known as DROP OUT RATE or conversely
when client continue to use the services this is known as CLIENT RETENTION RATE.
A low client retention rate indicates or shows dissatisfaction of MFIs services. However,
the MFI should also assess to keep the customer; the customer may not be a good credit
risk.
There are different reasons for drop out such as:
o Limited loan size
o Lack of time to manage groups’ loan
o High opportunity cost
o Finding better services
o No need to borrow
o Personal reasons may come into play such as leaving an area
o An effective methodology will minimize risk to the lender. Credit is based on
risk and that risk is based on some future behavior and the future is uncertain.
There are several ways an MFI can reduce risk, these are
 Screening out people who cannot or will not repay based on viability of the
business, character references or in the case of group lending, an assessment of
the borrower themselves.
 Tracking transactions- Use of accurate and timely procedures for tracking
information and transaction enable the MFI to control cost and manage
information on income and later payment. So that steps can be taken
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immediately for default. The longer is in arrears the less likely it would be
repaid.
 Client contact establishes trust- Understanding of procedures encourages client
to repay and allows the loan officer to become familiar with client business and
economic situation. The less frequent the contact especially with first time
borrower the more likely on time repayment will suffer for a number of reasons.
 By creating incentives to motivate repayment- Motivating rather than penalizing
has proven a better way to encourage repayment. From the borrower’s
perspective, benefit of on timely repayment and cost late repayment far outreach
far outweighs the benefit of late repayment and cost of on time repayment.
 Delinquency policy- A good methodology prevents delinquency. Preventing
delinquency is more important and less expensive than managing delinquency.
Effective MFIs don’t wait for delinquency problems to occur; they establish
measures to prevent them. At the outset, successful MFIs established a
reputation that they do not tolerate delinquency and are tough on defaulters. The
methodology, the staff, the system and the philosophy of the organization must
support this stance.
TEST YOURSELF
Which actions reduce risk?
1. Only people who have been in business for at least a year are eligible for loans from
this MFI.
2. The microfinance institution calculates the loan amount based on the customer
existing repayment capacity and not the income that is expected to be generated
from the loan.
3. The solidarity group is allowed to include family members who live in the same
household.
4. The first loan from an MFI is smaller than the client wants. Within two successive
loans the borrower is eligible to for the amount she wants.
5. A loan officer accepts payment from two members of a five-man solidarity group
(by doing this, the guaranteed mechanism has been broken)
6. First time borrowers are visited more frequently even though the payment
installment may not be due at the time of visit.
7. Loan officers make daily reports on loan payments made as well as those that are
due but not paid.
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8. An MFI reviews its accounts and financial reports on a monthly basis, and then
determines which borrowers are delinquent.
9. For all borrowers who repay on time, the MFI offers a small percentage rebate on
the application fees.
10.For each on time payment, the borrowers earn a ticket to win a prize. The winning
ticket is drawn at the end of every quarter.
11.MFI tells all clients before they borrow that a list of delinquent borrowers is posted
on the wall of the branch office (note: the social cost of borrowing)
12.It is common knowledge in this community that late payments are acceptable as
long as the payment is made by the date the last installment is due.
13.MFI repossessed several pieces of equipment that defaulting customers purchased
on credit.
14.An MFI is closely associated with the charity work of the parent NonGovernmental Organization (NGO)
SUMMARY: Effective methodologies
o Enhancing value to the customer
o Minimize risk to the lender.
QUESTION
Outline/explain five ways each by which successful MFIs can
1. Enhance value to the customer
2. Minimize risk to the lender.
D.COMPARISON OF METHODOLOGIES
There are two primary types of lending methodologies
1. Individual lending
2. Group lending
o Solidarity group lending
o Village Banking
o Branch Banking through groups; example Grameen style lending
INDIVIDUAL LENDING
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Features of individual lending
 Individual lending is usually used for working capital or fixed asset purchase
 They vary in loan sizes and terms and repayment interval because they are tailored
to fit each individual needs.
 Approval based on conventional 3Cs of lending, but in different order of priority;
Character, Capacity to repay, non-traditional collateral
 Individual liability
 Quick access to repeat loans in large amount depends on repayment
 Stepped lending
It is sometimes used for big loans (lending); business plans and viability analysis are
necessary in this case
GROUP LENDING
i.
