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Microfinance - Where We Are Now: And Where We Are Headed

Written by: United Nations Capital Development Fund

Article Overview: All of us who are involved in microfinance know that it is neither just nor economically tenable for financial systems in poor countries to serve only a tiny proportion of the population and exclude the vast majority. We are no longer alone in this. All over the developing world people are waking up to the fact that poor people need - and will pay for - a wealth of financial options, solutions and services, just like rich people. They are realizing that poor people represent a vast untapped market opportunity. And as a result we are witnessing poor people's finance becoming mainstream finance in most poor countries.

Microfinance - Where We Are Now: And Where We Are Headed

By Elizabeth Littlefield, CGAP CEO and World Bank Director*

All of us who are involved in microfinance know that it is neither just nor economically tenable for financial systems in poor countries to serve only a tiny proportion of the population and exclude the vast majority. We are no longer alone in this. All over the developing world people are waking up to the fact that poor people need - and will pay for - a wealth of financial options, solutions and services, just like rich people. They are realizing that poor people represent a vast untapped market opportunity. And as a result we are witnessing poor people's finance becoming mainstream finance in most poor countries.

We have long outgrown the word microcredit. Today, the word microfinance doesn't even capture the scope and scale of what is happening in the world of finance for the poor. What was once a neat and tidy, well-delineated little sub-culture, now encompasses a dizzying range of delivery organizations and services, all increasingly interwoven with the rest of the financial sector. All around us, we are witnessing experimentation, and a surge of new entrants to the field. The result is an explosion of diversity: diversity of delivery channels, of services, of funding sources and, of course, clients.

The panoply of institutions includes new NGOs, Non-Bank Financial Institutions, cooperatives, commercial banks, postal banks, pawn shops, and retail shops providing "cash back", all learning from each other, partnering, and merging. At the same time we, as a growing community, are working on ever more diverse financial products and services: deposit services, credit lines and term loans, crop and life insurance, money transfers. And we are aiming to serve a staggeringly diverse clientele - a huge chunk of the world population - the urban micro-enterprise, the farmer, the rural household, the very poor and the sort-of-poor. We are also seeing ever-broadening sources of capital: donors, international financial institutions, private capital and, most importantly, domestic banks and capital markets. And we are working in nearly every developing country in the world.

We are aiming at a world where a wide variety of strong institutions jostle and compete with one another for poor people's business, innovating and improving services to earn their loyalty. We have set our sights high and the mission is ambitious. It requires passion and responsibility. It requires agility and humility. And it requires leaving our own egos behind. But, it's already happening. And happening fast.

So let us consider the evidence of this integration in three dimensions: institutions, funding sources and market infrastructure.

Increasingly diverse institutions

First, the delivery vehicles - the financial institutions. Access points for poor people to get financial services are exploding in three ways:


leading microfinance institutions with social origins at their core are scaling up,
banks and other institutions with commercial origins are using their branch infrastructure to reach out, and
partnerships between socially-oriented microfinance institutions and banks are being forged to leverage each other's comparative advantages.

It is as if the commercial sector is coming down and the microfinance sector is building out and they are meeting in the middle.

Leading microfinance institutions with social origins are growing and becoming more professional, transparent and profitable. Some are getting licensed to take deposits. Hundreds are getting credit ratings every year. Several are tapping domestic capital markets. Consider institutions like Caja Los Andes and Bancosol. Fitch, a mainstream rating agency, recently gave both a higher rating than most of the domestic banks in Bolivia. Likewise, Compartamos in Mexico, which began operations in 1991 as a small NGO, became a self-sufficient, regulated financial institution in 2001 and is now a profitable bank that has twice tapped the markets by issuing local-currency bonds.

Microfinance institutions are experimenting with new technology to expand services, compete and bring down costs. Pride Tanzania is introducing biometrics into its credit data systems. Some MFIs are linking into international ATM networks, while others, like Prodem in Bolivia, have built their own low-functionality, low-cost ATMs with picture and voice prompts for illiterate rural clients. In Senegal, Brazil and South Africa, there are promising experiments with smart cards and wirelessly connected point of service machines that allow the till of a rural shop, gas station or lottery outlet to act as a bank branch. In Zambia, MFIs are testing cell-phone based banking for remote villages. This is how the leading MFIs are poised for an explosion in access points - not just bricks and mortar branches, but virtual ones too.

At the same time, dozens of purely commercial retail banks in places as widespread as India, South Africa, Brazil and Egypt are starting to use existing branch infrastructure to go down market to tap lower income retail clientele. Four factors are driving that: competition is driving banks into new markets; the excellent repayment rates microfinance has demonstrated make it an attractive proposition; banks are seeking to pump more product through their infrastructure; and finally, the advent of new technologies that promise to make smaller transactions more cost effective. For these reasons, commercial banks are now seeing the poor as a viable and even attractive market. The power of building out microfinance on such vast existing networks, without having to grow organically branch by branch, may bring millions and millions of poor people into the financial fold at breathtaking speed.

At CGAP we have identified over 200 such domestic retail banks or consumer credit companies getting involved in microfinance: Banque du Caire in Egypt, Unibanco in Brazil, Capitec, a consumer credit company in South Africa with 300 branches is looking to expand from salary-based lending into the microenterprise market. SBI in India, with 13,000 branches, is reaching down by acquiring the portfolios of dozens of microfinance institutions. Other Indian Banks are planning the build-out of 10,000 wireless Personal Computer kiosks in rural villages with low cost ATMs attached to them.

