75183 Casual labor Harvest Sale of livestock Remittance School fees House repairs Agricultural inputs Medical expense Loan repayment The New Microfinance Handbook On microfinance and The New Microfinance Handbook “Financial services help to smooth cash flows, build assets, invest productively, and, importantly, man- age risks. Increasing the outreach of financial services that are affordable and meet the varied needs of poor women and men can contribute significantly to economic development and overall quality of life, key objectives of practitioners and policy makers alike.” —Maria Otero, former CEO, Accion International “The journey from microfinance to financial inclusion began in earnest when we understood that cli- ents need diverse services such as savings, payments, and insurance, as well as loans. The New Microfinance Handbook reflects a lesson we learned many years ago—that sharing knowledge and best practices is so important to help providers, policy makers, and others to continue to innovate, adapt, and scale financial services in order to add real value to customers in a responsible way.” —H.R.H. Princess Máxima of the Netherlands, The UN Secretary-General’s Special Advocate for Inclusive Finance for Development (UNSGSA) “The New Microfinance Handbook fills a critical gap in the current literature on financial inclusion. I am particularly pleased with the explicit focus on consumers and their needs—this, together with the onset of technology-based delivery models, has been the most important shift in the microfinance field over the past 15 years. I am sure that by taking the financial ecosystem approach and compiling all the current trends into one volume, this book will serve as a reference for the large and growing financial inclusion community for years to come.” —Brigit Helms, author of Access for All “Financial services that support asset building, investment, and risk management are critical for people of all ages in frontier and postconflict environments. In The New Microfinance Handbook, the authors highlight the importance of understanding client needs and the need for a more inclusive financial sector. This work provides an excellent resource for navigating a diverse and rapidly changing micro­ finance sector.” —President Ellen Johnson Sirleaf, Liberia “Poor people’s lives are complex; the goods, services and amenities that they need to escape from poverty—­ and the means by which they get them—are equally diverse. One-size-fits-all solutions are an illusion. Our challenge as development policy makers, researchers, and practitioners in all fields—be that in finance, agriculture, health or education—is to understand and respond to this complexity in ways that help build diverse, resilient socioeconomic systems that are able to serve the needs of the poor, sustainably and at scale. “The New Microfinance Handbook reflects this challenge. It moves beyond the original Microfinance Handbook’s focus on retail microfinance to deal with the imperative of understanding and strengthen- ing the wider financial ecosystem, which is essential to making financial markets genuinely work ­ better—inclusively and responsibly—for poor men and women. This shift has significant implications for development agencies, requiring ‘smarter’ subsidies, different types of partners, and more facilita- tive or catalytic interventions.” —Robert Hitchens, Director, Springfield Centre, United Kingdom The New Microfinance Handbook A Financial Market System Perspective Edited by Joanna Ledgerwood with Julie Earne and Candace Nelson © 2013 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 16 15 14 13 This work is a product of the staff of The World Bank and external contributors. Note that The World Bank does not necessarily own each component of the content included in the work. The World Bank therefore does not warrant that the use of the content contained in the work will not infringe on the rights of third parties. The risk of claims resulting from such infringement rests solely with you. 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Under the Creative Commons Attribution license, you are free to copy, distribute, transmit, and adapt this work, including for commercial purposes, under the following conditions: Attribution—Please cite the work as follows: Ledgerwood, Joanna, with Julie Earne and Candace Nelson, eds. 2013. The New Microfinance Handbook: A Financial Market System Perspective. Washington, DC: World Bank. doi: 10.1596/978-0-8213-8927-0. License: Creative Commons Attribution CC BY 3.0 Translations—If you create a translation of this work, please add the following disclaimer along with the attribution: This translation was not created by The World Bank and should not be considered an official World Bank translation. The World Bank shall not be liable for any content or error in this translation. All queries on rights and licenses should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. ISBN (paper): 978-0-8213-8927-0 ISBN (electronic): 978-0-8213-8928-7 DOI: 10.1596/978-0-8213-8927-0 Cover Image: Embroidery by Kaross Studio, Letsetele, South Africa. Used with permission from Gerhard Coetzee, who commis- sioned the artwork. Non-English terms in the image and their translations are as follows: ABSA: Bank; KAART: Card game; LOBOLA: Negotiated payment before a wedding; SAB: South African Breweries; STOKVELA: ROSCA (Rotating Savings and Credit Association). Cover design: Naylor Design Library of Congress Cataloging-in-Publication Data The new microfinance handbook : a financial market system perspective / edited by Joanna Ledgerwood, with Julie Earne and Candace Nelson.   p. cm.  Includes bibliographical references  ISBN 978-0-8213-8927-0 (alk. paper) — ISBN 978-0-8213-8928-7  1. Microfinance. 2. Financial institutions. 3. Poor–Finance, Personal. I. Ledgerwood, Joanna. II. Earne, Julie. III. Nelson, Candace. IV. World Bank.  HG178.3.N48 2012  332—dc23 2012035606 CONTENTS Foreword xv Preface xvii Acknowledgments xix About the Authors xxi Abbreviations xxiii Introduction 1 PART ONE.  UNDERSTANDING DEMAND AND THE FINANCIAL ECOSYSTEM 13 Chapter 1. The Evolving Financial Landscape 15 Joanna Ledgerwood and Alan Gibson Chapter 2. Clients 49 Stuart Rutherford, Daryl Collins, and Susan Johnson Chapter 3. The Role of Government and Industry in Financial Inclusion 71 Stefan Staschen and Candace Nelson Chapter 4. The Role of Donors in Financial Inclusion 97 Mayada El-Zoghbi and Barbara Gähwiler Chapter 5. Measuring Financial Inclusion and Assessing Impact 113 Joanna Ledgerwood Contents v PART TWO.  FINANCIAL SERVICE PROVIDERS 147 Chapter 6. Community-Based Providers 149 Candace Nelson Chapter 7.  Institutional Providers 171 Joanna Ledgerwood PART THREE.  FINANCIAL SERVICES AND DELIVERY CHANNELS 197 Chapter 8. Savings Services 199 Joanna Ledgerwood Chapter 9. Credit 213 Joanna Ledgerwood and Julie Earne Chapter 10. Agricultural Finance 231 Calvin Miller Chapter 11. Insurance 249 Craig Churchill Chapter 12. Payment Services and Delivery Channels 271 Joyce Lehman and Joanna Ledgerwood Chapter 13. Beyond Products: Building Integrated Customer Experiences on Mobile Phones 299 Ignacio Mas PART FOUR.  INSTITUTIONAL MANAGEMENT FOR SCALE AND SUSTAINABILITY 319 Chapter 14. Monitoring and Managing Financial and Social Performance 321 Joanna Ledgerwood, Geraldine O’Keeffe, and Ines Arevalo Chapter 15. Governance and Managing Operations 351 Peter McConaghy vi The New Microfinance Handbook PART FIVE.  SUPPORTING FINANCIAL INCLUSION 377 Chapter 16. Funding 379 Julie Earne and Lisa Sherk Chapter 17. Regulation 413 Kate Lauer and Stefan Staschen Chapter 18. Infrastructure and Outsourced Support Services 437 Geraldine O’Keeffe, Julie Earne, Joakim Vincze, and Peter McConaghy Chapter 19. Building Inclusive Financial Markets 459 David Ferrand Index 479 Boxes I.1 A Market This Big Needs Many Types of Providers  5 I.2 Latest Findings from Randomized Evaluations of Microfinance  6 1.1 From Microfinance to Financial Inclusion  17 1.2 Youth Financial Services: An Opportunity for the Future  18 1.3  Gambian Family Structure and Impact on Financial Behavior and Demand  19 1.4 The Financial Service Needs of the Poor in Mexico  21 1.5 Reaching the Poorest: Lessons from the Graduation Model  22 1.6 Religion and Caste in India  23 1.7  The Embeddedness of Financial Service Use in Gender Norms in Kenya  24 1.8 Understanding the Financial Market System  28 1.9 The Range of Providers in Sub-Saharan Africa  30 1.10 Savings-Led Financial Services in Bangladesh  31 1.11 Key Rules and Supporting Functions for Savings Services  33 1.12 Formal and Informal Rules  34 1.13 Understanding Informal Rules through Financial Landscapes  35 1.14 Potential of Mobile Banking  42 1.15 New Branchless Banking Business Models  43 2.1 Income Volatility, Week-by-Week and Year-by-Year  53 2.2 Cash Flow Management Given Volatile Seasonal Income  55 2.3 Ramna’s Top-Ups   56 2.4 Enayet’s Foot  57 2.5 Building a Home Little by Little  60 Contents vii 2.6 How MFI Loans Are Used in Bangladesh  62 2.7 Daisy’s ROSCA  65 3.1 Bank and Retail Network Partnership   73 3.2 Encouraging Stakeholders to Adopt New Rules  76 3.3 Policy for Microinsurance  76 3.4 Financial Capability Strategies  77 3.5 Financial Literacy in the Russian Federation  77 3.6 Financial Inclusion in Mexico  78 3.7 Financial Inclusion in India  80 3.8  Negotiating a Special Microfinance Law in Uganda: The Outcome of Competing Interests  83 3.9 The Maya Declaration  84 3.10 The G-20 Principles for Financial Inclusion  85 3.11 SEEP’s Toolkit for Policy Advocacy  87 3.12 Battling Over-Indebtedness in Azerbaijan  90 3.13 Financial Education as Part of the Business Model  92 4.1  Shaping Intervention from an Understanding of the Market System 105 4.2 Financial Sector Deepening Kenya (FSD Kenya)  106 5.1 Using Data to Increase Financial Inclusion  114 5.2 Evidence of Over-Indebtedness through Research  116 5.3 Microfinance Information eXchange  118 5.4 Savings Groups Information Exchange  120 5.5 Who Uses Landscape Supply Data?  121 5.6 Core Indicators of Global Findex  122 5.7 FinScope Surveys  123 5.8 Interpreting Financial Access Strands  125 5.9 Cash-In, Cash-Out: Financial Diaries in Malawi  127 5.10 Financial Landscapes in Kenya  129 5.11 Livelihood Landscape Studies  130 5.12 Measuring Outcomes of Facilitating Savings Groups  131 5.13 The Changing Focus of Impact Assessment  132 5.14 Participatory Rapid Assessment   135 5.15 The Difficulty of Proving Causation  137 6.1 Ghana’s Susu Collectors 152 6.2 Beyond Carrying Cash: Informal Money Transfer Systems  153 6.3 Rural ASCAs in India  155 6.4 Savings Groups and Other Activities  159 6.5 Paths to Savings Group Replication  160 6.6 Fee-for-Service: Variations on a Theme  161 viii The New Microfinance Handbook 6.7 Bank Linkages through Mobile Phones  162 6.8 Banks as Facilitators  163 6.9 Individuals as Facilitators  164 6.10 Self-Help Groups: A Holistic View  166 6.11 Financial Service Associations in Kenya  167 7.1 Reflections on Member-Owned Financial Service Provision   176 7.2 Transformation from an NGO to a Deposit-Taking Institution   179 7.3 NBFIs in India   180 7.4 Grupo Elektra and Banco Azteca in Mexico   181 7.5  Patrimonio Hoy: Housing Microfinance That Addresses Market Opportunities   182 7.6 Rural and Community Banks in Ghana   183 7.7 Post Office Banks in India   184 7.8 Increased Financial Inclusion through Postal Savings Banks   185 7.9 Privatization: The Experience of Khan Bank in Mongolia   187 7.10 Bank Rakyat Indonesia   187 7.11 Subsidiary Model in Practice: ACCION-Ecobank Partnership   188 7.12 Microfinance Networks and Commercial MFIs   189 7.13 Linking Different Types of Institutions   191 7.14 Allianz in West Africa   193 7.15 Western Union and MoneyGram   194 8.1 Savings Patterns in India  201 8.2  Savings Constraints and Microenterprise Development: Evidence from Kenya  202 8.3 Inspiring Trust  204 8.4 Savings Services—Not Only about Products  206 8.5 Saving for Education  208 8.6 Borrowing to Save  208 8.7 Nicaragua—Promoting Agriculture Savings  209 8.8 Grameen’s Deposit Pension Scheme (GPS)  210 9.1 Islamic Finance in Practice  216 9.2 The Flat-Rate Method  219 9.3 Declining Balance Method  220 9.4 Equating Declining Balance and Flat-Rate Methods  221 9.5 The Effect of a Change in Loan Fees and Loan Terms  223 9.6 Financing Education through Human Capital Contracts  225 9.7 Cow Leasing  226 9.8 Affordable Housing in Ghana   228 10.1 The DrumNet Project  238 10.2 Factoring to Support Agriculture  240 Contents ix 10.3 Warehouse Receipt Systems: Lessons from Niger  242 10.4 Crop Receivables  244 10.5 Heifer International  245 10.6 FONDECO: Microfinance Innovations along the Value Chain  246 11.1 Key Insurance Terms  251 11.2  AKAM’s Experience with Village-Based Health Microinsurance in Pakistan  253 11.3 IFFCO-Tokio’s Bundled AD&D Coverage  255 11.4 Collaborating with a Utility Company in Colombia  257 11.5 Savings Completion Insurance Offered by TUW SKOK  262 11.6 Microfund for Women’s “Caregiver” Product  263 11.7 Public-Private Partnerships and Health Microinsurance in India  264 11.8  Index Insurance and Technology: The Case of Kilimo Salama, Kenya 265 12.1 Trends in the Average Cost of Remittance Services  273 12.2 Mobile Money Innovations in Microinsurance in the Philippines  274 12.3 Mobile Money in Papua New Guinea  275 12.4 Glossary of Terms Related to Alternative Delivery Channels  276 12.5 Expanding Rural Finance in Sri Lanka  279 12.6 World Food Programme Card Pilot, 2009  281 12.7 Cardless ATM Transactions  281 12.8 Payment Terminals in the Russian Federation  282 12.9  Urwego Opportunity Bank’s Mobile Bank and Open Sky System  283 12.10 M-PESA Reaching Scale with Mobile Money  285 12.11 Banking with a Mobile Phone: The Customer Experience  286 12.12 Third-Party Providers: New Business Models  289 12.13 bKash Ltd.  290 12.14 Branchless Banking in Brazil  291 12.15 From Payment Terminals to Multiple Services  292 12.16 Cost of Managing Agent Liquidity  293 13.1 IFMR Trust in India  303 13.2 What Are the Attributes of Success in Adjacent Sectors?  305 14.1 Performance Monitoring of Savings Groups  323 14.2 Software Application Controls  327 14.3 Universal Standards for Social Performance Management   341 14.4 Social Audit Tools   346 15.1  Board Consideration for NGO MFIs Transforming into Regulated Institutions   353 15.2 Principles of Well-Designed Incentive Schemes   357 x The New Microfinance Handbook 15.3 Client-Focused Product Design in Practice   359 15.4 Microfinance Opportunities’ Listening to Clients Series   360 15.5 The Cost of Failure: Equity Bank’s Painful Lesson   361 15.6 IT Disaster Recovery and Business Continuity Management   370 15.7 Audits Performed by the Internal Audit Department   372 16.1 Glossary of Funding Terms  380 16.2 Institutional Investors in Microfinance  388 16.3 Commercial Bank Investment in Microfinance  389 16.4 Aggregating Data on MIVs  390 16.5 The Changing Character of Structured Funds  393 16.6 Funding Concentration   396 16.7 Subordinated Debt and Regulatory Capital  399 16.8 Bond Issuance in Financial Services for the Poor  400 16.9 Quantifying Foreign Exchange Risk for Currency Mismatch  401 16.10 Specialized Currency Funds  402 16.11 Microcredit Securitization  404 16.12 Access to Capital Markets  407 16.13 Responsible Investor Principles  408 16.14 Microfinance Institutional Rating versus Mainstream Credit Ratings 409 16.15 Ratings for MIVs and Funds  410 17.1 Regulatory Impact Assessment  418 17.2 Examples of Tiered Approaches  420 17.3 Certain Prudential Requirements  421 17.4  Adjustments to Prudential Requirements to Accommodate Microfinance Activities  423 17.5 Financially Inclusive Ecosystems  426 17.6  Making Insurance Markets Work for the Poor—Emerging Guidelines for Microinsurance Policy, Regulation, and Supervision  428 18.1 Lighting Africa  438 18.2 IRnet for Credit Unions  440 18.3 Regional or National Switches   441 18.4 Payment Integrators  442 18.5 The Evolution of Credit Reporting in Ecuador  446 18.6  Modern Credit Databases: Transforming Low-Income Financial Services in South Africa  447 18.7 India’s New Unique Identification System  449 18.8 Training Courses for Capacity Building  451 18.9  Making Microfinance Work: The ILO’s MFI Management Training and Trainer Accreditation Program  452 Contents xi 18.10 Call Center at the First Microfinance Institution Syria  454 18.11 In Practice: Paraguay Financiera El Comercio  455 Figures I.1 Financial Access Strands—Country Comparisons (July 2012)  4 1.1 Financial Service Needs for Different Livelihood Segments  20 1.2 Stylized View of the Financial Ecosystem  27 1.3 The Range of Financial Service Providers  29 B1.9.1  Number of Clients, Loans, and Deposit Accounts in Africa, by Type of Provider  30 1.4 Market System Players and Facilitators  37 1.5  Evolution of Intervention Focus from Financial Institutions to Financial Systems  39 B2.1.1  Revenues and Inventory Expenses of a South African Small Businesswoman, Daily Cash Flows Aggregated Fortnightly  54 3.1 Financial Inclusion Strategies and Responsible Finance  80 3.2 Responsible Finance: A Multiple-Stakeholder Approach  86 4.1  The Role of Donors in Financial Market System Development 98 4.2 Stylized View of the Financial Market System  100 4.3 The Purpose of Donor Commitments   102 5.1 FinScope Financial Access Strand: Definitions  124 5.2 FinScope Access Frontier  124 B5.8.1 Access Strand Analysis  125 B5.8.2 Service-by-Service Analysis  126 5.3 Logic Model Definitions  130 B5.15.1 The Spectrum of Evidence  137 6.1 The Range of Financial Service Providers  150 7.1 The Range of Financial Service Providers  172 8.1 How Savings Can Improve the Lives of the Poor   200 10.1 Using the Value Chain for Agricultural Financing  237 10.2 The Warehouse Receipts Financing System  241 12.1  Relationship between the Customer, the Agent, and a Bank in Conducting a Mobile Banking Transaction  287 12.2  Monthly Costs in Dollars Associated with an Illustrative Transaction Account  294 13.1 A Platform Perspective  307 13.2 Transactions in Space and Time  311 13.3 Channel Mix  316 14.1  The Social Performance Process, Indicators, and Assessment Tools 343 xii The New Microfinance Handbook 15.1 Traditional Cost Allocation versus Activity-Based Costing   363 15.2  Relationship between Risk Management and Internal Control   366 15.3 Components of Internal Control   367 16.1 Sources of Microfinance Funding  385 B16.4.1 Source of MIV Funding  391 B16.5.1 REGMIFA’s Structure and Flow of Funds  393 16.2 Three Main Stages in the Processing of Large Public Issues  406 19.1 Variation of Credit Provision with GNI per Capita  460 19.2 Variation of Formal Financial Inclusion with GNI per Capita  461 19.3 Financial Frontiers  469 Tables 1.1 Gender-BasedObstaclesinMicrofinanceandMicroenterprise  25 1.2  Illustrative Solutions to Household Financial Management Needs 32 1.3 Key Characteristics of Facilitators and Providers in the Financial Market System  38 3.1  Potential Barriers to Effective Consumer Protection through Standards and Guidelines  91 4.1  Spectrum of Donors in Financial Inclusion and the Way They Operate  99 5.1 Research Methods and Their Usefulness  139 5.2  Main Poverty Assessment Tools Available for Microfinance Practitioners 140 6.1  Characteristics of Community-Based Financial Service Providers: Indigenous Groups  151 6.2  Characteristics of Community-Based Financial Service Providers: Facilitated Groups  157 7.1  Characteristics of Institutional Financial Service Providers 173 11.1 Two Long-Term Insurance and Savings Products in India  261 Key Indicators of Performance for Savings Group B14.1.1  Facilitation 323 14.1 Efficiency and Productivity Ratios (MFRS)  335 14.2 Profitability Ratios (MFRS)  336 14.3 Asset Quality (Portfolio Quality) Ratios (MFRS)  337 14.4 Capital Ratios (MFRS)  338 14.5 Liquidity Ratios (MFRS)  339 14.6 Balanced Performance Management  342 14.7 Indicators in the Social Performance Standard Report  344 Contents xiii 15.1 Roles and Responsibilities for Risk Management  365 16.1 Public and Private Funders  384 16.2 Holding Company Investment Examples  394 17.1 Regulatory Objectives for Microfinance  417 18.1 Implications of Telecommunications Connectivity for the Provision of Branchless Financial Services  443 xiv The New Microfinance Handbook FOREWORD When first published in 1998, Joanna Ledgerwood’s Microfinance Handbook was an indispensible guide for donors, policy makers, and practitioners who were working to expand access of the poor to microfinance. In the intervening years, the opportunities and pressures of commercialization have driven a reassessment of what microfinance is and whom it should serve. Today, in addition to building the capacity and ensuring the sustainability of institutions, the larger microfinance community is taking a closer look at the diverse needs of clients, the broader finan- cial ecosystem, and the transformational nature of technology. This reassessment has become a regular fixture of global conversations about poverty alleviation.  The New Microfinance Handbook, then, is timely. The microfinance sector now reflects the multidisciplinary intersection of finance, technology, and develop- ment, where new ideas are changing the art of what is possible. The actors reflect this diverse ecosystem and include everything from mobile operators to microfi- nance institutions to community networks. This book has brought an impressive array of the field’s experts to an area of practice in constant change. We are pleased that this book asks the hard questions about what people living in poverty really need. This means moving the conversation beyond the walls of insti- tutions and into the complex worlds of clients. The needs of a rural farmer are differ- ent from those of an urban microbusiness owner. A young woman embarking on a life after school has different priorities than a mother seeking to protect the assets of her family. For microfinance to deliver on its original promises, we need to put the needs of persons living in poverty at the center of this work. It is time for us to take stock of what we have learned as we move forward. The New Microfinance Handbook will play an important role, helping us to advance our understanding about how financial services can serve the diverse needs of the poor.  Reeta Roy Tom Kessinger President and CEO General Manager The MasterCard Foundation Aga Khan Foundation Foreword xv PREFACE Imagine a life without access to financial services: no deposit account, no debit card, no fire insurance, no college savings plan, no home mortgage. Life would be an incredibly stressful roller coaster ride, and most dreams would remain unfulfilled. The day you get paid for work would be good, the other days rough. Any accident would set your family back. Sending the kids to college? Too difficult. Buying a house? Forget it. Nobody can pay for such needs out of cash accumulated under the mattress. For us, life without access to financial services is unimaginable. Yet according to 2011 data from the World Bank, an estimated 2.5 billion working-age adults globally—more than half of the total adult population—have to do exactly that. They live a life without access to the types of financial services we take for granted. Of course, they cannot do without financial intermediation, so they rely on age-old, informal mechanisms. They buy livestock as a form of savings; they throw a village feast to cement local ties as insurance against a future family crisis; they pawn jewelry to satisfy urgent liquidity needs; and they turn to a moneylender for credit. These mechanisms are risky and often very expensive. Increasingly robust empirical evidence demonstrates how appropriate finan- cial services can help to improve household welfare and spur small enterprise activity. Macro evidence also shows that economies with deeper financial inter- mediation and better access to financial services grow faster and have less income inequality. Policy makers and regulators worldwide recognize these connections. They have made financial inclusion—where everyone has the choice to access and use the financial services they need, delivered in a responsible fashion—a global development priority. A powerful vision of responsible financial market development is ­ emerging—a vision that aims to bank the other half of the global working-age adult population by leveraging what we have learned from the microfinance story to date, using advances in technology to spur product and business model innovation, and encouraging new ways of thinking about how to create an enabling, risk-­ proportionate regulatory and supervisory environment. Preface xvii The New Microfinance Handbook reflects the current frontier of our collective thinking and experience. It starts with the need to understand the demand side. Poor households in the informal economy are producers and consumers. They need access to the full range of financial services to generate income, build assets, smooth consumption, and manage risks. The global financial inclusion agenda rec- ognizes these broader needs. It also recognizes the importance of financial literacy that builds consumer financial capabilities and of consumer protection regimes that take into account the conditions and constraints of poor families in the infor- mal economy. The Handbook also takes a broad look at the diversity of providers required to meet these needs and at the business model challenges of different products. The original microcredit revolution found an ingenious way to overcome the previous obstacle to providing credit for the poor. How do you manage credit risk and repayments at the local level when working with a segment of the p ­ opulation that has no traditional collateral? The breakthrough was the joint-­liability group loan— social collateral to allow the poor to pledge for each other. But the business model challenges are different for other financial services. For small-denomination sav- ings and remittances, transaction costs must be ultralow; for insurance, risks must be pooled and managed at an actuarially relevant scale; for pensions, micro contri- butions must be invested in ways that ­ generate adequate long-term returns. Continued innovation in products and business models is needed so that we can reach more people with a broader range of products at lower costs. No one type of provider will be able to overcome the very different business model challenges of all products. What is needed instead is a variety of financial service ­ providers that come together in a local-market ecosystem that works for the poor at the base of the economic pyramid. Lastly, the Handbook takes a fresh look at the enabling infrastructure and ­ regulatory environment. The infrastructure requirements range from a larger num- ber of low-cost, physical access points in harder-to-reach geographic areas to nationwide unique financial identities that facilitate consumer enrollment and pro- tection. On the regulatory side, policy makers are recognizing that financial exclu- sion poses a risk to political stability and impedes economic advancement, and they are increasingly willing to balance the ultimately mutually reinforcing needs for financial stability, financial integrity, and financial inclusion. With a better understanding of demand, ongoing innovation in products and business models to better meet that demand, and recognition of the need for a protective and supportive enabling environment, I believe we have the knowledge and the means to achieve full financial inclusion in our lifetime. Read on to learn how this is already happening and what more is needed. Tilman Ehrbeck CEO Consultative Group to Assist the Poor (CGAP) xviii The New Microfinance Handbook ACKNOWLEDGMENTS The writing of this book has been a highly collaborative effort and there are many people we wish to acknowledge and thank for their support and contributions. First of all, our Advisory Committee, composed of David Ferrand, Steve Rasmussen, Tom Austin, Ann Miles, and Benoit Destouches, provided sound guidance and leadership for which we are very grateful. We also appreciate the significant effort and expertise of the contributing authors, without whom this book would not have been published: Ines Arevalo, Craig Churchill, Daryl Collins, Mayada El-Zoghbi, David Ferrand, Barbara Gähwiler, Alan Gibson, Susan Johnson, Kate Lauer, Joyce Lehman, Ignacio Mas, Peter McConaghy, Calvin Miller, Geraldine O’Keeffe, Stuart Rutherford, Lisa Sherk, Stefan Staschen, and Joakim Vincze. In addition, we are deeply grateful to Peter McConaghy, who conducted excellent research and provided significant draft material for a majority of the chapters. We also thank those who contributed to specific chapters, including Cheryl Frankiewicz, Liz Case, Alyssa Jethani, Linda Jones, Emilio Hernandez, and Ruth Dueck-Mbeba. For their insightful feedback, we thank our peer reviewers of which there were many: Elizabeth Berté, Anita Campion, Liz Case, Gerhard Coetzee, Monique Cohen, Christoph Diehl, Thomas Engelhardt, Laura Foose, Cheryl Frankiewicz, Martin Habel, Michel Hanouch, Tor Jansson, Susan Johnson, Kabir Kumar, Kate Lauer, Joyce Lehman, Ignacio Mas, Janina Matuszeski, Sitara Merchant, Ann Miles, Hanif Pabani, JR Rao, Steve Rasmussen, Rich Rosenberg, Adam Sorensen, Ingrid Stokstad, Joakim Vincze, Leah Wardle, Martina Wiedmaier-Pfister, and Kim Wilson. In particular we are extremely grateful to Bob Christen for reviewing the initial draft of the book and suggesting a significant new direction that, at the time, seemed like a very big task but was exactly what was needed; we appreciate his honesty and guidance. We are indebted to Ruth Dueck-Mbeba, who reviewed the entire book, providing excellent feedback and suggestions as well as a signifi- cant portion of chapter 15. We are very grateful to The MasterCard Foundation and the Aga Khan Foundation for the support provided throughout the making of this book, in Acknowledgments xix ­ articular Reeta Roy, Ann Miles, Ruth Dueck-Mbeba, David Myhre, Tom Kessinger, p Mike Bowles, Erin Markel, Sam Pickens, Helen Chen, Jayne Barlow, and especially Tom Austin. We greatly appreciate the efforts and patience of Paola Scalabrin for her persis- tence in requesting this update, ensuring that the book was published, and her patience and advice during the process. We thank Aziz Gökdemir for a brilliant job managing the publication process and we extend our thanks to Elizabeth Forsyth and David Anderson for their excellent editing, as well as to Nora Ridolfi for dili- gently overseeing the printing of the book. Thank you as well to Ellie Mendez and Alyssa Jethani for checking sources. Joanna would like to thank Alan Gibson for sharing his deep knowledge and experience of the market systems framework, David Ferrand for suggesting we use the framework and his guidance in doing so, and Steve Rasmussen for his thought- ful and generous support. She also thanks Alyssa Jethani for taking on much of what needed to be done at the Aga Khan Foundation during the process of bring- ing this book together, for her high level of productivity, and for being a wonderful colleague. She is grateful to her family, especially Joakim, and her parents, for their consistent support throughout. In particular, she thanks her father, Doug Ledgerwood, for his guidance and advice during this project and always. Julie is grateful for the encouragement and technical guidance from her col- leagues at the International Finance Corporation, in particular Jean Philippe Prosper for his strong support and endorsement of this book to the World Bank publication committee; Tor Jansson for his numerous reviews of chapters; and Barbara Sloboda and David Crush for always finding a solution. She would also like to thank her many clients in Africa who have provided years of inspiration through their hard work and success in some of the world’s frontier countries. Finally, Julie thanks the many friends who have supported her work on this book with every- thing from advice, shelter, and a friendly ear; and gives a special thanks to her family for keeping her close despite how far away she lives. Candace has deep appreciation for several long-term colleagues who have done so much to cultivate and sustain her commitment to clients, including Paul Rippey, Monique Cohen, Kathleen Stack, Jeffrey Ashe, and Jennefer Sebstad. Seasoned professionals, they have inspired her with their intelligence, integrity, and passion. As ever, Candace is grateful to SEEP’s Savings-led Financial Services Working Group for its high degree of collaboration; she would especially like to thank the authors of the SEEP publication, Savings Groups at the Frontier, from which she drew extensively in writing chapter 6. Joanna Ledgerwood Julie Earne Candace Nelson xx The New Microfinance Handbook ABOUT THE AUTHORS Ines Arevalo is a consultant to the Aga Khan Agency for Microfinance. She holds an MA in Development Economics (University of Sussex) and focuses on client research and social performance management. Craig Churchill is the head of the International Labour Organization’s Social Finance Programme, which supports the use of productive and protective financial services, particularly for excluded populations. He serves as the team leader of the Microinsurance Innovation Facility and the chair of the Microinsurance Network. Daryl Collins is a Director at Bankable Frontier Associates, a niche consulting practice aimed at providing financial services to low-income people. She is also co-author of Portfolios of the Poor. Julie Earne is a Senior Microfinance Specialist at the International Finance Corporation. She has worked extensively throughout Africa, investing in and enabling financial sector development in frontier countries for more than 15 years. Mayada El-Zoghbi is head of CGAP’s office in Paris. She manages CGAP’s support to donors and investors as well as in the Middle East and North Africa Region. She holds a Master of International Affairs from Columbia University. David Ferrand is Director of Financial Sector Deepening Kenya, a multidonor facility supporting market development. He holds a PhD from Durham University and has worked in the financial inclusion field for 20 years. Barbara Gähwiler is a microfinance expert at GIZ in Tunisia and previously worked with CGAP’s donors and investors team. She holds a Master of International Affairs from University of St. Gallen and Sciences Po, Paris. Alan Gibson is a Director of the Springfield Centre. He has been influential in developing the “making markets work for the poor” (M4P) approach and in sup- porting its application in different spheres of development. Susan Johnson is a Senior Lecturer in International Development at the University of Bath. She has extensive research experience in the microfinance field, in particular in impact assessment, gender, and the embeddedness of local financial markets in social relations. About the Authors xxi Kate Lauer is a policy advisor to CGAP and a Senior Associate with Bankable Frontier Associates. She has a JD from New York University and has written and worked extensively on legal and policy issues related to financial inclusion. Joanna Ledgerwood is Senior Advisor at the Aga Khan Foundation, leading its financial inclusion initiatives in Africa and Central and South Asia. She is the author of the Microfinance Handbook and Transforming Microfinance Institutions with Victoria White. Joyce Lehman is an independent consultant focusing on financial inclu- sion. Previously Joyce was with the Bill & Melinda Gates Foundation, managing projects to support mobile payment platforms in Bangladesh and Pakistan. Ignacio Mas, an independent consultant, was Deputy Director of the Financial Services for the Poor team at the Bill & Melinda Gates Foundation, and Business Strategy Director at Vodafone Group. Peter McConaghy is a Financial Sector Development Analyst in the Middle East and North Africa Region at the World Bank, with a focus on expanding financial inclusion in postrevolutionary countries through policy reform, provider down­ scaling, and demand-side research. Calvin Miller is Senior Officer and Agribusiness and Finance Group Leader in the AGS Division, Food and Agriculture Organization of the UN (FAO). He has exten- sive experience in agricultural and value chain finance and investment in develop- ing countries. Candace Nelson is a trainer, facilitator, researcher, and writer with 30 years of expe- rience supporting microfinance, specifically financial education and Savings Groups, in Africa and Latin America. She is the editor of Savings Groups at the Frontier. Geraldine O’Keeffe is the Chief Operating Officer of Software Group, an informa- tion technology company focused on the provision of solutions to the financial sector. She has over 12 years of experience working with technology for microfi- nance, primarily in Africa. Stuart Rutherford is a microfinance practitioner and researcher. He is the founder of SafeSave, a Bangladeshi MFI, and cowrote two studies of  how poor people manage money: The Poor and Their Money and Portfolios of the Poor.  Lisa Sherk is an independent consultant based in Amsterdam. She specializes in microfinance investment fund management, focusing on financial and social per- formance assessments of microfinance institutions globally. Stefan Staschen is an economist specializing in regulation of inclusive financial sectors. He works as a consultant for CGAP, Bankable Frontier Associates, and others. He holds a PhD from the London School of Economics. Joakim Vincze is a consultant specializing in sustainable use of technology for development, focusing on providing affordable broadband Internet to rural areas. He holds an engineering degree and an MBA from the University of Western Ontario. xxii The New Microfinance Handbook ABBREVIATIONS AFI Alliance for Financial Inclusion COSO Committee of Sponsoring Organizations of the Treadway AKAM Aga Khan Agency for Commission Microfinance DFI development finance ALM asset-liability management institution AML anti-money-laundering EFT electronic fund transfer APR annual percentage rate EIR effective interest rate ASCA accumulating savings and credit FAS Financial Access Survey, IMF association FATF Financial Action Task Force ATM automated teller machine FinDex Global Financial Inclusion B2P business-to-person database BCBS Basel Committee on Banking FIU financial intelligence unit Supervision FSD Kenya Financial Sector Development CAR capital adequacy requirement Kenya CBS core banking system FSP financial service provider CDD consumer due diligence G2P government-to-person CDO collateralized debt obligation GDP gross domestic product CFT combating the financing of GNI gross national income terrorism GPRS general packet radio service CGAP Consultative Group to Assist the GSM Global System for Mobile Poor IAIS International Association of CLO collateralized loan obligation Insurance Supervisors Abbreviations xxiii ID identification PSP payment service provider IMF International Monetary Fund RCT randomized control trial IPO initial public offering RIA regulatory impact assessment IT information technology ROSCA rotating savings and credit association IVR interactive voice response RTGS real-time gross settlement KfW Kreditanstalt für Wiederaufbau SaaS software as a service KYC Know Your Customer SACCO savings and credit cooperative MDB multilateral development bank SAR Special Administrative Region MDI microfinance deposit-taking institution SAVIX Savings Groups Information Exchange Me2Me me-to-me (payment) SEEP Small Enterprise Education and MFI microfinance institution Promotion MFRS Microfinance Financial SG Savings Group Reporting Standards SHG Self-Help Group MII microfinance investment intermediary SIM subscriber identity module MIS management information system SMART specific, measurable, achievable, realistic, and time-bound MIV microfinance investment vehicle SMS short messaging service MIX Microfinance Information eXchange SPV special purpose vehicle MNO mobile network operator SRI socially responsible investing NBFI non-bank financial institution STK SIM Tool Kit NGO nongovernmental organization SWIFT Society for Worldwide Interbank Financial Telecommunication P2B person-to-business TCP transmission control protocol P2P person-to-person USAID U.S. Agency for International PAT poverty assessment tool Development PCG partial credit guarantee USSD unstructured supplementary PIN personal identification number services data POS point-of-sale VPN virtual private network PPI Progress out of Poverty Index WSBI World Savings Banks Institute PRA participatory rapid assessment WOCCU World Council of Credit Unions xxiv The New Microfinance Handbook Introduction Microfinance in 2013 widespread concern for “financial inclusion”5 is directing attention to the broader “financial eco- It has been 15 years since the original system” and how to make financial markets work Microfinance Handbook (Ledgerwood 1998) was better for the poor. For example, a recent CGAP written, and much has changed since then. Focus Note looks at the financial ecosystem Microfinance is now a household term with within the context of the supply of financial ser- frequent articles in the media about its growth, vices: “Different products present different risks innovation, and impact. The industry has grown and delivery challenges, and it is unlikely that a exponentially, in terms of both the number of cli- single class of service providers will effectively ents as well as the number and type of providers provide all the products poor people need. A key and products.1 The focus is no longer only on credit challenge is how to create the broader intercon- for investment in microenterprises: Today there is nected ecosystem of market actors and infra- broad awareness that poor people have many and structure needed for safe and efficient product diverse financial service needs, which are typically delivery to the poor” (Ehrbeck et al. 2012, p. 1). met by a variety of providers through multiple To this end, policy makers have begun to financial services. We know this because data have address financial inclusion in their economic much improved in the past 15 years,2 allowing us to agendas with the belief that access to financial better understand barriers to access and use, and services improves the ability of consumers to we are beginning to examine impact.3 access markets, which contributes to monetizing Over the years, the discourse has shifted the values of products and services, enables risk from  “microcredit” to “microfinance,”4 and now pooling, and allows value storage, thus affecting Introduction 1 economic growth and the overall stability of the expected increase in financial inclusion resulting system. from the gradual substitution of donor funding Increasingly, best practice in microfinance is with private sector capital has yet to happen. The responsible finance, defined as the delivery of retail majority of poor people remain outside the main- financial services in a transparent, inclusive, and stream financial sector, and many MFIs continue equitable fashion (BMZ, CGAP, and IFC 2011). to depend on subsidies. Consumer protection and financial capability are Looking forward, it appears likely that tech- now seen as important policy objectives, particu- nology will enable customer touch points to pro- larly in a context of new providers, more sophisti- liferate among nontraditional service providers. cated products, and technology-­ enabled delivery The technology drivers of financial inclusion will channels. Recent media attention to the significant come from innovations in mobile money, biomet- profits made through initial public offerings of ric identity systems, smart phones, and wireless microfinance banks6 have highlighted the need for broadband Internet access. At the same time, transparent pricing and appropriate interest rates. however, much remains to be learned to effec- Unlike 15 years ago, funding for microfinance tively increase outreach in a substantial way, today is no longer the purview of donors alone. As including, for example, developing appropriate of 2011 more than 100 microfinance investment regulatory frameworks for branchless banking vehicles were managing close to US$7 billion models (Alexandre 2010). Further, it is vitally (Symbiotics 2011), making private and quasi-­ important to better understand the social dimen- private sector capital readily available. With the sions of how households manage financial recognition that grant funding crowds out the resources, particularly in the informal sector, and private sector, responsible donors have shifted ­ the role of technology to work within these social from providing funds for loan capital and operat- dynamics (Johnson 2012). ing subsidies to more of a facilitation role Thus, the well-documented and widely ­ supporting the development of enabling environ- applauded achievements of microfinance are ments, provision of information, and financial increasingly coupled with recognition of its lim- infrastructure. itations and the need to take a more holistic view. Although significant investments have been Concerns include the following: made to reform regulatory systems to accommo- • Outreach—In many countries outreach date microfinance and transform microfinance remains a small percentage of the population; institutions (MFIs) into regulated institutions only 41 percent of adults in developing econo- complete with return-seeking investors, rela- mies report having an account at a formal tively few MFIs can absorb a significant amount financial institution,8 8 percent report having of capital. “However, the pool of investment-ready originated a new loan from a formal financial MFIs is small and is not expanding at the speed of institution in the past 12 months, and 2 percent the supply of equity investment. Indeed, 52 per- report having personally paid for health insur- cent of all foreign debt is channelled to only 25 ance (Demirgüç-Kunt and Klapper 2012); MFIs, out of a total of 524 MFIs that receive for- more than half the world’s adult population eign debt finance. At the country level, foreign does not use formal or semiformal services, investment is, to a large degree, still focused on a nearly all of whom live in Africa, Asia, and small number of countries in LAC and ECA7 with Latin America (Chaia et al. 2009). only moderate levels of financial exclusion” (Reille et al. 2011, p. 10). Given the concentration • Sustainability—Although figures are not pre- of investment in relatively few institutions, the cise, many microfinance operations continue 2 The New Microfinance Handbook to receive subsidies; commercial funding is might challenge this assumption, and are thus highly concentrated in Latin America and beginning to invest much more in assessing Eastern Europe, while most of the world’s impact, if we just look at access figures, how has poor (less than US$2/day) live in Asia and microfinance fared? Despite several decades of Africa (Wiesner and Quien 2010). Beyond significant investments in the sector, access to or direct microfinance operations, many other usage of formal financial services remains low, activities important in the microfinance sys- particularly in Sub-Saharan Africa (SSA) (see tem (for example, training, product develop- figure I.1). Data from the World Bank Global ment, and technical advice) are often Findex database (Demirgüç-Kunt and Klapper subsidized. 2012) shows that in SSA only 13 percent of indi- viduals aged 15 years and older saved at a finan- • Impact—Recent research based on random- cial institution in the last 12 months, and only 5 ized controlled trials (RCTs) has found the percent received a loan from a financial institu- impact of microcredit to be mixed. RCTs have tion. Such low usage does not, however, indicate shown that increases in consumption and weak demand; at the same time, 19 percent saved business investment do not always correlate in a savings club, and 40 percent received a loan with measures of poverty reduction (O’Dell from family or friends in the past year. In South 2010). Furthermore, the distribution of gains Asia figures are similar, with 11 percent saving in is uneven. The broader effect of microfinance a financial institution in the last 12 months and 9 on poverty is limited by low levels of usage percent receiving a loan from a financial institu- and persistent barriers to inclusion (Johnson tion.10 And yet the massively popular Self-Help and Arnold 2011). Group movement in India counted 97 million households affected by March 31, 2010.11 But At the heart of these concerns over the efficacy even this indication of participation is weak of microfinance is a better understanding of how when compared to the potential market of the the poor need and use financial services. Research 900 million households in India that live on less (Collins et al. 2009; Demirgüç-Kunt and Klapper than US$2 a day (Chen et al. 2010). 2012) has revealed that the poor manage their One reason for low outreach is the traditional financial lives with complex strategies that utilize microfinance business model itself, which is multiple forms of savings, lending, and bartering based on generating revenue from primarily pro- from a mix of formal and informal providers. ductive loans and other fee-based services to Achieving financial inclusion for the poor thus cover costs. Yet in microfinance, costs are high, cannot rely on MFIs alone; rather, it requires and the revenue base is relatively low. This is improving the quality and frequency of services especially true for the rural poor whose limited from a multitude of provider types and fully investment opportunities and capacity for debt understanding client behavior and how it affects translate into lower revenue for MFIs and banks financial service needs. who may lack the incentives, information, and sometimes ability to mitigate perceived risks of operating beyond urban markets or with very Measuring Progress poor clients. Thus it is important to focus on low- At the time of the original Handbook, a broadly ering costs both for institutions to provide ser- accepted assumption was that “increased vices and for clients to use them. And although access” and a “willingness to pay” provided a technology will continue to push this frontier, good proxy for impact.9 Although today we access figures alone may offer a misleading view Introduction 3 Figure I.1  Financial Access Strandsa—Country Comparisons (July 2012) RSA'11 63 5 5 27 Namibia'11 62 3 4 31 Swaziland'11 44 6 13 37 Botswana'09 41 18 8 33 Lesotho'11 38 23 20 19 Ghana'10 34 7 15 44 Nigeria'10 30 6 17 47 Zimbabwe'11 24 14 22 40 Kenya'09 23 18 26 33 Uganda'10 21 7 42 30 Malawi'08 19 7 19 55 Rwanda'08 14 7 26 53 Zambia'09 14 9 14 53 Tanzania'09 12 4 28 56 Mozambique'09 12 1 9 78 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Banked Other formal non-bank Informal only Excluded Source: FinMark Trust. Note: a. The formal sector is divided into a “banked” segment (the percentage of adults with a bank account), and a formal “other” segment (the percentage of the adult population with a formal financial product, such as insurance or a microfinance loan, but no bank account). Together, these two groups are defined as formally included. The informal sector comprises all the organizations that provide financial services but are not legally registered to do this business, for example, savings clubs, burial societies, and money- lenders. The informally serviced category in the access strand represents the percentage of adults with an informal product but with no bank account or a product from another formal financial institution. It is necessary to add the informal segment to the formally included segment to derive the percentage of the adult population that is financially served. Anyone who is not financially served is financially excluded, which means they are not using financial products (formal or informal) to manage their financial lives; for exam- ple, they may simply be using cash. See www.finscope.co.za. of benefits; increased access and more choice do improvement in access does not develop in a not automatically translate into effective client competitive manner, benefits may be restricted. use. For example, the major growth in access for Clients with limited information and/or choices saving services through the Mzansi account in may not be able to exert competitive pressure on South Africa disguised a large number of dormant providers to improve services. accounts, opened but often unused, because cli- Providers and other stakeholders need to take a ents either found better options for their needs or more proactive approach that recognizes the diver- were too poor to utilize the account.12 The path sity of barriers to access, the heterogeneity of from uptake (that is, opening an account) to usage consumers, and the variety of financial service ­ is still an uncharted course. needs among various lower income segments and Growth in access, especially if accompanied by underserved or excluded groups. Looking for major access to more diverse services, may require cli- impact from a single product or institution type ents with greater financial capabilities to ensure risks overlooking the inherent complexity of liveli- effective usage and benefits. As in any market, if hoods and financial service needs (see box I.1). 