FAQ's

Dos en don’ts voor microfinance amateurs; een lijst met vragen en aantworden over microfinanciering

 

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In Dutch

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In English

 /Documents/faqs microfinance en.doc 

 

1.1 What is microfinance and why microfinance?

Microfinance is the supply of loans, savings, and other basic financial services to the poor. People living in poverty, like everyone else, need a diverse range of financial instruments to run their businesses, build assets, stabilize consumption, and shield themselves against risks. Financial services needed by the poor include working capital loans, consumer credit, savings, pensions, insurance, and money transfer services.

The poor rarely access services through the formal financial sector. They address their need for financial services through a variety of financial relationships, mostly informal. Credit is available from informal commercial and non-commercial money-lenders but usually at a very high cost to borrowers. Savings services are available through a variety of informal relationships like savings clubs, rotating savings and credit associations, and mutual insurance societies that have a tendency to be erratic and insecure.

Providers of financial services to the poor include donor-supported, non-profit non-government organizations (NGOs), cooperatives; community-based development institutions like self-help groups and credit unions; commercial and state banks; insurance and credit card companies; wire services; post offices; and other points of sale. NGOs and other non-bank financial institutions have led the way in developing workable credit methodologies for the poor and reaching out to large numbers of the poor.

1.2 Who are the clients of microfinance?

The clients of microfinance -female heads of households, pensioners, displaced persons, retrenched workers, small farmers, and micro-entrepreneurs- fall into four poverty levels: destitute, extreme poor, moderate poor, and vulnerable non-poor. While repayment capacity, collateral availability, and data availability vary across these categories, methodologies and operational structures have been developed that meet the financial needs of these client groups in a sustainable manner.

The client group for a given financial service provider is primarily determined by its mission, institutional form, and methodology. Banks that scale down to serve the poor tend to reach only the moderate poor. Credit union clients range from the moderate poor to the vulnerable non-poor, although this varies by region and type of credit union. NGOs, informal savings and loan groups, and community savings and credit associations have a wide range of client profiles.

1.3. How do financial services help the poor?

Poor people, with access to savings, credit, insurance, and other financial services, are more resilient and better able to cope with the everyday crises they face. Even the most rigorous econometric studies have demonstrated that microfinance can smooth consumption levels and significantly reduce the need to sell assets to meet basic needs. With access to microinsurance, poor people can cope with sudden increased expenses associated with death, serious illness, and loss of assets.

Access to credit allows poor people to take advantage of economic opportunities. While increased earnings are by no means automatic, clients have overwhelmingly demonstrated that reliable sources of credit provide a fundamental basis for planning and expanding business activities. Many studies show that clients who join and stay in programs have better economic conditions than non-clients, suggesting that programs contribute to these improvements. A few studies have also shown that over a long period of time many clients do actually graduate out of poverty.

By reducing vulnerability and increasing earnings and savings, financial services allow poor households to make the transformation from "every-day survival" to "planning for the future." Households are able to send more children to school for longer periods and to make greater investments in their children’s education. Increased earnings from financial services lead to better nutrition and better living conditions, which translates into a lower incidence of illness. Increased earnings also mean that clients may seek out and pay for health care services when needed, rather than go without or wait until their health seriously deteriorates.

1.4. What is the relationship between microfinance and the Millennium Development Goals?

In September 2000, the member states of the United Nations unanimously adopted the Millennium Development Goals (MDGs). The MDGs commit the international community to a common vision of development—one in which human development and poverty reduction have the highest priority. The objective of the MDGs is to serve as guideposts and focus the efforts of the world community on achieving significant, measurable improvements in poor people’s lives. The goals grew out of the agreements and resolutions of various development conferences organized by the UN in the 1990s.

Eradicate extreme poverty and hunger: Access to financial services enables the poor to increase income and smooth consumption flows, and thus expand their asset base and reduce their vulnerability.

Achieve universal primary education: Empirical evidence indicates that, in poor households with access to financial services, children are not only sent to school in larger numbers, but they also stay in school longer.

Promote gender equality and empower women: Overall, the experience of microfinance programs points to strong evidence that the access to financial services and the resultant transfer of financial resources to poor women, over time, lead to women becoming more confident, more assertive, and better able to confront systemic gender inequities.

Combat HIV/AIDS, malaria, and other diseases: Increased earnings and savings allow clients to seek out and pay for health care services when needed, rather than wait for conditions to deteriorate. In addition, many microfinance institutions actively promote health education.

Reduce child mortality and Improve maternal health: Several studies show positive impact of access to microfinance on different health aspects such as breastfeeding practices, contraceptive use and rates of vaccination.

