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Guest post by: International Monetary Fund Become an Author

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(IMF Working Paper, Prepared by Anupam Basu, Rodolphe Blavy, and Murat Yulek1, September 2004)

Donors and NGOs have generally provided support through two main channels: domestic
NGOs or donor-managed microfinance projects, and microfinance institutions that function
more or less like leasing companies (receiving wholesale external resources and lending to
clients). These are mainly “credit-only” schemes that receive wholesale funds from external
sources, often donors, instead of collecting deposits, and the lending methods (successfully
introduced by NGOs) are often based on the “group solidarity” method (Box 3). Policy
makers may be tempted to emphasize the lending function in the microfinance sector more heavily than deposit mobilization, as they may assume that increases in lending would
promote investment and hence enhance economic growth. The difficulties and costs of
achieving the geographical outreach and managing numerous small depositors also work in
favor of credit-only institutions. Deposit collection entails a different technology than
lending, and if the main social benefit from microfinance is seen as the lending function,
policy makers may be biased toward credit-only institutions.

Direct support from NGOs in lending schemes has received some criticism because of their
potential adverse effects on the operation of MFIs. NGO support could weaken financial
discipline in MFIs, and dependence on donor money rather than deposit mobilization could
constrain growth and sustainability. Donor-directed lending may also crowd out
commercially viable projects that would not qualify for donor funds. While increased lending
may take place, this may not be directed towards the needs of the economy. This does not
invalidate the benefits of donor funding of MFIs, but points to a need to weigh the options
carefully. At the same time, NGO-based MFIs are limited in their outreach by their
dependence on external sources of donor funds, and also by their need to allocate their
limited resources to a wide range of activities outside the microfinance sector. NGOs have
proven particularly efficient in working with community-based organizations, in regions where licensed MFIs are scarce8 and their reach is generally limited to specific locations.
Donor interest in supporting MFIs may partly address the resource problem, but does so only
temporarily and to a limited extent.

While donors could support MFIs’ lending operations with resources, they could also
encourage efforts to build the resource base through domestic saving mobilization.
Emphasizing full intermediation does not necessarily preclude donor involvement in assisting
the MFIs with capacity building (in both physical, and human resources), which will remain
essential. The experience of countries in SSA suggests that NGOs and donors can play an
important role in the dissemination of best practices tested internationally and regionally and
remain important in building borrowers’ entrepreneurial skills and capacity to graduate to the
formal banking sector. In some situations, NGOs have been engaged in building local
capacity through the creation of institutions specifically dedicated to training (Box 3).9

In many cases, NGOs and donors have tended to focus on social programs and services for
which they have particular expertise, including programs aimed at reducing poverty. NGOs
have in some cases also focused on providing welfare and socially-oriented microfinance,
when the push toward financial sustainability was seen to induce a reorientation of MFI focus
from the very poor to the lower-middle and middle classes. While NGOs may continue to
play an important role in providing social services to the very poor and the more remote
areas, it is debatable whether this is more efficient in promoting poverty reduction than direct
subsidization of social services (such as primary education and basic health care).

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