4 The New Microfinance Handbook Box I.1  A Market This Big Needs Many Types of Providers Back in 1982, when Citi made its first loan to a ­ opulation is unbanked. This is too big a seg- p nongovernmental or­ ganization (NGO), the mi- ment to cover with just one or two approaches crofinance world was much simpler. There and institutional forms. We have the ultra- were the few global networks, and we were poor and displaced people at one end of the ­ still using the term “micro­ credit.” It was a scale, and the very eco­ nomically active peo- much more focused, smaller community. The ple who might even be employed on the other industry has grown tremen­ dously since then. end. Their needs are different. From a few mil­ lion clients in the 1980s, I get concerned with some of the ar­ microfi­nance now reaches more than 190 guments that take place in microfi­ nance to- million families. We have seen tre­ ­ mendous day. It seems like there is an underlying as- growth in the size of microfinance organiza- sumption that there is only one type of tions and the scale of their operations, but we microfinance client and that client should be are also seeing that there is a price for grow- served by only one type of institution—when ing too fast—in any industry. You can grow the opposite is true. There are many different only so fast before burning out the staff, or client segments in micro­ finance, and MFIs you cannot bring on well-trained new staff to would do better to focus on each segment to keep up with your growth. develop the best business models to serve Most of this growth has come from organi- those clients. zations offering only one or two credit prod- In the next few years, the innovation needs ucts. The demand, the need, and perhaps the to be in designing products that fit who clients model lent itself to consistent growth be- are and what they want to become; we get cause it stayed very focused. However, fast there by get­ ting to know the clients, their growth of organizations using simi­ lar models needs, their cash flows and their aspirations and strategies in the same locations has led, much better. in some cases, to multiple loans to the same Within this microfinance ecosystem, we borrower and a breakdown of lending disci­ need some institutions to work with the very pline. We see these issues in Andhra Pradesh difficult-to-reach and vulnerable communities, in India where institutions’ client-base over- delivering social output of a very high calibre, laps are putting a lot of pressure on and they cannot then be devoted just to repayments. achieving scale and even full sus­ tainability. How do you provide financial access to the Their objective may never be to become a vast majority of the popula­ tion? It will take finance company, yet they may use financial ­ more than NGOs and commercial banks—we tools as one of the enablers toward progress need cooperatives, credit unions, and postal out of poverty along with health and educa­ tion savings banks. We need cell phone compa- training. nies that can make loan payments. We see Even as one part of microfinance becomes opportuni­ ties for many different services and more commercial, we have to keep thinking types of providers. about the many vulnerable, underserved, In most of the countries where we work, compli­ cated communities that mainstream anywhere from 60 to 80 per­ cent of the microfinance may not yet be able to reach. Source: Bob Annibale of Citibank, writing in Reed (2011). Reprinted with permission. Introduction 5 Redefining Objectives proposition (see box I.2). “While the language changed with insights and expanded horizons, At the time of writing the original Handbook, the the underlying fundamental idea has remained predominant microfinance model was an NGO the same: Help poor families in the informal MFI providing credit to microentrepreneurs for economy realize their economic potential and investment in microenterprises. This model was give them the financial services means to manage largely based on the belief that access to credit for their lives that most of us in the North take for productive investment would support entrepre- granted” (Ehrbeck 2012). neurship and economic development, empower Greater financial inclusion thus requires women, and alleviate poverty by generating addressing constraints and taking advantage of higher incomes and employment. However, opportunities in the financial ecosystem. increasing evidence of the impact of microfi- Stakeholders are now beginning to focus on the nance, particularly microcredit, indicates that it diversity of clients (geography, income levels, has some effect on the expansion of business and livelihoods, gender, life-cycle) and their needs increased profits, very little effect on women’s (growth, cash management, risk mitigation), as empowerment, and virtually no effect on poverty well as the wide range of financial services (credit, alleviation (O’Dell 2010). savings, payments, insurance), financial service Fifteen years later, the shift to financially providers (informal, MFIs, cooperatives, banks, inclusive systems, based in part on better under- insurance companies), and delivery channels standing impact, appropriately broadens the (branches, agents, mobile phones) to meet these objectives beyond economic development and needs. They are paying attention to the effective- poverty alleviation to include the ability of poor ness (social performance/impact, transparency, women and men to better manage risks, smooth and client protection) of financial services as well income, invest in productive activities, and build as the knowledge and skills that clients need to assets. These broader objectives demand more of use them (financial capabilities); the rules that stakeholders in terms of better understanding cli- guide financial markets (regulations, standards, ents and, in turn, delivering an improved value norms); the financial infrastructure (payment Box I.2  Latest Findings from Randomized Evaluations of Microfinance “The overall message from this body of work that allow it to view poor customers as individ- is that poor people face various limits, and uals. Some of those individuals will leverage their ability to capitalize on opportunities var- financial services to smooth consumption; ies greatly. … [N]ot all borrowers want to some to manage risk; some to make invest- grow a business. The variable results seen can ments they have the skill and resources to be as much a function of borrower intent as profit from; some will do all of the above. With borrower ability. A one-size-fits-all product will a view of serving all of these needs, microfi- not bring benefit to the borrowers or profit to nance providers may evolve a new generation the providers. Instead, the microfinance in- of improved services and products that reli- dustry needs to continue to mature in ways ably and flexibly help poor people.” Source: Bauchet et al. 2011. 6 The New Microfinance Handbook systems and credit bureaus) required to support providers, students and academics, and consul- well-functioning markets; and the information tants and trainers. services necessary to inform all stakeholders to Although this book is in part an update of the better improve the system. This book attempts original Handbook, the growth of the sector and to address all of these issues with the objective to the complexity of the financial market system promote financially inclusive ecosystems that have led to a perspective much broader than the work better for the poor. previous “financial and institutional perspective.” As a result, additional chapters have been added to address issues more relevant than when the About This Book original Handbook was written. To reflect this Given the importance of both understanding and complexity, we invited a number of experts to appreciating the complexities of financial ser- write many of the new chapters. In addition, vices for the poor, the New Microfinance Handbook given that this book does not go into as much takes a different approach from its predecessor. detail as the previous book did, a list of key In contrast to the “institutional” perspective resources at the end of each chapter provides (supply side) of the original Handbook, this book readers additional information on specific topics. considers first and foremost clients and their Finally, although the title still uses the term needs (demand side) and how the market system microfinance, the book very much addresses the can work better to meet these needs. It also wider financial ecosystem, moving beyond the attempts to address the rules and supporting traditional meaning of microfinance to inclusive functions required for financial markets to work financial systems. well and serve ever greater numbers of poor con- sumers. The result is a book that is less of a Book Structure and Content “how-to” guide but rather a description of the financial market system and the functions within The New Microfinance Handbook loosely follows it and how they work, or do not work, in serving the framework of the original Handbook and is the needs of the poor. The objective is to provide organized into five parts: a strategic guide to help assess the varied finan- Understanding Demand Part I:  and the cial service needs of poor people, and to then pro- Financial Ecosystem pose how a diversified financial sector can address these needs in an accessible and beneficial man- Part II: Financial Service Providers ner. Ultimately it is hoped the book will contrib- Part III: Financial Services and Delivery Channels ute to greater access to and usage of financial products and services that genuinely meet the Institutional Management for Scale and Part IV:  many needs of the poor through various sustain- Sustainability able market-based financial service providers. Part V: Supporting Financial Inclusion The New Microfinance Handbook provides a primer on financial services for the poor. It is Part I—Understanding Demand and the written for a wide audience, including practi- Financial Ecosystem updates Part I of the original tioners, facilitators, policy makers, regulators, Handbook and addresses big picture issues—the investors, and donors working to improve the financial landscape, clients, and strategies to financial system, but who are relatively new to achieve and measure financial inclusion. Given the sector. It will also be useful for telecommu- the changing landscape of the financial services nication companies and other support service sector, the book opens with Chapter 1—The Introduction 7 Evolving Financial Landscape, written by Joanna Providers, written by Joanna Ledgerwood, Ledgerwood and Alan Gibson, outlining three key describes financial service providers that are influences in financial services for the poor that more formal in nature. This grouping includes a are greatly affecting the way the sector is moving: wide variation of provider types, differing in the a renewed focus on clients, acknowledgment of services they provide as well as their ownership the wider financial ecosystem, and the potential structures, regulatory status, geographic focus, of technology. Chapter 2—Clients builds on the target markets, and objectives, but are similar in centrality of clients and financial management. that they have a more concrete structure than Drawing from Portfolios of the Poor (Collins et al. providers in the informal sector and are thus 2009), authors Stuart Rutherford, Daryl Collins, referred to as institutions. and Susan Johnson examine the financial service Parts I and II are the least technical parts of needs of poor people and how these needs are the handbook; they require no formal back- met. Chapter 3—The Role of Government and ground in microfinance or financial theory. They Industry in Financial Inclusion, written by Stefan will be of most interest to donors, policy makers, Staschen and Candace Nelson, addresses how key ­ students, and those interested in understanding players promote financial inclusion, from the role financial inclusion and the actors involved. of government as policy maker and legislator, to Part III—Financial Services and Delivery industry as it warms to responsible finance Channels expands on the original Handbook’s through self-regulation and the need for coordi- ­ discussion of savings and credit with new chap- nation. Chapter 4—The Role of Donors in Financial ters on agricultural finance, insurance, and pay- Inclusion, written by Mayada El-Zogbhi and ment services. It also addresses the many Barbara Gähwiler, focuses on the changing role of alternative channels that are beginning to show donors in microfinance and proposes ways to promise and includes a thought provoking chap- facilitate the market to work better for the poor. ter on supporting the poor through financial plan- Given that financial inclusion is on the agenda of ning tools. Chapter 8—Savings Services, written by many policy makers, much attention has recently Joanna Ledgerwood, considers the various sav- been invested in measuring it and assessing the ings products demanded by the poor and touches impact of using financial services. Supply and on the institutional capacity required to offer demand-side studies, impact assessment, and deposit services. Chapter 9—Credit, written by other rigorous research are addressed by Joanna Joanna Ledgerwood and Julie Earne, looks at Ledgerwood in Chapter 5—Measuring Financial pricing loans and types of credit products includ- Inclusion and Assessing Impact. ing traditional working capital and fixed asset Part II—Financial Service Providers updates loans, as well as newer products such as housing the original chapter 4 (The Institution), adding loans and leasing. Chapter 10—Agricultural an additional chapter to acknowledge the numer- Finance, written by Calvin Miller, acknowledges ous and varied providers in the informal sector. the substantial need for financial services for peo- Chapter 6—Community-Based Providers, written ple working in the agricultural sector (the vast by Candace Nelson, describes indigenous infor- majority of the poor) and the ways in which finan- mal providers, for example, moneylenders, cial products and delivery channels cater to meet deposit collectors, rotating savings and credit these needs. Although in the original Handbook associations and mutual aid groups such as burial insurance was only briefly mentioned, in this societies, and other providers such as Self-Help edition, given the growing importance of micro- ­ Groups and Savings Groups that are facilitated insurance in financial inclusion and acknowledg- by external agencies. Chapter 7—Institutional ment of the risk management needs of poor 8 The New Microfinance Handbook women and men, Chapter 11—Insurance, written Part V—Supporting Financial Inclusion is new by Craig Churchill, looks at the demand for micro- and includes four chapters that focus on the insurance, product characteristics, and delivery roles and functions of various stakeholders sup- mechanisms. Chapter 12—Payment Services and porting and promoting the overall financial eco- Delivery Channels, written by Joyce Lehman and system. Chapter 16—Funding, written by Julie Joanna Ledgerwood, describes transaction ser- Earne and Lisa Sherk, considers the significant vices such as money transfers and payments as role investors play in providing capital to finan- products in and of themselves, as well as the vari- cial service providers. Given the growth in the ous channels for delivering financial services. In number and diversity of providers, Chapter 17— particular, this chapter considers the different Regulation, written by Kate Lauer and Stefan ways in which clients access services through Staschen, addresses the laws and regulatory branchless touch points and the significant role frameworks in place to support proper oversight played by agent networks. Chapter 13—Beyond and safety of the financial market system and the Products, written by Ignacio Mas, proposes the various players. Chapter 18—Infrastructure, writ- delivery of financial products as an integrated ten by Geraldine O’Keeffe, Julie Earne, Joakim customer experience through mobile phones. Vincze, and Peter McConaghy, considers the sup- Part III will be of most interest to practition- porting functions required for well-functioning ers who are developing, modifying, or refining financial markets such as credit bureaus, deposit their financial products, as well as donors or insurance, clearing and settlement systems, and consultants who are evaluating financial ser- unique identification systems. Outsourced ser- vices for the poor and want to better understand vices such as “software as a service,” training, and financial products and services and ways to security are also described. Chapter 19—Building deliver them. Inclusive Financial Markets, written by David Part IV—Institutional Management for Scale Ferrand, uses the market system framework to and Sustainability includes two chapters and pro- discuss the roles development agencies can and vides an update of the original chapters on MFI should play to contribute to financial systems management. Chapter 14—Monitoring and that work more effectively for the poor, high- Managing Financial and Social Performance, lighting the different functions of market actors written by Joanna Ledgerwood, Geraldine ­ (service providers with ongoing roles) and those O’Keeffe, and Ines Arevalo, addresses core bank- facilitating the market (donors and other devel- ing systems and financial and social performance opment agencies with a temporary role). management. Chapter 15—Governance and Part V will be of most interest to those either Managing Operations, written by Peter providing or supporting the development of McConaghy, looks at various facets of institu- mesolevel functions in the financial ecosystem. tional providers including governance, human resource management, product management, and risk management. Part IV is more technical than Notes previous parts of the Handbook. Although specific  1. Total numbers are difficult to find, but David institutional performance is somewhat less Roodman in “Due Diligence—An Impertinent important given the client and financial system Enquiry into Microfinance” (2011, p. 67) focus of this book, Part IV is included for the ben- estimates there were close to 180 million loans efit of practitioners and/or funders interested in outstanding and 1.3 billion savings accounts at the operations and performance of institutions “alternative financial institutions” in 2000 and providing financial services to the poor. “microfinance has grown a lot since then.” Introduction 9  2. For example, national-level FinMark Trust’s credibly) can be difficult and expensive. FinScope surveys, www.finmark.org.za, and Addressing this dilemma, there is a school of Global Findex databases, http://data.worldbank thinking that advocates certain ‘proxies’ for .org/data-catalog/financial_inclusion. impact. Otero and Rhyne have summarized  3. For example, see Financial Access Initiative recent microfinance history by saying that (FAI), http://financialaccess.org; Abdul Latif there has been an important shift from Jameel Poverty Action Lab (J-Pal), http:// focusing on the individual firm or client of www.povertyactionlab.org/about-j-pal; and financial services to focusing on the Innovations for Poverty Action (IPA), http:// institutions providing services. This financial poverty-action.org. systems approach ‘necessarily relaxes its  4. Microfinance as defined by CGAP in CGAP attention to “impact” in terms of measurable Occasional Paper 15, “The New Moneylenders: enterprise growth and focuses instead on Are the Poor Being Exploited by High measures of increased access to financial Microcredit Interest Rates?” (Rosenberg et al. services’ (Otero and Rhyne 1994).” 2009), “usually refers to the provision of 10. Account at a formal financial institution financial services to poor and low-income denotes the percentage of respondents with an clients who have little or no access to account (self or together with someone else) at conventional banks. The term is often used in a a bank, credit union, another financial more specific sense, referring to institutions that institution (for example, cooperative or use new techniques developed over the past 30 microfinance institution), or the post office (if years to deliver microcredit—tiny loans—to applicable) including respondents who informal microentrepreneurs. The range of reported having a debit card (Demirgüç-Kunt services can include not only microcredit but and Klapper 2012). also savings, insurance, and money transfers.” 11. www.shgportal.com.  5. The ACCION Center for Financial Inclusion 12. E-mail exchange with Gerhard Coetzee, April defines financial inclusion as “Full financial 4, 2012, and Bankable Frontiers Associates inclusion is a state in which all people who (2009). can use them have access to a full suite of quality financial services, provided at affordable prices in a convenient manner, and References with dignity for the clients. Financial services Alexandre, Claire. 2010. “Policymakers Create are delivered by a range of providers, Room for Experimentation with Banking most of them private, and reach everyone beyond Branches.” Global Savings Forum, Bill & who can use them, including disabled, Melinda Gates Foundation, Seattle, WA, poor and rural populations” (www November. .centerforfinancialinclusion.org). Bankable Frontier Associates. 2009. “The Mzansi  6. See http://www.economist.com/node/ Bank Account Initiative in South Africa, Final 11376809 for information on the Compartamos Report.” Commissioned by FinMark Trust. Banco IPO. Somerville, MA, March.  7. Latin America and the Caribbean (LAC) and Bauchet, Jonathan, Cristobal Marshall, Laura Europe Central Asia (ECA). Starita, Jeanette Thomas, and Anna Yalouris.  8. Defined as “a bank, credit union, cooperative, 2011. “Latest Findings from Randomized post office, or microfinance institution” Evaluations of Microfinance.” Access to Finance (Demirgüç-Kunt and Klapper 2012). Forum, Reports by CGAP and Its Partners No. 2.  9. In chapter 2 of the Microfinance Handbook CGAP, Washington, DC, December. (Ledgerwood 1998, p. 49) Tom Dichter wrote, BMZ, CGAP, and IFC. 2011. “Advancing “Doing impact analysis well (and therefore Responsible Finance for Greater Development 10 The New Microfinance Handbook Impact: A Stock-Taking of Strategies and Johnson, Susan, and Steven Arnold. 2011. Approaches among Development Agencies and “Financial Exclusion in Kenya: Examining the Development Finance Institutions.” Changing Picture 2006–2009.” In Financial Consultation draft, Responsible Finance Inclusion in Kenya: Survey Results and Analysis Forum, Bonn and Washington, DC. from FinAccess 2009, ed. Steven Arnold et al., Chaia, Alberto, Aparna Dalal, Tony Goland, chapter 5. Nairobi: FSD Kenya and Central Maria Jose Gonzalez, Jonathan Morduch, and Bank of Kenya. Robert Schiff. 2009. “Half the World Is Ledgerwood, Joanna. 1998. Microfinance Unbanked.” Financial Access Initiative Handbook: An Institutional and Financial Framing Note. Financial Access Initiative, Perspective. Washington, DC: New York. World Bank. Chen, Gregory, Stephen Rasmussen, Xavier Reille, O’Dell, Kathleen. 2010 “Measuring the Impact of and Daniel Rozas. 2010. “Indian Microfinance Microfinance: Taking Another Look.” Grameen Goes Public: The SKS Initial Public Offering.” Foundation, Washington, DC. CGAP Focus Note 65, CGAP, Washington, DC, Reed, Larry R. 2011. “The State of the Microcredit September. Summit Report 2011.” Microcredit Summit Collins, Daryl, Jonathan Morduch, Stuart Campaign, Washington, DC. Rutherford, and Orlanda Ruthven. 2009. Reille, Xavier, Sarah Forster, and Daniel Rozas. Portfolios of the Poor: How the World’s Poor 2011. “Foreign Capital Investment in Live on $2 a Day. Princeton, NJ: Princeton Microfinance: Reassessing Financial and Social University Press. Returns.” Focus Note 71, CGAP, Washington, Demirgüç-Kunt, Aslı, Thorsten Beck, and Patrick DC, May. Honohan Beck. 2007. “Finance for All? Policies Roodman, David. 2011. “Due Diligence—An and Pitfalls in Expanding Access.” Policy Impertinent Enquiry into Microfinance.” Research Report, World Bank, Washington, DC. Center for Global Development, Washington, Demirgüç-Kunt, Aslı, and Leora Klapper. 2012. DC, December. “Measuring Financial Inclusion: The Global Rosenberg, Rich, Adrian Gonzalez, and Sushma Findex.” Policy Research Working Paper 6025, Narain. 2009. “The New Moneylenders: Are the World Bank, Washington, DC. Poor Being Exploited by High Microcredit Ehrbeck, Tilman. 2012. “More than Semantics: Interest Rates?” Occasional Paper 15, CGAP, The Evolution from ‘Microcredit’ to ‘Financial Washington, DC, February. Inclusion.’ CGAP Blog, May 16. Symbiotics. 2011. “Symbiotics 2011 MIV Survey Ehrbeck, Tilman, Mark Pickens, and Michael Report: Market Data & Peer Group Analysis.” Tarazi. 2012. “Financially Inclusive Ecosystems: Symbiotics, Geneva, August. The Roles of Government Today.” Focus Note Wiesner, Sophie, and David Quien. 2010. “Can 76, CGAP, Washington, DC, February. ‘Bad’ Microfinance Practices Be the Johnson, Susan. 2012. “What Does the Rapid Consequence of Too Much Funding Chasing Uptake of Mobile Money Transfer in Kenya Too Few Microfinance Institutions?” Really Mean For Financial Inclusion?” CGAP, Discussion paper I no. 2. ADA, Washington, DC. Luxembourg, December. Introduction 11 PART I UNDERSTANDING DEMAND AND THE FINANCIAL ECOSYSTEM CHAPTER 1 The Evolving Financial Landscape Joanna Ledgerwood and Alan Gibson Historically, the promise of poverty alleviation Many events have influenced the landscape for through microcredit was tied primarily to one financial services for the poor, but three signifi- product—the productive loan invested in a micro- cant “big picture” influences warrant discussion enterprise—delivered primarily by one type of and are the subject of this opening chapter. provider—a microfinance institution (MFI). Yet The first has been a shift from a narrow focus reality belies the premise of this model: clients do on the institution and its performance to a much not always use loans for productive purposes; broader focus on clients—understanding their they have either limited capacity to use invest- behavior, financial service needs, and how various ment credit or more pressing needs for products providers can better meet these needs. This that support consumption or income smoothing. shift  has been brought on by the recognition—­ Today, there is broad recognition that access to supported by significantly better data and more capital is only one of the inputs required for eco- robust research—that outreach and, perhaps nomic development and poverty alleviation. more important, impact have not been as Furthermore, there is wide acknowledgment that expected. This is also the result of a widening the poor, like anyone, require and use a variety of view of microfinance. No longer limited to invest- financial services for a variety of purposes. And ing in microenterprises, microfinance now some of these services work better than others, encompasses all financial services and how to for reasons we are just beginning to understand. provide them in a way that improves the quality Since the original Microfinance Handbook was of life of poor women and men. written, the field of microfinance has changed The second important shift, which greatly substantially, particularly in the last few years. influences this book, has been from a narrow The Evolving Financial Landscape 15 ­ upply-led view to a broader focus on the finan- s Focusing on clients is a welcome and neces- cial ecosystem. In addition to a renewed focus sary shift. However, the end game cannot simply on consumers (demand), proponents of the be to develop new products or make adjustments “systems” approach acknowledge the variety of ­ within institutions; an institutional response providers and services, including the substantial alone is not enough. We need to understand con- role of the informal sector. They also acknowl- sumer behavior and how it influences financial edge the need for effective rules that govern the service needs and use. While the ultimate solu- system and supporting functions such as credit tion may be a better product or service, an easier bureaus or payment systems. The result has been way to access an account, or a lower-cost delivery a much more holistic view of the sector and a option, to get there we need to appreciate the more coordinated effort by government and nuances and contextual factors that affect how industry to focus on increasing financial inclu- poor women and men behave and which financial sion and, ultimately, making markets work better services are of most benefit to them, for what pur- for the poor. pose, and why. For example, market research con- The third shift has been the massive opportu- ducted with MFI clients in Bolivia indicates that nity to expand outreach through new business clients identify respect as their greatest priority; models based on branchless banking using tech- product attributes are important, but they are not nology and agent networks. However, while the the most important consideration (Perdomo opportunity seems vast, to date only a few branch- 2008).3 Clients want to preserve their dignity less banking applications have reached significant when interacting with a financial institution, and scale. At the time of writing, this area of tremen- they want to borrow without fear or humiliation. dous promise requires a lot more work and test- To accomplish these goals, they need to under- ing to understand and determine ways to take stand the services they use and the contracts they advantage of the opportunities that technology sign, and providers need to value and invest in presents. customer service. The solution is unlikely to be This chapter considers each of these influ- simply new or more products. ences and places the new landscape in context. It Understanding how consumer behavior trans- will be of interest to readers seeking to under- lates into financial service needs requires under- stand some of the major influences in microfi- standing the uniqueness and heterogeneity of nance today. Each of the topics is introduced here clients and how life-cycle events, livelihoods, and elaborated in more detail in various chapters geography, income levels, and gender influence that follow. their behavior. The following section discusses the characteristics that define and influence client behavior and financial service needs, while chap- Focus on Clients ter 2 provides an overview of how clients use Almost everywhere, people involved in microf- financial services based on findings from Portfolios inance are talking about clients.1 As a result, of the Poor.4 the language of microfinance is changing. Initially microcredit became microfinance with Age, Life-Cycle, and Family Structure the recognition of the need for savings services; Financial needs and vulnerabilities change as today policy makers and industry players use people move through the life-cycle—from terms like inclusive finance, access to finance, dependence on family to independence and financial ecosystems, and financial inclusion from school to work, marriage, family responsi- (see box 1.1).2 bilities, and retirement. Sons migrate in search 16 The New Microfinance Handbook Box 1.1  From Microfinance to Financial Inclusion Financial inclusion is a multidimensional, pro- collection of loan payments collapsed in the client concept, encompassing increased Indian state of Andhra Pradesh (Chen, access, better products and services, bet- Rasmussen, and Reille 2010). These isolated ter-informed and -equipped consumers, and crises serve as a warning that microcredit can effective use of products and services. Putting cause trouble for clients. Over-indebtedness this concept into practice requires more than can increase financial and social vulnerabil- institutional expansion and portfolio growth, ity as borrowers take new loans to repay old goals that drove early development of the ones or resort to extreme measures to microfinance industry, when the original make their payments, including reducing Handbook was written. Balancing clients’ their consumption of food and selling pro- interests and providers’ viability, financial ductive ­assets. Such measures can lock bor- inclusion incorporates effective policies, legis- rowers into a downward spiral with severe lation, industry and consumer protection stan- consequences. dards, and financial capability. At the same time, innovation is bringing Several developments have converged to new customers and new service providers refocus thinking about best practice in finan- into the market. Diversification of products cial services for the poor. Commercialization and services has already resulted in more of microfinance has raised concerns about choices for consumers. However, although mission drift, eliciting calls for paying attention such diversity indicates a maturing industry, to social performance and the “double bottom increased access and more choice do not line,” which relies on strong financial perfor- automatically translate into effective use. ­ mance to fulfill a social mission. Further Simply opening an account does not mean ­ concerns have emerged with regard to high that it will be used. Effective use is ham- interest rates and private gains from public pered by asymmetries of information as well offerings of MFI shares and the concentration as unsuitable product features or accessibil- of investments in a small number of countries ity requirements (for example, minimum bal- and institutions. Microfinance, as the “new ances, age restrictions, regular contributions, asset class, may not be the newest emerging affordability, and distance to branch or cus- market; relatively few MFIs can absorb a sig- tomer service point). This can lead to an nificant amount of capital. imbalance of power between financial insti- ­ Furthermore, in some countries, client tutions and poor consumers, an imbalance over-indebtedness is attributed in part to mar- that grows as inexperienced and ill-informed ket saturation, with a narrow range of credit customers (for example, millions of unbanked products and competition among MFIs push- owners of mobile phones who are potential ing lenders to make increasingly risky loans mobile banking customers) choose among and pursue harsh collection practices when increasingly sophisticated products without repayment has faltered. In the first decade of recourse to adequate protective or grievance the new century, delinquency rates rose dra- measures (Cohen and Nelson 2011). matically in some countries, and, in 2010, the Note: This box was contributed by Candace Nelson. The Evolving Financial Landscape 17 of more income; young mothers manage child- acute vulnerabilities, including loss of produc- birth expenses, health care, and nutrition; par- tivity due to deteriorating health, physical ents struggle to educate their children. Widows immobility, and the loss of family support as are threatened with loss of land and other assets children become independent and develop their to their husbands’ relatives. Elderly clients face own financial commitments (Hatch 2011). These Box 1.2  Youth Financial Services: An Opportunity for the Future The 1.5 billion people between the ages of most cases, the scope of the products has 12 to 24 in the world today represent the larg- expanded to include interventions to provide est number of youth ever on the planet. Of financial education, develop capacity, and these, 85 percent, or 1.3 billion people, live in build youth skills, knowledge, and capital, developing countries (World Bank 2011). including life skills training, workforce training Although the “youth bulge” is declining in (such as vocational education), and mentoring East Asia and Central Europe, the youth popu- and internship or apprenticeship programs. lation is expected to grow in Sub-Saharan Community-managed finance models, includ- Africa for the next 40 years. In 97 developing ing savings-led groups and rotating savings countries, half of the population is 25 years of and credit associations (ROSCAs), have been age or younger. Worldwide, 47 percent of the adapted for youth and have shown promise. unemployed are youth. Most young people in Some preliminary evidence suggests that developing countries do not have access to access to financial services has improved the the financial services and education that ability of young people to manage their would help them to be productive, engaging finances and plan for their own futures. These citizens in their economies. results suggest that efforts are needed to This explosion of youth constitutes an innovate and experiment with product design immense challenge and opportunity for human as well as bundled packages of services that development. Youth is an excellent time to integrate financial with nonfinancial services. learn responsible habits and attitudes with Together, these offerings support the develop- regard to saving, borrowing, spending, using ment of a better-informed and financially insurance, and investing. Appropriate financial savvy generation. services, tailored to the unique needs and Youth financial services remain a niche field people to capabilities of youth, can help young ­ within the larger financial services industry, manage their finances better and potentially to driven mainly by a few donors, large interna- start and expand microenterprises to support tional nongovernmental organizations (NGOs), themselves and their families. and a few innovative providers. If we are to However, age restrictions, identification meet the needs of this growing segment of requirements, and relatively low profitability the population and ensure that they have the of small deposit accounts or loans can make it skills and resources to be economically active difficult for providers to meet the needs of citizens, we need to mainstream youth finan- young people. This nascent field has seen cial services within the financial inclusion much innovation in the past few years. In agenda—both nationally and globally. Source: Nisha Singh, Small Enterprise Education and Promotion (SEEP) Network. Statistics are from http://www .photius.com/rankings/population/median_age_total_2008_0.html, compiled from CIA 2008. 18 The New Microfinance Handbook changes result in the need for different financial compound, often combining financial resources services at different life-cycle stages. in order to meet daily needs or respond to emer- Other life-cycle events, such as celebrations, gencies. Similarly, income is often shared among religious ceremonies, or building a home, require the larger family. While saving may be difficult lump sums that are often hard to accumulate for an individual, sharing income facilitates risk without adequate financial services. Financial management in the absence of formal services exclusion is strongly influenced by age, with (see box 1.3). youth facing significant hurdles (Johnson and In many contexts, community elders control Arnold 2011; see box 1.2). To be relevant, finan- assets and decide how they will be distributed cial service providers must modify products, ser- throughout a given community. Thus an individu- vices, and delivery channels to accommodate al’s ability to access services may depend on his or differences in life-cycle and age. Providers can her social position relative to that of more senior respond to differing needs by developing members in the community. age-specific products, such as youth savings accounts or pension funds. Livelihoods, Geography, and Income Levels Family structure can also affect how financial The financial pressures of managing inconsistent services are used. In many communities, the income to cover daily expenses, unexpected concept of family extends well beyond spouses, emergencies, and life-cycle events weigh heavily siblings, children, and grandparents. Cousins, on the poor. Although millions of people—from distant relatives, and even neighbors are an the poorest of the poor to the economically active integral part of a family. Polygamy further poor to small business operators to salaried increases the size and complexity of the family ­ workers—face similar pressures, their responses structure. A large family may live together in one and need for financial services vary depending on Box 1.3  Gambian Family Structure and Impact on Financial Behavior and Demand A remittance landscape study conducted in and keep money away from male family The Gambia by Women’s World Banking members. ­ provides insight into how family structure In addition to earnings from small-scale affects the demand for financial services economic activities, women in The Gambia (Orozco, Banthia, and Ashcroft 2011). Women also depend heavily on international remit- often live in polygamist households and play tances to feed the family, send children to central roles in managing the household school, and pay for food and clothes for reli- budget. For many Gambian women, the gious events. In focus groups, many women financial goals of purchasing land or building said that remittance-linked savings accounts up savings often take a back seat to the would help them to meet their financial goals, ­ day-to-day financial needs of the extended but because of the financial needs of their family. Women often save in informal com- ­ extended family and the cost and time of get- munity-based savings clubs called ososus ting to a bank, consistent use of a savings because they are close at hand, c ­ onvenient, account would be challenging. Source: Banthia and McConaghy 2012. The Evolving Financial Landscape 19 their livelihoods and where they live, which, in products to address a multitude of financial ser- turn, affect their income level. vice needs. Historically, microfinance has focused on Geography matters as well. For example, peo- microentrepreneurs, with loan products designed ple living in rural areas likely earn income from primarily for traders with daily or weekly cash agricultural activities that generate very different flow and in need of short-term working capital. cash flows than traditional “microenterprises.” However, by focusing on productive credit, Financial services for smallholder farmers need microfinance providers may have missed serving to suit their cash flows and consider the produc- the majority of the potential market. As demon- tion and marketing risks specific to a given crop strated in figure 1.1, of the 1.6 billion working (see chapter 10). However, in general, it is more poor, less than 500 million are microentrepre- expensive for providers to operate in rural areas, neurs or salaried wage workers; the rest earn limiting clients’ choices and challenging provid- their income, likely low and irregular, from ers to reach scale, particularly where population farming, casual labor, fishing, and pastoral density is low, access to markets or supplies is activities (Christen 2011). They, like anyone, limited, and infrastructure is undeveloped. Rural need access to financial services to manage areas often have higher covariance risk due to the their daily lives, and they need a variety of lack of a diversified economic base and the risk of Figure 1.1  Financial Service Needs for Different Livelihood Segments Livelihood segment sizing Financial service needs (millions of people) 80m fishermen & pastoralists Asset protection 100m unemployed Payment and 180m micro– transaction mechanisms entrepreneurs 300m low Catastrophic health wage salaried event protection 1.6 billion working-age adults Start-up living on less than 370m casual laborers capital US$2 a day Consumption smoothing 610m small-holder Risk farmers protection Safe savings Source: Wyman 2007. 20 The New Microfinance Handbook crop failure or drought; in some rural areas, a his- Over the years, we have learned that the eco- tory of poorly designed rural credit programs nomically active poor rather than the poorest of (subsidized and/or directed credit, no savings the poor stand to benefit the most from access to mobilization) can affect people’s perceptions of financial services (without other interventions). financial services. “The majority of the world’s estimated 150 mil- And while having a bank account may seem lion microcredit clients are thought to live just more useful for an employee who receives regular below and, more often, just above the poverty wages than for, say, a laborer who is paid in cash, line” (Hashemi and de Montesquiou 2011, 1). farmers, wage earners, and laborers would all From the perspective of both the client and benefit from having access to a safe place to save the provider, it is generally more expensive to for lump-sum expenditures or respond to an transact in smaller amounts with greater fre- emergency or new opportunity (see box 1.4). quency. For providers, smaller transaction In addition to how consumers generate amounts also result in a smaller revenue base— income, the amount of income affects their access for example, people with lower incomes gener- to and need for financial services. To meet varying ally have lower savings balances, less capacity to income levels, products and services need to have take on debt, and fewer opportunities to gener- characteristics—minimum balances, eligibility ate income. Together, this makes it very difficult criteria, fees, and benefits—appropriate to each to provide financial services to the extremely level. poor. Box 1.4  The Financial Service Needs of the Poor in Mexico Although the need to save and borrow is common across all groups of people, the ability to save and pay back debt is constrained by illiquidity. Ideally, financial services should help people to create liquidity and increase their financial assets: • Formal salaried workers who earn a stable income would value a portfolio of savings products that provide options to save with different terms, returns, and liquidity features, including simple savings products to help plan for both foreseen and unforeseen expenses and commitment savings to achieve longer-term goals. They would also value ­ having easy access to credit or savings for smoothing shortfalls and meeting emergency needs and to transactional services for putting away money temporarily or transferring it to others. • Entrepreneurs who earn a variable income would value a portfolio of savings and credit options that provide liquidity to respond to business opportunities and smooth out expenses across business cycles. • Seasonal or agricultural workers have the most irregular income, often insufficient in itself. These households usually engage in multiple endeavors to supplement income and group together in extended families to pool resources and share expenses. They would value sav- ings services, insurance, and small loans for emergencies. Perhaps the most vulnerable, this group would benefit the most from broader financial planning and literacy. Source: Faz and Breloff 2012. The Evolving Financial Landscape 21 For the extremely poor, cash or asset transfers, individuals may be ­ systematically denied access rather than microcredit, are often a better solu- because they are from a lower caste or a different tion, at least initially. If possible, placing cash religion (see box 1.6). transfers into a bank account appropriate for the Islamic finance is possibly the best-known poor can also support financial inclusion (see example of religion influencing financial transac- chapter 3). tions. Islamic finance is based on Islamic or sharia While the majority of providers serve the law, but despite the term “law,” Islamic finance is economically active poor, an innovative model based largely on cultural norms. According to for providing financial services to the poorest Karim, Tarazi, and Reille (2008, 6), “Indeed, in Bangladesh, developed by BRAC, is being sharia compliance in some societies may be less a replicated in countries around the world (see ­ religious principle than a cultural one—and even box 1.5). the less religiously observant may prefer sharia-­ compliant products.” Ethnicity, Caste, and Religion A key overriding principle of Islamic finance is Building and maintaining a level of trust in all the need to provide for the welfare of the commu- circumstances can improve financial inclusion, nity by prohibiting practices considered unfair or and it is particularly important when different exploitative. Fundamental to the provision of ethnic or religious groups are involved. Caste, Islamic financial services is the inability to give or while not solely an ethnic factor, can pose cul- receive a fixed, predetermined rate of return. This tural barriers similar to ethnic differences. In principle is banned based on two sharia precepts: countries where caste systems or religion are money has no intrinsic worth, and providers of central to a community’s social organization, funding must share the business risk (Karim, Box 1.5  Reaching the Poorest: Lessons from the Graduation Model BRAC works in 70,000 rural villages and 2,000 small loans to accelerate livelihood develop- urban slums in Bangladesh, providing microfi- ment. In less than 20 years, the program nance, schooling, health care, legal services, reached 2.2 million households. In 2002 BRAC and marketing facilities. Realizing that its fine-tuned its approach, both through better microfinance programs were not reaching identification of the ultrapoor (defined as peo- many of the poorest, in 1985 BRAC partnered ple who spend 80 percent of their total expen- with the government of Bangladesh and the diture on food without attaining 80 percent of World Food Program to add a graduation lad- their minimum caloric needs) and through a der to an existing national safety net program set of more intensive, sequenced inputs. that was providing the poorest households By 2010, BRAC had reached around with a monthly allocation of food grain for a 300,000 ultrapoor households with this new two-year period. The graduation model is built approach, termed Challenging the Frontiers of on five core elements: targeting, consump- Poverty Reduction/Targeting the Ultra Poor. tion support, savings, skills training and regu- BRAC estimates that more than 75 percent of lar coaching, and asset transfers. BRAC these households are currently food secure worked with beneficiaries, eventually adding and managing sustainable economic activities. Source: Hashemi and de Montesquiou 2011. 