Ensure environmental sustainability: There is evidence that with increased earnings the poor do invest in improved housing, water, and sanitation. Many microfinance programs provide specific loans for tube wells and for toilets.

Develop a global partnership for development: access to financial services provides the poor with the means to make improvements in their lives -in other words, to achieve most of the MDGs- on their own terms, in a sustainable way.

1.5. What is a microfinance institution (MFI)?

A microfinance institution (MFI) is an organization that provides financial services to those without access to conventional banks, like the poor. This very broad definition includes a wide range of providers that vary in their legal structure, mission, methodology, and sustainability. However, all share the common characteristic of providing financial services to a clientele poorer and more vulnerable than traditional bank clients.

Historical context can help explain how specialized MFIs developed over the last few decades. Between the 1950s and 1970s, governments and donors focused on providing subsidized agricultural credit to small and marginal farmers, in hopes of raising productivity and incomes. During the 1980s, microenterprise credit concentrated on providing loans to poor women to invest in tiny businesses, enabling them to accumulate assets and raise household income and welfare. These experiments resulted in the emergence of nongovernmental organizations (NGOs) that provided financial services for the poor. In the 1990s, many of these institutions transformed themselves into formal financial institutions in order to access and on-lend client savings, thus enhancing their outreach.

An MFI can be broadly defined as any organization -credit union, down-scaled commercial bank, financial NGO, or credit cooperative- that provides financial services for the poor.

1.6. Can financial services for the poor be profitable?

Microfinance, or financial services for the poor, can be, and must be profitable. Mixmarket’s (2008) website published that in their database median returns on assets vary from +0.6 percent (in Africa) to +4.2 percent in Eastern Europe and Central Asia. Indeed, there are grounds for hope that microfinance can become attractive to mainstream retail bankers.

At the same time, some worry that an excessive concern for profit in microfinance will lead MFIs away from poor clients to serve better-off clients who want larger loans. It is true that programs serving very poor clients are somewhat less profitable than those reaching better-off clients, but this may say more about managers’ objectives than an inherent conflict between serving the very poor and profitability. MFIs serving the very poor are showing rapid financial improvement. Microfinance programs like Bangladesh Rural Advancement Committee and ASA in Bangladesh have already demonstrated that very poor clients can be reached profitably: both institutions had profits of over 4% of assets in 2000.

There are cases where microfinance can not be made profitable, for example, where potential clients are extremely poor and risk-averse or live in remote areas with very low population density. In such settings, microfinance may require continuing subsidies. Whether microfinance is the best use of these subsidies will depend on evidence about its impact on the lives of these clients.

1.7. Why do MFIs charge high interest rates?

To maintain and increase its services over time, an MFI must charge interest rates high enough to cover the cost of its loans.

There are three kinds of costs the MFI has to cover when it makes microloans. The first two, the cost of the money that it lends and the cost of loan defaults, are proportional to the amount lent. For instance, if the cost paid by the MFI for the money it lends is 10 percent, and it experiences defaults of 3 percent of the amount lent, then these two cost items will total $13 for a loan of $100, and $65 for a loan of $500. An interest rate of 13 percent of the loan amount thus covers both these costs for either loan.

The third type of cost, transaction costs (personnel, computer, office expenses), is not proportional to the amount lent. The transaction cost of the $500 loan is not much different from the transaction cost of the $100 loan. Both loans require roughly the same amount of staff time for meeting with the borrower to appraise the loan, processing the loan disbursement and repayments, and follow-up monitoring. Suppose that the transaction cost is $25 per loan and that the loans are for one year. To break even on the $500 loan, the MFI would need to collect interest of $50 + $15 + $25 = $90, which represents an annual interest rate of 18 percent. To break even on the $100 loan, the MFI would need to collect interest of $10 + $3 + $25 = $38, which is an interest rate of 38 percent. At first glance, a rate this high looks abusive to many people, especially when the clients are poor. But in fact, this interest rate simply reflects the basic reality that when loan sizes get very small, transaction costs loom larger because these costs can’t be cut below certain minimums.

1.8. Can poor people save?

Poor people save all the time, although mostly in informal ways. They invest in assets such as gold, jewelry, domestic animals, building materials, and things that can be easily exchanged for cash. They may set aside corn from their harvest to sell at a later date. They bury cash in the garden or stash it under the mattress. They participate in informal savings groups where everyone contributes a small amount of cash each day, week, or month, and is successively awarded the pot on a rotating basis.