SOLIDARITY GROUP LENDING
Features:
 Small loan size with short terms 1-12months
 Stepped lending (gradual loan size)
 Frequent repayment intervals
 Self-selected groups of 3-10 micro enterprises
 Collective guarantee of repayment
-Group liability (the default cause others to lose access to repeat loan)
-Joint and Several liability (each group member is liable for the default of
each group member)
ii.
 Quick access
 Approval is based on group assessment simple application, visit to the work
place
 No collateral, no co-signers
 Payment by one group member
 Subsequent loans depend on repayment by all members
 Group responsible for follow up with delinquent borrowers
VILLAGE BANKING (This is a sort of self-help group)
 Small loan size with short terms 3-9 months
 Frequent repayment intervals
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Financial intermediary
30-90 individuals
Capital lent to bank (village) which lends to members
Collective guarantee of repayment.
Group approves, disburses, collects repayment, follows up on delinquencies and
maintains records
Compulsory savings
Subsequent loans depend on repayment by by all members
Attendance at meeting required
Members developed by laws
Can capitalize and become autonomous.
NOTE: The role of outside agencies reduce as the capacity of village bank grows
iii.
BRANCH BANK: Grameen style Banking
 Small loan size less than one year term
 Weekly repayment intervals
 Self-selected groups of 5 members
 Five groups to a center
 Training required in weekly meetings
 Compulsory savings throughout memberships
 Loans provided on a staggered basis
 Branch banking methodology
 A bank worker disburses loan and collects savings and repayment
 Collective center guarantee
 Repeat loan dependent on repayment
E. TAILORING DELIVERY
Each methodology operates on the principles of microfinance, but the application of these
principles varies depending on how MFI structures each product and service to best serve
its customers.
When methodology is well adapted, the financial institution is likely to survive and
become financially viable, and serve the poor.
Methodology is the foundation on which sound institutions can build.
o Governance
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o Management systems must
o Human resources
o Product and services
Note: All must be oriented toward the goals of financial viability and serving the poor
FINANCIAL VIABILITY AND SERVING THE POOR
GOVERNANCE
HUMAN RESOURCES
MANAGEMENT INFORMATION SYSTEM
PRODUCT&SERVICES
METHODOLOGY
REVIEW QUESTIONS
Read the following two scenarios describing different lending operations and credit
methodologies. How might these be streamlined and adapted to clients’ demand?
1. Loan approval in a rural savings and credit cooperative: is operated by locally hired
staff in a remote village in your country. In order to keep costs low, financial
expertise resides in a loan approval committee, composed of banking and financial
experts from some of the larger market towns in the region. Members can apply for
a loan during the normal operating hours of the cooperative’s office, from9am to
11am everyday Monday through Friday. The loan committee meets every two
weeks for loan application review, and decides which applications to pursue in onsite visits. One of the committee members then visits the applicant in her place of
business and collects and confirms all financial data. Any loans destined for
29
committee approval are then presented at the next meeting. Disbursement follows
immediately through the local loan officer. The entire process from the time of the
borrower’s initial application to the loan disbursement takes six (6) weeks
2. Multipurpose NGO solidarity loan programmed: a multipurpose NGO running a
women’s health programmed through local dispensaries in villages throughout a
mountainous region of your country and has decided to add a microcredit
programmed to its current activities. The NGO reasons that financing
entrepreneurial women in their various income generating activities will support its
goals of increasing women’s wellbeing. Moreover, the solidarity lending
methodology appears to boost social cohesion among its women clients. The
solidarity loan that it offers requires that borrowers form groups of 10 women. In
order to reduce social strain, the women must all take the same size loan. As the
loans are given out to support small income generating activities suitable in a rural
environment, all loans are made for working capital for pig breeding. Group
members must pay installments every two weeks, and also attend training sessions
on health. These usually last about 3 hours and takes place at the local dispensary.
Subsequent loans are tied to 10% stepped increases.
3. You are a single mother, raising three children who attend a local primary school:
your household also includes your elderly mother and a brother who is presently
out of work. You work as a seamstress from your home, as your main economic
activity, allowing you to care for your mother and watch over the children when
they come home from school. You supplement the household income by raising
chickens and growing some vegetables in a small plot behind your dwelling. The
eldest daughter you weave rugs from wool that you buy every month when you
visit your extended family in a rural village a couple of hours away by bus.