22 The New Microfinance Handbook Box 1.6  Religion and Caste in India The caste system describes a stratification in provides indispensable conditions for capital which social classes or subclasses of tradi- accumulation: “In India, religious affiliation tional Hindu society are separated by distinc- can govern the creation and protection of rent, tions of hereditary rank, profession, or wealth. the acquisition of skills and contacts, the Different castes engage in different produc- rationing of finance, the establishment and tive activities according to their historical defense of collective reputation, the circula- connections. Skills are passed on through ­ tion of information, the norms that regulate apprenticeships gained through social net- the inheritance and management of property, works based on kin, caste, and locality. Caste and those that prescribe the subordination of is least flexible where social disadvantage is women” (Harriss-White 2004). In addition, most entrenched and poverty is most pro- religious groups provide insurance and last-­ found. Lower levels of technology are resort social security. Jains, for example, are relegated to lower castes—for instance, the ­ often wealthy local merchants, moneylenders, dalits have to carry heavy loads on their heads; and pawnbrokers who have indirect power they cannot use wheelbarrows. Workers over the local rural economy through webs of themselves may enforce caste stratification credit. The Muslim traders of Pallavaram, in to protect their place in the labor market. contrast, are limited in their economic growth Studies in India have found that religion by their lack of access to finance. can supply a collective identity, which, in turn, Source: Harriss-White 2004, as summarized on microLINKS. Tarazi, and Reille 2008). While these principles targeting a programme towards women. It reflect widely held beliefs, sharia-compliant reg- means recognising the position of women in ulatory frameworks are just beginning to be relation to men as actors in society: in the con- developed. text of husbands and families; local community Religion and ethnicity can also affect the abil- and authority; and more broadly their position ity of women to access services. For example, in in society at the national level as governed by some cultures women are home-bound for reli- laws and custom. Then it is necessary to act to gious reasons and unable to meet with providers support women to overcome the obstacles they outside the home or to form groups with other face in these relationships which prevent them women. Similarly, some cultures prohibit male from using financial services to achieve what staff from visiting female clients. Gender-based they wish for themselves (Johnson 2000). rules and norms can have a significant impact on Women often lack control over cash manage- both the financial service needs of women and ment within their household and may be depen- their ability to access and use services. dent on their husband to access financial services. Moreover, rules often prevent women from Gender owning assets or participating in wage-earning ­ Recognizing gender issues in microfinance, as activities outside the household (see box 1.7). For ­ in any project intervention, means more than example, in Morocco, women’s mobility outside The Evolving Financial Landscape 23 Box 1.7  The Embeddedness of Financial Service Use in Gender Norms in Kenya Research in the rural areas of central Kenya are less likely to use ROSCAs and more likely indicates that the use of formal and infor- to use banks or SACCOs to manage lump mal financial services is strongly influenced sums and hold them until needed or, if possi- by gender relations (Johnson 2004). Men ble, take loans. are much more likely to have accounts with Social differences also affect how men and banks or savings and credit cooperatives women engage with financial services. For (SACCOs), but women are much more example, men and women differ in their atti- likely to use informal group-based systems, tudes toward the social consequences of fail- especially ROSCAs. Men are also much ing to make a payment in a ROSCA. Women more likely to use M-PESA—e-money pay- said that they would experience embarrass- ment and transfer—services (Johnson and ment and shame if they were unable to pay Arnold 2011). the contribution; they would view this as It is necessary to understand how the divi- “spoiling” the group. Men said that they would sion of labor and control of income in the not be ashamed of not paying, would not trust household influences the type of financial ser- each other to make the system work, do not vices that men and women need. While like the strictness of the rules, and realize that women contribute important labor to agricul- little could be done if they did not pay. tural activities, men usually control the activi- Consequently, in Kenya, women’s ROSCAs are ties with the highest financial returns; women more successful than men’s ROSCAs. likely control smaller income streams, which These differences reflect deeply rooted enable them to pay for food and other house- gender norms. Women’s groups have a long hold items needed on a regular basis. These history in Kikuyu society, and participation is differences in income flows result in gender-­ considered an important social skill; groups differentiated demand for financial services. socialize women in how they should act and For women, ROSCAs are an ideal way of behave. Groups also enable women to pro- turning small but fairly regular incomes into a ­ vide some of the household essentials. larger amount over a period of weeks to pur- Additionally, since property, especially land, chase goods such as household utensils, blan- tends to be under men’s control, to the extent kets, or clothes. Moreover, the timing of these that land is used as collateral, men are more needs is not especially critical. Men’s incomes able to borrow from banks than women. are often larger and tend to be received in However, in Kenya men do not have exclusive lump sums. Men are responsible for larger control of land, and the family must agree to purchases, such as assets or farm inputs. its use as collateral. Women can refuse if they They find it difficult to make regular contribu- think the loan may be misused. In addition, tions to ROSCAs at levels that would produce men usually hold the licenses for the produc- the size of payouts needed. Also, since some tion of cash crops (tea, coffee) and can open of their expenditures have specific timing, an account with a crop-based savings and many men in a ROSCA may require access to credit cooperative, while their wives are usu- the payout at the same time. As a result, men ally simply a cosignatory. Source: Susan Johnson, Centre for Development Studies, University of Bath. 24 The New Microfinance Handbook Table 1.1  Gender-Based Obstacles in Microfinance and Microenterprise Wider community or Type of obstacle Individual Household national context Financial Women lack access Men control cash income and Men are perceived as controllers to banks or financial their expenditure patterns do of money and loans  services in their own not support the household right Economic Women undertake Women are underpaid for equal Households are characterized activities that work; women are locked in by gender division of labor, produce low returns; low-paid jobs; stereotypes unequal access and control of women have a determine the appropriate roles for land, labor, and inputs, and heavy domestic unequal control of jointwomen in the economy; women workload household produce and lack access to markets for inputs income streams from thisand outputs if their mobility is constrained due to social norms  Social or cultural Women are not Women have a limited role in Banks and financial institutions do literate or educated; household decision making; not view women as a potential girls’ education is polygamy results in conflict, market; women’s mobility is not prioritized  competition, and discrimina- constrained by social norms  tion between wives; violence toward women is common Political or legal Women lack Women lack legal rights to Women’s legal rights to household confidence to claim jointly owned household assets are not defined in law or political and legal assets useful for collateral; women lack rights political positions to establish appropriate laws; women lack both traditional and formal legal rights to land Source: Johnson n.d. the home is restricted, and women’s work is often The Financial Ecosystem associated with shame, as it reflects a man’s inability to be the sole financial provider (Banthia While understanding the behavior and needs of et al. 2011). clients is paramount, many stakeholders are also Table 1.1 outlines the most prevalent gen- concerned with the wider financial ecosystem der-based obstacles affecting financial service and how it affects financial inclusion (or exclu- access and use. sion). Financial inclusion efforts focus on how the Altogether, the need for and ability to use and supply of financial services (products and ser- benefit from financial services depend to a great vices provided by sustainable institutions) can extent on age and life-cycle income levels, cul- better meet demand; they also acknowledge the tural context, and gender. The more we under- functions within the wider market system that stand client characteristics and influences on support financial transactions. their behavior, the better equipped we will be to The contents of this book are shaped by the increase financial inclusion in a meaningful way. market system approach (see M4P Hub 2008). The Evolving Financial Landscape 25 This approach provides a practical means of • Core. Transactions between providers and cli- assessing consumer behavior, the demand for ents (supply and demand) and supply of financial services, and the r ­ules • Rules. Informal and formal rules that shape and functions that support transactions. the behavior of market players, including Whether financial service needs translate into consumers demand that is met by a financial service pro- vider depends on many factors, including the • Supporting functions. The collection of func- degree to which providers are sufficiently tions that provide information and services informed to identify client needs, potential cli- supporting the development and expansion of ents have information about providers, and trust the core. exists between the two. Beyond this, a provider’s ability to develop and offer an appropriate prod- Understanding financial market systems uct is shaped by its capacity in relation to product involves breaking down each of these functions development and delivery channels and by its into more detail to identify specific elements incentives to improve them. For example, do reg- within them and the main players who are likely ulations encourage the development and expan- to be directly engaged (see figure 1.2). Each set of sion of services? Do the laws on collateral functions can be viewed in isolation, yet in prac- requirements promote overall financial inclu- tice functions only have value when seen as inte- sion? Can providers access funding to support gral parts of a wider ecosystem. By incorporating growth? Do they have the right legal form and the interests and incentives of clients and other networks to do so? Do credit bureaus exist, and key market players and the influence of rules and are they effective? Does the accessible infrastruc- supporting functions with regard to financial ser- ture promote overall financial inclusion? Equally vice provision, the market system framework important, how do the attitudes and norms acknowledges that only by understanding the among both consumers (for example, to loan entire system can we address the constraints to repayment) and providers (for example, to risk and take advantage of the opportunities for and reward) influence financial inclusion? increasing financial inclusion (see box 1.8). This section describes the financial market system, specifically the functions within it and The Core the roles played by various market actors. A mar- Offering a combination of the appropriate ket system necessarily includes both private and instruments and an understanding of how public sector actors as well as civil society and, these can be used practically within the con- indeed, consumers themselves. Because the term text of current livelihoods and existing social market is often equated only with the private sec- and cultural norms will enable and encourage tor, the term ecosystem is used interchangeably people to shift towards improved management with market system in this book (see Ehrbeck, of their finances. The heart of the market sys- Pickens, and Tarazi 2012). tems approach is to understand the demand side and support customer-focused develop- Functions of the Market System ment and innovation driving the supply side. There are three main sets of functions in a market (FSD Kenya). system, each carried out by various market play- ers, including the private sector, government, For financial market systems to work more NGOs, community groups, representative associ- inclusively and successfully, two characteristics ations, and consumers. must be present. First, the number of transactions 26 The New Microfinance Handbook Figure 1.2  Stylized View of the Financial Ecosystem MARKET FUNCTIONS MARKET PLAYERS SUPPORTING FUNCTIONS Clients Information Funding Coordination Infrastructure Private sector Research Technical assistance Capacity develop- Advocacy Government ment Demand CORE Supply Community groups Representative associations Formal Not-for-profit sector rules Informal rules RULES must increase; expanding the access frontier to discussions are provided in the chapters that include previously excluded people is a key indi- follow. cator of financial system development and an offi- cial goal of many financial authorities. Second, Demand: Clients products must accurately address the needs of As discussed in the previous section on clients, clients, improving their lives or businesses.5 A poor households are in continual need of finan- better-functioning core is therefore manifested in cial tools to improve their productivity and secure more and better-quality transactions. The key the best possible consumption and investment players in the core of the market are clients choices, all the while managing potential or exist- (demand) and financial service providers (sup- ing risks. Understanding demand requires both ply), connected to each other by products (sup- an understanding of the financial service needs of ply). The following discussion provides a brief clients and, as well, their behavior with regard to overview of demand and supply. More detailed existing financial services. The Evolving Financial Landscape 27 Box 1.8  Understanding the Financial Market System For any organization involved in financial demand; it involves the many other functions market development—for-profit companies, ­ that influence transactions—attitudes and NGOs, governments, investors, donors, and values, skills, product and organizational other development practitioners—an under- ­ devel­ opment, regulations, and policies. These standing of the financial market system is ­ provide information, knowledge, and incen- important when considering their objectives tives that determine behavior and practices and roles. Building on a detailed understand- and shape relationships. ing of market systems and a clear vision of the The players in the system thus extend well future of financial inclusion, the market sys- beyond the “simple” duopoly of clients and tems approach guides stakeholders to providers to include government, private sec- address systemic constraints and bring about tor service providers, associations, and com- large-scale, sustainable change. It is through munities. When the functions and players in the development of inclusive and sustainable financial market systems work well, benefits financial market systems that financial ser- follow. When they do not, consumers, espe- vices will make a meaningful difference in the cially the poor, are likely to receive limited or lives of poor people and promote economic temporary benefits. Sustaining the benefits of growth. access depends on the stability of the finan- The financial market systems framework cial system and its ongoing ability to provide recognizes how different players fit within services and, indeed, ensure that people’s the system, including their main functions and savings are not put at undue risk. the relationships between them. Although the A functioning and inclusive financial market central function in market systems is to pro- system, therefore, is characterized by strong vide a space for transactions, the nature and and sustainable performance—demonstrated efficiency of those transactions are shaped by by size and outreach (number of clients and formal and informal rules and a range of sup- number and variety of providers), depth and porting functions. While supply-side factors quality (poverty level and degree to which (offering financial services) are crucial to mak- products meet client needs)—and the capac- ing the financial system work better for the ity and competence of rules and supporting poor, achieving this goal is more complicated functions, allowing the market to learn, adapt, than a straightforward equation of supply and and develop in a sustainable manner. Analyzing data from financial diaries collected 100 percent of their income. This reveals a remark- across Bangladesh, India, and South Africa, able resourcefulness, but when transaction costs Collins et al. (2009) suggests a much more com- don’t scale with transaction size, fragmenting plex picture of demand than previously assumed: transactions over many informal instruments can “The authors of the book, Portfolios of the Poor, be very costly. Therefore, they not only need found that households used between eight and 10 financial tools, they need well-performing and different types of mostly informal financial instru- cost-effective financial tools” (Kendall 2010, 1). ments with very high turnovers—often 10 times The poor often prefer the informal sector on the asset values through the year and more than most dimensions important to consumers (access, 28 The New Microfinance Handbook flexibility, product features, and service quality). While financial service providers are often However, informal financial mechanisms may characterized as formal, semiformal, or informal, entail cost, inconvenience, embarrassment, and traditionally referring to their regulatory status, sometimes depletion of the very social capital on we classify them as either community-based which they are built. More needs to be under- (generally informal with no legal status) or insti- stood about how the informal sector expands out- tutional (generally more formal and in some cases reach, if and how those relying on the informal regulated).6 sector are underserved, and how the quality of Community-based providers include both consumers’ lives could be improved as a result of individuals (such as friends and family, money- access to formal financial services. Chapter 2 pro- lenders, shop owners, traders, and deposit vides a more detailed discussion of demand and collectors) and groups, including indigenous ­ how we can learn from the informal sector and groups, such as ROSCAs and accumulating sav- the behavior of clients. ings and credit associations (ASCAs), and facili- tated groups trained by external agencies, such as Supply: Providers Savings Groups (SGs) and Self-Help Groups While most of the first microfinance institutions (SHGs). While more formal than ROSCAs, these were established as NGOs, the sector has evolved facilitated groups are not considered to be “insti- to include many types of providers. Specialized tutions,” as they, for the most part, are not legally commercial banks providing a range of financial licensed as financial service providers, have few services have proven that the poor are “bankable,” expenses, and provide services primarily within while member-based community groups have the group itself (see chapter 6). shown that financial services can be provided Institutional providers include member-owned directly by the community on a sustainable basis. financial cooperatives and NGOs, which are nor- Providers are discussed in detail in part II of this mally registered and possibly supervised, as well book; an overview of the types of providers is as banks (private and public), deposit-taking included here and illustrated in figure 1.3. MFIs, and non-bank financial institutions (NBFIs) Figure 1.3  The Range of Financial Service Providers Community-based providers Institutional providers Community-based groups Registered institutions Individuals Regulated institutions ROSCAs, ASCAs Financial cooperatives Moneylenders Deposit-taking MFIs Burial societies SACCOs Deposit collectors Savings and postal banks Savings groups Suppliers, buyers Pawnbrokers State banks Self-help groups NGO MFIs Traders Commercial microfinance banks Financial service Mutual insurers Shop owners Non-bank financial institutions associations Money transfer companies Friends, family Commercial insurers CVECAs Mobile network operatorsa Level of formalization Note: ROSCAs = rotating savings and credit associations; ASCAs = accumulating savings and credit associations; CVECAs = caisses villageoises d’épargne et de crédit autogérées; SACCOs = savings and credit cooperatives; NGO = nongovernmental organization; MFIs = microfinance institutions. a. Mobile network operators are regulated as communication companies; most are not licensed to provide financial services. The Evolving Financial Landscape 29 such as insurance companies and leasing compa- operators (MNOs) can offer services conveniently nies, which are normally regulated in some fash- in rural areas, although relatively few have ion (see chapter 7). achieved scale (see box 1.9). No single type of organization presents an While recent years have witnessed a consider- optimal solution to reaching all market segments able increase in the commercial provision of with all types of financial services. In remote rural microfinance and the emergence of publicly listed areas, the low cost structure and proximity of microfinance companies, informal providers user-owned and managed providers constitute remain the main source of financial services for significant advantages over more structured the vast majority of the poor. For example, MFIs or commercial banks. However, credit FinAccess data provide strong evidence that unions and banks have the advantage of being Kenyan consumers use a portfolio of financial able to offer a wider variety of products or a services. Of those using regulated formal services, broader spectrum of terms and conditions and only 11 percent rely solely on a formal service, 31 may be more reliable than community-based pro- percent use a semiformal service, 13 percent use viders. New entrants such as mobile network an informal service, and the remaining 45 percent Box 1.9  The Range of Providers in Sub-Saharan Africa In 2011 the Microfinance Information eXchange (MIX) compiled a data set on financial inclusion for Sub-Saharan Africa. The data set brought together information from more than 60 distinct industry resources along with hundreds of individual institutions, covering some 23,000 provid- ers of financial services reaching low-income populations in Africa. Africa has a diverse land- scape of financial service providers—of which specialized MFIs are an important part—but the poor also access financial services through banks, credit unions and cooperatives, postal sav- ings banks, SGs, and many other types of providers. Figure B1.9.1 shows the outreach of differ- ent types of providers across Africa. Figure B1.9.1  Number of Clients, Loans, and Deposit Accounts in Africa, by Type of Provider Provider type Credit union/Cooperative Mobile network operator NBFI/NGO Bank Savings bank Savings groups Postal savings bank 0M 5M 10M 15M 20M0M 2M 4M 6M 0M 5M 10M 15M 20M Number of clients Number of loans Number of deposit accounts Source: Linthorst and Gaul 2011. 30 The New Microfinance Handbook use all three categories of services. Similarly, The main financial services include savings, more than half of those who have a semiformal credit, payments, and insurance and are provider as their most formal source of finance described in part III of this book.7 While finan- also use an informal source. Furthermore, this cial products and services are generally defined pattern of multiple service use has increased from by standard characteristics such as term, size, 2006 to 2009. In 2009, a mere 2.5 percent of price, returns, and eligibility, their appeal to con- Kenyans relied solely on the regulated formal sec- sumers often depends on their reliability, acces- tor (FSD Kenya FinAccess data for 2011). sibility, flexibility, safety, and affordability. For example, products are accessible when provid- Supply: Products ers explain product features so that clients Clients benefit from having access to products understand the commitment they are making. that match the way they live and conduct business Products are safe if they are well-structured and and support them in addressing challenges. The meet client needs in a transparent way without irregularity and limited size of cash flows mean doing harm. Increasingly, more flexible terms that products that permit frequent, small, incre- and conditions are being offered, including the mental transactions are more useful and conve- ability to repay loans early, receive increases in nient than, for example, services that require a existing loans, and open savings accounts with minimum transaction amount or take significant no minimum balance. Payment services, loans time to access. Products provided directly in the for housing and education, or savings accounts community are generally used frequently because specifically for youth, as well as more complex they are accessible, convenient, and in close prox- products such as leasing and ­ insurance are imity to where poor people live (see box 1.10). beginning to reach low-income populations. Box 1.10  Savings-Led Financial Services in Bangladesh SafeSave, one of the world’s first MFIs to walks to households in the neighborhood, pro- offer basic money management services to viding services to individual clients. Clients poor clients, takes a client-centered approach, may deposit as little as Tk 1 (US$0.015) when acknowledging that the tiny incomes of poor the collector calls. Accounts with balances people are often irregular and unreliable, forc- above Tk 1,000 (US$15) earn 6 percent inter- ing them to use a complex set of financial est. Clients may withdraw up to Tk 500 per management strategies. With minimal access day (US$7.50) at their doorstep or up to to formal sector providers, they often save in Tk 5,000 per day (US$75) at the branch office. the home, borrow from moneylenders, and Long-term savings products are offered as participate in savings clubs—devices that are well as credit. All borrowers start with a credit accessible, but not always reliable. SafeSave limit of Tk 5,000 (US$75), but loans are not tries to provide the strengths of informal mandatory. A minimum passbook savings bal- finance, while redressing its weaknesses. ance equal to one-third of the loan balance is SafeSave offers savings and loan services required as collateral at all times. In March to anyone living within walking distance of a 2010, for the first time, SafeSave’s savings branch office. Six days a week, a collector portfolio surpassed its loan portfolio in value. Source: SafeSave (http://www.safesave.org/). The Evolving Financial Landscape 31 As services become more client-centered, prod- demand (the main financial service needs, uct delivery is also developing through innova- including cash management, accumulating tive channels (see chapter 12). lump sums, risk management, and money trans- Table 1.2 provides a simple illustration sum- fers) and supply (how poor people meet those marizing the core of the market system, that is, needs). Table 1.2  Illustrative Solutions to Household Financial Management Needs Financial man- Day-to-day cash Accumulating agement needs management lump sums Coping with risk Transferring money Default mecha- Carry cash Hide cash in a secret Reduce consumption; Deliver in person; nism used by the place sell assets send by friend or excluded family member Benefits Zero fees; zero Zero fees; zero Requires no planning Cheap; possible transaction costs; transaction costs; social benefits fully liquid fully liquid Costs High risk of Very high risk of Hardship; reduce Risk of theft or expropriation; no loss; lack of savings potential future diversion; time- ability to borrow discipline; too income consuming; slow accessible; loss of real value Community- ROSCAs; shop ROSCAs; ASCAs ROSCAs; other Bus or minibus taxi based mecha- credit community groups; nisms typically moneylenders used Benefits Zero fees; very Zero fees; very low Highly flexible; Familiar mechanism; low transaction transaction costs; very low transaction no access costs; social savings discipline; costs; social sup- requirements benefits investment returns ports; very rapid (ASCAs) response Costs Inflexible terms; risk Risk of loss; loss of Unpredictable Risky; slow; difficult of loss; unpredict- privacy availability; potentially to access; able; hidden costs high fees; high expensive of shop credit contingent liability Institutional Bank transaction Bank savings Insurance; emer- Mobile phone-based mechanisms account account gency credit payment typically used Benefits Fully flexible; secure Secure (deposit Can cover extreme Lower risk; fast; (deposit protection); protection); moves risks; no contingent easy to access; facilitates pay- savings ”away from liability; risk cover can lower cost ments; can lead to temptation”; can be defined credit access lead to credit access Costs High withdrawal High minimum High premiums or Account and fees; day-to-day balances; day-to-day interest rates; subscriber identity access difficult access difficult; low accessibility; long module (SIM) card returns and unpredictable required claims process Source: David Ferrand, FSD Kenya. 32 The New Microfinance Handbook Rules and Supporting Functions together create the de jure parameters that shape Rules and supporting functions influence the behavior (of clients and providers). Informal effectiveness of transactions (the core of the mar- rules are usually unwritten and are invariably ket) and provide an enabling environment to more nebulous and ill-defined than formal rules; allow markets to grow, adapt, and succeed in they manifest themselves in attitudes, behavioral changing circumstances. Ensuring that they norms, social organizations, and common prac- improve and increase transactions supports tices. These informal rules often drive incentives financial inclusion. and behavior and determine the extent to which Who establishes and enforces rules and who formal rules are adhered to (see box 1.12). provides supporting functions differs by f­ unction. The key players in relation to formal rules are Some functions, such as regulations, are appro- government organizations and industry associa- priately considered a “public good”; the key play- tions. The increasing complexity of financial sys- ers are the government and policy makers and, tems and new innovations within them—such as on occasion, business associations. Others, such the emergence of mobile banking—pose new as credit bureaus or rating agencies, are more challenges for rule makers in terms of not only appropriately provided by private sector firms what rules should be, but who should make and (see box 1.11).8 implement them. Formal rules play a public or collective role in Rules market systems, leveling the playing field for A broad term used to define the rules of the providers and consumers. Formal rules affect game,9 rules include formal rules (regulations clients by setting legal frameworks and industry and standards) and informal rules (social con- standards that influence market access, the ventions and cultural norms). Formal or infor- range of products, and the competitive land- mal rules—the rules themselves and their scape, which, in turn, affect providers and their enforcement—govern participation and behavior ability to serve their markets appropriately. For in financial market systems and strongly influ- example, the legal ability to enforce contracts ence financial market outcomes. Formal rules and register assets, the existence of a national have a defined, written set of responsibilities identification system, or the protection of public that are allocated to specific parties, which deposits are all critical parts of the “formal rule” Box 1.11  Key Rules and Supporting Functions for Savings Services • Rules. Prudential and supervisory regimes that balance increased access with stability and depositor protection • Operational and human resource development. A combination of training services and tech- nical consultancy aimed at building provider capacity • Payment systems. Requires collaboration between public and private players, enables orga- nizations to take deposits and transfer funds • Deposit insurance. Whether public or private sector–based, requires savings organizations to agree on deposit requirements Source: Glisovic, El-Zoghbi, and Foster 2011. The Evolving Financial Landscape 33 Box 1.12  Formal and Informal Rules Formal rules consist of the written laws, gov- ferent individuals based on a combination of ernment policies, formal regulations, and social norms, culture, and historical factors. industry standards that are formally docu- Any specific community tends to adopt such mented and (sometimes) enforced. They are rules, codes of conduct, and regulations based shaped and influenced by the informal rules of on a combination of norms associated with the society or business community. In turn, different social institutions. Sometimes these they influence how informal rules are informal rules fill an obvious gap in the formal expressed in the performance of the market. legislation. Informal rules are often psycholog- Informal rules are unwritten, tacit rules that ically internalized: not merely unwritten, but define acceptable roles and activities for dif- beneath people’s conscious attention. Source: microLINKS wiki 2010. system. Formal rules are discussed in more capital, where systems and structures have been detail in chapters 3, 17, and 19. developed to build trust and foster social and eco- Informal rules are an integral part of local cul- nomic transactions beyond the family and kin ture, value systems, and practices. By definition, group, it will be easier and less costly to build sus- they are not the responsibility of one player. tainable systems for financial intermediation Although particular individuals or organizations (Bennett 1997). may exert considerable influence, informal rules Informal rules can contribute to the effective- emerge organically and are the result of traditions ness of formal rules when the norm is compliance and habits influenced by social institutions, such or when formal rules codify informal norms as gender, religion, caste, tradition, inheritance already widely accepted (microLINKS wiki rights, and landownership.10 For example, accord- 2010), such as Islamic finance principles now ing to microLINKS wiki (2010), “Typically these being incorporated into regulatory frameworks. gender norms are expressed through informal Informal rules may also emerge in response to (and formal) rules that lead to discriminatory formal rules that do not work well for a particular property and inheritance laws, for example, differ- group or do not exist. For example, a village leader ent access to resources, and to restrictions on the can “vouch” for borrowers in the absence of a tasks or places of work that women may occupy.” credit bureau or can verify property ownership in Norms suggest a standard of conduct that the absence of a housing registry. Given that people believe they ought to follow to avoid sanc- ­ informal rules reflect long-held beliefs and social tioning (Coleman 1994). Social and cultural structures, they typically are difficult to change norms surrounding attitudes toward money, (although some can be addressed by corrective sharing, and authority can greatly influence the regulation or judicial decision). type of financial services that are most useful in a Informal rules also influence the supply side given community. Trust, for example, plays an of the market. They may be manifested in, for integral role in the decision to use a particular example, industry norms in relation to innova- financial service or adopt a set of financial behav- tion and risk, which, in turn, drive attitudes and iors (Shipton 2007). In societies with high social practices to develop new products. And for 34 The New Microfinance Handbook ­ roviders of all sizes, the level of trust clients p institutions do change and evolve in response to have, as well as the norms regarding repayment new technologies or interaction with new cul- of loans, is critical in determining the incentives tures. For example, mobile money may make it for increased financial inclusion. For example, easier to transfer money from urban to rural historical experience such as conflict or disaster areas, thus resulting in less reliance on commu- can create social dynamics that persist for gen- nity solidarity to manage risks and deal with erations, such as a lingering lack of trust, a lack emergencies.11 Understanding informal rules of available resources, infrastructure, and oppor- provides insight into what will work within a tunities, and overall difficulty in establishing particular community (see box 1.13). relationships and creating solidarity in the com- munity. Communities marked by significant eth- Supporting Functions nic conflict may be less receptive initially to Supporting functions provide the resources, peer-based group lending models that have his- information, and services that shape financial torically worked very well in microfinance. market behavior and enable markets to grow, Alternatively, a community where cash is less adapt, and succeed in changing circumstances. prevalent than in-kind assets ­potentially requires Weak supporting functions (and inappropriate unique financial services ­ outside traditional rules) leave markets vulnerable, lacking the credit and savings products. ­ necessary depth to be sustainable and fit into a While some informal rules may appear changing world. The composition and nature of unproductive, they serve an important purpose, supporting functions, and who provides them, such as providing a social safety net. These rules vary from one context to another but are con- might include shared access to income, common cerned generally with information and communi- understanding of property, and rigid social cation, capacity building, coordination, resource structures, as discussed earlier. However, social development, and innovation. All of these support Box 1.13  Understanding Informal Rules through Financial Landscapes The methodology (and metaphor) of financial landscapes seeks to examine the path through which the poor access services in relation to the world around them, including, for example: • Spatial. How distance and ease of travel in locating providers affect access to services, taking into account settlement patterns and physical infrastructure • Historical. How past policies and approaches have shaped existing service provision and attitudes • Sociocultural. How social and personal networks develop in response to limited access • Economic. How patterns of income and expenditure shape the demand for services. This type of research seeks not only to throw light on the specific situations of households but also to examine how this affects financial service provision and access. In doing so, a more complete picture should emerge of both the core and the “informal rules” that have shaped its development. Source: Bouman and Hospes 1994. The Evolving Financial Landscape 35 the core function—the exchange between clients • Funding. Can take various forms, such as (demand) and service providers (supply). equity or debt. The key players here are pri- Because they differ from one context to vate investors, but in practice, especially for another, there is no comprehensive list of sup- microfinance, a range of social investors are porting functions. However, the following are active, often supported by donor funds, not some of the main functional areas: usually seeking a commercial (or indeed any financial) return. • Capacity development. Concerned with devel- oping capacity of various players including • Infrastructure. The range of technical and policy makers and providers. It therefore may other support services required to enhance the involve training services or other means by efficiency of the overall system. This could which employees learn new skills. In more include credit bureaus, deposit insurance, and established markets, capacity development for accounting services. The key players are likely the industry as a whole may involve coordina- to be private sector companies and public reg- tion among private and public players.12 ulatory authorities. • Coordination. The capacity (within a market Supporting functions are described in more system) to go beyond the limitations of detail in chapters 3, 5, 16, and 18. individual perspectives, understand the sys- ­ tem as a whole, and support its development. Implications of the Market System This is a noncommercial, collective, public Framework: Providers and Facilitators role and therefore is likely to be the domain of While all organizations engaged in financial government or representative industry (and inclusion may agree that development of the sys- perhaps consumer) associations. tem as a whole represents a worthy aim, they do • Advocacy. Efforts to provide an appropriate not all have the same role or perspective. voice in the financial market system, especially Organizations differ with respect to several fac- for providers and consumers, and to ensure tors, for example, their legal status (for-profit that their views contribute to public functions business, NGO, association, government), funding such as regulations and standards. sources (grants, debt, equity, client-generated revenues), scale, and motivations. However, per- • Information. Refers loosely to the “informa- haps the most basic but useful distinction is tion environment,” for example, in relation to between organizations that see themselves as emerging trends and products (aimed at both market players with a continuing direct role providers and consumers) and to more spe- within the market system and facilitators that see cific information-based products and services. themselves as external actors with a mandate to The key players include specialized service act as temporary catalysts in stimulating others in companies and government or associations in the market (see figure 1.4). Knowing your place in relation to public information on, for example, the financial services landscape is an important standards and legal rights. step in determining what you should do and how • Research. The provision of knowledge-based you should do it. products or services related to, for example, • Market system players. Organizations or indi- the demand and supply sides of the core, viduals with an active and continuing role impact assessment and the implications of delivering functions in the financial eco­ wider trends. system. This includes providers of financial 36 The New Microfinance Handbook Figure 1.4  Market System Players and Facilitators FINANCIAL MARKET SYSTEM SUPPORTING Private FUNCTIONS sector Government Facilitators Community Seeking to groups develop the D CORE S market system Representative as external associations catalyst Not-for- profit sector RULES Players Specific roles within the market system ­ ervices, regulators, and other developers and s function more effectively and inclusively. enforcers of formal rules and providers of sup- Facilitation is therefore a public role (not com- porting functions. These entities are part of mercial); it is temporary (not permanent) and the system and envisage remaining part of it in requires understanding and capacity to inter- the future. vene with appropriate and timely resources (financial, human, and political). And while in • Facilitators. External players, standing outside the short to medium term, the role of the facil- the system, whose role is to facilitate positive itator may involve multiple activities—­ changes in the market system. Facilitators are including direct roles in the market if most often donors and development agencies required—in the longer term, the strategic that are funded by donors. (Investors who pro- purpose of facilitation is, by definition, not to vide debt or equity to providers are considered have any continuing role in the market system. to be market players, as they provide funding, an important supporting function.) Grant Table 1.3 outlines the strategic differences funding is used (or should be) to facilitate the between the two roles. In the long term, who market and to develop the capacity of market should be a market player (that is, provide a prod- players in the system. While facilitators work uct or service, public or private) and who should in a variety of ways, their role is to use resources pay for those ­ products or services? There is rela- to address constraints, allowing the system to tively little disagreement about who should fulfill The Evolving Financial Landscape 37 Table 1.3  Key Characteristics of Facilitators and Providers in the Financial Market System Characteristic Facilitators Market players Orientation and Broad. What is good for the market system Narrow. What is good for me and my clients purpose as a whole? or stakeholders? Long-term role No role in the longer term; facilitate others Continuing role with incentives and capacity in the market system to grow Activities Varies with market constraints identified, Consistent with long-term role; provision of for example, technical, financial, organiza- services, either financial services in the core tional, information assistance or supporting functions or formal rules Skills, knowledge Strategic overview and (flexible) technical Narrow technical competence to fulfill capacity to address constraints specific role Funding Development agencies and donors Other players in the market, clients (revenues from services), or government (for public services) Legal form Development mechanisms; donors, Appropriate to role; mainly private players foundations, contractors, NGOs (formal and informal) for service provision Cost base Appropriate for development agencies Appropriate for market system some functions in the financial system. Financial Banking without Branches service delivery is generally accepted as appropri- ately provided by the private sector, while the The third significant influence on financial ser- development of regulatory frameworks, for vices for the poor is the opportunity presented by example, merits public subsidy. Historically how- technology to increase financial inclusion.13 ever, ambiguity over the nature of some functions Building on the previous discussion of the finan- has provided justification for extensive donor cial ecosystem, this introduction to branchless subsidy in microfinance. Donors that fund market banking focuses on the new market players— players directly or themselves play market roles MNOs and agent networks—within the system only have a valid rationale for participating in the and the emerging new business models that short term (see chapter 4). result. Chapter 12 provides a more technical dis- If the financial market system is to be truly cussion of each of the various transaction or facilitated and a position reached where long-term access points—for example, mobile phones, financial inclusion has been achieved and facilita- Internet, automated teller machines (ATMs)— tion is no longer required, facilitators must figure and the development and management of an out how to play a role without becoming a market agent network; it also includes a glossary of player and how to implement their vision of how branchless banking terms. the market system should function without them Cost and proximity drive the delivery of finan- in the future (see chapter 19). Figure 1.5 illus­trates cial services. Historically, providing services in the evolution of taking a financial system close proximity to clients entailed high costs for approach rather than an institutional approach— both the provider and the client. However, from (a) strengthening supply to (b) understand- financial service providers are increasingly find- ing demand and from (c) building the core market ing innovative ways to integrate the delivery to (d) developing the wider market system. of financial services into the everyday lives of cli- ents. While community-based providers­are 38 The New Microfinance Handbook Figure 1.5  Evolution of Intervention Focus from Financial Institutions to Financial Systems (a) Strengthening supply SUPPORTING FUNCTIONS (b) Understanding demand (d) Developing the CORE wider SUPPLY DEMAND market system RULES (c) Building the core market Source: Rob Hitchins, The Springfield Centre. already largely “branchless,” for institutional transfers to full-service banking, allowing depos- providers, branchless banking is changing the its, withdrawals, and, if relevant, loan disburse- way clients and providers interact and is poised ment and payments or even insurance premium to lower the costs of delivery significantly and payments or payouts. to reach financially excluded households that In providing an overview of branchless bank- cannot be served profitably using conventional ing and the associated new business models, it is branch-based approaches—especially in remote, helpful to define a few terms. Mobile money sparsely populated areas and urban slums refers to a type of electronic money that can be (CGAP 2011). transferred over a mobile phone. The issuer of Banking without branches requires alterna- mobile money may (depending on the local law tive access points for client transactions. These and the business model) be an MNO or a third include self-serve solutions such as mobile party, including a bank (CGAP 2011). Mobile phones or ATMs, staff-based transaction points banking is the use of a mobile phone to access such as mobile branches that visit underserved services and execute financial transac- financial ­ areas on specific days, and third-party agents tions ­connected to a bank account. This covers including retailers (or in some cases, MFIs) both transactional and nontransactional ser- using card-reading point-of-sale (POS) devices, vices, such as viewing financial information on a mobile phones, or Internet-connected computing mobile phone (Chatain et al. 2011). An agent is devices. Branchless product offerings range from any third party acting on behalf of a bank or individual money transfers and government cash other financial service provider (including an The Evolving Financial Landscape 39 electronic money issuer or distributor) in its with reliable cash flow who can service clients dealings with customers. Agents perform seeking to deposit, withdraw, or send funds to a “cash-in” (the exchange of cash for electronic third party. Providers such as banks or MNOs value) and “cash-out” (the exchange of elec- often establish agent networks through a range of tronic value for cash) services. distribution networks, including airtime sellers, shopkeepers, retailers, traders, petrol stations, New Market Actors: A Wider Ecosystem post offices, or kiosks in markets. Agents charge Branchless banking is primarily about the emer- transaction fees, but because they serve areas gence of different kinds of businesses, often with where most institutional providers are unable to new kinds of players, to deliver multiple financial reach, these fees are often lower than the cost of services to a mass market through technology- traveling to a bank branch or using a traditional enabled business models that operate very differ- money transfer company. ently from more traditional financial service Agents can facilitate transactions via several delivery models. Branchless banking services access devices, including a POS device, a mobile require an ecosystem of players. For example, phone handset, a tablet, or a personal computer. mobile banking, a subset of branchless banking, A client can deposit cash with an agent in one requires partnerships between MNOs and banks location, and those same funds can be withdrawn or other financial service providers and agents.14 immediately by another client at a different loca- Mobile banking solutions “are hard to build tion.16 Agents must have an account at a bank that because they require strong multiparty orches- has a secure, real-time transaction-processing tration, in principle spanning several regulatory capability, either online using wireless or domains, and the proposition is severely weak- Internet connectivity or offline using smartcards ened if any one element of the solution is not capable of updating balances and recording properly primed. Indeed, the commercial transactions (see chapter 12). A payments system arrangements between the parties are what or network (see chapter 18) is needed that allows holds the system together” (Mas 2008, 8). This the agent’s bank to account for and settle trans- discussion focuses on agent networks and MNOs actions with all participating client banks. as the two main new entrants to financial service Consumer protection safeguards are also provision. required to minimize exposure of bank clients to agent risk (Mas 2008). Agent Networks Some providers use agents for more than sim- While branchless banking channels offer clients ple transactions, such as providing account bal- more convenience and access points, POS devices ances or notifying clients of payments coming on their own cannot accept deposits; Internet and due, delivering credit products, and, if properly mobile channels by themselves have no cash licensed, delivering insurance products. Based on transaction capability; and mobile branches may a representative case in the Mexican market, as not visit often enough to meet all the needs of cli- much as 20 percent of the transactions coming ents.15 Thus these channels individually cannot into branches could be handled by agents (Mas replace traditional channels altogether (Mas and Kumar 2008). 2008). This is where agents enter the picture. Depending on the regulatory environment, An agent network is a group of retailers with sometimes MFIs can act as agents for larger existing businesses or retail locations who (pri- commercial banks or for MNOs. This strategy marily) provide cash-in, cash-out services. An allows microfinance customers to gain exposure agent may be any retailer conveniently located to mobile banking and can also help MFIs to 40 The New Microfinance Handbook ­ifferentiate themselves from the competition d New Business Models: Partnerships for and bring enhanced liquidity to their branches Branchless Banking (Kumar, McKay, and Rotman 2010). Developing partnerships between financial Agents provide the customer interface. service providers and MNOs is not easy. A key ­ Therefore, when developing a network of agents, consideration when developing partnerships is providers must address the operational chal- how flexible the service will be in terms of trans- lenges in a way that fosters a positive and consis- mitting and receiving funds from clients with tent customer experience that will create and other financial service providers or MNOs. maintain trust in the system. Strategies for MNOs may partner with multiple financial insti- enrolling, training, incentivizing, managing, and tutions, increasing the ability of clients to trans- retaining agents are critical considerations for all act across financial institutions (interoperability), providers that use agents to deliver financial but diminishing the unique added value for the ­ services. Providers can hire and manage their financial partners (see chapter 12). At the same own agents, or they can outsource this function time, banks and other providers that partner (see chapter 12). with only one MNO restrict the use of the ser- vice to clients of that MNO. Financial service Mobile Network Operators providers must balance the need for universal, Mobile network operators provide the ability to multi-MNO solutions with the practicality of use mobile phones for financial services—either outsourcing more functions to a single MNO. directly to consumers or on behalf of other finan- At the outset, it can be expensive to engage in cial service providers, usually through an agent mobile banking; partners may be scarce and the network. MNOs can provide money transfer and incentives to reach a broad mass of people may payment services directly without being linked not be aligned between the necessary actors. to another financial service provider (mobile Some providers, including MNOs, do not have money), or they can partner with a bank or other the high market share that might translate into provider to increase outreach both in terms of the volume of transactions needed for mobile numbers as well as available products (mobile services to break even. Furthermore, adequate banking) (Kumar, McKay, and Rotman 2010). back-office and transaction-switching capability The role of MNOs in mobile banking can vary as well as sufficient internal controls are required, from simply selling text-messaging services to which smaller providers may not have or not providing a full-fledged parallel banking infra- have access to. To increase adoption rates, banks structure (although it is still early in the process and others need to drive awareness of the service to fully understand what this involves). Which and ensure strong branding. While mobile bank- role(s) a bank or other financial service provider ing reduces the cost of service delivery and wants the MNO to play depends on how much increases convenience for both providers and it wants to integrate mobile banking services clients, significant efforts are required to allay into its core business and its ability to implement security fears and natural resistance to new technology-­based deployments.17 Customer technologies. experience is determined directly by the tech- In addition, negotiations between the MNO nology platform used and the ability to access and the financial service provider need to con- cash-in, cash-out services (Mas and Kumar sider the customer service interface (for exam- 2008). These and other issues are still being ple, the MNO’s customer call center) and the worked out, and expectations for the future are marketing and cross-selling of bank services uncertain (see box 1.14). to  telephone customers. MNOs can use their The Evolving Financial Landscape 41 Box 1.14  Potential of Mobile Banking Mobile banking has great potential to reach other services. Mobile money has often fallen vast numbers of low-income, unbanked peo- between the regulatory cracks, and MNOs in ple at affordable prices with a wide range of several countries are offering mobile pay- products to meet complex financial needs. Yet ments without being regulated as banks. early experience suggests that, although the Simply put, MNOs are poorly positioned on potential is strong, it is by no means guaran- their own to offer a broader range of products. teed that mobile banking will deeply pene- Strategic partnerships with providers that bet- trate low-income, unbanked segments with ter understand the financial landscape and appropriately designed products. needs of the client are critical. For some First, the very qualities that endowed MNOs, mobile payments do everything they mobile network operators with a head start in want them to do: increase loyalty among mobile money may work against their capac- voice clients and decrease the cost of distrib- ity to field a more complex suite of products. uting airtime. In other words, they have no The common mobile money product—a liq- motivation to do more unless they have uid, electronic wallet with the capability to strong, strategic partners. Because financial transfer money—is quite simple, akin to the services are not their core business, MNO preexisting airtime wallet. However, MNOs owners and shareholders may not be inter- know little about credit, savings, and insur- ested in investing in more services or ance. They also lack regulatory room to offer partnerships. Source: McKay and Pickens 2010. extensive agent networks and retailers to pro- define the options for mobile banking, including vide cash-in, c ­ash-out services and to sign up regulatory restrictions on outsourcing cash-in, customers for banking services. The MNO’s cash-out functions, know-your-customer (KYC) brand can be leveraged to appeal more directly to obligations, and limits on mobile money transac- ­ ffiliations to mobile phones clients with stronger a tions. In fact, the maximum amount allowed for and mobile brands than to banking. This may be transfers is generally relatively low, which may particularly appealing for efforts to increase limit the use of this service. Other issues include financial inclusion among youth. However, using data security and customer privacy regarding the MNOs’ distribution and marketing channels e-banking, account issuance of non-banks, and also has revenue implications: fees are split taxation. among the MNO as a brand, the MNO as a trans- At the time of writing, various new technolo- action channel provider, and the bank as finan- gy-enabled business models are emerging: those cial intermediary. that provide money transfer services (mobile And lastly, in many countries, regulation of money), those that link MNOs with bank services MNOs by the banking authorities is not yet clear, (mobile banking), and agent banking being estab- although this is beginning to change as new mod- lished by large retailers. Some of the more inter- els emerge and the various stakeholders better esting ones are described in box 1.15, although understand the systemic risks inherent in mobile time will tell which ones will reach significant banking. Ultimately, significant regulatory factors scale and longevity. 