However widely used, informal savings mechanisms have serious limitations. It is not possible, for example, to cut a leg off a goat when the family suddenly needs a small amount of cash. In-kind savings are subject to fluctuations in commodity prices, destruction by insects, fire, thieves, or illness (in the case of livestock).

The poor lack access to safe, formal deposit services. Institutions that mobilize deposits like banks, credit unions, and postal savings banks are often too far away, or the time and procedures needed to complete transactions are too onerous. These organizations also may impose minimum transaction sizes and/or require depositors to retain a minimum balance, both of which can exclude the poor. Operating hours may not be convenient for poor depositors, nor are they welcome as clients.

1.9. When is microcredit NOT an appropriate poverty alleviation tool?

In the last two decades, substantial progress has been made in developing techniques to deliver financial services to the poor on a sustainable basis. Most donor interventions have concentrated on one of these services, microcredit. For microcredit to be appropriate however, the clients must have the capacity to repay the loan under the terms by which it is provided. Otherwise, clients may not be able to benefit from credit and risk being pushed into debt problems. This sounds obvious, but microcredit is viewed by some as "one size fits all." Instead, microcredit should be carefully evaluated against the alternatives when choosing the most appropriate intervention tool for a specific situation.

Microcredit may be inappropriate where conditions pose severe challenges to standard microcredit methodologies. Populations that are geographically dispersed or nomadic may not be suitable microfinance candidates. Dependence on a single economic activity or single agricultural crop, or reliance on barter rather than cash transactions may pose problems. The presence of hyperinflation, or absence of law and order may stress the ability of microfinance to operate.

However, strong and innovative microfinance providers are able to operate even in extremely challenging circumstances. These providers uphold two prerequisites of successful microcredit: discipline—both for clients (timely repayment) and institutions (business practices that lead to sustainability); and no subsidization of interest rates.

2.1. Can I launch myself in microfinance?

Microfinance is not a miracle remedy. Microfinance is a very complicated tool to combat poverty. The complexity is generally gravely underestimated. Compared to other financial institutions, operational costs are relatively high for microfinance institutions. These can only be covered by a professional, super efficient organization that exploits economies of scale through aggressive expansion, standardization and professional data processing.

Growth and processing administration effectively and efficiently are the major challenges. Institutions can choose to apply innovative technological solutions (if available) such as mobile banking. In any case, efficient management information systems are required to record and store data. Kiva’s website can provide a clear picture on what kind of data needs to be gathered to issue and manage loans.

Many small organizations fail to set up these systems. The microfinance sector is much more easily accessible if you seek out and support an organization that has the required information systems, processes and networks readily available.

2.2. What are the major caveats for amateurs in microfinance?

Microfinanciers often feel they play a dual role. On the one hand they are development aid workers, but on the other, they must be stern interest- and debt collectors. One of the major problems in microfinance is the inherent conflict between these two roles. Microfinance organizations make a common mistake when they assume the position of a development aid organization. Not being strict is pernicious for the clients’ attitudes towards repayment behavior. One of the difficult tasks of a microfinance institution is to develop and stimulate good repayment practice and to make it part of the local culture.

Some benefactors have a naïve and idealistic portrayal of clients. In practice, many clients will seize every opportunity to not pay back if they are not strictly monitored. Microfinanciers only have a chance to become self-sufficient when they are very tough towards clients. Matters can get emotional and serious conflicts can arise within self-help groups or between MFI personnel and a client.

Microfinance institutions require a stronger local organization, a clearer demarcation of the target group and a stricter planning than other, less complex development aid organizations. Good management is impossible without constant presence in the target area. In most cases selection of clients is carried out by local agents. Management should monitor these agents’ behavior well and take into account that they do not ignore the poorest.

In order to combat poverty through microfinance in a sustainable manner, microfinance initiatives should be able to stand on their own feet in the long run. To achieve this, the model must be scaled up drastically. At least around fifteen- to twenty thousand clients have to be reached. However, when this growth objective is overemphasized, it can harm meticulousness in other business processes. If the institution does not manage to become self-sustainable in the long run, it has failed to contribute to the poor structurally. The communities will remain dependent on subsidies and charity. In this case the initiative is nothing more than temporary emergency aid.

Many private initiatives lack a proper exit strategy. When the critical number of clients is not reached and the initiator leaves the country, their organizations shrink or cease to exist. To prevent this from happening, one should carefully pay attention to transferring knowledge and responsibilities to the local population. The growth- and self-sustainability pursuing strategy should be continued under local leadership. If not, it may affect self discipline and willingness to pay, also in a future generation…

Sometimes, microfinance is applied as a part of a broader development strategy. In itself this is not wrong, but organizationally and financially it must be separated from other forms of aid. The management of an MFI must consist of people specialized in culturally and financially adept people. It is unrealistic to use microfinance proceeds for other social goals.