Below are three various methodologies of MFIs operating in the neighbourhood
where you live and work. Whose services would you prefer? What do you like
most/least about each methodology?
o A local state-owned bank has opened a microfinance window in its
operations. It offers small, individual loans for specific investment
opportunities. The loan requires collateral. The collateral is non- traditional,
and the bank credit explains to you that it could be, for example the wedding
necklace inherited from your mother. You would have to state the purpose
of the loan on the application, which the bank verifies after disbursement.
Loans are approved and disbursements are made on an ongoing basis. If you
invest your loan as stated and repay on time, you are eligible for larger loans
for the same productive investment. The bank also offers savings services.
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o The local village bank offers small loans to his members. This requires that
you deposit a percentage of your loan amount with the bank before
borrowing. Each subsequent payment must also be accompanied by small
savings contributions. The loan can be used for any purpose. The bank
disburses every two weeks. You are also required to attend weekly meetings
during which members repay their loans and receive financial planning
advice. You must join the village bank by paying a small membership fee.
o An NGO in your neighborhood offers solidarity group loans. As part of its
general poverty reduction scheme, the NGO targets the poorer clients by
performing a wealth ranking of all potential applicants. It subsequently only
lends to those in the lowest quartile of the ranking, and disbursements are
made after weekly committee meetings for loan approval. Loans are made
to individuals in the group, but each borrower guarantees the others’
repayments. Loan increases are stepped according to fixed increases, and
such increases are considered only if the entire group reapplies for a loan.
Model Solutions:
1. This local cooperative is trying to save on costs by not hiring loan officer staff
with appropriate financial skills. This choice has affected its lending
methodology and service to clients. The loan process is lengthy and would not
meet the basic criterion of timeliness in responding to clients’ needs. More than
two (2) months can go between the initial client visit and actual loan
disbursement. While this may meet the needs of clients with more long term
needs, like planned educational expenses or home repair, it would not be
beneficial to clients with more immediate requirements for funds, like taking
advantage of market opportunities. Even if the cooperative could not afford
more skilled staff, it could make some changes to approve efficiency such as
devolving appropriate levels of decision making on loans. This may include
allowing the loan officer to disburse repeat loans that do not go beyond a certain
amount for borrowers with a good repayment history without committee
approval. Initial loans of given amounts could also be approved by local staff.
Finally, with minimal appropriate training, the loan officer could collect the
necessary data at an on-site visit to the entrepreneur, avoiding the credit
committee high degree of involvement in operations. This would also avoid the
need for two committee meetings in approving the loan.
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2. The multipurpose NGO has designed a financial product that fits its own needs
and objectives more so than those of the borrowers. Tying loans to a given
purpose, especially if significant verification is performed by the lending
institution, can create a costly burden for the institution. More importantly, this
does not provide the borrower with enough flexibility to meet the multiple
resource constraints and investment opportunities that she might have.
Requiring that all borrowers take the same loan size, again, molds the
borrowers’ activities to fit the needs of the institution. A better practice would
be for the institution to design a financial product that fits the borrowers’
requirements for credit. If the loan amounts are too small, this constraint might
encourage women borrowers to seek out other microfinance operations or
moneylenders, leading to over-indebtedness. The fixed step increase in the size
of loans, likewise, does not properly account for the changing financial needs
of the borrower. Lastly, making loans contingent on training is an added cost to
the borrower. The health training represents substantial time away from work,
an added transaction cost to these financial services. As the training is not
offered in a place convenient to the women, these transaction costs increase.
The multipurpose NGO would be better to separate the credit programmed from
its other activities and free the financial services from the training. More flexible
loans would better meet customers’ needs.
3. Answers will vary, but they should address, at minimum, the following factors:
o Flexibility of the purpose of the loan
o Timeliness of the loan disbursement
o On- going access to additional loans for larger amounts
o Flexible loan size and terms
o Cost to client: financial costs and non-financial costs
o Convenience for the initial application and installment payments
o Loan approval: the length of time and the required procedures and
paperwork
o Social cohesion: the extent to which the individual is dependent on the
behavior of the group
o Savings: mandatory savings requirements increase the cost of the loan, as
well as the availability of voluntary savings facilities
EFFECT OF THE LOCAL ENVIRONMENT
1. Self-assessment
2. Economic/Social Environment
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3. Regulation and Supervision
4. Self-assessment revisited
1. SELF ASSESSMENT
The effect of both economic and social policy environment and regulations all have
effect on MFIs.
