Microfinance refers to the provision of basic financial services like credit, savings, insurance and fund transfers to poor and near-poor households which are normally excluded from the formal financial system. It is therefore an important instrument of development policy. “Modern” microfinance was initially developed by and is today still primarily deployed by non-government organizations (NGO) though the importance of commercial banks and credit unions increased.
Principles and Characteristics of Microfinance
Theoretically, microfinance may encompass any efforts to increase access to, or improve the quality of, financial services poor people currently use or could benefit from using. Therefore, there are not many bright lines that enable to sharply distinguish microfinance from similar activities. Furthermore, supporters of “modern” microfinance argue about the restrictions which should be applied to the principles, practices and products of microfinance. Also due to these problems the more recent “inclusive financial system” approach to microfinance takes a pragmatic stance to the immense diversity of institutions serving poor people in the developing world today by e.g. distinguishing between general categories of microfinance providers. These include also informal financial service providers like moneylenders and pawnbrokers and member-owned organizations like self-help groups and financial cooperatives. Though these providers have indeed a non-negligible role in serving the financial needs of the poor this article merely focuses on “modern” microfinance offered by NGOs or formal financial institutions.
Microcredit (or the provision of loans to poor people) has been and continues to be in the centre of microfinance. Hidden information, moral hazard, absence of credit history, and lack of collateral are the most important challenges associated with lending to the poor which microfinance tries to address with specifically suited instruments and methods.
Methods which are generally associated with microfinance include group lending and liability, pre-loan or forced savings requirements, gradually increasing loan sizes, (an almost) exclusive focus on women as borrowers and credit for income generating activities, as well as an implicit guarantee of ready access to future loans if present loans are repaid fully and promptly. The best known savings institution which embraces most of these methods is the Grameen Bank in Bangladesh. Though many providers still adhere to these methods of microfinance, individual lending, voluntary savings, lending to men and for consumption needs is made available on an increasing scale. However, the aforementioned methods address the primary problem with lending to the poor – banks’ lack of information about the inherent riskiness of potential clients – probably best.
Perhaps the most important of the microfinance innovations is lending to solidarity groups. The original Grameen model required that loans were made to a solidarity group of five women. All members received loans individually though on an equal base and made repayments on the same, fixed schedule. As all individuals in the group were only able to receive future credits if entire group’s debt was repaid, each participant borrower was, in effect, responsible for the debt of others.
The reason why women are the primary focus of service delivery is based in the evidence showing that they are less likely to default on their loans than men. Also the restriction of loans for productive purposes aims to reduce the likelihood of defaults.
The main objective of forced savings is the belief that a process of small, regular payments will contribute to repayment performance. Many of these programs lock in the savings, restrict opportunities to withdraw them, and utilize them as collateral substitutes. These programs perceive savings as an integral part of credit; savers learn financial discipline and qualify for credit by a convincing savings record. However, several microfinance institutions have discovered that offering other, voluntary savings products enables them to become self sufficient and thus independent of donor money. Unfortunately, legal structures and donor practices often do not allow voluntary savings services to develop fully.
The regulation of microfinance institutions is still a contested issue and handled differently from country to country. Microfinance organizations have started to make the transition from unregulated NGOs to regulated financial institutions. However, with the increasing pace of inclusion of microfinance institutions among the ranks of regulated financial institutions, issues and problems associated with financial regulations have taken on greater urgency.
Microfinance institutions fund with money from donor agencies or government, with deposits of their customers, and/or outside credit lines. According to the MicroBanking Bulletin deposits (45 per cent) provided as much total funding as borrowings (45 per cent), whereby development organizations provided most of the latter (over 40 per cent) at a global level in 2007. In 2006, microfinance institutions were serving 52 million borrowers ($23.3 billion in outstanding loans) and 56 million savers ($15.4 billion in deposits) according to the Bulletin.
Microfinance for housing is an offspring of the general microfinance approach. In 1984, Grameen Bank introduced housing loans, partly in response to an improvement in members’ income-generating capacities. The aim of the program was to make funds available to members in good standing for building new houses or rehabilitating their old ones. Microfinance for housing approaches the largest problems of poor people wishing to improve or build/acquire their homes: the absence of formal titles and the unattainability of conventional mortgages. Despite the fact that some institutions require that members have legal land ownership to receive housing improvement mortgages are generally not considered suitable (or the best) instruments for housing microfinance. Though dependent on the country under discussion, this is mainly because mortgage laws are often non-existent or weak, the fees associated with taking on mortgages are prohibitive for the clients, and they do not offer significantly added security to the loan as foreclosure procedures are lengthy and difficult. Therefore, standard approaches to collateral and guarantees will suffice in most cases, e.g. alternative forms of collateral, such as co-signers, forced savings, home appliances and other nonmortgage forms of guarantee. Besides this, housing microloan products offer small shorter-term loans and also typically have flexible repayment systems. A precondition to qualifying for housing loans is very often an already demonstrated credit-worthiness. Furthermore, the principle of progressive lending is also regularly applied to housing microfinance; i.e. if the debt is repaid in a timely fashion the borrower will be eligible not only for a new loan, but for a larger loan as well.