2.3. Is it advisable to seek local cooperation?

Many small microfinance organizations re-invent the wheel without realizing that other initiatives are active in the near vicinity. Donors are advised to join forces with active organizations in order to achieve economies of scale. Especially in countries such as India, Bangladesh, Kenya, Ghana and Tanzania countless initiatives are active. Figures estimating the number of active development organizations vary from six- to fifteen thousand (including non-microfinance organizations). Therefore it is imperative to gather information about the presence of other organizations in the target area. There are thousands of organizations specialized in microfinance.

Private initiatives tend to prefer to target areas that are popular tourist destinations. Because of this, microfinance remains out of range for many of the poorest poor.

Generally, credit risks are estimated at a very low level for large, professional MFIs. A default rate under five percent is not uncommon. However, this is often misinterpreted as evidence that lending to the poor is not risky. The truth behind these figures is that successful MFIs struggled resolutely to collect repayments and assumed a tough stance towards defaulters.

The administrative organization and management information systems must be well-organized. Successful organizations reach a very large clientele and need efficient and transparent systems to process information efficiently. Ideally, these systems should be able to generate comparable indicators so performance can be compared to that of other similar institutions. CGAP and The Microfinance Gateway offer reporting standards on their websites.
For this reason as well it is recommended to closely cooperate with existing MFIs.

2.4. Are there special challenges in setting conditions for microcredit?

When issuing credit, debt maturity should be well adjusted to the loan’s purpose. When a loan is issued for growing potatoes, repayments should be collected after the harvest. Before that, clients will not have money, but wait to long and the money is gone.

Especially agricultural credit is very risky. The credit maturities are long and crops can fail due to insects, natural disasters or bad weather conditions. Even when rich harvest is yielded price risk can still cause low revenues.

Because microcredit borrowers are often people without a credit history, it is not easy to determine their creditworthiness. For starters, amounts lent should be as small as possible, yet large enough to enable clients to invest in assets that are capable of significantly increasing incomes. Loans should be issued exclusively to people who are expected to pay back the principle and interest in full.

Many microfinance clients do not possess the necessary knowledge and analytical skills to distinguish good from bad investment opportunities. In some cultures, especially in the third world, people are much more worried about securing their dowry than they are about insuring their livestock on which their income is dependent. In practice, microcredits are often used for non-income generating practices.

While this is not what microfinance was meant for, one should keep in the back of one’s mind that a client who need money for e.g. dowry can also turn to an informal moneylender. He will do so when his or her request is denied by the microfinance institution. Then, he may well be worse off.

In a nutshell, one should only envisage starting a microfinance programme on the following conditions:
- If one has the ambition and resources to grow as quickly as possible towards a professional, efficient organization serving at least more than 15.000 clients;
- A long-time active involvement can be assured;
- One can travel regularly (and at own expenses) to the area;
- One establishes collaboration with local banks and/or MFIs;
- Professionnal and trained staff is appointed and well paid;
- If one is able to design credit products and related services that are competitive in the local market.

Initiatives that cannot meet these requirements will not improve the lives of the poor in a durable manner, and instead may do more harm. Such people better venture into other type of projects or seek to support microfinance in manners like described below.

2.5. How can (private) donors best support financial services for the poor?

Donors who support financial services for the poor are advised to search out microfinance institutions (MFIs) that are committed to financial self-sufficiency. Sustainability—the ability of an MFI to cover all of its costs through interest paid by its clients and other income—is a cornerstone of sound microfinance. Financially sustainable MFIs can become a permanent part of the financial system because they can stay in business when grants or soft loans are no longer available.

To promote sustainable providers of financial services to the poor, donors are advised to make capacity building a key component of their microfinance programming. Many small MFIs require institution-strengthening grants and technical assistance before they can reach the operational and financial self-sufficiency needed to sustain large-scale growth.

At the other end of the spectrum, donors are discouraged from only funding strong MFIs that already have access to commercial and quasi-commercial banks and investments from socially responsible investors (SRIs). The principal task of donors should be to identify and bet on promising but riskier MFIs, leaving the known winners to commercial investors.

When supporting a large, successful MFI, support aimed specifically at reaching risky, remote areas or new product development can prove very useful. Another possibility is to assist a large MFI with the development of consulting programs in support of smaller, growing MFIs.

2.6. I want to take action myself. Where can I find advise and financial support?

In the Netherlands, several organizations exist that can (financially) support private initiatives that  support development initiatives. Examples are CordAid, Hivos, ICCO, Oxfam Novib, Plan Nederland and NCDO.