42 The New Microfinance Handbook Box 1.15  New Branchless Banking Business Models Safaricom’s M-PESA: mobile money. Telenor and Tameer’s EasyPaisa (Pakistan). Safaricom’s M-PESA is a transfer and ­payment The partnership between Telenor, an MNO, service with close to 17 million customers in and Tameer Bank grew out of a strategic Kenya, a country with 7 million bank accounts, ­alliance that started after Tameer Bank decided most of which are considered active. The indi- to use mobile phone banking services to reach vidual accounts only exist on the M-PESA plat- rural clients. Telenor had 18 million subscribers form, not in bank accounts. Bank accounts in Pakistan, and Tameer Bank wanted to take hold the float that backs the e-accounts one- advantage of Telenor’s prepaid card distribu- to-one on a daily basis, which makes Safaricom tion network and to act as its cash-in, cash-out a non-bank e-money issuer, though it is not agent. Tameer Bank had already decided to licensed or regulated by the central bank or co-brand the new service—EasyPaisa—with under e-money regulations (as of February the MNO in order to reach the millions of sub- 2012). In M-PESA’s case, the float is held by a scribers who had a strong affinity to Telenor trust, not by Safaricom itself. M-PESA has a but were not bank clients. After realizing the mixed-agent model. Some agents also sell air- advantages of having a bank license to facili- time and are directly managed by Safaricom, tate mobile money, Telenor acquired a 51 per- but most agents are managed by intermedi- cent share in Tameer Bank in November 2008. ary companies under arrangements agreed In 2012, millions of people were using over- with Safaricom. the-counter services of EasyPaisa agents on a M-Kesho, Iko Pesa: mobile money and recurring basis, and more than 500,000 had bank account links. In Kenya M-Kesho links mobile wallet accounts. With a network of the M-PESA wallet offered by Safaricom with 12,000 agents, EasyPaisa was growing quickly. a bank account offered by Equity Bank, allow- Tameer’s traditional core business (credit, sav- ing customers to move money back and forth ings, insurance) is enhanced by EasyPaisa, as between the M-PESA wallet and the bank Tameer holds the float from all EasyPaisa account. Orange in Kenya has transitioned all account balances, adding liquidity and dramati- of its Orange Money accounts into Equity cally reducing the cost of funds for its loan port- Bank accounts (Iko Pesa), which they did tech- folio. Tameer pays all staff salaries via EasyPaisa; nically by integrating the Orange Money plat- in the future, it could experiment with different form with Equity’s core banking system. kinds of savings and other accounts, potentially Rather than add a link to move money from an switching its good customers to receiving M-PESA account to a bank account like and paying their loans via this mobile platform. M-Kesho, the accounts of Iko Pesa are fully Telenor benefits from customer loyalty integrated, making them one and the same. (reduced churn) and lower airtime distribution Several banks and MNOs are establishing costs, all of which significantly enhance its core partnerships of this kind. In West Africa, Airtel voice and text business. EasyPaisa illustrates Money has established a link with Ecobank in the importance of understanding and manag- Ghana and Burkina Faso. In Madagascar, ing partnerships in which the parties have their Orange has partnered with a microfinance own core business but see advantages to join- bank to offer interest-paying savings accounts ing forces for some things. on Orange Money. It is not yet clear, however, Oxxo (Mexico): agent banking. Oxxo shows how successful these models will be. how retail chains with their large retail (continued next page) The Evolving Financial Landscape 43 Box 1.15 (continued) ­ f ootprint and relationship with customers Oxxo is already involved in financial across income segments can play an impor- ­ervices and has sizable bill payment and s tant role in new technology-enabled finan- insurance businesses. It is negotiating with cial service business models. Oxxo is the multiple banks to serve as a cash-in, cash-out largest retail network in North America, with merchant for their bank accounts. It is also more than 9,000 locations in Mexico. Oxxo offering its own branded electronic wallet in claims to open a new store every eight partnership with one of the banks, which will hours and serves 7.5 million people every be accessible to customers using both cards day. It is 100 percent owned by FEMSA, the and mobile handsets. Oxxo’s main customer largest beverage company in Latin America, base is unbanked, so its offer of financial ser- which was originally set up to distribute vices is expected to significantly contribute to beer. financial inclusion. Source: Steve Rasmussen and Kabir Kumar, CGAP. Branchless Banking and MFIs • Use mobile financial services to update or MFIs, both regulated and NGOs, have generally replace practices related to the core business, not played a critical role in branchless banking; for example, use mobile payments for loans rather they have used the new technology to and insurance premiums enhance customer service and reduce costs. For • Act as an agent on behalf of a bank or an MNO. example, as MFIs become licensed, they can join the national payments system, gaining the use of Together, these three drivers—a focus on ATMs and cards or POS devices to provide ser- understanding clients better; acknowledgment vices through new channels. While some MFIs of the multiplayer, multifunction nature of the are able to take advantage of opportunities made financial ecosystem; and the opportunities tech- available through technology, many struggle, and nology presents—can support increased finan- the expectations and hopes for what might have cial inclusion. The following chapters provide been have not materialized at any scale. MFIs much more detail on each of these areas, describ- require superior customer service skills, sophisti- ing the functions and roles within the financial cated back-office systems, and strong leadership market system and how they can work better for and technical skills to achieve the organizational the poor. changes required, and many are simply not there yet. However, MFIs and other smaller providers Notes can engage in branchless banking in several ways  1. For example, see the Clients at the Centre (Kumar, McKay, and Rotman 2010): Initiative of the Consultative Group to Assist the Poor (CGAP) or the Center for Financial • Use mobile phones (or personal digital assis- Inclusion of ACCION. tants, notebooks, or any other technology) to  2. The Scottish government defines financial collect data in the field inclusion as access for individuals to appropriate­ 44 The New Microfinance Handbook financial products and services. This includes but they are not addressed in this book people having the skills, knowledge, and because poor populations use them so understanding to make the best use of those infrequently. products and services. Financial exclusion is  8. In practice, rules and supporting functions— often a symptom of poverty as well as a cause. whatever their type—are often delivered or See http://www.scotland.gov.uk/ subsidized directly by development agencies. Publications/2005/01/20544/50280. Sustainability analysis in microfinance has  3. Findings are based on focus group discussions historically focused on providers at the core with 64 clients from regulated and unregu- and the extent to which their operations are lated MFIs and 20 in-depth interviews with financed from operational revenues, rather members of the Debtors Association, the than extending to the wider market system as Superintendencia de Bancos, and MFI staff in a whole. Yet if the objective is to develop El Alto, La Paz, Santa Cruz, and Montero, functioning, sustainable market systems, Bolivia. sustainability analysis needs to be equally  4. Portfolios of the Poor is a seminal work comprehensive, extending beyond the core to synthesizing research findings from financial include supporting functions. diary studies in Bangladesh, India, and South  9. The concept of rules of the game is central in Africa (Collins et al. 2009). institutional economics. See chapter 19 for  5. This has become an issue of some controversy, further discussion. with some believing that the microfinance 10. According to microLINKS wiki (2010), “Social industry as a whole—led by donor funding— institutions are complex, enduring structures has developed a supply-side/product-push or mechanisms of social order (and coopera- character that emphasizes credit rather than tion) that govern customs and recurring other services, especially savings, increasing behavior patterns important to a society. They personal debt without bringing commensurate are usually identified with a social purpose benefits. (e.g., mitigating conflict, validating an elite).  6. There are, of course, exceptions. Some large Enduring institutions such as gender, race or cooperatives operate very much like regulated ethnicity, class, and religion help to shape financial institutions, while some rural banks individuals’ beliefs and expectations. Social are tiny and somewhat informal, despite being institutions exist because they serve a purpose, subject to formal regulation. Furthermore, the which is often to protect the power or degree of formality or legal form does not privilege of particular groups.” always equate with sustainability. Some 11. Although mobile money still relies upon, and state-owned banks may rely heavily on indeed may be successful because of, social subsidies, while most commercial banks are institutions. See Susan Johnson’s blog where financially independent. And while Savings she states, “These interpersonal transfers Groups can have very formal operating operate within social networks that involve procedures and are generally sustainable and relationships of ‘give and take’ that can operate independent of any external assistance in the over long periods of time and in which long term, some externally facilitated groups resource transfers may be given in one form, such as Self-Help Groups and Financial Service for example, cash, and returned in another, for Associations are designed to use outsiders on a example, support with resources of many medium- to longer-term basis, and most NGO different kinds or social connections to a job MFIs continue to rely on donor subsidies. and so on. Hence mobile money transfer has  7. Other products such as foreign exchange or brought a range of financial transactions that bonds are also available in the formal sector, involve a reciprocal dimension.” http:// The Evolving Financial Landscape 45 technology.cgap.org/2012/04/19/what-does-the- and The Gambia: Understanding the Supply rapid-uptake-of-mobile-money-transfer-in- and Demand of Remittances between Spain and kenya-really-mean-for-financial-inclusion/. The Gambia and Its Impact on Financial 12. Financial literacy or education could be Service Access. New York: Women’s World included within this function—or as a separate Banking. category—for the demand side of the market. Bennett, Lynn. 1997. “A Systems Approach to 13. This section draws on various CGAP focus Social and Financial Intermediation with the notes, including Mas and Kumar (2008); Mas Poor.” Paper presented at the Banking with the (2008); Kumar, McKay, and Rotman (2010); Poor Network and World Bank Asia regional and McKay and Pickens (2010). conference “Sustainable Banking with the Poor,” Bangkok, November 3–7. 14. The exception is that, if a bank wants to launch its own direct mobile payments system, Bold, Chris, David Porteous, and Sarah Rotman. it only needs regular data services from an 2012. “Social Cash Transfers and Financial MNO and could therefore launch without any Inclusion: Evidence from Four Countries.” real partnership. It would just require normal Focus Note 77, CGAP, Washington, DC, use of the mobile phone network. February. 15. This section is adapted from Flaming, McKay, Bouman, F. J. A., and Otto Hospes. 1994. Financial and Pickens 2011 and Lehman 2010. Landscapes Reconstructed: The Fine Art of Mapping Development. Boulder: Westview 16. While POS devices provide access to bank Press. accounts as well, how quickly the funds can be accessed will depend on clearing arrange- *CGAP (Consultative Group to Assist the Poor). ments between the institutions. 2011. “Global Standard-Setting Bodies and Financial Inclusion for the Poor—Toward 17. At a minimum, banks or other providers need Proportionate Standards and Guidance.” to buy wireless connectivity from the MNO. White Paper prepared on behalf of the G-20’s The next step is to seek access to the memory Global Partnership for Financial Inclusion, in the subscriber identity module (SIM) to use CGAP, Washington, DC, October. the encryption keys and phone service menu, CGAP and World Bank. 2010. Financial Access which they get from an MNO. A more involved 2010: The State of Financial Inclusion through role would be for the MNO to manage the the Crisis. Washington, DC: CGAP and World entire communications between the client and Bank. the back-office server of the bank. The bank could even have the MNO host and run the Chatain, Pierre-Laruent, Andrew Zerzan, Wameek core banking system. In such a case, while the Noor, Najah Dannaoui, and Louis de Koker. 2011. bank owns the accounts, the MNO operates “Protecting Mobile Money against Financial the system. Crimes.” World Bank, Washington, DC. *Chen, Greg, Stephen Rasmussen, and Xavier Reille. 2010. “Growth and Vulnerabilities in References and Further Reading Microfinance.” Focus Note 61, CGAP, * Key works for further reading. Washington, DC. http://www.cgap.org/gm/ Banthia, Anjali, Janiece Greene, Celina Kawas, document-1.9.42393/FN61.pdf. Elizabeth Lynch, and Julie Slama. 2011. Christen, Robert Peck. 2011. “What Does Focusing Solutions for Financial Inclusion: Serving Rural on the Client Really Mean?” CGAP Blog, Women. New York: Women’s World Banking. CGAP, Washington, DC. Banthia, Anjali, and Peter McConaghy. 2012. CIA (Central Intelligence Agency). 2008. CIA Remittances and Access to Finance in Spain World Factbook 2008. Washington, DC: CIA. 46 The New Microfinance Handbook *Cohen, Monique. n.d. “The Emerging Market-Led Needs.” Workshop paper commissioned for Microfinance Agenda.” MicroSave Briefing the 2011 Global Microcredit Summit, Note 25, MicroSave Kenya. Valladolid, Spain, November 14–17. Cohen, Monique, and Candace Nelson. 2011. Hudon, M. 2008. “Norms and Values of the “Financial Literacy: A Step for Clients towards Various Microfinance Institutions.” CEB Financial Inclusion.” Workshop paper Working Paper 08/006, Centre Emile commissioned for the 2011 Global Microcredit Bernheim, Brussels, February. Summit, Valladolid, Spain, November 14–17. *Johnson, Susan. n.d. “Gender and Microfinance: Coleman, J. C. 1990, 1994. Foundations of Social Guidelines for Good Practice.” http://www Theory. Cambridge, MA: Harvard University .gdrc.org/icm/wind/gendersjonson.html. Press. ———. 2000. “Gender Impact Assessment in *Collins, Daryl, Jonathan Morduch, Stuart Microfinance and Microenterprise: Rutherford, and Orlanda Ruthven. 2009. Why and How?” Development in Practice 10 Portfolios of the Poor. Princeton: Princeton (1): 89–93. University Press. ———. 2004. “Gender Norms in Financial Markets: *Demirgüç-Kunt, Aslı, and Leora Klapper. 2012. Evidence from Kenya.” World Development “Measuring Financial Inclusion: The Global 32 (8): 1355–74. Findex.” Policy Research Working Paper 6025, ———. 2011. “Understanding Kenya’s Financial World Bank, Washington, DC. Landscape: The Missing Social Dimension.” *Ehrbeck, Tilman, Mark Pickens, and Michael FSD News 17 (August): 2. Tarazi. 2012. “Financially Inclusive *Johnson, S., and S. Arnold. 2011. “Financial Ecosystems: The Roles of Government Today.” Exclusion in Kenya: Examining the Changing Focus Note 76, CGAP, Washington, DC, Picture 2006–2009.” In Financial Inclusion in February. Kenya: Survey Results and Analysis from Faz, Xavier, and Paul Breloff. 2012. “A Structured FinAccess 2009, 88–117. Nairobi: FSD Kenya Approach to Understanding the Financial and Central Bank of Kenya. Service Needs of the Poor in Mexico.” CGAP *Karim, Nimrah, Michael Tarazi, and Xavier Brief, CGAP, Washington, DC, May. Reille. 2008. “Islamic Microfinance: An *Flaming, Mark, Claudia McKay, and Mark Pickens. Emerging Market Niche.” Focus Note 49, 2011. “Agent Management Toolkit: Building a CGAP, Washington, DC. Viable Network of Branchless Banking Agents *Kendall, Jake. 2010. “Improving People’s Lives (Technical Guide).” CGAP, Washington, DC. through Savings.” Global Savings Forum, *Glisovic, Jasmina, and Mayada El-Zoghbi with November. http://www.gatesfoundation.org/ Sarah Foster. 2011. “Advancing Savings financialservicesforthepoor/Documents/ Services: Resource Guide for Funders.” CGAP, improving-lives.pdf. Washington, DC. *Kumar, Kabir, Claudia McKay, and Sarah Rotman. Harriss-White, B. 2004. “India’s Socially 2010. “Microfinance and Mobile Banking: The Regulated Economy.” Indian Journal of Labour Story So Far.” Focus Note 62, CGAP, Economics 47 (1). Washington, DC, July. *Hashemi, Syed M., and Aude de Montesquiou. Ledgerwood, Joanna. 1998. Microfinance 2011. “Reaching the Poorest: Lessons from the Handbook. Washington, DC: World Bank. Graduation Model.” Focus Note 69, CGAP, *Lehman, Joyce. 2010. “Operational Challenges of Washington, DC, March. Agent Banking Systems.” Brief written for the Hatch, John. 2011. “When Clients Grow Old: The Global Savings Forum, Bill and Melinda Gates Importance of Age in Addressing Client Foundation, Seattle, November. The Evolving Financial Landscape 47 Linthorst, Audrey, and Scott Gaul. 2011. “What Do Orozco, Manuel, Anjali Banthia, and Mariama We Need to Know about Financial Inclusion in Ashcroft. 2011. “A Country Profile on The Africa?” SEEP Network, Washington, DC. Gambia: The Marketplace and Financial *M4P Hub. 2008. “A Synthesis for Making Markets Access.” Women’s World Banking, New York. Work for the Poor (M4P) Approach.” http:// Perdomo, Maria. 2008. “Consumer Protection: A www.m4phub.org/resource-finder/result Client Perspective.” Research note prepared .aspx?k=m4p%20synthesis&t=0&c=0&s=0. for Microfinance Opportunities and Freedom *Mas, Ignacio. 2008. “Being Able to Make (Small) from Hunger. Deposits and Payments, Anywhere.” Focus Pickens, Mark. 2011. “Which Way? Mobile Money Note 45, Washington, DC, CGAP. and Branchless Banking in 2011.” CGAP ———. 2010. “Savings for the Poor: Banking on Technology Blog, CGAP, Washington, DC, Mobile Phones.” World Economics 11 (4). March 9. *Mas, Ignacio, and Kabir Kumar. 2008. “Banking *Porteous, D. 2005. “The Access Frontier as an on Mobiles: Why, How, for Whom?” Focus Approach and Tool in Making Markets Work Note 48, CGAP, Washington, DC. for the Poor.” http://bankablefrontier.com/ Mas, Ignacio, and Dan Radcliffe. 2010. “Mobile assets/pdfs/access-frontier-as-tool.pdf. Payments Go Viral: M-PESA in Kenya.” Rankin, Katharine N. 2002. “Social Capital, http://papers.ssrn.com/sol3/papers Microfinance, and the Politics of .cfm?abstract_id=1593388. Development.” Feminist Economics 8 (1): 1–24. *McKay, Claudia, and Mark Pickens. 2010. Rotman, Sarah. 2010. “An Alternative to M-PESA? “Branchless Banking 2010: Who’s Served? At Orange and Equity Bank Launch Iko PESA.” What Price? What’s Next?” Focus Note 66, CGAP Technology Blog, CGAP, Washington, CGAP, Washington, DC. DC, December 6. microLINKS wiki. 2010. “Informal Regulations Shipton, Parker. 2007. The Nature of Entrustment: under BEE.” Value Chain Framework wiki Intimacy, Exchange, and the Sacred in Africa. page. http://apps.develebridge.net/amap/ New Haven: Yale University Press. index.php/Informal_Regulations_under_BEE. World Bank. 2011. World Development Report 2011: ———. n.d. “Social Institutions Comprising Conflict, Security, and Development. Informal Regulations.” http://microlinks.kdid Washington, DC: World Bank. .org/good-practice-center/value-chain-wiki/ Wyman, Oliver. 2007. “Sizing and Segmenting social-institutions-comprising-informal- Financial Needs of the World’s Poor.” Bill and regulations. Melinda Gates Foundation, Seattle. 48 The New Microfinance Handbook CHAPTER 2 Clients Stuart Rutherford, Daryl Collins, and Susan Johnson No matter how it is measured, the number of unbanked poor—dwarf the number of clients people without access to financial services is already served by microfinance, estimated at 190 very large indeed. In 1976, when Muhammad million at the end of 2009 (Microcredit Yunus in Bangladesh started the experiment that Campaign Summit 2011). led to the Grameen Bank, he focused on the very In chapter 1, “The Evolving Financial poor. As microfinance grew, it attracted the “eco- Landscape,” we discussed who the poor are, how nomically active poor,” people who might be they differ, and how various influences such as expected to take loans to run a small business, life-cycle stages, geography, livelihoods, and for example. More recently with the drive for informal rules and norms, such as gender, affect “financial inclusion,” attention has turned to the their access to financial services. This chapter “unbanked” poor—poor people not using formal examines financial services from the point of financial services of any sort (including microfi- view of poor people. It looks at the kinds of tools nance, sometimes referred to as “semiformal” that the poor need to manage their money, services). Just over half of the world’s adult pop- shows why they need them, and assesses the ulation is unbanked, most of them poor: In extent to which they already have access to Africa, four out of five adults are unbanked, and them. It describes the key characteristics of in South Asia, three out of five (Chaia et al. 2009). good quality pro-poor formal financial tools and In rich countries, by contrast, fewer than one in shows how and why the poor, the extremely ten adults lacks a formal means to save or to bor- poor, and the unbanked poor might use and ben- row (Chaia et al. 2009).1 All these numbers—of efit from such services if they were more widely the extremely poor, the moderately poor, and the available. Clients 49 The Poor and Financial Services: their money management needs are presented, Diverse Needs and Common beginning with the most basic question of all: Problems Why do poor people need financial tools in the first place? To answer that question, we need to The poor, as broadly defined in the opening para- move into the villages and slums and find out graph, make up half or more of the world’s popu- more about how poor people manage their money. lation, and although they are somewhat clustered regionally, above all in Africa and Asia, in all other The “Financial Portfolios” respects they are diverse. It follows that their of the Poor financial behavior is similarly diverse. The bor- rowing and saving patterns of an agricultural Finance is the intersection of money and time. day-laboring household are not the same as those Looking at one element in the absence of the of a farmer, let alone those of a household that other tells less than half the story. One-off surveys depends on a small shop or workshop in an urban that focus on the finances of poor households may slum, or on low-paid wage jobs in a factory, or on identify which savings institutions are used or domestic service. Even where livelihoods are sim- what types of loans are outstanding, but say little ilar, innate differences between households will or nothing about how the timing of cash flows is generate different financial patterns, according to managed to accumulate savings or repay loans. To the age, the gender, and the health of the house- see how poor households try to reconcile con- hold members. Research shows that women and strained incomes with expenditure needs, and men tend to have different attitudes toward how financial tools, no matter how crude, are household resources and their allocation, includ- employed to achieve that end, we need to look at ing financial resources.2 At an individual level, their household finances as a totality, as a portfo- personality counts: Some people are more cau- lio of tools, each with its particular cash flow. To tious than others and may therefore be more understand how and why poor households averse to loans and more ready to save. Conversely, choose and use their financial tools, we need to there are overarching cultural traditions—for observe how these portfolios change over time: example, the preference for certain types of “What has been missing is a close look at how ­ savings-and-loan clubs among the ethnic Chinese portfolios function: not just how well the pieces or among the slum dwellers of Nairobi—that give work, but how well they work together. Focusing a distinctive shape to the financial behavior of on how gives new insight into the day-to-day whole groups of people. The degree of monetiza- nature of poverty and yields concrete ideas for tion of a country’s or of a district’s economy will creating better solutions for it” (Collins et al. affect the scope for financial intermediation. And, 2009, p. 14). last, a household’s financial service needs change For the book Portfolios of the Poor, the authors over time with life-cycle events: for example, as conducted year-long “financial diaries” in urban the children are educated and leave home and and rural sites in Bangladesh, India, and productive activities in the household decline. South Africa, to better understand this three- Nevertheless, poverty presents poor people dimensional view of household finances. These with a number of financial management prob- were not “diaries” that the households them- lems that cut across differences in traditions, live- selves kept, but reports from interviews carried lihoods, and household composition. These out by trained investigators, speaking the local commonalities are the subject of this chapter. language, on a frequent and regular basis through- Here general observations about poor people and out a full year.3 The investigators recorded as full 50 The New Microfinance Handbook an account as possible of income and expendi- take, almost always require large sums of money if ture, and focused especially closely on financial they are to be coped with successfully. The poor’s flows—flows in and out of savings and loan tools. need for ways to save and to borrow—their need At the same time, they probed for an understand- for financial services—is greater than the needs of ing of how circumstances, preferences, and aspi- the nonpoor: not in monetary value, of course, but rations shaped the financial decisions the in intensity. Being able to take a dollar from a households made. From these “diaries” it was bank, or borrow it from a helpful neighbor, may often possible to construct not just the balance allow a mother to take her child to the clinic and sheets of the household accounts but also—and have her conjunctivitis cleared up; not being able much more revealing—cash flow statements to do so may lead to her daughter going blind in showing the activity that lay behind the balance later life. Managing money well is an essential life sheets, all set in the context of the particular skill that most poor people take very seriously. household’s circumstances. Altogether, data for To manage their money, the households that about 250 households were gathered, supple- took part in the “diaries” research pushed and mented by a further 50 households from pulled more money through informal tools than Bangladesh collected in a subsequent and slightly through formal savings, loan, or insurance modified “diary” exercise.4 accounts at banks, insurance companies, or microfinance institutions (MFIs). This was true Active Money Managers even where banks were near at hand (as in South The “diary” research revealed that poor people Africa) or where MFIs had already reached the use financial tools intensely. At first this finding slum or the village (as in the Bangladesh case). seems counterintuitive. It is easy to suppose that This can be partly understood from the “supply very small incomes lead to a “hand-to-mouth” side.” Banks are mostly set up to serve corporate existence in which income is consumed as soon clients and wealthier individuals and were never as it arrives and there is no need and no scope for designed to cater to the needs of the poor. MFIs intermediation and thus no need for the financial are built to serve the poor, but so far at least, they tools that make it possible. This turns out not to have focused most sharply on one particular be the case. The poor, rather, tend to be intensive financial service they believe will help poor peo- money managers, constantly seeking ways to set a ple to climb out of poverty—the short-term loan bit of money aside or to borrow. This is not in spite for small-business investment. Investing in a of incomes being small, but precisely because they business may indeed provide the potential to are small. Small incomes are often unreliable and increase incomes, but it is rarely the financial ser- irregular, so there is an ever-present need to make vice in greatest demand. Many MFIs and other sure there is enough money to put food on the service providers now recognize this and are table every day and not just on those days when beginning to offer a broader range of products tai- money comes in. Small incomes, even if they lored to the poor, but most of these services are arrive regularly, also mean that large-scale but relatively new and have yet to reach large num- unavoidable expenditures—for marriage, educa- bers of clients. tion, homemaking, and festivals, for bicycles, If we look at the “demand side” and see things fridges, fans, televisions, and mobile phones, and from the point of view of poor households it is for business and bribes and so on—can almost easier to understand why they rely most often on never be found from current income, and so must informal devices and services. They need ways to be saved or borrowed, or both. The same applies build sums of money: small sums to keep the to emergencies, which, no matter what form they household fed and clothed, and bigger amounts Clients 51 for life-cycle expenses of all kinds and for emer- includes the financing of productive activities, gencies. Because such sums can be built only by such as setting up and stocking small businesses, capturing money squeezed from already very or buying assets for self-employment, such as small cash flows, they need tools that help them rickshaws. do exactly that—set aside a little money each day or each week or month that can be used to build Cash Flow Management and Income savings or to repay loans. Such tools need to be Smoothing close at hand, and flexible enough to catch as When the World Bank says that a percentage of many deposits and repayments as possible. The the world’s population lives on US$2 a day, it financial diaries revealed that saving at home, means that the average monthly income, multi- often in very small values, is the most common plied by 12 and divided by 365, comes to US$2. But and frequent kind of transaction carried out by most people who live on low incomes do not actu- poor householders as they seek to protect money ally receive US$2 each and every day. Many poor from many competing demands. Then comes people derive their income from one or several borrowing and lending small sums in the village ­ informal activities that produce income sporadi- or slum, among family and friends, and often cally. An Indian slum dweller may pull a rickshaw interest free. To build larger sums, poor people most days, but not on days when he cannot find typically save through savings groups of various one to hire, or it is raining heavily, or he is too ill, sorts (some of them very sophisticated) or use or the streets are blocked by a demonstration. larger-scale informal borrowing, often from mon- Meanwhile his wife has a low-grade job in a gar- eylenders and usually with interest. ments factory where, in theory, she gets paid monthly, but in practice she can never be sure when her floor supervisor is going to get around Understanding the Poor’s Financial to paying her, or how much he is going to hold Service Needs back for how long. Research exercises such as the financial diaries Income irregularity and unreliability make up reveal the complexity of money management one leg of a “triple whammy” of financial handi- among the poor and the intimate way in which it caps faced by the poor. The other legs are low shapes and is shaped by the circumstances of incomes and the lack of adequate financial tools. individuals and their households. Nevertheless, The effect of all three working together and rein- the research also provides an opportunity to look forcing each other is reflected most sharply in the at the financial lives of poor people in aggregate, poor’s struggle to manage life on a day-to-day and when that is done, dominant themes emerge basis. If income really did come in at a reliable that respond to the set of most pressing financial US$2 a day, not only would planning expendi- needs faced by all poor people. One of these is tures be much easier, but the poor might also be short-term cash flow management to deal with offered better financial services by lenders or day-to-day life—what economists might call “con- deposit collectors who would know their clients sumption smoothing.” Another is the problem of could save or repay at least a small amount every how to deal with emergencies when they arise, or day. But with US$8 coming in one day and then “risk management.” A third is how poor house- nothing for a week, just putting food on the table holds struggle to assemble the large sums of each day becomes a logistical problem that needs money they need to take care of major life-cycle help from financial tools if it is to be solved. events and to build up household assets. For some Widening the timescale reveals an extra layer households, an important part of this last ­category of seasonal problems. Farmers or traders whose 52 The New Microfinance Handbook income is “lumpy,” arriving with the harvest or a handful of grain into a “reserve” bag each time with the good trading months when festivals they cook a meal. They borrow and lend, close by occur, can face two intertwined cash flow man- in their slum or village, both small sums of money agement problems. First, they have to find a way and small amounts of rice, kerosene, salt, and to retain liquidity throughout the year, perhaps by soap. The disadvantages of one financial tool lead keeping back most of the harvest and then selling to the use of another, sometimes in a chain. For it in smaller amounts from time to time. Second, example, because saving money in the home is so they have to make sure the money raised by such hard when there are so many requests for help or sales is stored somewhere where it can be called for loans from family and neighbors, demands for on for daily expenditure without being eroded by candies or a drink by children and husbands, or the many other demands they face. Boxes 2.1 and the temptations offered by peddlers, people often 2.2 illustrate this with two households from the use “moneyguards”—other trusted people in their financial diaries studies. extended family or neighborhood with whom It is not surprising, then, that the financial dia- they can keep a little money out of harm’s way. ries showed that day-to-day money management, Because moneyguards are not always reliable— both in towns and in villages, is the most intensive they may not have the money on hand the day it is part of the poor’s money management efforts. needed—the poor end up borrowing from other Almost everywhere housewives keep a little neighbors (often interest free if the sum is small), money back each time they shop, but they also put or buying goods on credit at the local shop, or Box 2.1  Income Volatility, Week-by-Week and Year-by-Year Pumza lives in Langa, a township near Cape her inflows of cash, that is, the cash revenues Town, South Africa. She supports herself and that Pumza receives as well as the collections four children by selling sheep intestines that she makes from clients who bought from her she grills on the side of the street. Every day on credit. The lighter, solid line shows her she buys and cooks intestines and sells business outflows of cash, that is, inventory them to passersby. “This can be a fairly prof- purchases and business expenses, such as itable business, and indeed Pumza makes a wood to cook the sheep intestines. Both lines profit averaging about US$95 per month. A are quite volatile, but most importantly, they government-provided child support grant of do not always move in step. Sometimes busi- US$25 a month supplements this income, ness does not go well, and Pumza does not so Pumza’s five-person family lives on a earn enough revenue to buy stock for the next monthly income of about US$120. These fig- day. In the time we knew her this happened ures show that Pumza is not among the twice—indicated by the arrows in the chart. poorest of households, but they do not reveal She could have sold her old stock, but cus- the fluctuations in cash flow that Pumza tomers prefer fresh meat and might choose to experiences in her business life.” go to one of the other several sheep intestine Figure B2.1.1 shows these cash flows on a sellers in the area. If she’s lucky, these times fortnightly basis. The dark, solid line shows coincide with the receipt of her child grant, (continued next page) Clients 53 Box 2.1  (continued) which helps tide her over, but on the two of US$30. In this way, she was able to fund occasions when we observed this problem, her first cash flow shortfall in figure B2.1.1. she was not lucky in this way. However, dur- Unhappily her savings club failed her during ing May, she and a group of three other sheep the next shortfall, because one of the club intestine sellers had formed a savings club. members failed to pay in. Pumza ended up From Monday to Thursday, they each paid in going to the moneylender, where she paid an US$7.70 and took turns getting the entire pot interest rate of 30 percent per month. Figure B2.1.1  Revenues and Inventory Expenses of a South African Small Businesswoman, Daily Cash Flows Aggregated Fortnightly (Twice Monthly) US$ converted from South African rand at US$1 = R 6.5, market rates 120 100 Used moneylender loan Used savings club payout 80 US$ 60 40 20 0 04 04 4 04 4 4 4 4 04 00 00 00 00 00 20 20 20 20 ,2 ,2 ,2 ,2 ,2 1, 1, 1, , 21 21 21 21 21 21 r2 r2 t2 r ch il e ay ly us be be e pr n Ju ob ar M Ju ug em em A M ct A O pt ov Se N Revenues plus credit collections Inventory purchases and expenses Source: Collins et al. 2009, p. 41. Source: Collins et al. 2009, p. 42 and passim, with permission from Princeton Press. 54 The New Microfinance Handbook Box 2.2  Cash Flow Management Given Volatile Seasonal Income Sita, a widow, farmed a little land in northern During the household’s eight-month-long India. Two of her sons lived with her, and as “low season” it sometimes fell to less than well as helping on the land, they took casual half of that. laboring work. Nevertheless, 60 percent of Astonishingly, Sita and her sons still man- their income was earned in just four months, aged to save enough grain and cash, at home, from June to September, and in the year to ensure that they could eat throughout the that we tracked their lives, bad weather year. To get hold of a larger sum they mort- meant that that income was especially low. gaged land to borrow from a grain trader for Averaged over the year, total household whom one of the sons worked, and repaid income was just under US$30 per month, or that debt by deducting a little at a time from about 32 cents for each member of the his wage. In these ways, over the year they household (about US$1.20 per person per saved and repaid about US$63, almost a fifth day when adjusted for purchasing power). of their total income. going into rent arrears. Then, when the rent financial tools to average annual income varied arrears have built to the point where the landlord between about 75 percent and 175 percent in begins to threaten eviction, they borrow larger India, a similar amount in Bangladesh, and a figure sums, with interest, from a moneylender. To repay somewhat higher in South Africa (Collins et al. the moneylender, saving efforts have to be 2009, pp. 31–33). This is because much day-to-day redoubled, or assets have to be sold off. But selling management involves short-term, rapidly revolv- off assets—for example, selling roof sheets to ing exchanges of cash. Many of the smallest loans repay a creditor—simply creates another essential from neighbors were repaid in a matter of days. item that requires the poor to save. No wonder “Big flows and small balances” is a good general households in the financial diaries told the description of poor-owned portfolios, and they researchers that “All this keeps us awake at night,” are matched in the experiences of MFIs that have or confided that “I hate having to borrow money a track record of offering unusually convenient from other people—but there is no life without passbook savings to poor communities. When money, so we just have to do it.” examining the accounts at BURO, an MFI in But although day-to-day money management Bangladesh, researchers found that the annual is where the majority of financial services are flow through the passbook savings product was used, this does not show up much in the balance four and a half times the value of the year-end sheets of the poor. Year-end balances of most savings balance (Rutherford et al. 2001). Poor “diary” households revealed rather low levels of people need to save short term to form small sums household savings and of local borrowing and that can be withdrawn to cope with everyday life. lending. It is only when cash flows are examined Saving, for the poor, is a verb before it is a noun: that this intensity of use can be seen. Typically a something you do rather than something you pos- household’s annual financial cash flow was many sess. More often than not, saving is a way of cop- times the value of their financial assets and liabil- ing with small and unreliable incomes rather than ities. The ratio of cash pushed and pulled through a way of building capital. Clients 55 A reliable lender of small loans can also help to for the borrower or built into the price of the smooth income, as box 2.3 shows. loan). Lacking formal insurance, most poor peo- ple must look for other ways to anticipate risk and Dealing with Emergencies and to deal with emergencies when they occur. Anticipating Risk Poor households are peculiarly vulnerable to When emergencies strike, poor people, like every- emergencies. Many live in fragile ecosystems: one else, need large amounts of capital if they are Pushed to the margins by poverty, they are closer to have a chance of fending off the worst effects of than others to seas that breed cyclones or rivers the event. In wealthy countries, and among the that flood, or farmland prone to drought. Close to better-off in poorer ones, insurance is available to one-fifth of the burden of disease in developing provide that capital, in the right amount at the countries can be attributed to environmental right time. Insurance is a fast-growing and excit- risk—with unsafe water, poor sanitation, and poor ing part of microfinance, but it has reached hygiene as leading risk factors causing premature few poor households so far (though many deaths (World Bank 2005). The poor may live in microlenders do provide insurance against debt if provisional slums with uncertain legal status a borrower dies holding a loan, either as an option where they can be pushed out by landlords or Box 2.3  Ramna’s Top-Ups One of several innovations that Grameen in a tea stall. Ramna was in charge of keeping Bank introduced in 2002 in an effort to make the home ticking and making sure everyone its products less rigid was the loan “top-up.” was fed. She found Grameen’s top-up sys- Under this provision, borrowers may top-up tem useful. Every six months she got a use- their loans to the original disbursed value fully large lump sum that helped her keep the once they are about halfway through the household stable. The researchers saw her annual repayment schedule. In effect, they spend these sums on stocks of rice, manag- can take smaller loans every six months ing her father-in-law’s funeral, buying medi- rather than a bigger loan once a year. Ramna cines for her husband, and paying for school and her husband provide a good example of fees and books and clothes. Once she simply Grameen clients who benefited from the top lodged her loan top-up with a moneyguard up loan. They were getting on in age, neighbor until she needed to take it back to unskilled, uneducated, and unlikely to run pay off a private loan that became due. On any kind of business, but they still had two another day she was found keeping back sons at home whose schooling they desper- some of her top-up in a locked box at home ately wanted to continue. Their income came because she knew that a “down” period was from whatever casual employment or coming and she would need an extra source self-employment Ramna’s husband could from which to make the regular weekly find: During the three years that their finan- Grameen loan repayment—behavior that cial life was tracked, he did farm labor, col- indicated the value she placed on getting her lected crabs from the sea nearby, and worked biannual infusions of useful capital. 56 The New Microfinance Handbook governments at short notice, or suffer from fires ceremonies, many of them related to the ignored by the municipality. Unable to buy suit- HIV/AIDS pandemic. able drugs or quality feed, their animals die How did they cope when these crises struck? younger and produce less than those of wealthier Often they did not: The illness was never properly farmers. Cooking over an open flame near homes cured, the home or the job was lost for good, and built of bamboo walling or straw roofs, they expe- the cousin was given only the most basic of buri- rience a higher risk of destructive fires. That same als. The question then becomes, How did they try wood smoke damages lungs and eyes, an example to cope? When disaster strikes, people pull in of how health problems start more often and whatever resources they can reach. Assets may be are cured less easily among the poor than among sold or, in the case of precious metals, pawned. If the population in general. there is time for the deal, any land in the house- In Bangladesh, half of the households studied hold’s ownership may be mortgaged out. Savings in the diaries project suffered serious financial may be exhausted. Social networks are called on disruption from ill health during the study year, for gifts in kind or in money, and for interest-free and in India the figure was two in five. One in five or low-cost loans. Nonessential spending is fore- of the Bangladesh households lost a home during gone. Without access to insurance services poor the year, and four out of five of the South African people use whatever financial tools they have households had to contribute to expensive funeral available to them to manage risk (see box 2.4). Box 2.4  Enayet’s Foot Enayet worked on building sites with his factory, money she had planned to use for her father in a slum in Dhaka, Bangladesh. When marriage. But the sum they raised was still far he was about 17, his parents realized he was from enough, and faced with a “no fee no becoming dependent on drugs. They remon- treatment” ultimatum from the doctors, strated with him, and Enayet ran away from Enayet’s father went to better-off people in home and lived on the streets of Chittagong, the neighborhood—a retired teacher with a a port city several hundred kilometers away. pension, a shopkeeper, and a small-time His father drew down their meager savings pawnbroker—to take loans on interest of 10 and gave up working to search for his son. He percent a month. Later, in the time of the found him, but only because Enayet got into a financial diary research, Enayet was back brawl and broke his leg. He had no money to home, walking with a crutch. The expensive treat the injury, and it worsened: Eventually loans had not been repaid, and very little inter- he contacted his father when he could bear est had been given. Enayet’s mother suffered the pain no longer. Back in Dhaka, Enayet’s verbal abuse from one of the lenders and did family gave up almost everything to have him her best to ignore it. Almost certainly, the admitted to the hospital. They sold their furni- debt will not be repaid; from time to time ture, their jewelry, and their bicycle. They got Enayet or his father will make token interest loans from extended family. Enayet’s younger payments, hoping that eventually the principal sister withdrew her savings from a club run by will be forgiven or forgotten. women working on her floor in a garments Clients 57 Nevertheless, when a particular risk is espe- Building Bigger Sums for Life-Cycle Events, cially expensive, or has an unusually high likeli- Assets, and Businesses hood of happening, poor households may try to The constant threat of emergencies requires buy protection from it, using formal insurance or households to find large sums of money quickly. informal substitutes. Such is the case in South But they are by no means the only reason why Africa of funeral insurance, where many poor poor households need to build large sums. All of households anticipate having to pay out for funer- us, including the poor, need to be frequent big als and invest in devices specifically designed to spenders, to deal with life’s big events—annual deal with this event. Many of the “diary” house- festivals, ceremonies to celebrate birth, marriage holds belonged to an informal burial society into and death, costs for education and home building, which they pay monthly premiums and in return and assets to make life better, such as fans and receive financial benefits to help cover the high televisions. Some will also want to build large costs of burials. Some of the same households also sums to establish a new business or expand an paid into formal funeral insurance policies.5 existing one, or to invest in a large asset for Many households used both the informal and self-employment, such as owning one’s own rick- the formal schemes, so the financial diaries shaw rather than hiring one on a daily basis, or authors were able to compare how well they buying or leasing-in more land to farm. Others worked. Within an overall financial portfolio of will migrate to find work, in the big city or over- 8 to 12 financial instruments, South African dia- seas, and will need to finance these often costly ries households usually had at least one burial journeys. How do they go about building these society and one formal funeral insurance policy. bigger sums? These households spent, on average, 3 percent of We have seen that most of the financial tools gross monthly income in total on all of their used by poor people are informal. But informal funeral cover instruments. sector finance is not geared to handling large On pure economic terms, formal funeral insur- sums of money over protracted periods of time. It ance has about the same value as informal burial is not safe to hold large amounts of savings at insurance:6 Formal funeral insurance tends to home, or in a savings club, because the longer cost more on average per month than informal these savings have to be kept, and the greater burial insurance, but it also pays out more. their value, the greater the risk of loss or theft or Looking beyond economics, burial societies have misuse. Similarly, even the greediest money- the advantage of providing a great deal of physical lender is not willing to lend large sums to the poor assistance and moral support around the time of because large loans need lengthy repayment peri- the funeral. Fellow members take on a signifi- ods, and the longer the loan is held the greater cant role in preparing and serving the feast dur- grows the risk of default. ing the burial, often providing the cookware and So, even though these kinds of large expendi- eating utensils. However, burial societies can be ture can usually be anticipated, rather than being quite unreliable. Evidence suggests that close to needed suddenly, poor people nevertheless find 10 percent of them run out of money (FinMark themselves building up sums piecemeal, just as Trust 2003). Therefore, although many poor they do when faced with an emergency. It is not households may continue to belong to burial soci- unusual for a big asset to be bought with a mix of eties for the social benefits they provide, formal savings, loans, gifts from family, and the proceeds insurance providers have a clear contribution to from the sale or mortgaging of other assets. The make in this market by continuing to offer good piecemeal approach also characterizes the way value products with reliable service. that savings for large-scale expenditures are 58 The New Microfinance Handbook assembled. Certain items, notably gold jewelry, or a large compound (in the case of South Africa). roof sheets (and bricks and cement blocks and In the urban areas renting a home was more com- lengths of timber), and, in many households, mon. In some cases, such as in some slums in livestock, are used as long-term stores of value, Dhaka, Bangladesh, families owed the physical and although the terms of most informal finan- structure of a simple timber-and tin-sheet one- cial tools are short, they can be used to finance room home and perched it rent free on land these savings-in-kind. ROSCAs are particularly owned officially by the government or some other good at this. institutional landlord. In South Africa some of the ROSCAs, short for rotating savings and credit diaries households owned a permanent brick associations, are savings clubs in which members home, although others with shaky tenure in the pay regularly into a pot that is taken in its entirety urban areas could simultaneously be building a by one of their number in rotation and are com- home in the rural areas. mon around the world. Pumza, the sheep-intestine Financing the ownership of a home, then, was seller featured in box 2.1, was in a four-member a challenge being faced by only a minority of the daily ROSCA, and Enayet’s sister, mentioned in diary households—but where that was the case, box 2.4, belonged to a much bigger monthly the challenge was considerable, and the solution ROSCA run by fellow workers at her garments to it required huge self-discipline, as the case of factory. ROSCAs are often deliberately designed Jonas and Mimimi, from South Africa, shows to make it easier to obtain expensive items. In the (box 2.5). Although many MFIs and other provid- Philippines, for example, rural school teachers ers are beginning to offer housing loans or use ROSCAs to help furnish their homes after ­ contractual savings products to invest in a home, marriage: They persuade their colleagues to join a these tools were not available to this couple. ROSCA and use the proceeds to buy sofas and Therefore, like many others around the world, chairs. they did their home building in a piecemeal Where MFIs have become common, as in fashion. much of South Asia, the short terms that charac- Much of what is observed about the financing terize their lending (mostly about one year) lead of domestic assets is also true of productive assets. to similar uses of the sums loaned. To the conster- They too are often acquired through a range of nation (and sometimes disapproval) of MFI field sources including gifts, asset sales, remittances officers, MFI clients may take a loan ostensibly from family members working in the big city or for business investment and use it to buy gold overseas, and savings and loans. The savings may jewelry. From the clients’ point of view, buying have been held until needed in lower-value items such a store of savings is as legitimate a use for a acquired through saving or borrowing short term loan as any other, especially when other opportu- in the informal sector. nities to save (or invest) are so scarce.7 The piece Once again, community-based devices such as of jewelry may serve as decoration until called on the ROSCA, with its simple and flexible formula, to help finance something on a much larger scale, can be a powerful way of assembling cash for such as the wedding of the young woman whose working assets. In Vietnam fishing communities neck it adorns. have used “auction ROSCAs” (ROSCAs in which In all three countries in the financial diaries the order in which the lump sum is taken is deter- studies, most of the rural sample owned their mined not by lottery but by bidding for it at each home and the parcel of land on which it stood, draw) to raise money for boats and equipment. So often through inheritance. The better-off also had high is the demand for capital that club members land to farm (in the case of India and Bangladesh) sometimes forego as much as 50 percent of the Clients 59 Box 2.5  Building a Home Little by Little Jonas and Mimimi, a married couple who run a shebeen (township bar) in Langa near Cape Town, have an impressive capacity to save. Mimimi’s profits from the shebeen business are about US$324 per month, while Jonas works as a gardener and is paid US$185 per month, for a total monthly household income of US$509. Compared with other diaries households in Langa, which have an average monthly income of US$425, they are doing quite well. Mimimi typically manages to send about US$31 per month to her relatives in a rural area of the Eastern Cape. Their children live there with Mimimi’s mother, and she sends money every month to pay for their food and school fees as well as to contribute to a home they are building there. She then manages to stretch about US$87 for their living expenses every month. A typical monthly budget is detailed below. Mimimi’s typical monthly budget (US$) 509 Source of funds   Business profits 324   Regular wages 185 Uses of funds 486   Cell phone 6  Cigarettes 3  Electricity 16  Food 49   Money sent to Eastern Cape 31   Transport to shopping 1   Transport to work 13   Savings clubs 367 Net savings in bank 23 Jonas and Mimimi’s most important savings devices are two informal savings clubs. Together, they save about US$367 with these clubs. A total of US$3,065 was paid out from one of them during the research year, and it was all used to build the house in the Eastern Cape. The other club paid out US$725 a few months later. From this payout, they spent the majority on a Christmas feast and Christmas presents when they went to the Eastern Cape for the holidays. But that still left about US$260 to buy cement for the floors and to buy doors for the house. In the end, between the two savings clubs and the money they retained from Jonas’s salary in a bank account, this young couple built up about US$4,000 in savings (not counting the money sent to the Eastern Cape every month). Of this, 12 percent was spent on Christmas, 6 percent was retained in the bank, and 82 percent was used to build the Eastern Cape house. The way they saved to build the house and the proportion of savings that went toward the house is similar to that of many other households in South Africa.a Note: a. See “Housing and the Finances of the Poor” at www.financialdiaries.com for more details regarding how financial diaries households acquired housing. 