Franchising and other partnership arrangements which allow banks and microfinance institutions to exploit their competitive advantages blur the edges between microfinance and the formal financial world even more. At CGAP we have counted at least 280 such partnerships worldwide.

As MFIs reach up and commercial banks reach out, we are finally together building the architecture of a fully-fledged financial sector.

Sources of Funding

The vast majority of microfinance loan portfolios are - and will increasingly be - funded by domestic savings and local banks. And that is as it should be. Our overall aim is clearly to help build domestic financial markets that function efficiently for their populations, re-channeling the vast pools of domestic savings into productive loans for the poor. To have these systems function effectively we need strong local financial intermediaries. Safe and strong institutions can provide poor people with both a safe place to save money outside the household, and also a place to borrow money when needed at other times of the year. External funds are needed to build the institutions and their human capacity, but external funds have a far lesser role in building financial intermediaries than in building roads and bridges.

In the meantime, donors still have an important role, especially in improving the effectiveness of the five hundred million to one billion dollars a year they currently spend in microfinance.

There is also increasing interest amongst mainstream social investors, as witnessed by the 58 new investment funds recently launched. However, over 90 percent of the so-called 'private' socially responsible money is really public money at its origin (much of it from IFC, or its European equivalents). The sector is fragmented too - the funds are too small and too numerous given the universe of institutions that are suitable for such investments. But the microfinance fund industry is young and will no doubt consolidate and shift around. The main concern I have is that of the $185 million invested in these funds, over three quarters of it is in debt, and of that, two thirds is in hard currency. This is a real problem as we have a strong indication that most borrowing microfinance institutions do not understand the risks, and if they did, they could not hedge them. This brings me back to the importance of focusing on building domestic markets, with domestic sources of funds.

The Financial Market Infrastructure

When we talk about the financial market infrastructure, we are really talking about three interrelated aspects: high quality information on financial performance at the institutional level; shared information systems with client credit histories, like credit bureaus; and new technologies that enable financial institutions to make smaller and smaller transactions more cost effectively. It is the coming-together of these three dimensions of the financial market architecture that will enable the exponential growth we have been working towards for so long.

The industry is making excellent progress on the quality of information on financial performance as the systems and standards now in place are being taken up and used. Financial reporting is improving at a healthy pace as microfinance and international financial reporting standards converge, and the quality of audits improves. The Microfinance Information Exchange (the MIX), a centralized database for microfinance reporting - now has 420 microfinance institutions and over 50 funds reporting high quality data. Over the last four years, the number of MFI credit ratings has increased from just fifty a year to over two hundred and fifty last year. At the same time, mainstream agencies are starting to get involved through local affiliates (Moody's just rated Acleda Bank in Cambodia). The industry is making moderate progress on creating credit bureaus with formal microcredit information - they now exist in thirteen countries, including in isolated countries like Turkey, with another ten on the way.

This information infrastructure is allowing MFIs and funders to connect, facilitating the allocation of capital and stimulating improved performance. All in all, we are seeing the early development of new delivery technologies that just might revolutionize microfinance.

So, this is an overview of the good news. But there still remain significant challenges.

Challenges Ahead

The main challenge to significant expansion is efficiency and institutional capacity. There are still far too many small, weak and inefficient institutions operating and soaking up valuable donor subsidies. While efficiency is stunning in Asia (5 percent), and making steady progress in Latin America, it is stuck at nearly 0.5 percent in Africa. Investing money is easy. But investing human capital in the slow, hard work of building strong institutions that are well managed and efficient, is what is really needed.

Reaching sparsely populated rural areas remains one of the major challenges. Could technology be the answer here?

The other persistent challenge is reaching the very poorest clients - the destitute and hungry who have no incomes - with grant instruments that enable them to stabilize and climb up onto the ladder of financial services. The micro-grants program of ABA and several programs in India, China and Bangladesh are promising but still very small, and donors will never have enough funds to do justice to the problem. Here we need the governments to recognize and act on their obligations, perhaps with donor help.

Next on my list of priorities: keeping our eye on the ball of building domestic markets, which means finding ways to bring in domestic funders. We need to understand the incentives and disincentives of local banks to lend to microfinance in local currency and design instruments that encourage their entry into the market.

But perhaps the most important question facing our industry today is the extent to which technology will be able to bring down transaction costs to enable commercial players to really serve this market globally. The secret to microfinance has been that poor people repay faithfully. We know that they do so because they value the access to services. Do we think they might pay back money into a machine as faithfully as they have paid back their loan officer at weekly meetings?

If the answer is yes - and if we were able to build national identity systems that underpinned credit scoring models, and to develop the delivery technologies - could thousands of commercial banks reach the last mile of a poor, rural community profitably without loan officers, except perhaps at account opening?

The challenge today is to roll out the methodology refined by microfinance institutions on a mass scale: to engage more types of distribution systems, more technologies and more talent to create financial systems that work for the poor. The time has come to make microfinance fully part of the mainstream, so it can boost equitable economic growth while at the same time lifting millions of people out of poverty with self-determination, self-respect and dignity.

Related Articles
  IV Module I Key Principles for an African Model of Microfinance
  Enhancing Microfinance Efficacy through Integrated Services
  Increasing Microfinance’s Reach with Integrated Services
  Central Bank of Nigeria (CBN) Approves Conversion of Community Bank into Microfinance Institution (MFI)
  Who are the clients of microfinance? FAQ

Article Tags: bank director, cgap, commercial banks, delivery channels, financial institutions, financial options, financial sector, life insurance money, littlefield, market opportunity, micro enterprise, money transfers, panoply, pawn shops, poor countries, retail shops, term loans, tiny proportion, untapped market, world population



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