Students should check out the following scenarios and answer the question: after.
Country A
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Moderate level of inflation
Highly regulated financial sector
MFI regulatory framework is based on 10 years’ experience
Robust market and cash economy
Q: Is this an enabling environment for sustainable microfinance?
Country B
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Economic and political stability
Low employment
Widespread formal banking sector with deep outreach
Strict usury law
Non-banking illegal
Q: Is this an enabling environment for sustainable microfinance?
Country C: - An African country
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Poverty and illiteracy are widespread
Sparsely populated
Political stability
Strict regulation of commercial banks
No regulation of MFIs – the government has adopted a wait and sees approach
concerning MFIs, provided savings is not mobilized from the public.
Q: Is this an enabling environment for sustainable microfinance?
Country D
An Asian country
 Where government has just passed several laws government all MFIs to be
registered as operatives
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 There is an interest rate cap on smallest loan.
 Inflation decreasing to moderate levels
Q: Is this an enabling environment for sustainable MF.
MFI services can be successfully delivered in a wide range of policy and economic
environments. Studies of successful MFIs have shown that they can survive, grow and
prosper in very different environment and at very different regions of the world. However,
there are certain factors that affect the viability of MFIs viz:
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.
i.
INFLATION
INTEREST RATE
ECONOMIC STABILITY
POVERTY LEVELS, MARKETS AND CASH ECONOMY
POLITICAL UNREST.
POPULATION DENSITY
LITERACY AMONG THE POPULATION
LEGAL FRAMEWORK
ATTITUDES TOWARDS INTEREST
INFLATION: Some degree of inflation is present in every economy and must
be considered in designing and pricing savings and credit products.
Inflation results in real cost to both clients and MFIs; the cost of inflation must therefore
be covered by the interest charged on loans otherwise capital will soon be eroded
Also, many MFIs borrow money in currencies other than their own. Funds borrowed in
other currencies are subject to the inflation of that currency.
If inflation is too high, clients will not be motivated to open and maintain savings accounts
and may hold their savings as assets other than cash e.g. inventory, animals or gold since
these may not lose value with inflation. This does not mean an MFI cannot succeed during
inflationary period.
These strategies may be employed to counter inflation.
STRATEGY 1
Provided that the inflation is not fluctuating widely, interest rate can be adjusted to
accommodate inflationary rate.
34
STRATEGY 2
If the inflationary rate is high and fluctuating, interest rate can be pegged to an inflation
index rather than fixed to the period of the loan.
STRATEGY 3
Make loans in more stable currency
STRATEGY 4
Loan terms can be short and capital can be re-lent at adjusted rates.
ii.
INTEREST RATE
Interest rate ceiling or strict usury laws undermine sustainable microfinance.
Administering small loans usually comes with a high cost, so that this particular
environmental factor will not allow cost to be covered. In order to cover costs, MFIs
charge high interest rates than convention banks. Interest rate ceilings rarely achieve the
purpose for which they are intended or even protect the poor as often argued. MFIs still
provide the only means by which the poor can get loans.
These two factors inflation and interest rate ceiling are two key factors that will influence
an MFI’s success of reaching sustainability.
In fact, an analysis of top performing MFIs found that the only macro economic
conditions that were really prohibitive for MFIs are
(1) Hyper inflation
(2) Rigorously enforced interest rate controls
In other words, an MFI is more likely to succeed if inflation is under control and
interest rates are unrestricted.
Even if inflation rate continues to rise and interest rates remain stable, the interest rate
charge will not cover cost as the rising inflation will likely erode capital- the two are
related
iii.
ECONOMIC STABILITY
This is another factor that provides an enabling environment for microfinance to
succeed.
(1) A country must have some level of commerce with people operating in a economy
35
(2) A relatively non-volatile economic base
(3) And some future growth prospect for the microfinance to succeed
Commerce or economic activity is necessary because when the economy grows, so
does the demand for financial services. Even, stagnant economies can become
potential markets for microfinance services, because if unemployment increases,
more people may engage in micro or small enterprises.