60 The New Microfinance Handbook sum in bidding for it. In Bangladesh rickshaw of default—the shame and maybe a bit of rough drivers run “rickshaw ROSCAs” to build a big treatment at the hands of other members—but, enough sum to buy their own rickshaws. At some more importantly, because the inability to keep gathering place, often the garage where their up the repayment schedule is a very good indica- hired rickshaws are parked overnight, each rick- tor that one’s financial position is not strong shaw driver in the club sets aside a fixed contribu- enough to maintain the asset once it is acquired. tion from his daily earnings, and when there is Many rickshaw drivers who struggle to meet enough in the kitty to buy a rickshaw it is decided ROSCA dues or repay MFI loans used to buy a by lottery which member of the club is to receive rickshaw end up having to sell their machine, it. By a clever twist, which illustrates well the almost always at a big discount, because they lack sophistication that often characterizes ROSCAs, the means to bring financial stability to other after a club member has received his rickshaw he aspects of their life. puts in double the usual amount each day: He can That leads to an important observation: All afford it because now he does not have to pay rent poor households need financial tools to handle for a rickshaw. This has the effect of accelerating their basic needs—day-to-day consumption the ROSCA so that the next rickshaw purchase smoothing, dealing with emergencies, and build- comes along sooner, reducing the length of time ing sums to pay for life’s big occasions. If those that members’ investments are at risk. A few men basic needs are not being at least partially met, have used these clubs so successfully that they lending to poor people exclusively for productive have acquired fleets of rickshaws, and then grad- investment may not be wise. At best, the loans uated to motorized rickshaws. meant for business will be diverted to the more Note, however, that not every Dhaka rickshaw basic needs. At worst the loan will go into a busi- driver wants to own his own rickshaw. Costs and ness that will prove short lived or loss making in risks are associated with owning such assets. the face of other financial demands made on the A rickshaw needs maintenance. It needs to be borrower. stored somewhere safely at night. It has to be pro- In the case of Bangladesh, one of the world’s tected from confiscation by police officers run- most mature microfinance markets, MFI lenders ning extortion rackets. Not every poor rickshaw have by and large learned to turn a blind eye to the driver can manage these tasks, so many prefer not fact that many poor clients use their MFI loans to try. It is not only because they cannot afford primarily or even exclusively for nonproductive them—or do not have access to the right financial purposes—even though some of these MFIs con- products at the opportune time—that poor people tinue to insist in public that loans are given only own few productive assets or invest in few pro- for microenterprise investment. A set of financial ductive activities: Other aspects of their poverty diaries carried out to examine how informal may make it unprofitably hard to benefit from devices and MFI services fit into the financial investment. lives of the rural poor in Bangladesh sheds light Nor does every self-employed person want to on this: Productive investment is only one of a join a dedicated ROSCA of this sort, again for rea- range of uses that people borrow from MFIs for, sons to do with the financial facts of his or her life. as box 2.6 shows. The pressure to keep up with the payment sched- Other evidence suggests that business owners ule is severe, and if one cannot be sure that one’s can benefit from small, flexible cash infusions in cash flow will allow one to pay on time every time, a cash flow crunch, but that they may not lead to it may be better to avoid the commitment. This is business growth. Financial diaries done with a not just because of the immediate consequences modest sample of small business owners in Clients 61 Box 2.6  How MFI Loans Are Used in Bangladesh Out of a total of 237 microfinance loans care- more than a timber hut with a few dollars’ fully tracked through repeated visits to bor- worth of stock. Then one finds only a handful rowers of Bangladeshi MFIs over a three-year of households with a more than nominally period, just under half were used to stock productive business: perhaps a couple of fam- retail or trading businesses, or to finance ilies running rice mills, and someone success- small-scale production, or to buy or maintain fully recycling garment-factory waste into assets of one sort or another. One in ten loans stuffing for mattresses.a Most of the other were on-lent to subborrowers outside the villagers are agricultural day laborers or are household (neighbors and relatives), and a self-employed service workers, pushing rick- similar number were used to pay down exist- shaws or ferrying boats or loading trucks in ing debt (including, sometimes, debt from the neighboring market or selling tea from a other MFIs). The remainder were used for microstall. The small number of better-off consumption or for a mix of uses. Half of farmers, with landholdings big enough to pro- these MFI loans, then, by number and roughly duce more rice than the family can eat, are by value, were used for what could broadly be mostly not MFI clients because they dislike called “income-generating activities.” But this having to attend weekly meetings and find the does not mean that half of the borrowers loans too small for their needs: They may also used their loans in this way, because a small have access to formal finance, particularly if number of commercially active borrowers they have land they can pledge. Putting this took bigger loans and took them more fre- into numbers, the study found that 14 percent quently from more than one MFI. Imagine a of the MFI borrowers were responsible for small Bangladesh village: Just a few house- taking two-thirds of all MFI loans used for holds are running shops that are anything businesses. Note: a. This was the situation in one village where these diary studies were undertaken. South Africa8 showed that business owners were people to borrow to establish and expand able to start operating with fairly small sums of businesses. upfront capital. However, to keep their business Most MFIs began with the primary purpose of in operation, they need frequent fresh infusions providing loans to the poor to start or expand a of capital. Rarely did these business owners small business, but the early hope that every poor dream of expanding their business, or imagine person can become a successful entrepreneur is that they would make more money if they did. now giving way to an understanding that enter- They were rather more concerned about just prise lending is best when targeted at clients keeping it going, to provide a stable, if small, selected for their aptitude for business and their source of income. stable domestic finances. As a result, the Enterprise borrowing, then, is not for every- enterprise-investment side of microfinance is ­ one. Nevertheless, a good proportion of MFI gradually moving away from loans with weekly borrowers—at least one in seven in the sample ­ repayment schedules that may not match the cash from Bangladesh described in box 2.6—respond flow patterns of small business, and toward loans well to the microcredit dream of enabling poor given to and tailored for individuals rather than 62 The New Microfinance Handbook group-based borrowers. This should leave room “Moneyguards”—people trusted to hold money for group-based saving and borrowing for the non- safely on one’s behalf—are common. They may be entrepreneurial poor to adapt better to their wide neighbors, relatives, or employers. Often the range of nonbusiness money-management needs. transactions take place in both directions: The diary research found several households that both take in and put out money in this way, at the How Good Are the Financial same time.9 Moneyguarding is closely related to Tools Used by the Poor? casual interest-free borrowing and lending among So far this chapter has provided numerous exam- kin or neighbors. Sometimes it is hard to tell them ples of how poor people choose and use their apart: In Bangladesh diary households might say financial tools. In this section we step back to they had “put” some money that week with a review the overall quality of these services and neighbor, and they would give vague answers devices. Understanding better the strengths and when asked to specify whether this was a loan or weaknesses of the present set of tools should help a savings deposit or a repayment on a loan. to structure thinking about how microfinance Nothing better illustrates the complex ways in might, in the future, add more value to the finan- which a community’s aggregate cash savings flow cial lives of the poor. back and forth between its members. This ambi- guity is, like much in the informal sector, a Convenient, Frequent, and Flexible—But strength and a weakness: It enables a good deal of Not Always Reliable interaction to take place, but at low levels of reli- The most convenient tools of money manage- ability that in turn place limits on the values and ment are ones that can be organized by the users durations of this kind of intermediation. themselves, without the need to interact with Where greater certainty or larger sums are others, without the need to travel, available at any needed, a price is usually demanded. Village or time of the day or night, and at little or no cost. It slum moneylenders who lend as a business ask is not surprising then that the financial diary for interest, and many who lend merely to fulfill research found almost every poor household family or social obligations do likewise. The held—or tried to hold—savings at home. But this interest is often at a high rate, either to compen- level of convenience and flexibility comes with sate for the evident risk of lending to very poor obvious drawbacks: It is just too easy to take back people (in the case of professional lenders) or, in these savings, so only those with exceptionally the case of those lending as an obligation, to help strong willpower (and there are such people) are limit the amount of money being lent. There is able to build or keep large sums at home. Security more on the social aspects of this kind of lending is another obvious weakness of home savings: below. They are vulnerable to theft or misuse, or to One way to borrow free of social entangle- being lost in floods or storms, and at the very least ments is to use a pawnbroker. The limitation here they will lose value to inflation. Self-help home is that poor people rarely hold much in the way of saving, then, illustrates the trade-off very com- pawnable goods, so very large sums cannot usu- monly found in informal finance—between con- ally be obtained by this route. The mortgaging of venience on the one hand, and low reliability, land has other disadvantages: The land mort- short-termism, and insecurity on the other. gaged may have been the household’s main One way to mitigate these drawbacks is to income source, and the larger sums that can be form a financial relationship with somebody else. had from mortgaging land often prove very Clients 63 ­ ifficult, if not impossible, to repay, so the land is d discipline. Saving within a bigger group, as in a in effect lost for good. ROSCA or an ASCA10 (accumulating savings and MFIs have been much better able than banks credit association, described in chapter 6, to approximate the convenience of informal “Community-Based Providers”), offers much finance. They have done this in various ways. more discipline, relying on the power of group First, they got physically close to their clients, by pressure and sanctions to keep the transactions holding meetings right in the village or slum. flowing regularly. Many poor people are well Soon, they settled on a form of lending in which aware of the flip side of informal finance’s flexibil- repayments were made easy by being small and ity and convenience—its lack of discipline—and frequent—often weekly, at the meeting, some- this helps to explain the popularity of devices like times even daily, through itinerant collectors. It the ROSCA. Researchers have also suggested that was this level of convenience and frequency— when people are distracted by the problems of rather than anything to do with microenterprise poverty, and have to juggle several income flows development, or “group solidarity”—that led to from different sources and deal with the individ- microcredit’s extreme popularity in its early days. ual cash flows of numerous financial tools, they Provided that their household cash flows were can lose sight of their longer-term financial posi- strong enough to come up with a small weekly tion.11 By joining a group such as a ROSCA poor toll, people could borrow for whatever purpose people may inject enough regularity into their was most pressing at the time. Later, when some financial lives to help them plan for and meet of the disadvantages of a credit-only regime ­longer-term goals. became apparent (such as the risk of overindebt- In earlier sections we have seen how ROSCAs edness), MFIs, where regulators allowed them to, help their members build sums that can be used to introduced passbook savings that could be depos- meet emergencies or acquire assets. ROSCAs can ited into or withdrawn from at will, at the village fail, but as well as offering a disciplined environ- or slum meeting. Nevertheless, most general ment that encourages regular saving, they have lending to the poor by MFIs (as opposed to their other advantages. One is that because they never lending to microenterprises) is short term and require cash to be stored (at each meeting the therefore of low value relative to incomes: A typi- money goes straight to that meeting’s taker) there cal loan may have a term of 11 months and be is no risk of the treasurer dipping into the fund. worth the equivalent of two or three months’ Another is that the combined eyes of all the mem- household income. This is very useful for con- bers ensure that transactions will be more than sumption smoothing (as shown by Ramna’s usually transparent and verifiable. These virtues behavior described in box 2.3) but not for the big- offset the moderate risk of the ROSCA going ger sums that all households need from time to wrong because a member simply fails to pay in time. To accumulate big sums, with most MFIs, after he or she has taken his or her turn at the borrowers still need to build a series of modest lump sum. Other features of ROSCAs make them sums through successive rounds of borrowing, suitable for poor people: They require no book- and find their own ways of storing their value— keeping, so the illiterate are rarely confused by most commonly by holding them in nonfinancial more literate members of the group. They are assets such as jewelry or livestock. without cost: Money goes straight from the depositors to the taker in what must be the Disciplined—But Only in the Short Term world’s swiftest and cheapest form of financial Saving on your own is hard. Saving with a money- intermediation. And they are close at hand and guard helps impose some distance but not enough convenient: People set up ROSCAs right where 64 The New Microfinance Handbook they live or work and hold meetings at times that credit union to become a permanent formal suit them. Box 2.7 illustrates several of these institution, providing the members with ongo- ROSCA features. ing services and, crucially, enough security to Poor people find it easier to form larger sums allow members to build up large deposits over through ROSCAs than they do through saving at the long term, or pay steadily into insurance or home or saving with partners such as money- pension policies. What has stopped this admi- guards. Nevertheless, really big sums—enough to rable system from becoming the obvious first buy a home or business outright or fund a pension choice for poor people around the world is that annuity—cannot usually be formed through the degree of formal organization needed to ROSCAs because, like all informal schemes, keep a credit union stable requires levels of ROSCAs become riskier the longer they run, the education and financial sophistication that are more members they have, and the bigger the simply not available in most of the world’s amounts transacted. ROSCAs are time bound: As poorer village and slums. soon as every member has received the “prize” Credit unions are inventions of the nine- once, it comes automatically to an end, although teenth century. More recently, nongovernmental the members are, of course, free to start another organizations (NGOs) have taken up the basic cycle and accumulate another modest sum. idea of the savings club and used it to work with ROSCAs illustrate another typical informal- poor people on a range of development issues, finance trade-off—security versus longevity and not just finance. The largest endeavor of this volume. kind is India’s Self-Help Group (SHG) move- The group-based approach to financial ser- ment, which counts its members in millions. vices to the poor has been taken up by outsid- SHGs are basic savings clubs linked to formal ers in various ways. The oldest and most banks, which recognize them as legal entities impressive is the credit union movement, now and lend to them at favorable rates. More recent found throughout the world.12 Credit unions still is the Savings Groups movement,13 which take the basic idea behind all ROSCAs and has been building steadily over the last 20 years ASCAs—the idea of a group of people coming and follows a rather different course. The NGOs together voluntarily to pool their savings—and that promote savings groups prefer to tackle the submit it to enough ­ formalization to allow the weaknesses of savings clubs, especially problems Box 2.7  Daisy’s ROSCA Enayet’s sister’s saving club (see box 2.4 about one of the women, in a fixed order ­decided by Enayet) was a ROSCA (she called it a lotteri lottery on the first day of the ROSCA, took the shomiti). Daisy earned 1,500 taka a month whole 5,100 taka, a sum equivalent to two or (about US$25 at the market rate). In a meeting three months’ salary. When Enayet was admit- that took place each monthly payday, when ted to the hospital, Daisy’s turn to take the she and 16 other women on her floor con- money was still a long way off, but, in return ducted their ROSCA, they each contributed for a modest tip, she was able to get another 300 taka from their wages, and each month member to swap turns with her. Clients 65 of poor governance, by training members in the the social relationships in which people are use of improved practices. Because these savings engaged may be complex, involving labor groups are standalone entities not linked to exchange and land rental as well as money. In banks or other institutions, they are seen as par- such contexts “moneylenders” may act as patrons ticularly suitable to remote and sparsely popu- who assist their “clients,” and this remains true lated areas. even when such help could result in cycles of debt Microcredit MFIs, as is well known, of course, that are ultimately damaging to the long-term lend through groups. But MFI groups in the welfare of the borrower. In these cases, with few ­ fastest-growing microcredit traditions, such as competing options, poor people often prefer to that based on the work of Grameen Bank, are not retain such avenues of access to resources than to mutual entities that own or share their own group avoid them. funds, but simply groups of retail customers Another way in which the informal sector brought together by the MFI to reduce service operates through social relationships is in the delivery costs. ways people assist each other, especially family and friends. Poor people may help their friends Social Embeddedness—A Strength and relatives in ways that are quite open-ended. If and a Weakness a child needs school fees and parents cannot pro- The discipline that ROSCAs offer is in part a vide, another relative—or even a friend—may result of the social relationships they embody: help. Such assistance creates a debt that takes the Being a member of the group creates an obliga- form of a future obligation to reciprocate. It may tion to contribute or to be shamed in front of the not be reciprocated in cash, or in school fees, but group.14 However, this discipline is often tem- in a completely different form such as labor, lend- pered by flexibility in the way in which the ing animals, or taking care of a child. It is a form of ROSCA responds to clients’ needs. The essential saving with others that is not directly financial feature of the group is that it represents a source and in which the return is unknown at the time, of liquidity that members can access one way or but is indeed an obligation. In this way debts are other. This can involve direct negotiation at a not to be avoided: They create relationships of group meeting to obtain the payout because of a reciprocity that can be drawn on in the future. In pressing need, shock, or emergency, or members the case of Enayet (see box 2.4) the loans his par- can negotiate directly with each other to change ents took were never repaid in full and were on the order in which the payout is received (as in the way to being “forgiven”—but public disap- Daisy’s case; see box 2.7) or borrow the payout proval and comment ensures that the borrowers from the member who did receive it. Groups cannot forget that the obligation represented by organize themselves in many ways, and they vary the unpaid debt continues. in how flexible they are prepared to be, but the The social relationships in which informal key feature is that by jointly creating a source of financial services are embedded are both one of liquidity, members have a right to make claims on their greatest strengths as well as their greatest that resource and to be listened to by other mem- weakness. For those who are able to manage bers, either formally at the club meeting or at its “negotiability” successfully they offer flexibility margins. This feature can be referred to as and responsiveness for risk management in par- “negotiability.” ticular, but also for productive investment and Although the mechanism differs, this negotia- asset building. However, such relationships are bility is also a feature of moneylending. not open to all, and the poorest people are less Moneylending is often seen as exploitative, but able to engage with them because they are less 66 The New Microfinance Handbook able to reciprocate, although they may also be the enabling them to transact frequently, through recipients of assistance from time to time. out-of-branch banking of the sort seen in weekly village or slum meetings or in mobile- Creating Better Financial Services phone banking, will remain vital. Breaking for the Poor the formation of sums down into small bite- size pieces, as in Grameen- or village bank– The picture this chapter has painted of the cur- style weekly savings and repayments or via rent state of financial services for poor people has daily collection agents, will still be essential. numerous implications for microfinance. They Above all, the MFI’s superior level of reliabil- are overwhelmingly positive. Taken together, ity and transparency, relative to much infor- they suggest that microfinance enjoys big oppor- mal finance, needs to be retained and tunities to grow in both quality and quantity: strengthened. • First, the picture implies a very high demand • Fifth, it shows where microfinance will have from poor people for financial services. This is to improve and extend its products and deliv- seen in the intensity with which poor house- ery systems. Two very important goals are holds use whatever financial tools they have at finding ways to introduce greater flexibility hand. into loan terms and repayment schedules (while still offering discipline) and finding • Second, it implies that this high level of ways of enabling the poor to engage in much demand is by no means fully met, neither in longer-term intermediation, through long- volume nor in quality. This is seen in the fail- term commitment savings plans (including ure of the existing, largely informal, tools to insurance and pension plans) and loan terms satisfy in full the financial needs of the poor, in longer than the six months to one year com- the low levels of reliability that characterize mon to much microlending at present. much informal intermediation, and in the still very modest numbers of poor people reached • Sixth, it suggests that the demand by poor peo- by MFIs and other formal providers. ple for financial services may be quite similar across regions and districts, which implies • Third, it implies that a great deal of the demand that although microfinance practitioners will from poor people is not for the products and need to modify their work to suit each loca- services that the microfinance industry has tion, a core set of needs is present that can be emphasized during its first three decades. In met by broadly similar products. This is seen particular, the demand for savings (including in the remarkable congruence of behaviors insurance) may outstrip the demand for loans; observed in the two South Asian nations and in the demand for general-purpose loans may South Africa—countries that have very differ- outstrip the demand for loans for micro-­ ent histories, cultures, and levels of economic business investment; and the demand for long- and financial development. term saving, borrowing, and insurance instruments is at least a strong as the demand A key challenge for formal service providers for short-term savings and loans. has been the struggle to get close enough to the • Fourth, it implies that much of the methodol- poor to compete with the proximity and fre- ogy that microfinance has already developed quency of informal tools. Informal tools are cer- will be relevant to meeting this demand. tain to keep their advantage in this respect, and it Techniques for getting close to clients and would be foolish to think that formal services will Clients 67 entirely replace them. But by finding ways to con- school fees, for example—can be met. This range tact their clients where they are, in the village or of plans can be offered, more reliably, by a formal slum, and doing so as often as they can, through provider that is in regular frequent contact with regular weekly or daily routines, or via cell phones its clients. and bank agents, formal services should be able to These challenges are well worth formal pro- gain a much bigger share of the everyday financial viders tackling. Informal finance, where poor intermediation of the poor than they have at pres- people conduct most of their financial lives, can ent. Recent innovations that will help them do suffer from low reliability and an inability to offer this include mobile-phone banking and legisla- long terms to create large-value sums. These are tion to allow banks to operate through agents— major deficiencies, and formal services can and either peripatetic as in India’s recent “banking should offer something better. Reliability, in the correspondent” provisions or as a supplemental sense of ensuring that agreed contracts are hon- business for local shops, as in Brazil. ored, is fundamental. The poor live in environ- Another challenge for formal providers is to ments that are continuously changing; most have make products more flexible, to respond better to neither cash flows, nor living arrangements, nor the irregular cash flows of poor clients. Here environmental and social conditions that are again there is cause for optimism: Worries about static or reliable. Bringing more reliability into internal control, and a sensible concern to keep financial tools will provide a significant boost to things simple, caused early microcredit pioneers the ability of the poor to plan and envision a to begin with rigid payment schedules, such as future beyond the short term. This requires ser- the strict weekly repayments of Grameen-style vices that are offered in a timely manner and microlending. But with experience and the astute under clear conditions, with terms that are use of technology they are now able to offer “pass- upheld and with opportunities to easily ask book” savings—savings accounts where the client ­ questions and seek redress. can deposit or withdraw as much as he or she A minimum “menu” of financial services for all likes at any time—and flexible loan repayments, at poor clients in the second decade of the twenty- least for modest value loans. first century would ideally include passbook Because they are permanent institutions, it is ­ savings and flexible small-scale loans (for short- much easier for MFIs and other formal providers to-­medium-term money management), medium-­ to offer long-term intermediation. Formal com- term loans (such as up to three years) with mitment savings plans for the poor (which structured repayments suited to whatever is include endowment and other forms of insur- known about the client’s household cash flow, ance, and pension plans) will be a huge growth and medium-to-long-term commitment savings. area for microfinance. They offer the discipline As techniques for doing so evolve, providers that poor people so often seek when they use should aim to add pensions, and insurance cover, group-based devices such as ROSCAs but add starting with the risks that are easiest to calculate, value by having much longer terms, allowing such as life insurance, but aiming eventually at much larger sums to be formed. They can also the more difficult ones, above all health and agri- offer a “one-stop shop” for such services. In East culture. To carefully selected segments of clients, Africa it is common for people to take member- providers should also learn how to offer longer- ship in several ROSCAs at once, each with its term loans for productive investments tailored to own term, frequency, and value, so that the user business cash flow, and for big life-enhancing can ensure that different spending needs— investments (in homes, household goods, and weekly consumption, quarterly rents, or annual education) tailored to repayment capacity shown 68 The New Microfinance Handbook to exist by the transaction records of successive 10. For descriptions of some of the most common loans. There is nothing in the history of microfi- forms these clubs take, see Rutherford nance to suggest that offering these services to a (2009). majority of the world’s poorest households can- 11. For a view of how the realities of poverty affect not be achieved in this decade. financial decision making among low-income people, see Bertrand et al. (2004). 12. See, for example, http://www.woccu.org. Notes 13. See http://savingsgroups.com and http://  1. http://financialaccess.org/sites/default/ savings-revolution.org. files/110109%20HalfUnbanked_0.pdf. 14. This section was contributed by Susan  2. Susan Johnson, “Gender and Microfinance: Johnson, Centre for Development Studies, Guidelines for Good Practice,” http://www University of Bath. .gdrc.org/icm/wind/gendersjonson.html.  3. Details on how the households were selected and how the fieldwork was executed can be References found in Appendix I of Collins et al. (2009).  4. These diaries ran for three years rather than Bertrand, Marianne, Sendhil Mullainathan, and 12 months, but with monthly interviews rather Eldar Shafir. 2004. “A Behavioral Economics than biweekly. The objective was to under- View of Poverty.” American Economic Review stand how households used MFI services 94 (2): 419–23. rather than how they manage money generally. Chaia, Alberto, Aparna Dalal, Tony Goland,  5. For more analysis on how well both types of Maria Jose Gonzalez, Jonathan Morduch, funeral insurance helps cover the event of and Robert Schiff. 2009. “Half the World Is death in poor households, see Collins and Unbanked.” Financial Access Initiative Leibbrandt (2007). Framing Note, Financial Access Initiative, New York.  6. See Daryl Collins, “Focus Note: Financial Decisions and Funeral Costs,” http://www Cohen, Monique. 2012. The Emerging Market-Led .financialdiaries.com/Funerals_and_ Microfinance Agenda. PoP Briefing Note 25, Financing.pdf. MicroSave, Lucknow.  7. For more on “borrowing to save” see Jonathan Collins, Daryl, and Murray Leibbrandt. 2007. “The Morduch, “Borrowing to Save: Perspectives Financial Impact of HIV/AIDS on Poor from Portfolios of the Poor,” http:// Households in South Africa.” AIDS 21 financialaccess.org/sites/default/files/FAI_ (suppl. 7): S75–S81. Borrowing_to_Save_0.pdf. Collins, Daryl, Jonathan Morduch, Stuart  8. Bankable Frontier Associates, “Small Business Rutherford, and Orlanda Ruthven. 2009. Financial Diaries: Report of Findings and Portfolios of the Poor: How the World’s Poor Lessons Learned,” http://www.bankablefrontier Live on $2 a Day. Princeton: Princeton .com/assets/pdfs/Small-Bus-Fin-Diaries_Pilot- University Press. Study.pdf. FinMark Trust. 2003. FinScope Survey South  9. In Uganda a MicroSave team found two Africa. Johannesburg: FinMark Trust. women who always “kept” a few dollars of Genesis Analytics. 2005. “A Regulatory Review of each other’s money. They explained that by Informal and Formal Funeral Insurance doing so they could resist their husbands when Markets in South Africa.” www.finmark.org.za. they asked for cash, by saying “Oh, no, you Helms, Brigit. 2006. Access for All: Building can’t have that money—it belongs to the lady Inclusive Financial Systems. Washington, DC: next door” (Rutherford 1999, p. 23). Consultative Group to Assist the Poor. Clients 69 Kuyasa Fund. 2005. Kuyasa Fund: Community- ———. 2010e. “The ‘Triple-Whammy’ of Poverty: Based Lending. Marshalltown, South Africa: Lessons from Portfolios of the Poor: How the FinMark Trust. World’s Poor Live on $2 a Day.” PoP Briefing Microcredit Summit Campaign. 2011. “The State Note 1, MicroSave, Lucknow. of the Microcredit Summit Campaign Report Rutherford, Stuart. 1999. “Savings and the Poor: 2011.” Microcredit Summit Campaign, The Methods, Use and Impact of Savings by the Washington, DC. Poor of East Africa.” MicroSave, Lucknow. MicroSave. 2010a. “Borrowing to Save: Rutherford, Stuart, with Sukhwinder Arora. 2009 Perspectives from Portfolios of the Poor.” PoP The Poor and Their Money. Rugby: Practical Briefing Note 3, MicroSave, Lucknow. Publishing. ———. 2010b. “Grameen II and Portfolios of the Rutherford, Stuart, with S. K. Sinha and Shyra Poor.” PoP Briefing Note 7, MicroSave, Aktar. 2001. Buro Tangail Product Development Lucknow. Review. Dhaka and London: BURO and DFID. ———. 2010c. “How Do the Poor Deal with Risk?” World Bank. 2005. Environment Matters: Annual PoP Briefing Note 3, MicroSave, Lucknow. Review. Washington, DC: World Bank. ———. 2010d. “Living on $2 a Day.” PoP Briefing Wright, Graham A. N. 2005. “Designing Savings Note 1, MicroSave, Lucknow. and Loan Products.” MicroSave, Lucknow. 70 The New Microfinance Handbook CHAPTER 3 The Role of Government and Industry in Financial Inclusion Stefan Staschen and Candace Nelson Tailoring a country’s financial system to enable from infrastructure to legally mandated outreach financial markets to work better for the poor targets. Industry players are rallying around codes involves the combined efforts of public and private of conduct intended to increase transparency and players. It is relatively recent, and commendable, fair treatment of consumers and are defining per- that both government and the financial services formance in financial, social, and environmental industry acknowledge the importance of increas- terms. Both spheres share the responsibility for ing financial inclusion. But financial inclusion is “responsible” finance, building financial inclusion not simply about numbers or attracting more cli- on a foundation of consumer protection. ents to the range of providers. “Responsible” This chapter outlines the role of government financial inclusion increases access to financial (through its policies, regulation, and other sup- services in ways that are safe for consumers, port for a stable financial sector) and industry enabling their participation informed by knowl- (through standards and guidelines) in promoting edge and choice. Increasingly shared by public and financial inclusion, as both separate and some- private actors, this vision requires coordinated times overlapping arenas of activity. In addition, it efforts from both. Governments are investing recognizes coordination and advocacy as impor- authority in policies and rules that shape behavior tant functions within the market system. This in market systems; their imprint is wide-ranging, chapter provides a high-level perspective on the Contributions to this chapter were made by Kate Lauer. The Role of Government and Industry in Financial Inclusion 71 roles of government and industry, largely related more awareness of the reasons why market forces to formal rules that help to shape the financial will not—without an appropriate enabling envi- market system;1 more detailed information on the ronment, infrastructure support, and adequate specifics of regulation is provided in chapter 17. It consumer protection and financial capability— will be of interest to policy makers, industry asso- achieve the goal of improving financial inclusion. ciations, financial service providers, and other Policy making is a complex process bringing stakeholders seeking to understand the enabling together various actors who use a multitude of environment for financial services. tools and strategies to promote financial inclu- sion. Policy decisions influence where resources are allocated and how priorities are established The Role of Government in within political, economic, and social institutions. Financial Inclusion Policies are designed to guide decision makers and to achieve an intended purpose. They typi- Microfinance is now seen as an integral part of cally outline general principles, but they do not an inclusive financial system. As a result, finan- carry the force of law.2 cial inclusion has become an important policy Policy makers recognize the potential for eco- goal that complements the traditional pillars nomic growth and poverty alleviation through of monetary and financial stability, as well as the development of a more inclusive financial ser- other regulatory objectives such as consumer vices sector. In doing so, they also acknowledge protection (Hannig and Jansen 2010). three primary barriers to financial inclusion: • Supply-side barriers such as transaction costs, Government as Rule Maker the inability to track an individual’s financial Governments have increasingly embraced finan- history, and lack of knowledge about how to cial inclusion as one of their policy objectives. serve poorer customers Data from the Financial Access 2010 Survey (CGAP 2011) show that in 90 percent of econo- • Demand-side barriers that restrict the capacity mies, at least some aspect of the financial inclu- of individuals to access available services and sion agenda is under the purview of the main products, including socioeconomic and cultural financial regulator. Furthermore, “As rule makers, factors, lack of formal identification systems, governments determine not only what efforts and low levels of financial literacy (AFI 2010) may be undertaken to promote financial inclu- • Poor regulatory frameworks, including con- sion, but also by whom, how, and when. In addi- sumer protection mechanisms that hinder the tion to prudential and consumer protection rule quantity and quality of financial products and making, governments can enable innovative services. financial inclusion business models, including permitting the entry of new actors into the finan- The main participants in developing formal cial service sector” (Ehrbeck, Pickens, and Tarazi rules include the legislature (typically the parlia- 2012, 6). Rather than provide financial services ment), the government unit (the relevant ministry directly, the government’s role is to maintain mac- and government bureaucracy), and the regulator roeconomic stability and provide appropriate reg- (the central bank or regulatory authority). A legis- ulatory and supervisory frameworks (see Duflos lative process in microfinance normally starts and Imboden 2004). And while the assumption with a mostly technical discussion among the still holds that the private sector plays the central experts and the regulator,3 but eventually depends role in providing financial services, there is much on the support of the legislature to implement 72 The New Microfinance Handbook legal changes. Educating lawmakers about the to reduce the risk of serving them, a deposit rationale and objectives of proposed rules early insurance system protects clients against loss of on can help to overcome any potential resistance savings, and a land registry system facilitates and create a joint understanding of what is needed access to loans using land as collateral. to achieve an enabling environment for financial Nonfinancial infrastructure also has a bearing services for the poor. on financial inclusion. For example, roads for trav- eling to the nearest service point, electricity for Infrastructure Support recharging mobile phones or running real-time The government has traditionally played a strong communication systems between remote areas, role in ensuring that infrastructure is in place and agents, and head offices, and national identification providing oversight. The front-end infrastructure systems all promote access to financial markets. In includes client access points, such as post offices, all these areas, the government plays a crucial role, automated teller machines, point-of-sale devices, either as provider or as regulator and promoter. and retail agents, all of which are subject to ­specific rules and regulations. The back-end infra- Promoting Savings through Government structure includes automated clearinghouses, Payments real-time gross settlement systems, retail pay- The government can potentially play an impor- ment switches, and cash distribution networks tant role in promoting savings and catalyzing vol- (see chapter 18). Not least because of the growing umes by moving its social transfers, wages, and importance of branchless banking models, the pension payments onto electronic channels and payment system infrastructure has received a lot ensuring that these channels are linked to easily of attention, as it constitutes the rails for the accessible, basic transaction accounts. Its policy cost-effective provision of financial services. If the with regard to social safety nets and govern- government (for example, the central bank) does ment-to-person (G2P) payments can thus have an not run these systems, at least it nurtures them important impact on the viability of innovative and sets the general rules of operations. delivery channels and draw more clients into the In addition to service delivery infrastructure, formal financial sector. Both the government and several other supporting functions should be the poor benefit as G2P payments can often be considered in the government’s domain for finan- delivered at substantially lower cost and with less cial inclusion. For example, credit bureaus allow “leakage” if they are delivered electronically clients to build a credit history and help providers (Pickens, Porteous, and Rotman 2009; see box 3.1). Box 3.1  Bank and Retail Network Partnership The Mexican government is leveraging public harnessing its public infrastructure to pursue infrastructure for savings and G2P payment this goal. In areas with no financial services, it delivery. The 2010 Budget Law crafted by the is attempting to reach people by linking a net- Ministry of Finance stipulates that all govern- work of 23,000 community-owned stores ment payments (primarily administered by the with its conditional cash transfer program Ministry of Social Development) must be deliv- (Oportunidades) and the savings services of a ered electronically by 2012. The government is state-run bank. Source: Almazan 2010. The Role of Government and Industry in Financial Inclusion 73 Consumer Protection For countries characterized as “low-access In an environment of increasingly complex finan- environments” (where levels of financial access cial products and services, effective consumer and financial literacy are low and regulators face protection is important for the overall sustainabil- significant capacity constraints), the Consultative ity of the financial market system.4 Participation Group to Assist the Poor (CGAP) recommends in the formal financial sector must pose fewer that the government agenda for consumer pro- risks for vulnerable, low-income p ­ eople who have tection pursue three basic goals: transparency, little experience with formal finance and low lev- fair treatment, and effective recourse (Chien els of financial literacy and capability. 2012; Brix and McKee 2010).5 Governments have an important role in pro- Transparency covers broad disclosure of rele- viding the legal and enforcement muscle to ensure vant product terms and conditions, including that financial institutions do not undermine con- pricing, fees, and default provisions. When such sumer protection by intentionally capitalizing on disclosure rules require all providers of the same their advantages in information, knowledge, and type of product to use standardized formulas as power. Effective consumer protection legislation, well as plain language to communicate relevant applied equitably across providers, can facilitate charges, consumers are better able to compare comparison shopping and healthy competition, products. Disclosure requirements are consid- leading to improved products and practices. ered more market friendly and effective at reduc- Despite limited regulatory and supervisory capac- ing costs to the borrower than mandated interest ity and challenges in enforcing legal contracts in rate ceilings (Brix and McKee 2010). the countries where microfinance is needed most, Transparency targets two interrelated governments can ensure that providers disclose ­objectives—­increased consumer comprehension, prices and other characteristics of credit products ­ allowing consumers to understand and choose in a consistent manner using agreed terminology appropriate products, and increased market and definitions; and they can set rules for client ­competition, stimulated as consumers engage in privacy, out-of-court redress mechanisms, or rig- comparison shopping. Disclosure regulations orous safety of data storage and transmission to should govern both content provided to the con- protect customer funds and information (AFI sumer and how it is communicated for effective 2011). Some examples of consumer protection comprehension. Disclosure of the various cost regulations include the following: components and other product terms can be overwhelming to consumers and counterproduc- • The National Bank of Cambodia requires that tive to the objective of enhancing their compre- microfinance institutions (MFIs) state their hension. For example, creditors in Armenia are interest on a declining balance rather than a required to advise customers orally regarding flat-rate basis. terms, costs, risks, and obligations associated • South Africa’s sweeping National Credit Act with a service. A standardized summary sheet of addresses over-indebtedness and reckless lend- product costs and terms used by all providers is ing by defining these terms under the law. It sets one of the most useful tools for ensuring that con- clear rules governing disclosures, credit report- sumers have information they can understand ing, and advertising, among other practices. and compare. Standardized forms are also easier for providers, particularly smaller and less sophis- • Indonesian regulators require regulated pro- ticated ones, as they save time and resources by viders to have written procedures and a formal not having to develop their own disclosure forms complaints unit. to meet regulatory requirements (Chien 2012). 