EconSouth (Second Quarter 2003)
A Little Credit Goes a Long Way: The Global Microfinance Movement
A proverb says that ready money works great cures. Unfortunately, many of the worlds citizens have little or no ready money to cure the ills of living in poverty. But a decades-old movement that makes credit available to low-income families and businesses is gaining momentum worldwide, offering millions of people hope for greater financial security.
f its true that a little credit goes a long way, then Lucila Mendoza Moisin of Otava, Ecuador, is living proof of the adage. Through access to small loans, known as microcredit, Moisin was able to start her own crafts business, which provides a relatively steady income for her family and enabled her to buy a small house. Moisin and millions of people just like her have launched or are working in small businesses made possible by small loans and other financial services that were previously unavailable to them. They are benefiting from a global movement known as microfinance.
Microfinance is commonly defined as the provision of a broad range of financial services including loans, savings deposits, payment services, money transfers and insurance to low-income households and their respective microenterprises. Microenterprises are more difficult to define because the term covers such a wide range of business types. However, in general, microenterprises have the following characteristics: They are run by their owners, they depend on family labor, they employ fewer than 10 workers, and they have limited access to formal financial services.
Recipients of microfinance services are typically struggling entrepreneurs who lack much-needed access to credit. Recipients may also include people who have lost their jobs as a result of a weak economy as well as underemployed workers earning extremely low pay. In the short term, access to microfinance services can help individuals increase their income, smooth consumption, build small enterprises and reduce their vulnerability to economic shocks. In the long term, microfinance aims to break the poverty cycle by contributing to food security, childrens education, investment opportunities, self-empowerment and gender equity.
One hallmark of the microfinance industry is its outreach to women, many of whom otherwise would not have an opportunity for fiscal independence. Especially in some developing countries, women are traditionally excluded from commerce and have limited access to most financial services. Approximately half of all microfinance clients worldwide are women, with many programs targeting them exclusively.
But microcredit is not a handout. It constitutes a loan, bound with the expectation of repayment of both principal and interest, which is often well above market rates because of high transaction costs. Several studies show that clients willingly, and successfully, pay the higher interest rates necessary to ensure long-term access to credit.
Currently, thousands of institutions commonly referred to as microfinance institutions (MFIs) exist to provide loans and other financial services to the worlds poor and their microenterprises. Just as people such as Moisin benefit from greater access to financial services, MFIs benefit from being able to draw on a vast pool of underserved potential clients, who in the majority of cases have proved creditworthy, with average repayment rates higher than 90 percent.
As an industry, microfinance has grown remarkably. From its origins in the 1950s when its roots were based in agricultural development microfinance has broadened its range of services and in many cases has grown into a profitable, self-sustaining industry.
The evolution of microfinance
In the early development of microfinance, state-run Rural Development Institutions (RDIs) in the developing world provided small loans at highly subsidized terms to farmers to enable them to slowly increase their assets and build their small businesses. These programs had mixed success. Although farm production improved, loan repayment rates were extremely low.
From these experiences of early RDIs, microlending programs learned to focus on greater institutional sustainability and emphasized achieving high loan repayment rates. Nongovernmental organizations (NGOs) then dominated the landscape, and the concept of microlending began to broaden, encompassing other industry sectors, including simple manufacturing and trade.
Grameen Bank in Bangladesh emerged as a leader in this new environment. Grameens microlending program was one of the first to provide very small loans of roughly $50 to $100 to the countrys poor to build microenterprises. Nearly 95 percent of Grameen Banks clients are women. On average, Grameen Bank has reported a recovery rate of 98 percent, which matches traditional banks recovery rate. By the mid-1980s, other programs began to notice Grameen Banks success. Microlending programs started emerging all over the world, including in developed countries such as the United States, Britain and Canada (see the sidebar).
The success of microlending programs eventually led to an institutional structure for microfinance. Microfinance also expanded financial services available to the poor. Most notable has been the growing presence of formal, regulated MFIs. Some of these formalized institutions have transformed from NGOs into regulated institutions. Others include already formal credit unions, consumer finance companies and private commercial banks, all of which have a small portion of their assets devoted to financial services for the poor.
At the most basic level, formalized MFIs emerged as a result of rapid growth and the need to finance that growth. A regulated, commercial environment has afforded these institutions greater credibility, freed them from the constraints of donor funding and allowed them to pursue a range of other viable financial services. In most cases, microcredit NGOs are not allowed to accept savings deposits from the general public and are restricted to offering only limited savings services to their own borrowers. Regulated MFIs enjoy greater flexibility in administering a wide range of financial services, including credit, savings and insurance. Despite the growing presence of formalized MFIs, informal NGOs still predominate. NGOs receive the majority of their funding from multilateral institutions, such as the World Bank and the United Nations Development Program, bilateral institutions such as aid agencies of donor countries, and individual governments.
The current microfinance landscape
The World Bank estimates that more than 7,000 MFIs exist worldwide, serving more than 16 million people in developing countries. MFIs are widely spread across the globe; a particularly high concentration of MFIs exist in Latin America. Statistics from the International Food Policy Research Institute support this picture. For example, in 1999 Latin America had the greatest concentration of microfinance clients as a percentage of population at 1.6 percent, followed by 1.5 percent for Asia and 1.0 percent for Africa.