However, housing microfinance differs also considerably from the normal microcredit (for productive purposes). Conventional micro loans are generally smaller, with an amortization period of a year or less, and the revenue from the productive activity helps to repay the loan, while housing loans typically involve larger sums repaid over longer amortization periods and the investment may not produce income right (if after all) away. Therefore, group lending is less suited to housing loans than to microenterprise loans so that housing microcredit is preferably granted to individuals. Holding a group collectively liable for all members’ repayments of large sums of money over long spans of time creates higher risks that are less likely to be accepted by either lenders or borrowers. Interest rates with substantially lower rates than available for the normal microcredit are also sometimes used.
Incremental housing microfinance loans – like implied by progressive lending – meet the financial needs of poor people better than conventional mortgage finance as poor households usually improve their homes by building in stages. According to a World Bank study about 70 per cent of investment in microfinance housing has in fact been utilized in such “incremental building”. It has been proposed that, at scale, several successful housing microfinance providers can be a good tool for national governments in solving the shelter and settlement problems.
The impact of microcredit has been studied more than the impact of other forms of microfinance. Empirical studies on the impact of credit are difficult and expensive to conduct and pose special methodological problems. Most impact studies to date have found significant benefits from microcredit. However, only a few studies have made serious efforts to compensate for the methodological challenges. In fact, many studies would not be regarded as meaningful by most professional econometricians. Even so, there is a strong indication from borrowers that microcredit improves their lives. Other microfinance services like savings, insurance, and money transfers have developed more recently, and there is less empirical research on their impact. However, client demand indicates that poor people value such services. Microfinance institutions that offer good voluntary savings services typically attract far more savers than borrowers. Unfortunately, the share of institutions that offer such programs is limited due to restrictions posed by legal structures and donor practices.
Yet, a World Bank study in the year 2003 estimated that in Bangladesh, one of the most well-developed microfinance markets, only 18.4 per cent of the poor were reached; at the other end of the spectrum, microfinance services in Brazil were limited to 0.4 per cent of the poor. Though the rapid growth of microfinance in the last years has changed these figures dramatically (with 35 per cent of the poor reached in Bangladesh and 2 per cent in Brazil), it still remains the critical challenge to make microfinance a sustainable and ubiquitous methodology.
“Scaling up” will require increasing the scope (number of individuals reached), impact (effect on the well-being of borrowers), and depth (ability to reach the poorest of the poor) of microfinance. The idea is to make microfinance available not just to the moderate poor at whom it has traditionally been targeted, but also to the extreme poor and the vulnerable non-poor, and to expand the set of microfinancial products offered. It is also the emerging consensus that for achieving an order of magnitude change in the scale of microfinance will require deposit mobilization. Continued reliance on donor or government funds is both detrimental and unrealistic; yet, these sources of money still play an important role in funding microfinance institutions. This is also due to the fact that the further development of microfinance is often hampered by lacking or inappropriate regulation. Practitioners and academics alike agree that the future for microfinance lies in developing a well-regulated microfinance environment that will allow the poor to access a wide variety of financial services, effectively linking them to the developed sectors of the economy. It is agreed upon that the involvement of mainstream financial institutions in housing microfinance is critical to leverage local capital necessary to scale up and make micro lending sustainable.
Microfinance in times of financial crisis
The exceptional growth microfinance enjoyed a decade long has come to an end due to the crisis. The credit crunch and economic recession are clearly forcing most microfinance institutions to slow down the growth of their microcredit portfolios. However, institutions that depend solely on credit as a source of funding are significantly more negatively affected than those that mobilise savings. Therefore, the drop in portfolio growth can be partly attributed to the increasing liquidity constraints most microfinance institutions (52 per cent in 2008) report. But also the savings-based institutions which by and large do not face liquidity constraints are far from being immune to the effects of the crisis as the loan portfolios of microfinance institutions show greater similarities. The large majority of microfinance institutions reported a considerable increase in Portfolio at Risk, though it is most likely that loan portfolios of those institutions that had started to go up-market are affected most by non-performing loans.
Although microfinance faces challenges as slowing growth and funding opportunities force microfinance institutions to refine their risk management systems, to tackle rising delinquencies, and to actively manage their liquidity this situation in the microfinance market is also an opportunity for the best run institutions to distinguish themselves. Indeed, microfinance is not decoupled from the global economy, but has proven to be utmost resilient in comparison to conventional financial institutions.
Discuss this topic!
(You have to be logged in for direct access to the discussion)
Microfinance for housing - is it able to meet the demand?
Information-Portals and Networks