74 The New Microfinance Handbook The perspective of the individual consumer is financial institutions not only handle complaints, critical to tailoring disclosure regulations. Loan but also often handle questions and can play a pricing provides a good example. Because nominal role in facilitating consumer comprehension of interest rates do not reflect the total cost of a loan, disclosed information. Sometimes the regulatory regulations should mandate that pricing be agency takes responsibility for this function, and expressed using one or more of the following sometimes it assigns the role to an industry asso- ­ methods: (1) total financial cost of credit, (2) repay- ciation, ombudsman, or other entity. Rules gov- ment schedules, and (3) annual percentage rate erning these processes should specify all aspects (APR) or effective interest rate (EIR; see chapter 9). of customer complaints, including the method of While the use of APRs and EIRs allows for greater submission, location, and time frame for resolu- comparability, total loan cost and the amount and tion. Providers need to display such information frequency of repayment may be easier for low-­ clearly and communicate it directly to clients. income consumers to comprehend. Limited data While these three goals—transparency, fair suggest that borrowers tend to focus on the amount treatment, and recourse—are basic to protecting of the installment payment rather than the interest consumers, it may not be feasible or practical to rate, because their main concern is whether their address all of them at once. An incremental cash flow will cover loan payments (Chien 2012). approach to developing a set of disclosure poli- For example, policy makers in Peru and Ghana cies and regulations may be necessary, taking into standardize the calculation of APR or EIR with consideration compliance costs for industry and regulators specifically to address the capacity con- supervisory capacity of government. A starting straints of smaller, less formal institutions. Allowing point might be to tackle the most critical yet for the monthly presentation of APRs or EIRs is ­ discrete transparency issues in a given context. another practical option introduced in the At an intermediary level, governments can target Philippines. Monthly APRs or EIRs may be more broader consumer comprehension. Finally, regu- appropriate for loans of less than a year and more lators can reinforce market competition by comprehensible to consumers (Chien 2012). requiring broad dissemination of comparable Fair treatment covers ethical staff behavior, the metrics for total costs (such as APRs and EIRs) sale of appropriate products, and acceptable mar- and other key terms through advertising and keting and reasonable collections practices. Rules media channels, allowing market forces to apply governing truth in advertising support transpar- pressure on providers. Extensive dissemination ency through disclosure. Codes of ethics guard of new disclosure requirements, coupled with against overly aggressive responses to delinquency. sufficient time for implementation, can help to Zero tolerance of delinquency, a cornerstone of reduce the industry’s costs of compliance. institutional performance, can result in abusive Consumer testing can be used to refine disclosure collections with adverse effects on poor house- rules at each stage and build a stronger disclosure holds. In India, Ghana, and elsewhere, r ­ egulators regime over time (Chien 2012; see box 3.2). have established rules governing fair debt collec- However, even where provided for by law, tion and prohibiting intimidation and coercion. broad application and enforcement of consumer Effective recourse is necessary for consumer protection regulations can be difficult to achieve trust in the formal financial system; when things in practice. Challenges include consistent appli- go wrong, consumers need to know they have a cation of rules and coordination among multiple way to communicate their complaints and regulators where supervisory authority is resolve their issues. Consumer recourse mecha- divided. Microinsurance provides a good exam- nisms such as specialized help desks within ple of this (see box 3.3). The Role of Government and Industry in Financial Inclusion 75 Box 3.2  Encouraging Stakeholders to Adopt New Rules The success of the disclosure regime in Peru Financial institutions in Peru are required to can be attributed in part to the extensive resolve all questions related to the content of efforts of the Superintendency of Banking and a contract before it is signed. In addition, they Insurance. Regulators spent two years dis- must designate customer service personnel cussing disclosure rules with the industry, to consult with clients on the scope of stan- addressing issues of compliance costs, and dardized contracts. Such an approach shifts developing providers’ familiarity with formulas the burden of achieving comprehension onto for calculating EIRs. In addition, a large cam- the provider, but should not be viewed as a paign was launched to educate consumers on substitute for clear instructions on what and EIRs and to ensure they understood the new how information is disclosed. disclosure rules. Source: Chien 2012. Box 3.3  Policy for Microinsurance Policy makers need to understand the insur- microinsurance. Government can consider ance needs of low-income households and treating microinsurance products differently ensure that policies facilitate the market-based than commercial products for tax purposes. provision of microinsurance. They can engage Increasingly, central banks and finance minis- the insurance industry and other actors—such tries have become engaged in promoting finan- as unregulated insurers and networks—in cial literacy, as low levels of information and a dialogue on microinsurance and involve trust are probably the biggest barrier to uptake them in educating the market and promoting of insurance among low-income populations. Source: Martina Wiedmaier-Pfister. Building Financial Capability exercise them. These include the right to under- Although historically governments may have stand product choices, often offered by competing focused on limiting harmful credit products providers, and the right to choose the services that through interest rate caps and debt forgiveness, are best for them.6 Consumers need to develop the focus has shifted toward the need to empower relationships with financial service providers on financial service users, to inform them, and to give the basis of knowledge and choice as opposed to them tools to protect their rights (CGAP 2010). fear. Ill-informed consumers and unsupervised CGAP identifies consumer financial capability, providers can undermine the impact of financial government regulation, and industry codes of inclusion efforts; this risk is especially high in a conduct as the three principal consumer protec- context of rapid, often technology-driven, change tion strategies (McKee, Lahaye, and Koning 2011). in the financial service marketplace. Given the Consumers need to know their rights in order to asymmetries in knowledge, as well as access to 76 The New Microfinance Handbook information and skills between providers and Financial capability is the ability to apply consumers, governments can help to meet ­ that knowledge, to make informed decisions, the c ­hallenges—educational, regulatory, and and to take effective actions regarding the cur- financial—­­­of empowering consumers to use finan- rent and future management of money. It cial services effectively and participate in their includes the ability to save, borrow, and spend own protection. However, with limited ­experience wisely, to generate more stable cash flows, and in addressing this need, government strategies to to manage the challenges associated with support responsible finance are key to learning costly life-cycle events (see box 3.5). Challenges what works (see box 3.4). of money management are never static, and Three overlapping terms are used in relation neither are the solutions, especially given the to the concept of consumer financial capability: unpredictable and seasonal incomes that financial literacy, capability, and education. are  common among the poor. Financial capa- Financial literacy is the ability to understand bility is an evolving state of competency basic information about financial products and ­ subject to ever-changing personal and eco- services. nomic circumstances. Box 3.4  Financial Capability Strategies A Ghanaian government survey in 2007 strategy for financial literacy and consumer revealed a low level of knowledge of financial protection in the microfinance sector was institutions, services, and products among adopted that addressed three pillars of finan- adults. As a result, the government launched a cial capability: knowing, understanding, and financial literacy program in 2008 to create changing behavior. The strategy featured edu- awareness and build trust between consum- cation materials describing key products and a ers and service providers. In 2009, a national road show that toured rural areas. Source: AFI 2011. Box 3.5  Financial Literacy in the Russian Federation In Russia, research was conducted to study having more unspent income at the end of the the consequences of greater financial literacy month and higher spending capacity. The rela- on the use of financial products and financial tionship between financial literacy and the planning. The study found that financial liter- availability of unspent income was even more acy was positively related to participation in evident during the recent financial crisis, sug- financial markets and negatively related to the gesting that better financial literacy may better use of informal sources of borrowing. equip individuals to deal with macroeconomic Individuals with higher rates of financial liter- shocks. acy were significantly more likely to report Source: Klapper, Lusardi, and Panos 2012. The Role of Government and Industry in Financial Inclusion 77 Financial education is a key tool, coupled with other stakeholders for achieving an inclusive experience using financial services, to build finan- financial sector. It also raises awareness of and cial literacy and capability. It introduces people to secures commitment to sound practices and estab- good money management practices with respect lishes the means for communication and coordi- to earning, spending, saving, borrowing, and nation around implementation to avoid gaps or investing. Its power lies in its potential to be rele- duplication of efforts (Porter 2011). In 2010, 45 vant to anyone and everyone, from the person percent of the countries participating in the who contemplates moving savings from under the Financial Access 2010 Survey had a dedicated mattress to a Savings Group to the saver who tries strategy document for promoting financial inclu- to compare account features between competing sion (see box 3.6). Regulators in countries with a banks. Serving multiple, interrelated purposes, financial inclusion strategy also have, on average, financial education promotes personal financial more financial inclusion topics under their pur- management, product uptake and use, and con- view and more resources and staff working on sumer awareness and protection. these matters (CGAP 2010). Matching the content of financial education to Financial inclusion strategies are developed the target group is essential to making it relevant. through a consultative process among the key Target groups for financial education can be stakeholders in financial inclusion (government, defined by age, gender, employment status, or regulators, the industry, and consumer associa- relationship to a specific financial product. For tions) and approved by a government body. They example, financial education targeted to youth is typically include a diagnostic of the current state likely to focus on negotiating with parents about of the sector to ensure “evidence-based policy spending money, the value of saving, and planning making,” policy objectives, strategies, and an for the future. action plan for implementation (Duflos and Finally, to ensure financially capable consum- Glisovic-Mézières 2008). Financial inclusion ers, financial education must be integrated with strategies need to consider existing capacity as hands-on experience; consumers need to choose well as the need for reform and capacity building and use financial products and services if they are (Porter 2011). to understand their full benefits. An important element is the process itself: bringing a diverse range of actors to the same Financial Inclusion Strategies table whose only common denominator may be A financial inclusion strategy clearly defines and their potential to affect the financial ecosystem aligns a shared vision among policy makers and and getting them to agree on a shared vision for Box 3.6  Financial Inclusion in Mexico Under its National Development Plan for ­ ifferent services and were subject to ­different d 2007–12, the Mexican government reformed regulations than traditional banks. The plan banking laws to permit nontraditional entities also facilitated the transition of small savings such as banking agents to operate in rural and credit organizations into regulated deposit- areas. Niche banks were allowed to offer taking entities. Source: AFI 2011. 78 The New Microfinance Handbook the sector. The action plan for implementation to come to a common understanding on how to needs to consider all elements of the ­ financial reach this goal. market system: the core (clients and providers National strategies that focus on responsible and the products they exchange) and the rules financial inclusion, as opposed to simply access to (formal and informal) and supporting functions finance, might lead to significantly greater bene- (infrastructure, funding, and information). Only a fits for households and service providers alike. combined effort of all stakeholders is likely to While many financial inclusion strategies may have a significant impact on the overall goal of not focus on consumer protection and financial making markets work for the poor. capability, they should (see figure 3.1). While financial inclusion strategies have the potential to lead to better structured and more Legal Mandates evidence-based policy-making processes, they Some countries use quantitative financial inclu- have suffered from several shortcomings (drawn sion targets or specific product offerings man- on CGAP research summarized in Duflos 2011): dated by law as tools to promote the provision of financial services to underserved populations • Many strategies are driven by donors. Govern­ or geographic areas. These financial inclusion ment must have strong interest in and owner- mandates can be seen as a complement to other ship of the process and the outcome. financial regulations and incentives (for exam- • The outcome can only be as good as the analysis. ple, tax advantages for providers to reach At times, the diagnostic does not include all poorer segments of the population). Mandates relevant actors and institutions; the analysis appear to be a simple and effective tool for should be conducted by a team of experts with achieving financial inclusion targets; assuming a diverse set of skills and be updated regularly. that enforcing compliance is possible, prede- fined targets can be reached (for example, • The common vision does not sufficiently consider everybody has access to certain products or all the local context. This is particularly the case if districts are served by at least one branch). the document is drafted by an international However, in practice this might not always be consultant without much involvement of local the case. actors. Priority sector lending targets are the best- known example of financial inclusion targets. • The strategy is not disseminated widely or Priority sector lending usually requires a certain updated regularly. The success of implementa- percentage of a provider’s loan portfolio to be tion depends on broad dissemination, a clear dedicated to sectors such as agriculture, micro allocation of rules, sufficient funding, and the and small businesses, housing, or microfinance. setting of realistic targets; the strategy should Basic or “no frills” bank accounts, designed for be a “living document.” low-income clients with low or no fees, are The extent to which financial inclusion strat- another example of financial inclusion man- egies have improved access to finance is difficult dates; in some countries (including Belgium and to know, as we do not know how the sector France in the European Union, Indonesia, and would have developed without a strategy. What Mexico) banks are required by law to offer basic we do know is that financial inclusion strategies, accounts (see box 3.7). if taken seriously, are a powerful instrument for Expert opinions about the usefulness of legal convening stakeholders who have a potential mandates are divided. Opponents give the follow- impact on financial inclusion and helping them ing reasons: The Role of Government and Industry in Financial Inclusion 79 Figure 3.1  Financial Inclusion Strategies and Responsible Finance ‘Responsible’ financial inclusion that raises financial capability in line with financial access leads to: • Stronger positive impacts at level of individual, firm, economy, financialsector • Lower risk (for individuals, financial institutions, and the financial sector) • Improved uptake of new technology FINANCIAL INCLUSION COMBINED WITH FINANCIAL INCLUSION FINANCIAL LITERACY, CONSUMER PROTECTION Examples of how households/firms can benefit Examples of how households/firms can benefit • MICROINSURANCE: Reduces exposure to potential • MICROINSURANCE: Understand the risks covered, losses to enable business growth cost compared to the potential benefit, select product • BASIC BANK ACCOUNTS: Low income household • BASIC BANK ACCOUNTS: Select a bank account that access through a mobile phone or ATMs meets its needs, manage fees and debt levels • REGULATORY REFORMS: Innovation by financial • REGULATORY REFORMS: Harmonization of institutions to serve lower income clients regulation to capability levels and objectives of education programs Financial inclusion Responsible finance Source: Tata and Pearce 2012. Box 3.7  Financial Inclusion in India India’s government has a long tradition of pro- In a parallel initiative, in 2010 the govern- moting financial inclusion. For more than 40 ment and the central bank set goals to provide years, the central bank, the Reserve Bank of by 2015 all 600,000 villages in India with a India, has been operating priority sector lend- banking outlet (either by a branch or a retail ing mandating a portion of banks’ loan portfo- agent, in India known as a business corre- lios to be in the agriculture sector and to small spondent), with stipulated annual targets and micro enterprises. In 2005, it required along the way. While these targets were not banks to offer basic no-frills accounts with no, specified by law, the Reserve Bank of India or very low, minimum balances and affordable requires all banks to report progress regularly charges. However, use of these accounts has and closely monitors their achievements. been very low. In 2011, banks were advised to It is still too early to say how successful the provide at a minimum four products: (a) a sav- implementation of these ambitious goals will ings or overdraft account, (b) a remittance be. Some banks have risen to the challenge product for electronic transfer of government and opened numerous new outlets (mostly benefits and other remittances, (c) a pure business correspondents). Others have com- savings product (ideally a recurring-deposit plained that the financial inclusion targets hurt scheme), and (d) entrepreneurial credit. their profits. 80 The New Microfinance Handbook • In a market economy, it is assumed that pro- Standards for supervision are largely set by inter- viders know best how to serve the market. It is national financial standard-setting bodies; they also assumed that a decision not to offer a cer- reflect national and global experience with differ- tain product is informed by economic factors. ent types of institutions and the risks and benefits If mandated to do so, providers will incur of different activities. While standards represent losses that have to be recovered elsewhere. formal rules, they are typically “soft law”; there is no technical means of enforcing them, although • Targets can be achieved at lowest cost if they there may be consequences (in terms of reputation focus on those providers that are best posi- and pricing) for failure to comply with them. In tioned to contribute to their achievement.7 some cases, the threat of these consequences can • On a more practical level, it is difficult to set up have significant impact on the actions of a govern- rules in a way that does not encourage regula- ment or its regulator. tory avoidance (for example, providers choos- Global standard-setting bodies set standards ing a different legal form, moving to another and provide guidance for the regulators of finan- jurisdiction, or bending the rules). cial institutions. Due to the historical emphasis on setting standards for existing institutions and • The achievement of targets has to be moni- their clients and the supervision of such institu- tored, and an effective enforcement mecha- tions, many standards have not yet considered the nism, including penalties for nonachievement, issues of particular relevance to providing the has to be established, which requires additional poor with financial services. Moreover, these resources. standards may inhibit new approaches, including technical and nontechnical innovations, and new Proponents, however, argue that mandates products and services that the poor need. to explore new markets are needed to counter However, the global standard setters have begun the complacency of financial institutions. When to consider how existing standards might need to mandates are imposed (if applied to all so that no be revised in order to facilitate financial inclusion. individual provider’s competitive position is com- This effort requires understanding the risks of promised), financial institutions will do their best financial exclusion as well as the changing risks to comply with the targets at the lowest cost and and benefits of increased financial inclusion. In eventually may even be able to cover their costs. In addition, attention is required to understand the some cases (South Africa and Germany), the mere situation of poor countries with high levels of threat of a legal mandate prohibiting commercial financial exclusion and weak supervisory capac- banks from refusing any customer the opportu- ity (both staffing and experience) and to adjust nity to open a bank account was sufficient to lead standards accordingly (CGAP 2011). the banking industry, of its own accord, to offer Of the various standard-setting bodies, the basic accounts to everybody.8 The ultimate deci- three most relevant to financial services for the sion whether to mandate financial inclusion in poor are the Basel Committee on Banking law depends on the specific context of a country. Supervision (BCBS), the Financial Action Task Force (FATF), and the International Association Global Standards and Standard-Setting of Insurance Supervisors (IAIS). Bodies The BCBS formulates standards and guide- The term “standards” encompasses many things in lines for the supervision of banks and other the financial sector.9 Standards may be general or deposit-taking institutions and is best known for specific, and they may be national or international. its international standards on capital adequacy The Role of Government and Industry in Financial Inclusion 81 and its Core Principles for Effective Banking and higher borrowing costs, among other conse- Supervision (known as the Basel Core Principles). quences (Isern and de Koker 2009). In December 2011, the BCBS proposed revised The IAIS is a broad-based forum composed of principles intended to address the postcrisis les- insurance regulators and supervisors from some sons for promoting sound supervisory systems. 190 jurisdictions in almost 140 countries. Its These proposed principles are significant for the stated mission is to promote effective and glob- prominence given to the principle of proportion- ally consistent regulation and supervision of the ality (see chapter 16). In 2010 the BCBS issued insurance industry in order to develop and main- guidelines on applying the Basel Core Principles tain fair, safe, and stable insurance markets for to microfinance activities of depository institu- the benefit and protection of policyholders. The tions. The guidelines highlight the importance of IAIS issues standards and guidance material a proportionate (risk-based) approach as well as (including Issues in Regulation and Supervision of the key differences between a microloan portfolio Microinsurance; IAIS 2007) and has recently and a commercial loan portfolio. The key differ- revised its Insurance Core Principles to incorpo- ences include (a) the particularities of the rate the principle of proportionality. Specifically, labor-intensive microlending methodology, (b) the Insurance Core Principles state, “Supervisors the licensing requirements, which should reflect need to tailor certain supervisory requirements different risks than those of commercial banks, and actions in accordance with the nature, scale, (c) the particular provisioning and reserve and complexity of individual insurers. In this requirements that should be applied to micro- regard, supervisors should have the flexibility to loans, and (d) the need for different liquidity tailor supervisory requirements and actions so requirements (BCBS 2010). that they are commensurate with the risks posed The FATF is the global standard-setting body by individual insurers as well as the potential for anti-money-laundering and combating the risks posed by insurers to the insurance section financing of terrorism (AML/CFT) rules. It is or the financial system as a whole” (IAIS 2011, organized as a task force–style body with 34 para. 8). member countries and two regional organizations (the European Commission and the Gulf Coordination and Advocacy Cooperation Council).10 The FATF recommenda- tions articulating standards for national regimes An important element of policy and rule mak- on AML/CFT have recently been revised to incor- ing for financial inclusion is the interaction of porate a risk-based approach that is critical to various stakeholders and how those interac- financial inclusion efforts (FATF 2012). For exam- tions shape policy outcomes. The development ple, under the revised recommendations, a mobile and implementation of formal rules are not a money account with strict transaction limits does one-off event; rules need to be revised regularly not require the same customer due diligence rules in light of experience and learning. As with as a current account with no limits. Specifically, every other part of the financial market system, FATF recommendations outline the measures the process of how rules are developed and who that countries, financial institutions, and related is involved needs to be understood and sup- businesses should institute. While the recom- ported in a way that encourages pro-poor regu- mendations are not legally binding, countries that lation (Gibson 2010). do not adhere to them run the risk of being con- How rules develop depends on the level of sidered a haven for illicit transactions or criminal accountability and responsiveness among rule activity. This can result in international sanctions makers to the advocacy “voice” of different 82 The New Microfinance Handbook interest groups and the wider political economy poor is a key element in designing and imple- around financial regulation. This means that menting effective financial inclusion reforms and coordinating bodies, such as the G-20 Global policies (see box 3.8). This is particularly impor- Partnership for Financial Inclusion, and advo- tant as new partnerships develop between pro- cacy groups, such as associations of providers or viders, including banks and mobile network consumer groups, are important players in rela- operators, or as retailers and agents become tion to the rules regarding financial services. involved in the delivery of financial services. A Each group has its own motivation and objec- lack of coordination can increase risks such as tives, which may or may not always result in improper sequencing of regulatory changes or what is best for the ultimate beneficiary of poli- regulatory changes in one sector that undermine cies, the wider public.11 efforts in other areas (AFI 2010). Coordination Alliance for Financial Inclusion Coordination of policy makers and various stake- More and more policy makers and representative holders interested in financial services for the bodies are beginning to coordinate formally with Box 3.8  Negotiating a Special Microfinance Law in Uganda: The Outcome of Competing Interests In 2003 Uganda passed a special law for the contrary, MFIs knew about microfinance microfinance deposit-taking institutions. A and increasingly learned about financial regula- detailed analysis of the process leading to the tion; donor projects at the time were led by adoption of this law and the role of participat- knowledgeable microfinance “champions.” ing interest groups can explain why the law Policy makers (the government and the has generally been regarded as a success, parliament) also had a strong interest in the despite its bias toward overregulation (which topic of microfinance, viewing it as a way to occurs at the expense of improving access to gain political capital, but knew much less financial services) and weak emphasis on about the rationale for and objectives of regu- consumer protection. lating it. They could easily have derailed the The interest groups with the strongest process, but donors, MFIs, and the Bank of influence on the outcome were the central Uganda prevented that. Finally, clients had the bank (Bank of Uganda), donor agencies, and most to gain from adoption of the law because the most mature MFIs in the country (which they would acquire better access to financial planned to apply for a license under the new services (savings, in particular). However, their law). All three groups had the highest level of voice was hardly heard in the process. The knowledge about what an enabling legal absence of client consultation and the conser- framework for microfinance should look like: vative approach taken by the regulator explain The Bank of Uganda knew about financial reg- why the new regime has not been as success- ulation and acquired increasing knowledge ful in increasing access as hoped and is rela- about microfinance, but was biased toward tively weak on consumer protection. overregulation (as regulators typically are); on The Role of Government and Industry in Financial Inclusion 83 one another to influence financial inclusion. For at all levels of policy development … Dialogue example, as of 2012, government institutions from between policy makers and the industry is 78 countries had joined the global Alliance for also a powerful tool for deciphering and Financial Inclusion (AFI), a network of financial mitigating risks that help to create regula- ­ policy makers that promotes peer learning and tion and foster innovations in access (AFI the implementation of effective policies that 2010). advance the goal of financial inclusion: A good example of coordination efforts is the A global policy response based on leader- Maya Declaration initiated by AFI to commit pol- ship from developing countries, closer icy makers to prioritize financial inclusion (see international cooperation, and strong and box 3.9). coordinated partnerships between relevant Other coordination and advocacy efforts public and private sector stakeholders at include the G-20 Global Partnership for national and international levels could be Financial Inclusion and the Responsible Finance the most effective way to support countries Forum. Box 3.9  The Maya Declaration Launched under the auspices of the Alliance for Financial Inclusion (AFI), the Maya Declaration is the first global set of measurable commitments, spearheaded by developing- and emerging-­ country governments, to unlock the economic and social potential of the 2.5 billion poorest people through greater financial inclusion. In the declaration, members recognize the key role that financial inclusion policy plays in enhancing stability and integrity, its role in fighting poverty, and its essential contribution toward inclusive economic growth. The Maya Declaration raises the profile of financial inclusion and provides public visibility to ensure that policy makers are held accountable for their commitment. Among AFI members, 24 have made specific national commitments to financial inclusion. For example, • Central Bank of Brazil pledged to launch a National Partnership for Financial Inclusion. • Bank of Tanzania pledged to raise its level of financial access to 50 percent of its population by 2015 through mobile banking. • Mexico’s Comisión Nacional Bancaria y de Valores committed to establishing banking agents or branches in every municipality of the country by 2014. • Reserve Bank of Malawi pledged to introduce agent banking in 2012. • National Bank of Rwanda set a target of 80 percent financial inclusion by 2017. • Peru’s Superintendency of Banks and Insurance pledged to enact a new law regulating electronic money within the next year. In support of the Maya Declaration, AFI is establishing a peer review mechanism, serving as a policy clearinghouse for peer-reviewed solutions, and providing subject matter expertise to help members to implement commitments. It will award grants to support knowledge exchange, develop financial inclusion strategies, and provide advocacy tools to help institutions win the support of key partners needed for implementation. Source: http://www.afi-global.org/gpf/maya-declaration. 84 The New Microfinance Handbook Global Partnership for Financial Inclusion reference for policy makers and other stakehold- In 2010 the G-20 recognized financial inclusion ers seeking to promote increased financial inclu- as a key pillar of the global development agenda sion (see box 3.10). and created the Global Partnership for Financial Inclusion as an implementing body open to G-20 Responsible Finance Forum countries, non-G-20 countries, and other rele- The Responsible Finance Forum is an interinsti- vant stakeholders (Ehrbeck, Pickens, and Tarazi tutional community of practice for exchanging 2012). The G-20 principles for innovative finan- knowledge and building consensus on responsible cial inclusion play an increasing role as a point of finance. It was created to support participating Box 3.10  The G-20 Principles for Financial Inclusion At its first summit in June 2010, the G-20 identified a set of principles that reflect conditions conducive to spurring innovation for financial inclusion while protecting financial stability and consumers: • Leadership. Cultivate a broad-based government commitment to financial inclusion to help to alleviate poverty • Diversity. Implement policy approaches that promote competition, provide market-based incentives for delivering sustainable financial access, and promote the use of a broad range of affordable services (savings, credit, payments and transfers, insurance) as well as a diver- sity of service providers • Innovation. Promote technological and institutional innovation as a means to expand financial system access and use, including by addressing infrastructure weaknesses • Protection. Encourage a comprehensive approach to consumer protection that recognizes the roles of government, providers, and consumers • Empowerment. Develop financial literacy and financial capability • Cooperation. Create an institutional environment with clear lines of accountability and coor- dination within government and encourage partnerships and direct consultation across gov- ernment, business, and other stakeholders • Knowledge. Use improved data to make evidence-based policy, measure progress, and con- sider an incremental “test and learn” approach acceptable to both regulators and service providers • Proportionality. Build a policy and regulatory framework that is proportionate with the risks and benefits involved in such innovative products and services and based on an understand- ing of the gaps and barriers in existing regulation • Framework. Consider the following in the regulatory framework, reflecting international standards, national circumstances, and support for a competitive landscape: an appro- priate, flexible, risk-based AML/CFT regime; conditions for the use of agents as a cus- tomer interface; a clear regulatory regime for electronically stored value; and ­ market-based incentives to achieve the long-term goal of broad interoperability and interconnection. Source: G-20 Information Centre (http://www.g20.utoronto.ca/2010/to-principles.html). The Role of Government and Industry in Financial Inclusion 85 institutions, including development agencies and generally developed on the basis of member development finance institutions, in sharing needs, internal capacities, and the external politi- knowledge and information on development cal environment. For example, regional or interna- efforts and potential collaborations, to build on tional associations, whose membership typically responsible finance frameworks and foster broad- comprises national-level networks and providers based dialogue and facilitate convergence of from multiple countries, engage in policy in a views, and to support coordinated action. The more indirect manner. Regional associations often Responsible Finance Forum considers issues publish information on industry practices or related to consumer protection regulation, indus- lobby market players on issues affecting their try action, and financial capability, with an empha- members across countries and markets. By doing sis on more transparent, inclusive, and equitable so, they facilitate the work of local association financial sectors (Responsible Finance Forum representatives. 2012; see figure 3.2). National associations can influence policy more directly by engaging with local authorities Advocacy who can pursue direct changes to various laws or Industry networks or associations often take a secondary legislation (for example, regulations central role in advocating the interests of provid- and guidelines). They can pursue specific actions ers. As associations are formed on the premise of that advance an advocacy strategy—letter writing, common interests, they can effectively communi- publicity campaigns, or direct lobbying with pol- cate members’ shared concerns about a particular icy makers—to communicate or publicize their issue. The activities that constitute advocacy are support for change on a particular issue. Industry Figure 3.2  Responsible Finance: A Multiple-Stakeholder Approach 1. Consumer protection (regulations): A regulatory framework for financial consumer protection, at both national and international levels 2. Responsible providers: Voluntary commitments, practices, standards, and Areas of initiatives in the financial sector (individually and at industry level, action nationally and internationally) 3. Financial capability: Interventions aimed to build and enhance financial capability of financial institutions clients – the consumers of financial products and services Consumers- Providers of financial Regulators (central individuals and Key services – banks, banks, financial businesses – and stakeholders MFIs, NBFIs, others – regulators, consumer advocacy and their associations protection agencies) organizations Cross-cutting Financial markets stability, poverty reduction, access to finance, job creation and issues SME development, health and education, sustainable development Source: Responsible Finance Forum 2011. 86 The New Microfinance Handbook associations often provide policy advocacy as a their divergent interests pose a challenge to col- service to members. If implemented effectively, lective action. Although consumer associations advocacy can strengthen the voice of providers try to overcome both of these challenges, they are and their associations and thus help to design not yet widespread in microfinance. More effec- rules that are tailored to their specific needs (see tive representation occurs through the intersec- box 3.11). tion of client and provider interests. While the While clients should be the main beneficiaries interests of providers and clients are not identical of financial inclusion efforts, their voice is rarely (for example, they differ with regard to product heard; often, they lack the technical expertise to pricing), the fact that providers depend on the lobby effectively for their interests. In addition, satisfaction of their clients creates substantial Box 3.11  SEEP’s Toolkit for Policy Advocacy The Small Enterprise Education and Promotion (SEEP) Network connects microenterprise prac- titioners from around the world in efforts to develop practical guidance that supports their com- mon vision of creating a sustainable income in every household. The SEEP Network has an advocacy planning model that seeks to develop the capacity of advocacy within microfinance. The following are the most common forms of advocacy it promotes: • Engagement is a gradual process of relationship building. It is not focused on a particular policy goal, but rather on the development of greater familiarity, trust, and mutual under- standing. Associations can engage stakeholders through invitations to association-sponsored events, educational opportunities, and formal and informal meetings. • Facilitation and consultation are based on working with policy makers and affected stakehold- ers to create opportunities for action. Facilitation involves creating opportunities for direct contact with decision makers to promote dialogue and build awareness through conferences, workshops, field trips, and meetings. Facilitation may also involve creating strategies for policy creation more directly. Consultation with a diverse base of members and a broad range bution of individuals and organizations, while of stakeholders is required to increase the contri­ engendering greater overall participation in policy-related discussions. • One of the most significant contributions advocates can make to policy reform is through the dissemination of high-quality research and information. Association members have a direct understanding of the concerns of affected populations. By promoting credible and well-documented information on the sector, associations can build legitimacy as a repre- sentative voice. Examples include industry assessments, benchmarking reports, market studies, and focused policy investigations. In its most direct form, advocacy is about promoting concrete solutions to problems. Advocates can promote the reform of existing laws and the creation of new ones, oppose legis- lative initiatives considered damaging to the sector, and promote changes to the implementation of existing policies and regulation. By lobbying decision makers as well as stakeholders who can influence them, advocates can directly affect policy outcomes. Source: D’Onofrio 2010. SEEP Network, http://networks.seepnetwork.org/ppt-newhtml/Policy_Advocacy_ mar2010_web.en_.pdf. The Role of Government and Industry in Financial Inclusion 87 overlap. Furthermore, because clients constitute can be challenging: There is typically no legal an important voting bloc, policy makers should be consequence for failure to comply, and influential motivated to consider their current and potential financial institutions may use their power to dis- interests. courage the self-regulatory body (for example, a microfinance association) from taking action. Without enforcement, such standards can only The Role of Industry in Financial exert a weak influence. Inclusion CGAP has developed numerous guidelines Financial inclusion calls for better outreach, for the industry based on consensus from vari- appropriate products and services, and consumer ous stakeholders, including, for example, trust. Responsible finance emphasizes value, “Microfinance Investment Vehicle Disclosure respect, and protection of the consumer (McKee, Guidelines”; “Good Practice Guidelines for Lahaye, and Koning 2011). Efforts by providers to Funders of Microfinance”; “Regulation and encourage responsible finance influence institu- Supervision Consensus Guidelines”; “Infor­ tional behavior, market access, the range of prod- mation Systems Implementation Guidelines”; ucts and services on offer, and the competitive “Disclosure Guidelines for Financial Reporting landscape, all of which have an impact on the by Microfinance Insitutions”; “The Role of functioning of the market and the suitability of Funders in Responsible Finance”; “Due Diligence financial services. Given that financial services Guidelines for the Review of Microcredit for the poor are most prevalent in countries with Loan Portfolios”; “Developing Deposit Services limited supervisory capacity, often providers may for the Poor”; and “Definitions of Selected need to take the lead in promoting responsible Financial Terms, Ratios, and Adjustments for finance. Microfinance.”12 Other industry representative bodies such as Industry Standards and Guidelines the Social Performance Task Force, the Smart Standards of practice and codes of conduct that Campaign on Client Protection Principles, and financial service providers and other market Microfinance Transparency have all launched actors abide by can contribute to financial inclu- initiatives and advocacy campaigns. sion and help to build the industry’s commitment to consumer protection. In recent years, multilat- The Social Performance Task Force eral agencies have promulgated many initiatives The Social Performance Task Force, with more to provide guidelines and principles, and the than 1,000 members in 2011, represents the pri- titles of their documents define the targeted mary stakeholders in financial services for the areas: the “United Nations Principles for poor: practitioners, donors and investors, indus- Investors in Inclusive Finance,” the “World Bank try associations, technical assistance providers, Draft Guidelines for Consumer Financial rating agencies, and academics. It defines social Protection,” and the “Organisation for Economic performance as the “effective translation of a Co-operation and Development (OECD) microfinance organization’s mission into prac- Principles and Good Practices for Financial tice in line with commonly accepted social val- Awareness and Education.” Often these are living ues.”13 Its mission is to promote standards by documents, open to review and revision as mem- which providers can manage the double (and, bers respond to issues raised by stakeholders and for some, triple) bottom line that is at the core of better understand what is missing or inadequate providing financial services to the poor. Seeking in the standards or codes. However, enforcement to ensure that services focus on clients, the 88 The New Microfinance Handbook Social Performance Task Force promotes the process to determine that clients have the following: capacity to repay without becoming over- indebted. In addition, providers will implement • Efforts to serve increasing numbers of poorer and monitor internal systems that support the and more excluded people sustainably prevention of over-indebtedness and will foster • Systematic assessment of the target popula- efforts to improve market-level credit risk man- tion’s specific needs to improve the relevance agement (such as sharing credit information). and quality of services • Transparency. Providers will communicate clear, • Benefits for microfinance clients, their fami- sufficient, and timely information in a manner lies, and communities, including increased and language that clients can understand so that social capital, assets, income, and access to they can make informed decisions. The need for services; reduced vulnerability; and fulfill- transparent information on pricing, terms, and ment of basic needs conditions of products is highlighted. • Social responsibility of the provider toward • Responsible pricing. Pricing, terms, and condi- its clients, employees, and the community it tions will be set in a way that is affordable to serves.14 clients, while allowing financial institutions to be sustainable. Providers will strive to provide Tools covering a wide range of purposes sup- positive real returns on deposits. port the measurement and achievement of strong social performance (see chapter 14). • Fair and respectful treatment of clients. Financial service providers and their agents The Smart Campaign will treat their clients fairly and respectfully. Under the broader umbrella of social performance They will not discriminate. Providers will management, the Smart Campaign, initiated in ensure adequate safeguards to detect and cor- 2009 by the Center for Financial Inclusion at rect corruption as well as aggressive or abusive ACCION International, advocates consumer pro- treatment by their staff and agents, particu- tection principles and has recruited hundreds of larly during the loan sales and debt collection organizations and individuals to endorse them. processes. The shift from assumed to explicit articulation of • Privacy of client data. The privacy of individual consumer protection measures followed debates client data will be respected in accordance about pricing and profits in microfinance, as well with the laws and regulations of individual as the emerging crises related to over-indebtedness jurisdictions. Such data will only be used for and abusive practices. The Smart Campaign has the purposes specified at the time the informa- advanced seven consumer protection principles:15 tion is collected or as permitted by law, unless • Appropriate product design and delivery. otherwise agreed with the client. Providers will take adequate care to design • Mechanisms for complaint resolution. Providers products and delivery channels in such a way will have in place timely and responsive that they do not cause clients harm. Products mechanisms for handling complaints and and delivery channels will be designed taking resolving problems for their clients and will client characteristics into account. use these mechanisms both to resolve individ- • Prevention of over-indebtedness. Providers will ual problems and to improve their products take adequate care in all phases of their credit and services. The Role of Government and Industry in Financial Inclusion 89 Of the seven principles, over-indebtedness and are not always measured accurately or reported transparency receive the most attention. Efforts to and remain widely misunderstood. Consequently, prevent over-indebtedness have included more the need for the industry to improve the disclo- careful assessments of client debt capacity, staff sure of interest rates and the standardization incentive schemes focused on portfolio quality, and communication of costs is a priority. and attempts to identify or limit the number of MicroFinance Transparency (MFTransparency) loans a client carries from multiple lenders (see is a global initiative committed to promoting box 3.12). In addition, lenders have found that pricing transparency in the microfinance sector. the policies developed for markets with minimal The organization aims to achieve its mission in competition need to be adjusted for more mature the following ways: data collection, standardiza- markets with multiple providers (Rozas 2011). tion, and dissemination; training and capacity The Smart Campaign conducts a global cam- building for financial institutions; development paign to garner support for these principles. It of educational materials; and consulting with also promotes activities that help providers to regulators and policy makers on price disclosure move from endorsement to implementation, legislation.17 including developing numerous tools for assess- Microloans often have higher interest rates ment, training, and client protection and educa- than mainstream commercial loans because they tion (Rozas 2011).16 are more expensive to make and manage. This Both the Social Performance Task Force and challenge has driven many providers to quote the Smart Campaign also work with microfinance prices that are significantly lower than the effec- rating agencies and investors to achieve align- tive prices. Once providers in a specific market ment between their rating frameworks or due dil- begin to employ confusing product pricing, it igence processes and consumer protection becomes very difficult for any single provider to principles. maintain transparent pricing. Standardized forms of disclosure can help to address this problem. MicroFinance Transparency Pricing is central to the debates regarding profits Compliance and the broader social responsibility of financial Industry associations and individual financial service providers. The true prices of microloans providers have an important role to play in Box 3.12  Battling Over-Indebtedness in Azerbaijan In addition to serious internal efforts to avoid loan to another MFI’s client commits to pay- over-indebtedness among its own clients, ing off the client’s existing loan. Thus if a AccessBank has been spearheading a cam- lender wishes to issue a US$3,000 loan to a paign to reduce over-indebtedness at the client who already has US$5,000 outstand- sector level. Collaborating with the Azerbaijan ing with another lender, that new lender Microfinance Association, AccessBank has would have to issue a US$8,000 loan, part of promoted a “one-client, one-lender” strat- which would go to pay off the client’s out- egy, in which a lender seeking to provide a standing debt. Source: Rozas 2011. 90 The New Microfinance Handbook promoting responsible finance through stan- intended to benefit both financial service provid- dards. However, industry standards rely on com- ers and their clients and pricing transparency pliance with self-imposed codes of conduct and initiatives are intended to benefit clients, the explicit rejection of strong incentives for decep- asymmetries between what providers endorse tive behavior. Furthermore, membership of and what clients understand have the potential industry associations rarely comprises all rele- to undermine those efforts. Identifying the pri- vant providers, which limits the scope of protec- orities of consumers and providers highlights tion and may place compliant providers at a potential barriers to translating principles of competitive disadvantage (Chien 2012). For responsible finance into effective practice, as sig- example, although the consumer protection nificant distance separates clients from financial principles advanced by the Smart Campaign are institutions (see table 3.1). Table 3.1  Potential Barriers to Effective Consumer Protection through Standards and Guidelines Target group and barrier Details Clients Low literacy Illiterate clients cannot read published lists of consumer protection principles and client rights. They may have trouble filing complaints. High priority assigned to accessing Fear of not getting a loan often drives client behavior, serving as a loans deterrent to asking for product information or raising issues of unethical behavior. Lack of knowledge Clients often do not know their rights or what constitutes a violation. Violations are not limited to cases of borrower versus lender. In Bolivia, in focus group discussions, group lending members reported the use of abusive debt collection practices— intended to shame defaulters—that violated members’ rights. Clients often do not understand the products on offer. At a basic level, many do not understand that interest is charged as a percentage of the loan; few can evaluate the difference in interest cost calculated using a flat rate or declining balance. Financial institutions Overestimation of consumer Institutional investments in product development have not been knowledge matched by investments in client education about new offerings. Potential conflict with profitability Efficiency requirements and financial incentives can undermine staff motivation to spend enough time with clients to ensure that they understand the products they may purchase. Institutions have a bigger vested interest in product-specific marketing than in education that will enable customers to compare products across lenders. Transparent presentation of rates and fees could be a disadvantage if not done uniformly and universally by all lenders in the same market. Implementation of consumer Implementing new codes can be costly, involving revisions to protection principles human resource systems, new mechanisms for customer feedback and complaints, and monitoring of compliance by providers in multiple countries (for example, by an MFI network) Source: Nelson 2009. The Role of Government and Industry in Financial Inclusion 91 Box 3.13  Financial Education as Part of the Business Model Over a period of just three years, the Kenyan clips, comic strips, and interactive work- financial market experienced significant sheets, delivered by professional trainers. growth, exposing many previously unbanked Training was supported by interactive coach- clients to an increasingly complex array of ing sessions with loan officers. An impact products. Without adequate information to evaluation, using a quasi-experimental design, make informed decisions about these prod- revealed improvements in specific indicators ucts, clients were often confused and vulner- of knowledge and behavior among the treat- able to exploitation. Faulu Kenya believed that ment group. Most significantly, portfolio at inappropriate use of financial services was risk was lower in the four pilot treatment leading to over-indebtedness and default. branches than in the nontreatment branch. Clients lacked information on how best to use Training for staff was initially planned to credit and how to make decisions about how facilitate client recruitment. Yet, with the much and when to borrow (or not) and from inclusion of financial education as part of where. In 2009 Faulu Kenya embarked on a staff curriculum, the results were much financial education project Elewa Pesa greater. Staff became more knowledgeable (Understand Your Money), co-funded with the and better equipped to answer clients’ ques- Financial Education Fund. Faulu’s objective tions and more engaged in coaching and was to equip nearly 50,000 clients at 26 advising them; they even began saving more branches with the necessary financial knowl- themselves. edge and skills to facilitate prudent money Finding that financial education has bene- management, premised on the belief that fits both for the client and for the institution, educated people are better clients. Financial Faulu has incorporated financial education in education was provided through a one-time its loan orientation training and as a key indica- training workshop complemented by video tor of performance. Source: Alyna Wyatt, Financial Education Fund; Jacqueline Nyaga, Faulu Kenya. The barriers noted in table 3.1 highlight the Notes need to understand the perspectives of both  1. As discussed in chapter 1, formal rules are providers and consumers. They also indicate ­ generally the purview of government or another role for industry in consumer industry stakeholders. They include primary protection­—­developing the financial capability legislation (also referred to as laws), whether of consumers. By having direct contact with statutory (that is, passed by the legislature) or consumers, some providers are actively choos- established by the judiciary; secondary ing to invest in building their clients’ financial legislation (which may be entitled regulations, capacity. Financial education is relatively new, guidelines, or circulars) issued by a government with initial efforts emerging only after 2000, agency or executive body pursuant to a law; but many institutions have embraced it,18 as and other legal proclamations imposed on illustrated by the case of Faulu Kenya, an MFI financial service providers and other players supporting the financial system. Formal rules (see box 3.13). 