The Inter-American Development Bank (IDB) estimates that Latin America has more than 65 million microentrepreneurs, who collectively employ more than 100 million people. This pool represents an enormous potential market for microfinance services. Although the level of market penetration is limited at this point, the growth in microfinance in Latin America has been astoundingly rapid. According to MicroRate, a leading microfinance tracker, from 1998 to 2001 leading Latin American MFIs expanded their loan portfolios by an average of 32 percent, even amid regional instability and banking crises (see the sidebar).
The move toward commercialization. The tremendous growth in microfinance has spurred and reflected a rapid movement toward formalization and commercialization unmatched in any other region of the world. In terms of loan volume, formalized MFIs now dominate in Latin America. In 2001, formalized financial institutions provided 76 percent of the microloans to borrowers in Latin America. In addition, regulated MFIs have achieved much greater leverage as expressed in their debt-to-equity ratios than their nonregulated peers.
Perhaps the most pronounced example of the transformation from a nonregulated to a regulated MFI is Bolivias BancoSol. Bolivia has long been the most concentrated microfinance market in the Western Hemisphere. BancoSol emerged from a not-for-profit organization and received a full banking license in 1992. It now operates as a licensed commercial bank subject to the supervision of Bolivias banking authorities. One of Latin Americas leading MFIs, BancoSol possessed a gross loan portfolio in 2001 of U.S.$81 million serving 61,368 clients (see the table).
Still, the overwhelming majority of MFIs in Latin America remain unregulated NGOs. These NGOs remain dependent on donor funding and focus on small market niches that large formalized institutions are less interested in or are less able to penetrate.
Benefits. The shift toward commercialization has produced some favorable outcomes for Latin American MFIs and their clients. In particular, loan products and other financial services have become more diversified. Traditionally, microfinance NGOs in Latin America implemented group-lending techniques because a peer dynamic acted as a suitable proxy for collateral. These lending methods included solidarity group lending and village banking, in which group members provide a mutual guarantee of loan repayment. While many MFIs, including BancoSol, remain committed to group lending, individual lending is accounting for an ever-greater proportion of the market. Greater institutional scale has provided MFIs increased means and resources to handle individual transaction costs and creditworthiness issues, enabling MFIs to respond to clients preferences for individual loans.
Meanwhile, the push toward formalization has also increased Latin American MFIs capabilities in providing other financial services, such as savings. Savings are desirable for several reasons. Savings provide a relatively stable source of funds to MFIs, enabling them to become financially self-sufficient. In addition, savings services provide low-income clients with both a safe place for funds and increased liquidity, allowing them to better manage their day-to-day lives. Savings services can help smooth out income for low-income individuals who face special circumstances, including life-cycle events such as festivals and marriages, and emergencies such as floods and drought. Savings services also enable low-income individuals to take advantage of business investment opportunities and can provide funding for life-enhancing activities such as childrens education and home improvement.
Drawbacks. Unfortunately, formalization of the microfinance industry in Latin America has not always led to positive outcomes. Increased competition has in some cases led to market saturation, predatory lending practices and a shift toward a higher-income clientele. The most salient example of such problems is the Bolivian Borrowers Revolt of 1999. An influx of consumer lending agencies into the Bolivian microfinance market was soon followed by microentrepreneurs becoming overindebted, often juggling several loans at once. Borrowers organized into large groups demanding debt forgiveness.
Since that time, increasing evidence shows that Bolivian MFIs are shifting their focus toward a higher-income market. This example illustrates how market saturation, coupled with a shift to more profitable markets, can lead MFIs to drift away from serving the poor the very clientele MFIs evolved to serve.
|Leading Regulated and Nonregulated MFIs in Latin America|
|Caja los Andes||Bolivia||$52.6||7.3||43,530|
|Caja Municipal Arequipa||Peru||$50.0||6.5||50,209|
|Source: Table (The MicroRate 29: December 31, 2001) from The Finance of Microfinance, MicroRate, October 2002|
Assessing impact and future direction
This development brings up an obvious question. What impact has microfinance had on the poor? Most efforts to evaluate microfinance have been geared toward monitoring the financial performance of MFIs in accordance with best practices lending techniques. Understanding the effect of microenterprise development on the worlds poor is largely limited to various case studies of individual programs. These studies findings are generally positive.
For instance, a study of Crédito con Educación Rural (CRECER), a Bolivian MFI, showed that the income of two-thirds of its clients had increased after joining the program, while 86 percent of clients reported increased savings.
Other studies have shown that children of microfinance clients are more likely to go to school and to stay in school longer. Households of microfinance clients appear to have better nutrition, health practices and health outcomes than comparable nonclient households do.
What does the future hold for microfinance and the worlds poor? Microfinance has made great strides in extending much-needed financial services to underserved populations throughout the world. Going forward, MFIs are geared for continued growth in loan portfolios and increased mobilization of savings deposits. MFIs also are moving toward incorporating business development services into their strategy.
Many microfinance practitioners are mindful of potential mission drift. They emphasize the need to balance the institutional approach, focused on industry expansion and financial self-sufficiency, with a community approach, committed to alleviating poverty among the very poor. But even a more balanced approach will face limitations in its outreach, especially in serving the extremely poor.
Microfinance practitioners recognize the risk of pushing these individuals further into debt and poverty with high-interest-rate loans they cannot repay. In spite of the limitations and downside risks, the success of many of these programs cannot be ignored. Microfinance provides a unique opportunity to help many low-income individuals improve their circumstances.
This article was written by analysts Elena Casal and Nicholas Haltom of the Atlanta Feds research department.