A volatile economy affects the risks and consequently the choices of financial
institutions and micro enterprises. In general, the stability of financial and other
markets makes small enterprises and microfinance services more viable.
iv.
POVERTY LEVELS, MARKETS AND CASH ECONOMY.
The demand for MF services will also depend on the degree of poverty in a country
or region. The balance between subsistence and cash economies, markets where
goods can be bought and sold, access to markets through transportation and
communication infrastructure and the level of cash economy must be adequate for
economic activity to be able to develop.
v.
POLITICAL UNREST.
MFIs can be threatened if conflict and political unrest develops in a country and existing
systems and social networks breakdown. During people of service unrest, MFI activities
may decrease or cease altogether especially if there is a concern for safety of staff and
clients. Microfinance is particular vulnerable because it is a cash based business.
vi.
POPULATION DENSITY.
MFIs can work in both urban and rural areas. Outside major cities microfinance is easier
to deliver in areas with moderate to high population density and adequate transportation,
communication and infrastructure.
In many cases, it makes sense to establish services in major populated centers and
gradually push them out to smaller market towns and rural areas. However, MFIs can
even in sparsely populated areas, if they find creative ways to take advantage of times and
places were come together.
vii.
LITERACY AMONG THE POPULATION
This can promote the viability of an MFI. On the other hand, in many countries MFIs
have successfully reached people who have limited literacy skills
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viii.
LEGAL FRAMEWORK
A legal framework for enforcing repayment is helpful though not essential to the success
of an MFI. Well defined property rights and good contract law help minimize the cost of
legal proceedings particularly for individual micro lending operations. In many cases,
legal recourse is valuable as a credible threat, even if not employed by the MFI.
ix.
ATTITUDES TOWARDS INTEREST
Some countries have negative cultural, political or religious attitudes to charging or
paying sustainable interest rates. Such attitudes can be overcome even though it is a
challenge.
MFIs that demonstrate the value of their services to the poor and maintain efficient
operations have been able to advocate for usury law revisions law and overcome such
negative attitudes.
Q. Which one of the following presents a most favorable condition for MFI services?
Note: Only one is correct
Case 1
-High literacy
-Dense population
-Strict interest rate ceiling
-Moderate inflation
Case 2
- Tight usury laws
-High poverty levels
-Sparse population
-Political unrest
Case 3
- Negative attitude towards interest
-Favorable legal framework
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- Hyper inflation
Case 4
- Stagnant economy
-High levels of poverty
-Low literacy
-Moderate inflation.
Case four (4) is the only one that does not contain the two macro-economic factors that
are prohibitive to the success of MFIs –hyper inflation and interest.
REGULATION AND SUPERVISION
Just as environmental factors play a significant role in determining an MFIs success, so
also does the degree of financial regulation and supervision a government requires.
FINANCIAL REGULATIONS: Consist of the principles, rules, standards and
compliance procedures that apply to financial institutions.
FINANCIAL SUPERVISION: Involves the examination and monitoring of
organizations for compliance with financial regulations.
Prudential regulations and supervision are the constraints placed on actions of the
financial intermediaries to ensure the safety and soundness of the financial system. They
are designed to:
1. Avoid a banking crisis by maintaining integrity of the payments system
2. Protect depositors
3. Encourage financial sector competition and efficiency.
Most analysts agree that it is not necessary to regulate organization that lend, but don’t
savings. There are good reasons why savings institutions should be regulated.
If a lending organization fails, it does harm its clients other than by discontinuing
services, it does pose a threat to the financial system. A variety or types of institutions
including associations, foundations and cooperatives can safely be permitted to lend.
On the other hand, the failure of an institution that takes deposits or mobilizes savings
38
harms its depositors. Failure may also damage other institutions by undermining public
confidence in the financial system.
It is also risky to set up regulations that broaden the range of institutions that are
allowed to take savings from the public if a capable, local or government supervisory
structure for those institutions are lacking.
Although, the degree of financial regulation and supervision differs from country to
country, almost all government applies regulation to certain types of institutions.
Q. Which types of institution do you think should be regulated by the central
bank?