92 The New Microfinance Handbook also encompass consumer protection Frontier Associates (2009); http://mg.co.za/ ­ guidelines and global standards and principles article/2012-02-17-mzansi-accounts-reach- that guide the actions of regulators and dead-end. supervisors as well as industry standards,  9. This section was contributed by Kate Lauer. nonstatutory codes of conduct, and other 10. www.fatf-gafi.org. principles that guide the actions of financial service providers, even though they may not be 11. For an example of an interest group analysis in legally enforceable. microfinance regulation, see Staschen (2010, ch. 7).  2. In some cases, market actors can be just as 12. See www.CGAP.org. concerned about public statements (such as policies) by the regulator as about legal 13. http://sptf.info/hp-what-is-sp. provisions. 14. http://sptf.info/.  3. And in many cases with donors playing a key 15. www.smartcampaign.com. role. 16. See http://www.smartcampaign.org/  4. This section draws on Brix and McKee (2010); tools-a-resources. Chien (2012). 17. Contributed by Alexandra Fiorillo.  5. CGAP is a significant provider of information 18. Microfinance Opportunities, an early and coordination in financial services for the champion of financial education in developing poor. An industry coordinating body housed at countries, reports that between May 2006 and the World Bank, CGAP focuses on “policy and December 2011, 469 organizations ­ participated research representing more than 30 development in financial education training-of-­trainers agencies and private foundations who share a workshops. It also reports outreach to more common mission to alleviate poverty. CGAP than 40 million end users through a provides market intelligence, promotes combination of direct financial education standards, develops innovative solutions, and training and delivery of financial education offers advisory services to governments, financial messages via mass media. service providers, donors, and investors.” See www.cgap.org.  6. Consumer protection is often discussed in References and Further Reading terms of the rights and responsibilities of both providers and clients. Clients need to develop * Key works for further reading. the capability to assess product offerings; to do AFI (Alliance for Financial Inclusion). 2010. this, they have the right to ask questions about “Consumer Protection: Leveling the Playing products, and providers have the ­ responsibility Field in Financial Inclusion.” Bangkok, to respond respectfully. Thailand: Alliance for Financial Inclusion.  7. This would argue for setting up a market for *———. 2011. “G-20 Principles for Innovative tradable “priority sector lending certificates,” Financial Inclusion.” http://www.afi-global as the Rajan Committee argued for the case of .org/library/publications/g20-principles- India. See Planning Commission, India innovative-financial-inclusion. (2009). Almazan, Mireya. 2010. “Beyond Enablement:  8. South Africa shows that such a self-commitment Harnessing Government Assets and Needs.” by the industry can lead to the opening of many Global Savings Forum, Bill and Melinda Gates new accounts (7 million accounts within four Foundation, Seattle. years, bringing the banked population to 20 *Bankable Frontier Associates. 2009. “The Mzansi million by the end of 2008). The banks now Bank Account Initiative in South Africa.” offer low-cost bank accounts. See Bankable FinMark Trust. The Role of Government and Industry in Financial Inclusion 93 *BCBS (Basel Committee on Banking Supervision). Objectives and Regulatory Options.” Focus 2010. “Microfinance Activities and the Core Note 64, CGAP, Washington, DC. Principles for Effective Banking Supervision— D’Onofrio, S. 2010. “Policy Advocacy: A Toolkit Final Document.” BCBS, Basel, August. http:// for Microfinance Associations.” SEEP www.bis.org/publ/bcbs175.htm. Network, Washington, DC. http://networks ———. 2011. “Core Principles for Effective Banking .seepnetwork.org/ppt-newhtml/Policy_ Supervision: Consultative Document.” BCBS, Advocacy_mar2010_web.en_.pdf. Basel, December. http://www.bis.org/publ/ *Duflos, E. 2011. “National Strategies for Financial bcbs129.htm. Inclusion: Lessons Learned.” Unpublished Bester, H., D. Chamberlain, L. de Koker, C. presentation. Hougaard, R. Short, A. Smith, and R. Walker. *Duflos, E., and J. Glisovic-Mézières. 2008. 2008. “Implementing FATF Standards in “National Microfinance Strategies.” CGAP Developing Countries and Financial Inclusion: Brief, CGAP, Washington, DC. Findings and Guidelines.” The FIRST Initiative, *Duflos, E., and K. Imboden. 2004. “The Role of World Bank, Washington, DC. Governments in Microfinance.” Donor Brief 19, *Brix, Laura, and Katharine McKee. 2010. CGAP, Washington, DC. “Consumer Protection Regulation in Low- EDA Rural Systems and M-CRIL (Micro-Credit Access Environments: Opportunities to Ratings International). 2011. “Of Interest Rates, Promote Responsible Finance.” Focus Note 60, Margin Caps, and Poverty Lending: How the CGAP, Washington, DC, February. RBI Policy Will Affect Access to Microcredit by *CGAP (Consultative Group to Assist the Poor). Low-Income Clients.” M-CRIL, Gurgaon. 2010. “Investors Implementing the Client *Ehrbeck, T., M. Pickens, and Michael Tarazi. Protection Principles.” CGAP, Washington, DC. 2012. “Financially Inclusive Ecosystems: The *———. 2011. “Global Standard-Setting Bodies and Roles of Government Today.” Focus Note 76, Financial Inclusion for the Poor: Toward CGAP, Washington, DC. Proportionate Standards and Guidance.” White *FATF (Financial Action Task Force). 2012. paper prepared on behalf of the G-20’s Global International Standards on Combating Money Partnership for Financial Inclusion. CGAP, Laundering and the Financing of Terrorism and Washington, DC, October. http://www.gpfi Proliferation: The FATF Recommendations. .org/sites/default/files/documents/CGAP.pdf. Paris: FATF, February. Chatain, P.-L., R. Hernandéz-Coss, K. Borowik, Gibson, Alan. 2010. “The Financial Market and A. Zerzan. 2008. “Integrity in Mobile Systems Framework.” Unpublished draft. Phone Financial Services: Measures for *Hannig, A., and S. Jansen. 2010. “Financial Mitigating Risks from Money Laundering and Inclusion and Financial Stability: Current Policy Terrorist Financing.” Working Paper 146, World Issues.” ADBI Working Paper 259, Asian Bank, Washington, DC. Development Bank Institute, Tokyo. *Chien, Jennifer. 2012. “Designing Disclosure *Helms, Brigit, and Xavier Reille. 2004. “Interest Regimes for Responsible Financial Inclusion.” Rate Ceilings and Microfinance: The Story So Focus Note 78, CGAP, Washington, DC, March. Far.” Occasional Paper 9, CGAP, Washington, Cohen, Monique, and Candace Nelson. 2011. DC, September. “Financial Literacy: A Step for Clients towards *IAIS (International Association of Insurance Financial Inclusion.” Workshop paper commis- Supervisors). 2007. Issues in Regulation and sion for the 2011 Global Microcredit Summit, Supervision of Microinsurance. Basel: BIS. Valladolid, Spain, November 14–17. *———. 2011. Insurance Core Principles, Standards, *Dias, D., and K. McKee. 2010. “Protecting Guidance, and Assessment Methodology. Basel: Branchless Banking Consumers: Policy BIS, October. 94 The New Microfinance Handbook *Isern, J., and L. de Koker. 2009. “AML/CFT: *Planning Commission, India. 2009. A Hundred Strengthening Financial Inclusion and Integrity.” Small Steps: Report of the Committee on Focus Note 56, CGAP, Washington, DC. Financial Sector Reforms. New Delhi: Sage. http://www.cgap.org/gm/document-1.9.37862/ *Porter, Beth. 2011. “National Strategies: Where FN56.pdf. Do They Get Us? A Roadmap for Financial Klapper, Leora, Annamaria Lusardi, and Georgios A. Inclusion.” Workshop paper commissioned for Panos. 2012. “Financial Literacy and the Financial the 2011 Global Microcredit Summit, Crisis.” Policy Research Working Paper 5980, Valladolid, Spain, November 14–17. World Bank, Washington, DC, February. *Porteous, D., and B. Helms. 2005. “Protecting MasterCard Foundation, Microfinance Microfinance Borrowers.” Focus Note 27, Opportunities, and Genesis Analytics. 2011. CGAP, Washington, DC. “Taking Stock: Financial Education Initiatives *Responsible Finance Forum. 2011. “Advancing for the Poor.” MasterCard Foundation, Toronto. Responsible Finance for Greater Development *McKee, Katherine, Estelle Lahaye, and Antonique Impact.” Consultation draft, BMZ, CGAP, and Koning. 2011. “Responsible Finance: Putting IFC, Washington, DC, and Berlin. Principles to Work.” Focus Note 73, CGAP, ———. 2012. “Global Mapping 2012: Progress in Washington, DC, September. Responsible Financial Inclusion, Terms of *Morduch, J. 2005. “Smart Subsidy in Reference—July 2012.” BMZ, CGAP, and IFC, Microfinance.” ADB: Finance for the Poor 6 (4). Washington, DC, and Berlin. Nelson, Candace. 2009. “Consumer Protection: A Rozas, Daniel. 2011. “Implementing Client Client Perspective.” Brief, Microfinance Protection in Microfinance: The State of the Opportunities, Washington, DC. Practice, 2011.” Center for Financial Inclusion, ———. 2010. “Financial Education for All Ages.” Washington, DC. Innovations 5 (2): 83–86. *Staschen, S. 2010. Regulatory Impact Assessment Nelson, Candace, and Angela Wambugu. 2008. in Microfinance: A Theoretical Framework and Financial Education in Kenya: Scoping Exercise Its Application to Uganda. Berlin: Report. Nairobi: FSD Kenya. Wissenschaftlicher Verlag Berlin. *Pickens, M., D. Porteous, and S. Rotman. 2009. *Tata, Gaiv, and Douglas Pearce. 2012. “Catalyzing “Banking the Poor via G2P Payments.” Focus Financial Inclusion through National Note 58, CGAP, Washington, DC. Strategies.” CGAP, Washington, DC, March 5. The Role of Government and Industry in Financial Inclusion 95 CHAPTER 4 The Role of Donors in Financial Inclusion Mayada El-Zoghbi and Barbara Gähwiler Financial inclusion is the state in which all indi- financial inclusion, what part of the financial sys- viduals and businesses have the choice to access tem needs donor support, how donors can sup- and the ability to use a range of appropriate finan- port the attainment of full financial inclusion, and cial services, responsibly provided by institutions the tools they have to do this (figure 4.1). permitted to offer such services. As described in chapter 1, demand and supply of financial ser- Donors That Support Financial vices meet in a broader financial ecosystem that Inclusion includes supporting functions and rules. Donors aiming for financial inclusion, as an end in itself In this chapter we use the term donors to mean or as a means toward economic development or entities that have an explicit mission to support poverty alleviation, can help make the financial development goals. A spectrum exists of these ecosystem work better and be more inclusive. actors in terms of their ownership, where they Chapter 1 makes an important distinction raise their resources, and how they operate in the between actors within the market system and market. Some donors are structured as state- organizations that are outside the system. For the owned agencies, whereas others are private foun- most part, donors are outside the system, but they dations. Some donors raise their funding from may enter the system temporarily to provide a public resources such as federal or state govern- catalytic role in market development. This chap- ment resources (that is, taxes). Donors may also ter will discuss who the donors are that support raise their resources from private donations. The Role of Donors in Financial Inclusion 97 Figure 4.1  The Role of Donors in Financial Market System Development FINANCIAL MARKET SYSTEM OUTSIDE THE MARKET SUPPORTING FUNCTIONS Private sector Government Facilitators Community Demand CORE Supply groups Seeking to develop the Representative market system Donors associations as external catalyst Not-for- profit sector RULES Players Specific roles within the market system Source: Adapted from Alan Gibson, The Springfield Centre. Some donors are highly concessional, whereas guarantee. DFIs should therefore enter markets others try to mimic private investors. Regardless only temporarily to play a catalytic role by of where they sit along this spectrum of behavior, “crowding in” other market actors such as the the fundamental role of donors in financial inclu- local capital markets, banks, or depositors. If DFIs sion is to provide catalytic support to market become permanent actors within a market, their development (table 4.1). stay defeats the purpose of their market catalytic It is important to point out here that develop- role. ment finance institutions (DFIs) are a distinct cat- Although many international nongovernmen- egory of development agency. They often see tal organizations (NGOs), such as World Vision themselves as market actors (inside the market) and CARE, raise significant amounts of private and try to mimic the behavior of private investors. donations that they either allocate to partners on Although they may temporarily play the role of a the ground or use for their own development market actor, their existence, mandate, and legal work, we do not classify NGOs as donors. The status entrust upon them the same catalytic mar- majority of NGOs rely on donor funding through ket development role that “traditional” donors either grants or cooperative agreements. How­ have. DFIs are part of the public system of devel- ever, among NGOs a large spectrum is seen of opment assistance and are able to raise money in how they operate, with some acting like donors, capital markets benefiting from an implied state others serving as facilitators, and others entering 98 The New Microfinance Handbook Table 4.1  Spectrum of Donors in Financial Inclusion and the Way They Operate Concessional Type of donor Examples Source of funding vs. commercial Ownership Foundations Bill & Melinda Gates Foundation Private donations Concessional Private Michael & Susan Dell Foundation MasterCard Foundation Bilateral donors USAID (United States) Public government Concessional Public DFID (United Kingdom) funding GIZ (Germany) SIDA (Sweden) Multilaterals UN agencies (IFAD, UNCDF) Bilateral donors Concessional Public European Commission (member states) World Bank Capital markets Regional banks African Development Bank Bilateral donors Mixed Public Asian Development Bank (member states) Capital markets Development IFC Bilateral donors Mostly Public finance KfW (Germany) Public government commercial institutions funding (some Proparco (France) concessional) Capital markets the market and delivering retail or support ser- unbalanced or unfair when the level of informa- vices directly. This chapter will not focus on the tion between parties engaging in an exchange is role of international NGOs, only noting where skewed. they may overlap with donors, facilitators, or With regard to the market for financial ser- market actors. vices, information asymmetry is a common mal- function in the market whereby suppliers do not Where Is Catalytic Funding Needed? have sufficient knowledge about certain segments Areas within a market system that may need cata- of clients (demand) or clients do not have suffi- lytic support from donors tend to fall into three cient knowledge and information to make categories: information, capacity, and incentives. informed choices among suppliers. Solutions to the problem of information in a Information market can include changing the rules, for exam- Markets are a mechanism for exchange. For ple, mandating disclosure about interest rates; exchange to occur between parties, whether this within the supporting functions, for example, exchange is monetized or merely traded, certain establishing a private credit bureau with data on information is required about the item being transaction histories of all income groups; or exchanged, about the entities engaged in the within the core itself, for example, making infor- exchange, and about the terms of the exchange mation available to suppliers about the nature itself. Markets can yield outcomes that may seem and quantity of demand among specific market The Role of Donors in Financial Inclusion 99 segments that may be excluded from current vices to reach the poor. The capacity of represen- exchange. tative associations may be too weak to advocate for the regulatory reforms needed. Capacity Solutions to capacity problems go beyond As described in chapter 1, the financial market delivering capacity outright, but require working system is made up of many actors (figure 4.2). with those in the market who can deliver capac- These actors are at the core but are also deliver- ity development. It requires strengthening their ing supporting functions and setting rules and ability to deliver long-term support on capacity norms. The capacity of certain actors within this development for the market as a whole. Many system may be holding back the development of actors within the local market may be able to the system as a whole. For example, the capacity fill this role, such as private consulting firms, of the government may be a major constraint in ­ universities, trade associations, and training allowing for enabling regulation for financial ser- centers. Figure 4.2  Stylized View of the Financial Market System MARKET FUNCTIONS MARKET PLAYERS SUPPORTING FUNCTIONS Clients Information Funding Coordination Infrastructure Private sector Research Technical assistance Capacity develop- Advocacy Government ment Demand CORE Supply Community groups Representative associations Formal Not-for-profit sector rules Informal rules RULES Source: Alan Gibson, The Springfield Centre. 100 The New Microfinance Handbook In some instances, the local market may be too above dealing with regulation, bankers may have small for a viable entity to deliver capacity devel- very deep and strong relations with their tradi- opment on a sustainable basis; searching for tional clientele: corporate clients and high net- regional or even global solutions may be the pre- worth individuals. Creating a new incentive ferred mechanism to ensure long-term delivery of system for financial service providers to serve capacity development. low-income clients may be threatening to a regu- latory system that is comfortable with the exist- Incentives ing level of risk inherent in serving the upper Incentives, whether material or immaterial, guide echelons of society. choices and behavior. Incentives can be explicit in that they are offered as a reward for accom­ Is Current Donor Funding Catalytic? plishing certain goals or targets. They may also be Over the last 30 years, we have seen considerable implicit in the sense that the system as a whole progress toward financial inclusion in many may reward certain behavior or choices. Incen­ countries. The picture will continue to evolve tives can be both positive and negative. It is because of the dynamic nature of financial ser- important to fully understand and acknowledge vices markets. Markets experience the entry of the incentives of actors to operate and deliver ser- new providers and supporting market actors and vices on an ongoing basis; that is, donor subsidies perhaps the exit of others. Demand evolves, and must be designed to work to ensure long-term new approaches and products emerge to meet cli- incentives exist to continue to deliver the service ents’ needs. As markets grow and become more after the subsidies end. sophisticated, the risks and returns for different A financial system may be plagued by negative market actors change as well. Donors need to incentives that reduce the likelihood of actors respond to these changes as they work to support within the system to think about or deliver ser- the development of inclusive financial markets. vices to the poor. For example, the regulatory sys- If we look at current donor commitments, data tem may incentivize the banking system to serve on where funding is allocated raise many ques- corporate clients at the neglect of other potential tions as to whether donor funding is used in a cat- market segments. A donor’s intervention may be alytic way and allocated where it can most add to work with regulators to change the rules that value. create the negative incentives for the banking system. Majority of Donor Funding Used for On-lending In many markets, financial service providers Depending on the constraints and opportunities have limited information on poor clients. Often in a given market, donor interventions might be they need both information and incentives to needed at different levels in the market system, adapt their products and services to meet these including at the core via funding for retail finan- market segments. Donor guarantees can be struc- cial service providers. Without thorough market tured in a way so that the negative incentives for assessments, we can therefore not make judg- financial service providers to serve this segment ments on whether donor funding is used in a cat- are reduced. alytic way. However, the amount of global donor Solutions to address problems of incentives commitments still allocated to retail financial ser- require strong awareness and understanding of vice providers for the purpose of on-lending to the political economy in a country. Ultimately, microfinance clients, a role that should be pro- modifying incentives often confronts entrenched vided by funders within the market system, raises power dynamics within a society. In the example questions. Over the last 20 years, growing investor The Role of Donors in Financial Inclusion 101 interest in microfinance as an alternative asset allocation of funding seems unbalanced and out of class has led to the emergence of more than 100 touch with a catalytic approach to market devel- specialized microfinance investment vehicles that opment. On the contrary, the easy availability of channel funding from institutional and individual donor funding can create disincentives for the investors, as well as from DFIs, to microfinance development or expansion of savings services and institutions (MFIs). The cumulative assets of undermines the borrowing institutions’ financial those vehicles are estimated at US$6.8 billion discipline. Too much funding can push MFIs to (Symbiotics 2011). In addition to foreign private embark on unsustainably steep growth paths, investments, mostly channeled through these which has led to repayment crises in some coun- microfinance investment vehicles, microfinance tries (CGAP 2010a). institutions increasingly have access to funding from local commercial banks or client deposits as Donor Funding Concentrated on Few a funding source. Despite the availability of fund- Institutions ing from actors within the market system, 86 per- Among donors, development finance institutions cent of donor commitments are still used for are the main providers of funding to MFIs. For on-lending, according to a survey with the 20 young MFIs or those in nascent markets, DFIs largest donors and investors (Gähwiler and Nègre can play a market development role by catalyzing 2011).1 Capacity building at the market infrastruc- private investment. Private sector investors are ture level (supporting functions) and the policy more likely to lend to MFIs that have received level (rules) account for only 2 percent of total funding from a DFI. Once an MFI has established commitments each (figure 4.3). Although it is dif- relationships with private investors, DFIs’ con- ficult to draw any conclusions only by looking at tinued investment arguably adds less value. In committed amounts of a subset of donors, this theory, DFIs should then move on and focus on less developed markets or riskier institutions with promising market development potential Figure 4.3  The Purpose of Donor Commitments (for example, innovative business models or underserved client groups). However, as of December 2009, more than 40 percent of loans 2% provided by DFIs are concentrated on 15 profit- 2% able MFIs, all of which receive funding from pri- Capacity vate sources (CGAP 2010b). On-lending building 86% 14% 10% Geographical Concentration of Donor Funding A CGAP survey conducted in 2010 with more than 60 donors found that donors supported projects in at least 122 different countries (CGAP On-lending 2010b). Out of the funding that can be allocated Capacity building at the policy level to one single country (regional and global proj- Capacity building at the market ects excluded), 15 countries received more than infrastructure level 50 percent of total commitments. Among the Retail capacity building countries receiving the highest donor commit- ments are some of today’s most developed micro- Source: Gähwiler and Nègre 2011. Note: Percentage of total commitments as of December 2010, finance markets, such as India, Bangladesh, data from 18 public donors and one private investor. Bosnia and Herzegovina, Morocco, and Kenya, 102 The New Microfinance Handbook where a variety of financial institutions offer ­egulation, payments systems, credit reporting, r a range of financial services to poor and low-­ and a host of other subspecialties, the donors that income households, and the level of financial are making funding decisions have less and less access to accounts with a formal financial institu- knowledge about the areas in which the field tion is higher than regional averages (Demirgüç- needs donor funding. Kunt and Klapper 2012). Today, local funding Shrinking aid budgets are also demanding that sources or foreign private investment are avail- donors demonstrate their effectiveness through able in these countries, implying the success of clear results. Calls for value for money are com- the catalytic approach that many donors have had. monplace in the media and in parliaments. For Nevertheless, microfinance institutions in these some sectors, it is easier to measure the impact of countries continue to receive significant amounts specific interventions; for example, in the health of donor funding. On the one hand, concentration sector, one finds decades of experience and data of funding is considered a positive element in the on measuring the number of children immunized broader aid effectiveness literature because it or the incidence of malaria infection. For private enables countries to have sufficient resources to and financial sector development, where donors address a particular issue.2 On the other hand, are trying to support market development, to develop markets, the role of donor funding is to demonstrating results is challenging, and estab- leverage private investment, and as such a decline lishing attribution is even more so. in donor funding should be seen over time. Thus a These very real constraints challenge donors concentration of donor funding in any set of coun- to consider the models for channeling the right tries for an extended period of time is worth fur- technical know-how, funding amounts, and over- ther exploration because it could signal “crowding sight without unduly distorting markets. We see out” as opposed to “crowding in.” two alternative options for donors that aim to achieve catalytic market development with lim- ited market distortions: (1) act as a facilitator or Donor Efforts to Support Financial (2) fund a facilitator. Inclusion Different donors are equipped with a different Internal incentives within some donor agencies set of funding instruments, which will be dis- run counter to many of the traits needed to sup- cussed in greater length later in the chapter. In port catalytic market development. Internal sys- understanding roles, however, it is important to tems often reward disbursements of large know that roles will be closely aligned with amounts of funding, creating a bias toward mar- instruments. For example, bilateral agencies tend kets and recipients of funding that can absorb to have grants as their main instrument, whereas large amounts easily. More challenging obstacles multilateral agencies such as the World Bank or for financial inclusion that may require small, International Fund for Agricultural Development long-term, and patient funding are too often work primarily through loans to governments, ignored. The trend in most donor agencies is to but may also have mechanisms to offer grants for support larger projects in fewer countries. technical assistance. DFIs mostly provide debt, To keep overhead costs low, donors are slash- but increasingly are also able to use equity invest- ing staffing budgets, and the predominant staffing ments, and some agencies, such as the Interna­ model is now one where generalists oversee large tional Finance Corporation, also have significant projects in a variety of fields and disciplines. This grant funding used for building market infra- means that even as the field of financial inclusion structure or technical support to investees. A few requires increasingly specialist knowledge in agencies rely primarily on guarantees, such as the The Role of Donors in Financial Inclusion 103 Overseas Private Investment Corporation and the standard recipe can be followed. There is no Development Credit Authority, both part of the blueprint that facilitators can take from one U.S. government. country and apply to the next. However, every The use of the funding instrument should be financial market can be viewed within the over- aligned with the type of facilitation that is needed all framework—and its multifunction and multi- rather than requiring the market to adapt to the player character—even if the detailed, instrument offered by the donor agency. For constituent elements vary. Although it is not a example, a donor that has only loans to govern- precise or formulaic model, it is an aid to strate- ment as its main instrument should be careful in gic analysis and decision making (see box 4.1). how it intervenes in the private sector develop- The market development process is necessar- ment arena more generally and in inclusive finan- ily dynamic, and whether a given type of inter- cial systems development more specifically. vention is appropriate depends strongly on the Ultimately, many of the actors engaged in the market’s stage of development. Although no delivery of financial services are from the private global definition is available of what it means to sector and thus an ability to work directly with be a nascent market, we can assume that it is one private institutions is first and foremost. where access and usage of financial services are Nonetheless, many aspects of the financial mar- low, where the enabling environment is not con- ket system are public goods where government ducive, and where little existing market infra- leadership is warranted. Thus donors with loans structure is in place. At the other extreme, we can to governments as their main instruments should assume that mature markets are where these focus primarily on their influencing role with things exist. In between are found many other government on policy issues and in supporting market development stages. The role of the facili- public goods within the financial system. They tator will be quite different depending on this should not force their instrument—loans to gov- market development spectrum. ernment—as a way to finance the private sector. In nascent or “frontier” markets, facilitators may need to support basic retail level capacity Act as a Facilitator (the supply side of the “core”). Although MFIs Provided that donors have the capacity to operate and other providers may have demonstrated their at the country level, they may be able to fill the success elsewhere, local actors in a nascent mar- role of facilitator directly. This role requires that ket would not necessarily have any information or the donor understands the constraints and oppor- share this knowledge. Thus, facilitators may need tunities in a given market and has the capacity to address this market deficiency. Because basic and flexibility to respond to the specific needs. market infrastructure and the regulatory environ- Chapter 1 noted that market development ment are also likely underdeveloped, significant facilitation must start with a mapping of the room exists for facilitators to intervene. financial landscape and then an identification of The role of facilitator becomes much more the opportunities within the market where facil- nuanced in a mature market. In these markets, we itation will lead to expanded usage of financial already find market actors that are functioning as services. This very important understanding of well as many entrenched ways of doing business. the market and what is needed is at the heart of Additionally, in these markets, facilitators may facilitation. Because everything starts with the need to bring in disruptive technology or business condition of the market and the opportunities models that threaten the existence of existing that lie within that unique market means that no market actors. Identifying the opportunities to 104 The New Microfinance Handbook Box 4.1  Shaping Intervention from an Understanding of the Market System The FinMark Trust’s approach to the development of transaction banking services in South Africa was distinctive from the outset. Faced with the challenge of how to improve access (in the core of the market), FinMark sought to identify the underlying causes of poor access in the support- ing functions and rules in the financial market system; that is, it took a systemic perspective to analysis and intervention to facilitate change. Although a conventional approach might have emphasized engaging directly with providers—with financial and technical assistance—in prac- ­ tice, FinMark identified a number of priority constraint areas (see figure below): • Rules—Numerous weaknesses in relation to, for example, consumer credit, and problem- atic capital requirements for new providers. • Informal rules—A prevailing culture that did not understand or emphasize low-income con- sumers (the “unbanked”) or consider how to innovate new services. ­ ccess • Coordination—Little constructive dialogue between stakeholders in relation to the low a problem and how to address it. • Information—An absence of detailed, analytical data on the low-income market as a whole, including its size, perceptions of services and providers, current use of money, and needs. SUPPORTING FUNCTIONS Coordination Information Reduced conventional focus Priorities Demand CORE Supply Main focus: facilitating systemic change Formal Informal RULES These constraints formed an agenda for action for the industry as a whole and for FinMark specifically. Its interventions focused on these as underlying causes—in rules and supporting increase functions—to bring about change in the core of the market and contribute to a substantial ­ in access from 2003 to 2010. Source: Alan Gibson, The Springfield Centre. The Role of Donors in Financial Inclusion 105 push the frontier becomes the most critical step Fund a Facilitator for a facilitator to make. Facilitators may also Although relatively few examples of this model need to directly confront political and influential are found, we see it as an emerging approach that actors that form the status quo. has the potential to ease the internal constraints Facilitators’ ultimate objective is to get the donors face while delivering catalytic market market to work without their support. This support at the country level. In this role, donors means that their support to any one actor in the fully outsource their funding to a facilitator at the market is de facto a temporary one. Because the country level. One example of this is the Financial risk of overextending a stay is so acute, facilita- Sector Deepening Trust in Kenya funded by tors should be extremely careful to structure DFID, the World Bank, the Swedish International funding mechanisms in a way that is time bound. Development Agency, the Gates Foundation, The litmus test of whether a facilitator is doing Agence Française de Développement, and the the right thing is to ask “what will this look like government of Kenya (see box 4.2). in ‘X’ years.” If the facilitator will still be required This outsourced model allows donors to place to deliver a specific function in the market, then a large amount of funding, thus easing disburse- this is a sign that the facilitator is not interven- ment pressure, into an entity that can then take its ing appropriately. The areas on which the facili- time to understand the local market, identify tator will focus should change over time as the which interventions can unleash market poten- market develops and new opportunities arise. tial, and help to build capacity among market To ensure that an intervention is “time bound,” actors to fulfill their long-term role of service facilitators must build in a convincing exit strat- delivery. This model allows multiple funders to egy in all of their interventions in the market pool their resources and support a joint facilita- (see chapter 19). tor, which is a good way to harmonize funding Box 4.2  Financial Sector Deepening Kenya (FSD Kenya) FSD Kenya started as a DFID project in 2001 mittee (PIC). The PIC comprises nominees but was transformed into a multidonor trust in from supporting donors as well as indepen- 2005. The creation of this independent trust dent experts. A specialist technical team is was motivated by the desire to strengthen responsible for developing and delivering FSD effectiveness by permitting a closer, more flex- Kenya’s strategy and managing its market ible, and responsive engagement with market making investments. As the market has devel- actors as well as to improve efficiency by pool- oped in Kenya the depth of expertise in this ing donor funds within a single special-purpose team has expanded, with the emphasis shift- vehicle. Fiduciary oversight is provided by a ing from funding to guiding market actors firm of professional trustees (currently the through research and technical assistance. For international accounting firm KPMG), and pol- FSD Kenya to function effectively as a market icy guidance and strategic direction are the facilitator, its core donors fund a single com- responsibility of the program investment com- mon approach, set out in its strategy paper. Source: FSD Kenya 2012, private communication. 106 The New Microfinance Handbook and increase donor coordination in a country. The required of donors to ensure they minimize mar- structure of this entity can be similar to FSD ket distortions. Kenya, an independent trust, or it can be a project, DFIs, some multilateral agencies, and regional an international NGO, or another structure that development banks all may have internal incen- can fulfill this facilitation function. tives that make outsourcing their funding to a Multiple facilitators can be working in any one facilitator difficult. Nonetheless, these donors market, each focusing on areas of core compe- have an important influence on governments and tence, as long as complementarity and a common significant funding levels and must prioritize vision on how to support market development are coordination if they want to remain catalytic. found. An example could be a facilitator that Coordination is the perennial development focuses on only capacity development. problem, and there are not many examples of suc- The distinguishing characteristic of a facilita- cess. Nonetheless, this fact does not alleviate the tor is that it operates at the country level. The burden of working toward possible solutions to level of market knowledge that is needed pre- improve the ways donors interact and comple- cludes actors at the global level from fulfilling this ment one another at the country level. role. Nonetheless, facilitators can be aided in their role by global actors who share and disseminate Donor Funding Instruments knowledge from elsewhere, helping to inject and cross-breed ideas in different markets. The ways in which donor funding is delivered will The key to ensuring that such an entity is able have a profound impact on its effectiveness.3 In to take on the role of facilitator, without the inher- using donor funding to develop the market one ent internal weaknesses of donors, lies in a few necessarily finds an acute risk that the resources key design considerations. Such entities must be provided could displace market-based activity. able to take risks, invest in innovations with small Even a relatively small subsidy can distort incen- grants, have a long-term perspective, and demon- tives by changing expectations. Perhaps one of the strate their influence on the market through both more obvious illustrations of this is in the subsidy direct and indirect means. We will explain below of interest rates, which can lead borrowers across how facilitators intervene in the market to be the market to expect lower rates.4 Using the right catalytic. tools can mitigate this risk. Nevertheless, regard- Donor funding to a facilitator would need to be less of which tool is used, there is no substitute for structured as a medium- to long-term project; maintaining a strong awareness of how the market however, the funding provided by this facilitator is developing and ensuring that the extra-market to the market would need to be able to offer many support provided by facilitation is withdrawn small, short-term funding agreements. when market actors are able to take over. Coordination with Other Facilitators Technical Assistance In light of political pressures and internal incen- Much know-how is about tacit knowledge, which tives, some donors will not be able to outsource cannot be readily generated and transferred out- their funding decisions to a facilitator. Donors side the circumstances in which it is generated. that continue to fund interventions directly must For example, although classroom learning can play work closely with other facilitator(s) at the local a useful role, the successful management of soli- level for access to the market knowledge that is darity groups is learned by credit officers through required to identify market-enhancing interven- actually doing it. Working with specific organiza- tions. This is the minimum level of responsibility tions to generate key aspects of know-how is often The Role of Donors in Financial Inclusion 107 essential. However, wherever possible the aim grants are increasingly relevant for building should be to find channels to disseminate this market infrastructure and supporting policy and knowledge to other players, both to increase regulatory reforms, particularly when we begin ­ ilting the play- impact and to minimize the risk of t to think beyond microcredit. ing field in favor of the institutions receiving Challenge funds provide a valuable way to use support. grants, particularly for encouraging the private sector to innovate to reach the poor. The terms of a Grants challenge fund are set up transparently in advance, Grants are commonly used to support the devel- seeking applications for grants on a competitive opment of microfinance. On the positive side, basis to undertake initiatives with specified end grants can be used to deliver a time-limited nudge objectives. Applicants propose how they want to to the market. Beyond the requirement to use the use the grants and compete for a limited pool of grant for the agreed purpose and usually rela- resources. Often the terms require that those tively modest reporting requirements, grants do applying for awards match the grant resources not convey any reciprocal obligations to the donor sought with their own funds and show in their on the part of the recipient. applications how the development will be sus- However, perhaps more than any other tool tained after the award funding has been exhausted. used, grants carry the risk of distorting markets This structuring helps mitigate some of the com- and incentives. Grants can be used as a simply mon problems associated with grants. Challenge bottom-line subsidy—enabling the survival of an funds can be especially helpful in encouraging activity or business where there is no real busi- innovation by offering a simple way to share the ness case or, worse, providing an advantage to one inherent risks, with open competition defusing player over another. It is not uncommon to see the risk of unfairly favoring some players. loss-making, inefficient MFIs continue for very Grants may also be essential for research- long periods simply by acquiring a sequence of related work, whether impact studies to under- donor grants. Unlike an equity investment, a grant stand the effects of interventions on clients or does not necessarily (and rarely does) tie the data collection on market segments and client donor into a long-term relationship with the demand. Although, in the long term, markets supported institution. This has the potential to should be able to deliver this kind of information weaken governance if there is no real owner of without donor assistance, donors may be needed the capital value created in the MFI business. The to build the capacity of the research institutions role of ownership is critical within a market econ- or demonstrate to private actors that this infor- omy for providing a long-term incentive frame- mation is useful for their business. It sometimes work for management to use scarce capital seems surprising how frequently existing market resources efficiently. players (or those in a linked market) are simply One encounters very limited circumstances unaware of the potential in a market. Financial in which grants to build retail institutions sector research can be an important first step in remain relevant in the current financial inclu- creating greater awareness in the industry and sion landscape. In some nascent markets, such helping to guide players toward opportunities to as postconflict countries, the use of grants to expand inclusion. The FinScope surveys, pio- help kick-start an industry may still be relevant. neered by the FinMark Trust in South Africa Grants may also be relevant to help institutions (and now used across Africa and in some parts of extend outreach in difficult-to-reach market Asia), have been very successful in this respect, segments, such as remote rural areas. However, helping commercial banks in seeing entirely new 108 The New Microfinance Handbook areas of the market. This type of research can be which might involve defining new processes, argued to have the key characteristics of a sec- deploying new technology, or training credit offi- toral public good,5 which is likely to be under- cers and risk management departments. The risk provided without external support. Therefore a is that without a clear development plan, the strong case can be made for its financing by institution will simply revert to its earlier prac- donors in the short term. Ultimately informa- tices once the guarantee is removed. tion providers should also seek to be viable commercially. Equity and Quasi Equity Providing risk capital using equity or quasi-equity Guarantees instruments can be valuable in supporting the Guarantees are very commonly used by govern- development of retail (or other) institutions and ment and donors in supporting financial mar- avoiding some of the problems with grants relat- kets. Many different forms of guarantee are used, ing to market distortion discussed earlier. If creat- but the core concept is the agreement to provide ing substantial new organizational capacity, financial resources in the future contingent on whether at the retail or market infrastructure specified conditions. Probably the most com- level, is essential to achieving progress, then monly seen form is a simple guarantee to repay investing by way of equity is often preferable. An part or all of a loan (or more often a portfolio of objection is sometimes raised that a new institu- loans) should the borrower default. A major tion may be loss making in the early years of its attraction to the providers is that funding is often development. This can easily be overcome by sim- not required up-front and a diversified portfolio ply rolling up the projected losses into the overall of guarantees offers the prospect of consider­ level of equity investment required. Many busi- able leverage. USAID’s Development Credit nesses are commercially financed in which inves- Authority, a well-established and managed pro- tors do not expect to break even for several years. gram, has been able to build a strong portfolio Equity as a form of financing has important leveraging the earmarked resources 28 times. A advantages over other instruments in relation to guarantee can be used to help cautious institu- governance and creating appropriate incentives tions enter new markets where they lack knowl- for managers (McKee 2012). It also potentially edge and proven techniques to manage credit mitigates the problem of market distortion and risk. The premise of their effective use to support can be more efficient allowing the eventual return market developments is that institutions will of capital to the market facilitator where success- learn through the process and change as a result. fully invested. However, use of investment instru- For this to be credible one must have both suffi- ments carries substantially higher transaction cient incentives and realistic potential for the costs, requiring careful structuring at the outset institutions receiving the guarantee to change. and ongoing management of the investment. The Simply reducing or eliminating the risk will not skills to undertake this effectively may not be necessarily achieve this. To be effective the insti- possessed by many broad-based market facilita- tution receiving the guarantee must generally tion organizations. Specialist impact investing bear part of the risk. Equal sharing often proves a funds that have the capacity and local presence good starting point. However, if behavior change required are better placed to manage a portfolio is to occur, it may be necessary to ensure that a of equity investments and play an active role in realistic plan is in place for this to happen. the governance of institutions they invest in. Typically this will require developing new Planning for exit may also be problematic, approaches to measuring and controlling risk, especially where capital markets are thin. Quasi The Role of Donors in Financial Inclusion 109 equity (various forms of debt with equity-like their relationships with governments and/or con- characteristics) is one way to address this diffi- ditions specified in lending agreements, funders culty if it is possible to credibly structure a repay- can influence the use of the funds by the govern- ment. A long-term engagement will nevertheless ments. However, loans to governments are not typically be required because the capital repaid adapted to provide support for private sector will need to be replaced—through either new actors, and the funder has little control of how investment capital or retaining earnings. projects are managed and implemented. The danger faced in using investment instru- ments is that a market facilitator investing in a company crosses the line to become, in effect, a Conclusion player. A risk exists of displacing commercial cap- Donors have played an important role in much of ital, especially where the investment funds used the progress achieved in inclusive finance. The derive from a concessional source. In the long large number of private funds that serve the term the aim should be to see concessional capital financial needs of MFIs are a testament to this (or capital with an explicit or implicit state guar- success. This role in helping to “crowd in” private antee, as is the case with DFIs) replaced by com- capital was arguably the market weakness that mercial sources. It should also be noted that needed correcting in the past. Today it is far less considerable heterogeneity exists in the sources common to identify a weak domestic funding of commercial capital. The objectives of investors market as the overarching problem that requires vary considerably. On a purely commercial level catalytic donor assistance. investors will have differing appetites for risk, Donors must thus respond and focus their minimum returns, and time horizons. Beyond attention on ways they can remain catalytic in this there is growing interest in looking at the building financial markets that serve the poor. social and environmental impact of investment, This chapter presented ways in which donors can which is clearly highly relevant to inclusive try to do this by working through or with facilita- finance. The availability of long-term social tors or behaving themselves like facilitators at the investment provides an opportunity for earlier local market level. In all cases a facilitator on the exit by the market facilitator. ground with market knowledge is key to making this role a success. Because one finds few donors Loans to Governments who structure their support in this way today and Loans to governments are an instrument typically because of the real internal challenges in being used by multilateral organizations, regional devel­ catalytic, much still can be done to realign inter- opment banks, and some bilateral agencies. nal incentives within funding agencies to mini- Overall, they represent about 25 percent of total mize negative market distortions. Much also can donor commitments for financial inclusion. Loans be learned in practice to improve how donors can to governments can have maturities of 11 years or fulfill this catalytic role. more, which makes them a good tool for long-term support, but bears the risk of subsidizing functions that the local government or the market could take Notes over. Loans to governments can be used for several  1. The largest 20 donors and investors include purposes, including budget support, on-lending to 10 DFIs, three multilaterals, three bilateral retail financial services providers via wholesale donors, two regional development banks, one financial institutions, or strengthening the market private foundation, and one private infrastructure and ­ policy environment. Through institutional investor. 110 The New Microfinance Handbook  2. See, for example, work by Bill Easterly and ———. 2010b. “Growth and Vulnerabilities in Tobias Pfutze (2008), which uses level of Microfinance.” Focus Note 61, CGAP, fragmentation as one of the criteria to rank Washington, DC. donor effectiveness. Demirgüç-Kunt, Aslı, and Leora Klapper. 2012,  3. This section was originally drafted by David “Measuring Financial Inclusion: The Global Ferrand. Findex.” Policy Research Working Paper 3628,  4. This is one reason why price subsidies should World Bank, Washington, DC. usually be avoided. Price-based signaling is a Easterly, William, and Tobias Pfutze. 2008. key mechanism in effective market operation, “Where Does the Money Go? Best and Worst and a supply-side subsidy can disrupt the Practices in Foreign Aid.” Journal of Economic signaling. Furthermore, given that in the Perspectives 22 (2): 29–52. financial services market one rarely finds a El-Zoghbi, Mayada, Barbara Gähwiler, and Kate public policy case or the resources to support Lauer. 2011. “Cross-border Funding in universal subsidies, targeting is the norm. Microfinance.” Focus Note, CGAP, Washington, Practically these often prove difficult to deliver DC, April. cost-effectively and to control the potential for FSD Kenya. 2005. “Policies and Procedures.” rent seeking created. Financial Sector Deepening Project, Nairobi,  5. Research data of this kind are certainly Kenya. nonrival, and the nature of the type of Gähwiler, Barbara, and Alice Nègre. 2011. “Trends information is such that it rapidly becomes in Cross-border Funding.” Brief, CGAP, nonexcludable (because it is difficult to keep Washington, DC, December. the results private). McKee, Katherine. 