Government subsidies are distributed through these organizations. All organizations receive development plans through their front offices. These are:

Organization	Front office	Maximum subsidies (indicative)
ICCO (in collaboration with Edukans and Kerkinactie)	Impulsis	€ 2.000 ~ 100.000
CordAid	Private Initiatives Fund	Up to € 20.000
Oxfam Novib	Linkis/Oxfam Novib
Hivos	Hivos Linkis	Average € 5.000 ~ 15.000
Rabobank	Share4more	Up to € 4.000

The PSOM-program (Programma Samenwerking Opkomende Markten) is run by the EVD (Ministry of Economic Affairs, The Hague). It supports investments programs run by Dutch companies in certain countries. Only applicants who have proven experience in the area of investment can apply to the program. A similar program (PSOM-Plus) is called into life to serve companies that target countries including in the Dutch Government’s list of vulnerable states.

The Dutch Ministry of Foreign Affairs installed the Ontwikkelings Relevante Export Transacties (ORET – export transaction relevant to development) program to support sustainable development projects in developing countries. This arrangement is aimed at increasing investment stimulating development from small- to medium enterprises.

2.7. How do I prepare a request for financial support?

Different organizations review proposals differently, so logically requisites differ. However, generally a few things always recur.

First of all, organizations serve a particular set of countries. The first step is to find out whether your country of choice in included in the set of countries the sponsor organization supports.

In any case, your proposal needs to feature a clear project description with financial foundations. Knowledge about and feeling for the market is essential. Make a clear specification of the amount needed, and the nature of the request (once-only or structural). Some organizations expect that part of the project’s funding comes from private resources.
Participation by the local beneficiaries is also a requirement.

Sponsor organizations have strong requirements on the quality of local partners. Individuals are not accepted, as this creates a weak legal position for the organizations. Local partners must be legally registered. It is advised to include registration documents with your finance request.

Furthermore measurable and realistic targets should be set. Also, the organizational structure, and tasks and responsibilities must be clarified. Relevant additional information will be appreciated as well.

2.8. Can I protect myself against currency fluctuations?

In microfinance, clients require financial services to be delivered in their local currency. Microentrepreneurs are too small and vulnerable to be able to bear currency risk of their small loan. If you issue a loan in a local currency, the funds are repaid in the same currency. In case the funds have to be returned to The Netherlands, there may be losses due to devaluation and inflation.

Banks can hedge these risks for large amounts only, and not even for all local currencies. FMO can provide currency or interest risk hedging products (the TCX-fund) for third world currencies. However these are only of interest for large scale investments. Smaller initiatives that fund microfinance loans have to bear the risk themselves.

Usually, small scale funds invested in microfinance keeps circulating in the destination country, so currency risk is not an issue.

2.9. Where can I find online job portals with ads on microfinance?

Microfinance job advertisements are most commonly found on the following websites:
http://www.microfinancegateway.org
http://www.microfinancejobs.com
http://www.idealist.com

2.10. Where can I find additional information on microfinance?

www.microfinancegateway.org, www.cgap.org and www.mixmarket.org are three in-depth resources websites for people who want to know more.

There are also simple handbooks in Dutch-language that offer practical information (see the Dutch FAQs)

3.1. Is it possible to invest in microfinance in small amounts?

It is possible to contribute with amounts as small as US$ 25. At the Kiva  website(www.kiva.org) you can lend to small entrepreneurs in the third world. The website of Kiva also gives more insights in the information that one needs to collect in giving microcredits.
For more commercially oriented loans to small African entrepreneurs you can visit www.myc4.com.

3.2. Can I buy shares in a microfinance institution?

Yes, this is gradually more opportunities through stock exchanges in the Third World. The first microfinance bank registered on the stock market is the Mexican bank Compartamos.
Some MFIs also issue bonds to the public. These are best obtained through local agents.

3.3. Are there microfinance investment funds for the general public?

More and more microfinance funds are coming up these days. In the Netherlands, a small number of funds operating in the area of microfinance are available.
At this moment, these include the following:

Oikocredit Nederland Fonds
ASN Novib Fonds
Triodos Fair Share Fund
Annexum Dutch Microfund

These funds are classified as ‘socially desirable’, so tax credits are available for Dutch citizens.

Private Banking customers of the large banks can contact their account manager in case they want to purchase shares of funds presented above.

References

cgap.org
microfinancegateway.org
mixmarket.org
Schulpen, Lau (2007), Development in the Africa for Beginners
Vossen, M. (2008), Eerste hulp bij ontwikkelingswerk