A. Community savings and loans
 Member-owned
 Isolated rural area
 Credit services for members
 Savings services for members
 Typical loan client-member
B. Non-Governmental Organizations (NGO)
 Non-government owned and operated
 Urban area
 Credit services for public
 No voluntary savings services
 Required compulsory savings
 Typically loan client: local micro entrepreneur
C. Commercial Bank
 Privately owned
 Urban area
 Credit services for public
 Typical loan client: large business
D. Post office
39
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Publicly owned
Rural and urban areas
No credit services
Savings services for the public
Typical savings client: anyone
NOTE
The last two should be subjected to prudential regulation and supervision because they
both mobilize savings from the public and failure may pose a threat to the financial
system.
The financial authority vouches for the soundness of the regulated to institution and is
responsible for closing it if it does not meet certain standards of performance.
The small community savings and loan are typically not subjected to regulation as they
mobilize savings from members only and the members act as de facto supervisors
NGOs are rarely subject to regulation because they do not mobilize voluntary savivgs and
are no threat to the financial system. Forced savings are quite different from voluntary
savings as they are perceived as fees for collateral borrowed funds and treated differently
by regulations.
Existing regulations governing commercial banks or conventional regulations are rarely
well suited for MFIs as MFIs differ in structure, ownership, and client base, intent etc
The largest single difference between the two actually is that micro loans are generally
unsecured.
Future: The future of MF lies in service provision by licensed financial intermediaries
that can attract private capital. However, regulatory framework developed for the
conventional banking industry are generally ill-suited to MF, but because the concept of
MF is new to many countries, government, donors and advocates often attempt to apply
a regulatory framework quickly.
This rush to regulate, to promote or control the industry may be premature.
QUESTIONS:
1. Why is it premature to implement regulations quickly?
-Rushing to regulate MFIs may actually limit their potential by not allowing them
to develop experience within the context. Regulations that are developed too soon
40
may not anticipate how MFIs will evolve. Mistakes are made by allowing only one
type of MFI to evolve such as co-operatives or nonprofit institutions. Controlling
organizational from limits the variety of institutions offering the services and
possibly the number of people who have access
2. What is wrong with encouraging the orderly development of MF?
-When governments create regulations for orderly development, they risk imposing
too much control. If an institution can experiment with products and services to
find out the needs of clients, they are likely to succeed.
Even like regulations can create bottlenecks especially if supervisory capacity is in
short supply.
3. Are there benefits to regulating micro credit operations such as applying
performance standards to improve quality?
-The benefits of regulating MF institutions are likely to outweigh potential
disadvantages e.g. many potentially successful institutions may be discouraging
from entering the market if there are arbitrary performance measures that must be
met.
4. Is there situation in which regulations may need to be implemented quickly?
Urgent legal changes may be needed in situations where current regulations
prohibit microfinance from starting. This has been the case in previously socialist
counties.
5. What is the best approach to regulating MFIs?
At the early stages of developing MF industry, the best policy is to permit
regulations to operate by using existing legal framework and allow some
experimentation in order to push the framework.
Whether a country decides to establish a special license for MFI, certain banking
regulations will have to be changed to accommodate MF methodologies.
TEST YOURSELF: Take a look at these specific regulations for conventional
financial institutions and discuss why they are usually inappropriate for MFIs some
will prohibits MFIs from operating while some are restrictive in that they will
restrict optimal operations.
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1. Interest rates on loan amounts- Under the average per capita GNP are limited to
an interest rate charge of 4% per year.
2. No person who has signed as a guarantor for someone’s loan is allowed to
borrow for the duration, he/she is serving as a guarantor.
3. The commercial bank must set aside a loan loss reserve of 100% for all
unsecured
loans with Central Bank. That is loans that are not backed by a property title.
REVIEW QUESTIONS:
1. Sketch a portrait of the environmental factors affecting MFI operations in your
local environmental
2. Capital Opportunities for All is an unregulated MFI that has achieved operational
self-sufficiency. It operates in a country where interest rate ceilings have been
established at an annual percentage rate of 15%. As the local Government struggles
to maintain the current level of government spending despite significant shortfalls
in income, the inflation rate has risen over the past one year from 15% to 18%.
Economists forecast continued inflationary pressures over the next few years. As
the Financial Director of Capital Opportunities for All, you are asked what you
expect some of the effects on portfolio growth and financial viability will be when
considering the local environment.
3. What kinds of factors might affect attitudes towards charging sustainable interest
rates in your local environment? How can an MFI overcome negative attitudes
towards such rates? Construct an argument to discuss with someone who holds
such attitudes in your own country.
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