2012. “Voting the Double Bottom Line: Active Governance by Microfinance Equity Investors.” Focus Note 79, References and Further Reading CGAP, Washington, DC. CGAP (Consultative Group to Assist the Poor). Symbiotics. 2011. “Symbiotics 2011 MIV Survey 2010a. “2010 CGAP Funder Survey.” CGAP, Report: Market Data & Peer Group Analysis.” Washington, DC. Symbiotics, Geneva, August. The Role of Donors in Financial Inclusion 111 CHAPTER 5 Measuring Financial Inclusion and Assessing Impact Joanna Ledgerwood To make financial markets work better for the inclusion and the importance of continuing to poor, it is valuable to understand what is taking invest in achieving it. place in the core of the financial market This chapter focuses on measuring and moni­ system—what services are provided by whom, toring financial inclusion—that is, supply and to whom, and how—and what is the impact. demand—and on assessing outcomes leading to Measuring financial inclusion helps us to impact. In doing so, it provides an overview of understand which segments of the population tools to measure and monitor financial inclusion lack what types of financial services, why they and to conduct research. It seeks to inform stake­ lack access, and which financial services they holders, including development agencies, regula­ use. Monitoring financial inclusion allows us tors, and providers, who are increasingly to determine if inclusion is improving over modifying policies, services, delivery channels, time and to compare countries within peer and outreach models, to capitalize on insights groups. Assessing impact helps us to under­ provided by databases and research findings. stand the quality of services—convenience, These modifications can occur either at the macro affordability, safety, dignity—and, ultimately, level, initiated by governments and regulators, or the long-­ term outcomes of using financial at micro levels, affecting financial service struc­ services. This provides a much better under­ tures within communities and financial service standing of the value of increased financial providers themselves (see box 5.1). Contributions to this chapter were made by Ines Arevalo and Alyssa Jethani. Measuring Financial Inclusion and Assessing Impact 113 Box 5.1  Using Data to Increase Financial Inclusion Better data can increase awareness of the bank’s decision to allow Safaricom to launch problem of financial exclusion and motivate pol- the M-PESA platform, an e-money transfer icy makers to enact market-expanding reforms. and payment system. M-PESA now reaches Data can also give the private sector the infor- 55 percent of all Kenyan adults. After the first mation it needs to expand and develop new FinScope data for Zambia were released in products and can stimulate new research into 2005, several institutions reported being moti- the drivers and impacts of financial inclusion. vated to launch new ventures. Barclays At the Alliance for Financial Inclusion’s 2009 reopened some of its rural branches, Zambia Global Policy Forum in Nairobi, Gerald Nyoma, National Commercial Bank launched a mobile director of the Central Bank of Kenya, credited banking venture, and Dunavant, a cotton com- the first FinAccess survey in 2006, which pany, created a mobile payment linkage for showed that only 14 percent of Kenya’s popu- 150,000 of its growers. Similar reports have lation had access to banking services, with come from policy makers and market players having a significant influence on the central in other countries. Source: Kendall 2010. Measuring Financial Inclusion it is necessary to determine the current state of the financial market and to identify population Financial inclusion refers to people and busi­ segments that are excluded from it. Measurement nesses having access to appropriate and afford­ also indicates the frequency of services accessed able financial services. Defining financial from various types of providers and allows for inclusion may also include factors such as prox­ comparisons between countries or regions and imity (being within a 20-kilometer range of an among poverty levels within an area. This access point, for example, a bank branch, auto­ enables stakeholders to be better informed and mated teller machine [ATM], microfinance insti­ to respond with appropriate policies and regula­ tution [MFI], or agent) or choice (having access tions. According to the Global Partnership for to multiple providers with varied and relevant Financial Inclusion (2011), “A comprehensive set products and services) and being financially of financial inclusion indicators should serve capable of understanding the available choices three purposes: i) to inform financial inclusion and how best to use them. However, increased policy making both domestically and interna­ access and choice of financial services do not tionally; ii) to provide a basis for measuring the always translate into increased use. In addition to current state of financial inclusion on a global studies that measure access, studies that attempt scale and at country level; and iii) to provide a to understand the use and quality of services, and basis for monitoring and evaluation of financial ultimately their impact, are also important. inclusion policies and targets, both domestically As discussed in chapters 3 and 4, the govern­ and internationally.” ment, industry, and others, including develop­ Measuring financial inclusion is not a straight­ ment agencies, have a role to play in expanding forward exercise, however. Financial inclusion financial inclusion. In order to achieve this goal, has to be clearly defined according to the needs of 114 The New Microfinance Handbook the country. The Alliance for Financial Inclusion Measuring access and usage requires assessing (AFI) puts forth four dimensions of financial both the supply of and the demand for financial inclusion—access, usage, quality, and welfare, services. Supply-side studies and databases such each requiring increasingly complex data collec­ as Financial Access 20101 or Microfinance tion and analysis—and proposes indicators for Information eXchange (MIX)2 use aggregate data each (AFI 2010a, 2010b). to understand the total outreach and perfor­ mance of various types of providers and to enable • Access refers to the ability to use financial comparative analyses over time. Demand-side ­ services, taking into consideration physical surveys such as FinScope3 or Findex4 seek proximity, affordability, and eligibility. Under­ detailed information about what and how finan­ standing levels of access may require insight cial services are used at the individual, household, and analysis of potential barriers to access. or community level. Indicators include number or percentage of Demand-side research offers richer informa­ people who access a certain type of service tion than supply-side research and provides new (credit, savings, payments, insurance) from avenues for analyzing how the poor manage their whom (formal or informal provider), client financial lives, highlighting the multifaceted touch points within a certain distance, and nature of financial management. It normally poverty levels. requires household surveys and therefore is more • Usage refers to the actual use of financial ser­ costly and thus less frequent. Furthermore, vices and products. Determining usage looks demand-side information can be susceptible to at the regularity, frequency, and patterns of use sampling bias and omissions by respondents, over time, including the combination of ser­ making it less comparable over time or across vices. Indicators include frequency of use or countries (Global Partnership for Financial percentage of active accounts. Inclusion 2011). Supply-side data can be collected more frequently and allow for comparisons; how­ • Quality considers the attributes or relevance of ever, such information often only includes formal the financial service or product to consumer and regulated providers, which can miss a signifi­ needs. Quality is determined by the nature and cant portion of what is taking place in the finan­ depth of the relationship between the financial cial market system. Demand-side research, in service provider and the consumer, including contrast, can provide insight on the value and the choices available, the financial capabilities vibrancy of the informal sector, highlighting the of the consumer, and how those capabilities flexibility and innovations inherent in family, kin­ affect the experience. Indicators include the ship, and community-based financial services. financial capability of consumers, choice of services and providers within a reasonable Supply-Side Research distance, and frequency of complaints. ­ Supply-side research collects and aggregates data • Welfare, the most difficult outcome to mea­ on number of providers, services used (primarily sure, focuses on the impact that financial credit and savings accounts and sometimes pay­ services have on the welfare of consumers, ­ ments and insurance products), and access points including changes in consumption, business (for example, bank branches and ATMs) and may productivity, and quality of life. Indicators also collect data on volume and costs. Supply-side include increased savings, increased consump­ data are generally gathered by regulators, other tion, and increased decision making in the government bodies, or development agencies household. (such as the financial access studies conducted by Measuring Financial Inclusion and Assessing Impact 115 the World Bank) or are self-reported by providers demographic outreach of financial services in to global databases such as MIX. Supply-side data about 160 countries. are, for the most part, publicly available and gen­ “Financial Access 2010 is the second in a series erally accessible online. Supply-side data indicate of annual reports by CGAP and the World Bank to the scale and trending of activities of financial monitor statistics for financial access around the service providers, allowing insight into the world and to inform the policy debate. The series growth, depth, and scale of outreach. Databases was launched in response to the growing interest also provide a valuable source of secondary data in financial inclusion among policy makers and to support impact assessments and understand the development community. The first report, key outcomes and may help to uncover pressing Financial Access 2009, introduced statistics on the issues in the industry, for example, over-­ use of financial services in 139 economies and indebtedness, improper pricing, or poor financial mapped a broad range of policies and initiatives and social performance of providers—and some­ supporting financial inclusion. Building on the times consumer abuse (see box 5.2).5 previous year’s data, Financial Access 2010 reviews survey responses from 142 economies, Global Supply Surveys updates statistics on the use of financial services, Two relevant global supply surveys (sometimes and analyzes changes that took place in 2009—a referred to as landscape supply data) are (i) the turbulent year for the financial sector” (CGAP Financial Access 2009 and 2010 of the and World Bank 2010). Financial Access 2010 Consultative Group to Assist the Poor (CGAP) ­ contributes to efforts to measure financial access and the World Bank Group, which gathers data at the country level worldwide, to develop a con­ from financial regulators in about 150 countries, sistent database, and to present the data in a and (ii) the Financial Access Survey (FAS) of the coherent manner for future analyses. International Monetary Fund (IMF), which The IMF conducts the Financial Access reports on key indicators of geographic and Survey annually and makes the data available to Box 5.2  Evidence of Over-Indebtedness through Research Over-indebtedness has become a cause for with the growing levels of default. The evi- concern and a new focus of research and dence to date is not clear-cut. The high levels data collection. Strong competition in some of default in Bosnia in the late 2000s are markets and the expectation of excessive proof of too much debt and a lack of financial returns on the part of some investors have capability to manage the credit. By contrast, led to predatory lending, with rising levels of in Ghana many possess the financial capabil- portfolios at risk. Explanations for these ity to juggle multiple loans, even when the behaviors are many, including the absence of personal cost is high. What has not changed credit bureaus, limited due diligence by lend- is that over-indebtedness has long been an ers, or the assumption that clients assume attribute of poverty and that a life of perpetual more debt than they can manage. Multiple shocks without protection keeps many stuck loans from an array of lenders are associated in the vicious cycle of poverty. Source: Monique Cohen, Microfinance Opportunities. 116 The New Microfinance Handbook the public through an online database. The FAS forming country-level aggregates and are prone database disseminates key indicators of geo­ to multiple counting (Global Partnership for graphic and demographic outreach of financial Financial Inclusion 2011). Also, generally no services as well as the underlying data. It mea­ information is provided on income levels or liveli­ sures outreach by bank branch networks and hood segments of those accessing services ATMs as well as the availability of three key (Kendall 2010). financial instruments: deposits, loans, and insur­ ance. New data on outstanding deposits and National Supply Surveys loans of households were added for the 2011 FAS. Regulators and others are beginning to measure The database helps policy makers and research­ financial inclusion at the national level. ers to understand the determinants and implica­ According to AFI (2011), “More and more, pol­ tions of financial access and usage. The financial icy makers are recognizing the importance of access indicators can help researchers and evidence-based policy making and the critical authorities to identify knowledge gaps, to devise role data play in the policy-making process, appropriate policies for broadening financial from design and implementation to monitoring access, and to monitor the effectiveness of poli­ and evaluation. With rigorous, objective, and cies over time (IMF 2011). reliable data, policy makers can accurately About 140 countries participated in the 2011 diagnose the state of financial inclusion, judi­ FAS, and the FAS website now contains annual ciously set targets, identify existing barriers, data for about 160 respondents covering a seven- craft effective polices, and monitor and assess year period (2004–10), including data for all G-20 policy impact.” countries. When determining how to measure financial Global supply surveys provide useful country-­ inclusion at the country level, the first step is to level data. As many are conducted annually, these define financial inclusion—that is, what providers data can indicate progress toward increasing and which services are considered financially financial inclusion. However, most supply-side inclusive.7 The next is to define the data needs, to surveys rely primarily on information from regu­ look at the information available from secondary lators or regulated financial institutions, which sources (on both supply and demand), and then to effectively excludes unregulated (or nonformal) determine how to obtain missing data. Options providers. Use of services from other providers— include enhancing an existing survey or creating for example, nongovernmental organization a new one (AFI 2010a). (NGO) MFIs, cooperatives, Savings Groups (SGs), In an attempt to create a consistent set of and the informal sector as a whole—is not indicators that are defined in the same manner counted.6 The resulting picture is distorted, par­ and therefore can be tracked in national surveys ticularly in Africa, where only five countries—the and compared across countries, AFI’s Financial Comoros, Ethiopia, Madagascar, Mauritius, and Inclusion Data Working Group developed a Rwanda—report data on credit outreach to the “core set” of indicators for use by regulators at FAS (Linthorst and Gaul 2011). the country level. The AFI core set of indicators In addition, because the data track accounts provides a framework to guide country-level rather than individuals, there is potential for dou­ data collection and to support policy making by ble counting. Furthermore, the general lack of creating a standard for what to measure and how financial identity in many developing countries (AFI 2011).8 weakens the reliability of supply-side data on The core set is a list of five quantitative usage; users cannot be uniquely identified in indicators that measure the most basic and Measuring Financial Inclusion and Assessing Impact 117 fundamental aspects of financial inclusion: remains a key challenge. Global databases and access and usage: provider networks are helping to fill this gap. In addition to supply-side surveys conducted • Access indicators include the number of access at the global and national (or regional) levels, points per 10,000 adults at the national level ­ supply-side data are also collected through and segmented by: type and by relevant admin­ self-reported databases such as MIX, the Savings istrative units; the percentage of administra­ Groups Information Exchange (SAVIX), the tive units with at least one access point; and Microcredit Summit, the World Council of Credit the percentage of total population living in Unions (WOCCU), and the World Savings Banks administrative units with at least one access Institute, among others. point. MIX is a global, web-based platform for • Usage indicators include the percentage of information on microfinance. It provides infor­ adults with at least one type of regulated mation on MFIs worldwide, public and private deposit account and the percentage of adults funds that invest in microfinance, MFI net­ with at least one type of regulated credit works, raters and external evaluators, advisory account. The following proxies may be used firms, and governmental and regulatory agen­ where data for usage indicators are not cies. Institutions self-report to MIX, with data ­ available: number of deposit accounts per checked by in-house analysts. While MIX col­ 10,000 adults and number of loan accounts lects data on nonregulated entities, the informa­ per 10,000 adults. tion requested is geared more toward sustainable institutions with the capacity to report pre­ It does not measure quality and welfare, which scribed indicators on a consistent basis. require more qualitative studies.9 Consequently, the majority of smaller MFIs, savings and credit cooperatives (SACCOs), and Global Databases others do not participate. However, the MIX While surveys continue to provide information database covers an estimated 85 percent of clients useful for establishing scale, expanding sup­ served by specialized microfinance providers ply-side data to include nonregulated providers (see box 5.3). Box 5.3  Microfinance Information eXchange Committed to strengthening financial inclu- the information for comparability. Its pub- sion and the microfinance sector by promot- lished data track development of the industry, ing transparency, MIX provides information on both for its operators and for those supporting the performance of MFIs, funders, networks, it through funding, policy, or analysis. Its and service providers serving low-income primary data platform, MIX Market, has ­ clients. delivered MFI profiles and annual standard ­ Incorporated in 2002, MIX collects and performance reports since 2002. Between reviews financial, operational, product, client, 2002 and 2012, its public database has grown and social performance data, standardizing from covering just over 100 MFIs to more than (continued next page) 118 The New Microfinance Handbook Box 5.3  (continued) 2,000 providers around the world. Its platform Active partners include the Small data include benchmarks and comparative Enterprise Education and Promotion (SEEP) analysis, along with quarterly results. In addi- Network for developing financial reporting tion, MIX publishes annual regional updates standards and the Social Performance Task and topical analysis of the sector through the Force for measuring MFI social performance. long-standing MicroBanking Bulletin. In addition, MIX encourages local microfi- The data available on MIX Market has nance associations to embed these reporting evolved with the industry. In the early years, standards in local markets and connects asso- data focused on outreach and financial perfor- ciations with a global network of analysts mance as the sector sought to understand the working with MFIs to collect, standardize, dynamics of building sustainable institutions. analyze, and disseminate data on MFI perfor- As funding sources and products diversified, mance. More than 30 associations have joined MIX’s data evolved to capture information on the network. the nature and terms of MFI funding as well Since 2011, MIX has published country as the growing array of credit and deposit briefings, quarterly updates on market devel- products. In recent years, a renewed focus on opments, and market forecasts for major understanding the social mission and results microfinance markets. These additional tools of the sector led MIX to work with industry and analysis are available through paid peers to standardize, collect, and analyze data subscriptions. on MFI social performance.  Source: Blaine Stephens, MIX; www.mixmarket.org. The SAVIX is a centralized reporting system the mission of promoting transparent pricing in that provides transparent, standardized data on the microfinance industry.12 SGs (see chapter 6). Data are collected and sub­ The World Council of Credit Unions, the mitted on a quarterly basis (see box 5.4). global trade association and development agency The Microcredit Summit database contains for financial cooperatives, promotes the develop­ information on more providers than other data­ ment of financial cooperatives worldwide and bases but only collects information on the num­ advocates for improved laws and regulations. It ber of borrowers (totaling 137.5 million in 2010), maintains a database on its members, providing the number of “poorest” borrowers, and profit­ information annually on the number of credit ability.10 Summary information is published unions (by country), total members, savings bal­ annually.11 ances, loan balances, reserves, and total assets.13 Microfinance Transparency is an NGO estab­ The World Savings Banks Institute represents lished to promote pricing transparency of provid­ savings and socially committed retail banks or ers. It maintains a database with microfinance associations. It maintains a database for savings interest rate data for individual country markets and postal banks that globally tracks total assets, and publishes the information as a series of inter­ loans, deposits, capital adequacy, outlets, employ­ active tables and graphs. The database supports ees, and customers annually.14 Measuring Financial Inclusion and Assessing Impact 119 Box 5.4  Savings Groups Information Exchange SAVIX is an online reporting system that pro- 22 countries were reporting to SAVIX on a vol- vides transparent and standardized data on untary basis and uploading quarterly program the performance of SGs and the agencies that data to the website. promote them. In 2012 it collected and vali- SAVIX enables users to conduct compara- dated financial and operational data from more tive, trend, and geographic analysis with a than 80,000 SGs representing over 1.8 million choice of filters and metrics. Informed deci- members in all regions of the developing sion making improves program planning and world. Metrics include measures of outreach management, and SAVIX seeks to facilitate (for example, number of groups), membership analysis, develop norms, and improve the per- data (for example, percentage of women formance of institutions that promote SGs. members), portfolio indicators (for example, The site also provides donors and facilitating value of loans outstanding), and performance agencies with industry benchmarks and analy- ratios (for example, annualized return on sis that support planning and investments assets). As of mid-2012, 142 projects in across the sector. Source: David Panetta, Aga Khan Foundation; www.thesavix.org. For the most part, these databases collect (RCTs), and focus group discussions, for exam­ information on outreach and financial perfor­ ple. Demand-side research may identify unmet mance used by various stakeholders (see box 5.5). demand as well as reasons why the uptake of However, some databases have recently begun to services offered (supply) may be lower than collect nonfinancial information. Since 2005, the anticipated. Researchers may also analyze industrywide Social Performance Task Force has structural deficiencies in markets that prevent developed ways to measure social performance the poor from accessing financial services and (see chapter 14), creating 22 social performance explore the opportunities for increased finan­ indicators to assess how an MFI aligns its systems cial inclusion. to its mission and measures its social perfor­ Demand-side research often begins with client mance. MIX began collecting information on behavior, attempting to assess transaction vol­ these social performance indicators in 2009, with umes at the individual and household levels and 212 MFIs reporting. SAVIX is considering adding identify links between use and quality of services. social performance indicators once they are This is in contrast to institutionally driven established for SGs. information-­ gathering techniques that focus on provider performance as a metric for financial Demand-Side Research access. Demand-side research seeks detailed informa­ Overall, demand-side research considers how tion about how financial services are used and poor households use financial services and who is from what providers. It can be carried out at the excluded, sometimes also looking at the nature of individual, household, or community level and household cash flow and how money is spent. uses a variety of tools, including national sur­ Examples of demand-side studies include the veys, panel studies, randomized control trials World Bank’s Access to Finance, Living Standards 120 The New Microfinance Handbook Box 5.5  Who Uses Landscape Supply Data? Knowledge is power only if it is used produc- into a new market or a new product. What tively. Who uses the data collected so pains- types of competition might they encounter? takingly by hundreds of organizations? And Which populations are most underserved? A who should be using the information? subnational view on the data—especially at a So far, much activity on financial inclusion branch or district level—can be valuable in has taken place in the high-level policy sphere. addressing such questions. Regulators and policy makers use data on Networks also use and potentially contrib- financial inclusion to develop policy and to ute to landscape data. Landscape data can monitor progress. For instance, the Superinten­ give members the big picture and place their dency of Banking and Insurance in Peru uses activities in context, whether the network benchmarks on financial inclusion to measure itself has a broad or a narrow focus for mem- progress in reaching underserved areas. bership. Networks can also use landscape However, MFIs can also use landscape data to data to highlight gaps or opportunities for support business planning when expanding donors and investors. Source: Linthorst and Gaul 2011. Measurement Study, Global Findex, and FinScope helping policy makers and others to understand databases—the latter two being the most relevant. the behaviors and constraints regarding consum­ Most financial diaries studies also conduct ers’ access to and use of financial services. Key demand-side research. characteristics include cross-country compatibil­ ity, availability of demographic covariates, and Global Findex regular measurement of the entire set of coun­ The Global Financial Inclusion (Findex) database tries over time (Demirgüç-Kunt and Klapper is a detailed demand-side survey covering 150,000 2012). Findex provides a baseline for benchmark­ individuals in 148 economies, measuring how ing financial inclusion and tracking progress over adults use financial services. According to time, leading to the identification of priorities Demirgüç-Kunt and Klapper (2012), “The Global (see box 5.6): “One of the most fascinating parts of Findex fills a major gap in the financial inclusion the results are people’s answers to obstacles they data landscape and is the first public database of face in getting access to finance, which range demand-side indicators that consistently mea­ from too expensive, document requirements, sures individuals’ usage of financial products and too far to travel” (Latortue 2012). across countries and over time. Covering a range of topics, the Global Findex can be used to track FinScope global financial inclusion policies and facilitate a FinMark Trust is an independent trust based deeper and more nuanced understanding of how in South Africa that seeks to extend financial adults around the world save, borrow, and make access by strengthening the market system. In payments.” 2003 FinMark Trust launched FinScope, a Findex provides demand-side data by gender, consumer survey that seeks to understand age, education, geography, and income levels, consumer demand with regard to access Measuring Financial Inclusion and Assessing Impact 121 Box 5.6  Core Indicators of Global Findex The core set of Global Findex indicators addresses five dimensions of individual use of financial services: accounts, savings, borrowing, payment patterns, and insurance. Use of financial ser- vices refers to how different groups (poor, youth, and women) use financial products. Financial inclusion also refers to how easily individuals can access available financial services and prod- ucts from formal institutions (defined as institutions that are authorized or licensed to offer finan- cial services and that may or may not be actively supervised). The demand-side data provided by Global Findex complement existing supply-side data collected by the IMF’s Financial Access Survey and the AFI’s core set of financial inclusion indicators. The following core set of indicators and subindicators of financial inclusion is based on the Global Findex database: • Use of bank accounts. Percentage of adults with an account at a formal financial institution (such as a bank, credit union, post office, or MFI that is registered with the government and possibly regulated), purpose of accounts (personal or business), frequency of transactions (deposits and withdrawals), percentage of adults with an active account at a formal financial institution, and mode of access (such as ATM, bank branch, retail store, or bank agent) • Savings. Percentage of adults who saved within the past 12 months using a formal financial institution (such as a bank, credit union, post office, or MFI), percentage of adults who saved within the past 12 months using an informal savings club or a person outside the family, and percentage of adults who otherwise saved (for example, in their home) within the past 12 months • Borrowing. Percentage of adults who borrowed within the past 12 months from a formal financial institution such as a bank, credit union, post office, or MFI (a flow measure), per- centage of adults who borrowed within the past 12 months from an informal source (includ- ing family and friends), and percentage of adults with an outstanding loan to purchase a home or an apartment (a stock measure) • Payments. Percentage of adults who used a formal account to receive wages or government payments within the past 12 months, percentage of adults who used a formal account to receive or send money to family members living elsewhere within the past 12 months, and percentage of adults who used a mobile phone to pay bills or send or receive money within the past 12 months (not collected in high-income countries) • Insurance. Percentage of adults who personally purchased private health insurance and per- centage of adults who worked in farming, forestry, or fishing and personally paid for crop, rainfall, or livestock insurance. Source: Demirgüç-Kunt and Klapper 2012. to transactions, savings, credit, and insurance their income and manage their financial lives. The from both formal and informal providers. sample covers the entire adult population, rich and FinScope, an initiative of FinMark Trust, poor, urban and rural, in order to create a seg­ "is a nationally representative study of consum­ mentation, or continuum, of the entire market ers’ perceptions of financial services and issues, and to lend perspective to the various market which creates insight into how consumers source segments." 15 122 The New Microfinance Handbook Primarily a demand side-survey, FinScope also ­nformal, and financially excluded) and enables i integrates supply-side information, leading to a comparison of levels of financial i­nclusion across more holistic understanding of usage. FinScope countries and market segments (see figure 5.1). data sets can be used to inform policies, commer­ Once the “formally unserved” is identified cial strategies, and product development as well through the FinScope survey, the FinScope as development agendas (see box 5.7). Donors ­ livelihoods framework is applied to assess the have traditionally financed the surveys, although individual and factors that affect usage of finan­ costs in some countries are partially recovered by cial services, leading to a better understanding a syndication process whereby stakeholders of the interventions required to increase finan­ (often commercial but also public) purchase cial inclusion, specifically the needs of consum­ access to the final results. ers.16 The result is the access frontier, which FinScope data are used to create three key provides an estimate of the percentage of people access indicators including the financial access who are unserved but could be financially strand, the access frontier, and the financial access included over time. This serves to identify both landscape. The financial access strand provides potential new market opportunities as well as detailed analysis of the financial market based on specific development needs to increase financial customers’ level of financial access (formal, inclusion (see figure 5.2). Box 5.7  FinScope Surveys The FinScope survey information supports private and public sector initiatives to improve the policy environment and stimulate commercial innovation. For example, • Bank Windhoek in Namibia used FinScope to develop its low-income savings product called EasySave. • In South Africa, the Financial Services Board has used FinScope to improve consumer finan- cial literacy. According to the board, “The FinScope surveys have played a major role in iden- tifying consumer financial education needs by following consumer financial behaviour over time and in making valuable information available to others for their consumer financial edu- cation programmes.” The National Treasury in South Africa also used FinScope data to sup- port the development of a policy of financial inclusion to feed into government processes for wide-ranging social security reform. • According to African Life Assurance Zambia, “From the time we started using FinScope, we have been able to develop a funeral insurance policy for the informal market ... and by under- standing the current coping mechanisms and the recurrent costs of such mechanisms used by the informal sector, we have been able to determine an affordable price.” • ABSA, South Africa’s largest retail bank, stated, “Until FinScope there was no single source of information that provided us with an in-depth understanding of the life styles of different segments of South Africa’s population … [FinScope] really gave us that edge in terms of getting such an insight that we could really develop a customer value proposition for the mass market.” Source: http://www.finscope.co.za/new/pages/About-FinScope/Using-FinScope.aspx?randomID=d2e9237a-4bf9- 4272-92ec-8c82443013ea&linkPath=2&lID=2_2; Makanjee 2009. Measuring Financial Inclusion and Assessing Impact 123 Figure 5.1 FinScope Financial Access Strand: Definitions The percentage of adults who are banked. The percentage of adults who are formally served Adults using commercial bank products. but who are not banked. Adults using financial May also be using informal products. services from providers which are not banks, such as microfinance institutions or insurance companies. May also be using informal products. Banked Other formal Formally included Informally served Financially excluded The percentage of adults who are not formally The percentage of adults who are excluded/ served but who are informally served unserved. Adults using no financial services (informal only). Adults using informal financial to manage their financial lives —neither products or mechanisms only, such as savings formal nor informal —and depend only on clubs or burial societies. family/friends for borrowing or saving at home. ” http://www.finscope.co.za/new/scriptlibrary/getfile.aspx?file Source: Adapted from FinScope, “From Data to Action Brochure, name=FS workshop 2011_brochureFNL.pdf&file=../module_data/71e3e62d-1eeb-412e-893b-970e98f6a3fa/downloads/03bcf1fe- 0fd2-40de-95f4-ffb73c12f1f0.file. Figure 5.2 FinScope Access Frontier Current Market frontier potential Already use Have access but Could have access Unlikely to ever do not use but do not have access Current market Enablement Development Redistribution Source: FinScope, n.d. The financial access landscape provides fur- savings, credit, insurance or remittance financial ther information on access to specific products by products or services. creating a diagram with five axes, illustrating the While the access strand is a key comparative percentage of adults who have used transactional, measure to see how access has changed over time, 124 The New Microfinance Handbook it is less successful in accounting for the use of sector of certain geographic areas, such as the multiple products and services. For example, research reported in Collins et al. (2009) and individuals who use both formal and informal summarized in chapter 2. services are only counted as formally included Financial diaries use detailed micro-level (see box 5.8). consumer data to paint a complex, realistic pic­ ture of the financial lives of the poor. Data are Financial Diaries gathered on income, consumption, savings, Financial diaries also assess demand, albeit of a lending, and investment over an extended (usually) much smaller group (and thus unlikely period of time (usually one year). A team of to be statistically representative at the national local field workers, trained and supported by level) because of the costs involved. Primarily the research organization, visits every partici­ longitudinal surveys, financial diaries are used to pating household each week or fortnight and understand consumer behavior in the financial asks members to recount all resources that Box 5.8  Interpreting Financial Access Strands The top-line findings for the access strands from the FinAccess Kenya 2009 survey show that the proportion of individuals included in the formal sector increased from 18.9 percent in 2006 to 22.6 percent in 2009 and that the proportion using “formal other” services (such as SACCOs, MFIs, and money transfer services) increased dramatically from 7.5 to 17.9 percent, while those using the informal sector (mainly informal financial groups such as rotating savings and credit associations, ROSCAs) declined from 35.2 to 26.8 percent. Hence services included in the “for- mal other” category increased, while informal services declined (see figure B5.8.1). Figure B5.8.1  Access Strand Analysis 2006 2009 100% 38.4% 32.7% 26.8% 35.2% 17.9% 7.5% 18.9% 22.6% 0% Excluded Informal Formal other Formal Source: FSD Kenya and Central Bank of Kenya 2009. (continued next page) Measuring Financial Inclusion and Assessing Impact 125 Box 5.8  (continued) However, the access strand classifies a person according to the “most formal” service used. A service-by-service analysis presents some contrasting points. Figure B5.8.2 disaggregates the “formal other” category and shows a fall in the use of SACCOs, a small increase in the use of MFIs, and a large increase in the use of M-PESA. The data also suggest an increase in the use of services in the informal sector (ROSCAs, ASCAs, buyers, hire-purchase, local shops, informal moneylenders). Although the use of formal sector services rose, so did the use of informal sec- tor services. This is not apparent in figure B5.8.1, which does not count the use of informal services once a person uses a more formal service (moves up the continuum). Figure B5.8.2  Service-by-Service Analysis 35 30 % of adult population 25 20 15 10 5 0 y O ed FI A A p nd et ho SC SC CC M er ie ci ls RO A fr SA st so ca gi or g re Lo in ily A ild m ES bu Fa -P or M nk Ba 2006 2009 Source: FSD Kenya and Central Bank of Kenya 2009. Thus the access strand approach needs to be used carefully. First, increased use of “formal” sector services does not necessarily mean that the use of “other formal” or “informal” services has declined. Second, it is very important to know how services in these studies are classified. In Kenya, M-PESA is classified as “formal other,” which implies a significant increase in financial inclu- sion. However, M-PESA does not intermediate funds in the way that SACCOs and MFIs do, and research suggests that many use it simply as a cash-in, cash-out mechanism. Hence being included in the category “formal other” via M-PESA use alone does not signal the same quality of inclusion as having access to a SACCO or an MFI and may result in misleading classifications of inclusion. Source: Susan Johnson, Centre for Development Studies, University of Bath. 126 The New Microfinance Handbook entered or left the household or business over financial service providers.17 To identify strate­ the prior period (week or fortnight). Financial gies for improving access, financial landscape diaries enable researchers to examine the studies focus on the needs of consumers. They dynamics of financial behavior by capturing do not have a bias toward any institutional form transactions data in near “real time” and to of provision; they use a supply-side survey examine data in sequence, providing a view (providers and products) and a demand-side inside the “black box” of the household budget survey (clients) to understand demand for and (MFO 2010). use of both formal and informal providers as Financial diaries can also be used to test a well as the enabling environment. They also new product or delivery channel for a specific may examine the rules and supporting func­ financial service provider to better understand tions needed to develop financial markets and its target market, such as the work carried out by expand inclusion of the poor. Based on this the Opportunity International Bank of Malawi understanding, they propose interventions to (see box 5.9). increase appropriate access.  Most often, land­ scape studies are conducted in smaller geo­ Financial Landscape Studies graphic areas rather than nationally and Financial landscape studies combine demand- sometimes in more than one location for com­ and supply-side data to document what finan­ parative purposes. Financial landscape studies cial services are available (both formal and also may focus on one type of institution or ser­ informal) and how they are used, including vice innovation, placing it in the context of consumer preferences and changes over time, local competition to examine how these inter­ drawing on data from both consumers and actions dampen or multiply its impact. Box 5.9  Cash-In, Cash-Out: Financial Diaries in Malawi Using financial diaries, Microfinance The study determined that the mean Opportunities (MFO) undertook research to number of weekly transactions per house- explore the extent to which the introduction of hold was 19. Cash exchanges between indi- a mobile “bank-on-wheels” serving rural loca- viduals were ubiquitous, largely from men to tions in central Malawi provided value in areas women, suggesting gender-based depen- without branch offices of the Opportunity dency on cash gifts and a pervasive informal International Bank of Malawi (OIBM). MFO safety net among family and friends. Savings collected transaction data (all inflows and out- transactions dominated bank use. Although flows, including use of financial services) from the mobile van was popular initially, OIBM just under 200 low-income households, half of services rarely replaced informal finance whom were OIBM clients using the mobile and use of the van dropped off markedly. Yet bank, for 18 months over 2008–09. The sample the OIBM van added value for women cli- was mostly a mix of poor farmers and micro- ents; furthermore, the analysis of aggregate entrepreneurs. Eight field workers interviewed transaction data helped the OIBM to under- participants at the van stops and recorded stand client behavior and develop better their financial transactions once a week. products. Source: Stuart, Ferguson, and Cohen 2011. Measuring Financial Inclusion and Assessing Impact 127 Financial landscape studies seek to answer the assessment tools), livelihood types, gender, and following questions: age segmentation. Data are analyzed for descrip­ tive patterns, and regression analysis is used to • Supply. What is the landscape of financial ser­ establish key socioeconomic, demographic, and ­ vice supply? Who are the providers of financial geographic factors determining access and use, services? What are the key products offered by including consumer preferences and changes over existing providers? What are the key charac­ time. In addition to the surveys, a comprehensive teristics of different types of providers (for desk review of secondary sources covering finan­ example, prices, volumes, market share, struc­ cial service outreach data (for example, FinScope ture of products offered)? What are the limita­ studies, if available) is generally included. tions of providers reaching the poor? The financial landscape approach provides • Access. What are the level and type of access to insight into the behavior of consumers and their financial services? What are the key barriers, use of financial services and allows results to be opportunities, and constraints to accessing contextualized within local profiles of provision— financial services? What interventions can be for example, understanding the nature of local considered to improve access and improve providers and how they fit into the market sys­ livelihoods in the proposed regions? tem. Combining quantitative and qualitative data allows much deeper insight into consumer pref­ • Use. What financial products and services do erences and strategies and greater understanding the poor use? Which providers do the poor of their engagement with the market (see box use? Are these providers in the formal or infor­ 5.10). Financial landscape studies begin to look at mal sector or both? To what extent do the poor the quality aspect of financial inclusion as defined use various financial services? Would the poor by AFI. use certain products or services that they do Financial landscape studies also examine the not have access to? Do the characteristics of wider environment and supporting functions at demand provide programming insights? local and national levels. Information is gathered through in-depth interviews with key informants • Rules and supporting functions. What rules (for­ (including policy makers, regulators, clients, pri­ mal, informal) and supporting functions (for vate sector providers, and donors). Rules and reg­ example, infrastructure, funding) do or do not ulations, infrastructure and delivery channels, exist in the market? For example, do weak sup­ information, and funding are all examined; sec­ porting functions constrain access? What role ondary research is used to support information does the government play, and do opportunities obtained from the interviews. exist to improve it? Is there sufficient telecom­ Sometimes financial landscape studies are munications and physical infrastructure to supplemented with further research carried out benefit from innovative delivery channels? through financial diaries, for example, or liveli­ On the supply side, as many providers as pos­ hood landscape studies (see box 5.11). sible are interviewed to establish what products and services they offer, prices and volumes Monitoring and Evaluation (accounts, savings, and loans), and competition and dynamics of their business. On the demand In addition to supply and demand research, side, a one-time access and use survey is carried monitoring outcomes and evaluating impact are out on a random sample to map existing pat­ important to understanding financial inclusion. terns of use against poverty levels (using poverty In particular, they help to assess quality and 128 The New Microfinance Handbook Box 5.10  Financial Landscapes in Kenya Landscape research maps the supply and demand sides of financial service provision—both formal and informal—and seeks to understand the patterns of use and the reasons for them. Financial Sector Development (FSD) Kenya commissioned a landscape research study in 2010–11 to examine what was occurring in smaller towns and their rural environs. The goal was to understand to what extent and in what ways the dynamic changes in the market evi- dent at the national level were being experienced in specific contexts and by people whom the financial sector finds it hard to reach (because of both low incomes and rural context). The research was conducted in three towns chosen to reflect different poverty profiles. A supply-side survey collected data from banks, SACCOs, MFIs, and informal groups on prod- uct profiles, number of clients, volume of savings and loans, competition, and local market context. On the demand side, questionnaires were completed with small samples (20 house- holds and multiple users in each household where possible) in each town and in two rural sites at different distances from the town, yielding an overall sample of 337 individuals in 194 households across the three sites. The surveys were followed by in-depth qualitative interviews with 148 individuals. ­ Supply-side data were compiled to develop a profile of service provision and products and provide insight into competition dynamics. The analysis involved probit regressions to ­understand socioeconomic characteristics most associated with the use of particular services (for example, employment type, poverty level, age, gender, marital status, and distance) and analysis of qualitative data to identify the reasons people gave for their service use and preferences. The results revealed the following: • Bank accounts and SACCOs are used to manage payments more than to make voluntary savings. • Financial groups are used extensively because they offer structure but also flexibility and liquidity—in particular, easy access to loans of sizes that individuals need on a frequent basis rather than the much larger loans offered by formal providers. • Mobile money services are used extensively because they allow access to liquidity through social networks but are not used for saving beyond an emergency reserve. Source: Susan Johnson, Centre for Development Studies, University of Bath. welfare, the last two dimensions of financial Generally four main components are included inclusion as defined by AFI. in monitoring and evaluation—inputs, activities, Monitoring involves the regular collection of outputs, and outcomes. Inputs are the basic data, generally quantitative, while evaluation resources used, activities are the set of actions involves periodic or one-time in-depth analysis of taken, outputs are the deliverables, and out­ performance against objectives and anticipated comes are the net result of the outputs over time. outcomes. Impact assessment attempts to deter­ Long-term outcomes are sometimes referred to mine if there is a change in consumer welfare and, as impacts. These can all be viewed within a if so, what the change is and if it can be attributed logic model (see figure 5.3). to the use of financial services (or an intervention The logic model (also known as the theory of seeking to enhance financial inclusion). change or results chain) links the results that we Measuring Financial Inclusion and Assessing Impact 129 Box 5.11  Livelihood Landscape Studies Livelihood landscape studies are similarly qual- Special attention is paid to understanding the itative in orientation and employ the same composite livelihood strategies that individuals methods as financial landscape studies, but pursue (for example, small business, plus with a focus on the livelihood strategies of the farming, plus support from family), how the target population, including the range of occu- pieces fit together, and the reasons for com- pations and perceived advantages and disad- bining them. These studies also attempt to vantages of each. Livelihood landscape studies understand differentiated access to livelihood move beyond occupation to encompass the strategies and the factors that boost or inhibit full range of activities that contribute to the access to financial services—for example, subsistence of individuals and households. class, gender, or ethnicity. Source: Microfinance Opportunities. Figure 5.3  Logic Model Definitions Long-term outcomes – Change of state: includes factors beyond what program can achieve on its own; program contribution Decreasing control and increasing time Medium-term outcomes – Change in behavior or practice; highest level for program accountability; measured at end of program Short-term outcomes – Change in skills, awareness, access, or ability, measured during program; often intangible Outputs – Completed activities Activities – Actions taken or work performed Inputs – Financial, human, material, and information resources Source: Aga Khan Foundation 2011. would like to see with the activities and inputs client welfare, help funders to understand the that are in place (see box 5.12).18 impact of their investments, and, coupled with measuring financial inclusion, help policy makers Assessing Impact to adjust policies and make budget allocation Impact assessments evaluate long-term outcomes. decisions. Academics use impact assessments to They help providers to understand the effect answer rigorous academic questions regarding of their services (both positive and negative) on the role and function of financial services in the 130 The New Microfinance Handbook Box 5.12  Measuring Outcomes of Facilitating Savings Groups Facilitators of SGs generally anticipate outcomes in multiple domains that take hold within the first two years of group participation and deepen with time. The five domains of outcomes are as follows: 1. Stronger economic capacity. Asset accumulation, consumption smoothing, income- generating investment, income, management of finances, savings 2. Increased social capital. Solidarity (with other members), collective activities taken on by members, increase in leadership roles taken on by members in the community 3. Increased self-empowerment. Increased self-confidence, greater decision-making power in the household 4. Greater food security. Increased food consumption or more varied diet 5. Other. Changes due to targeted activities, such as increased specific knowledge or changes in behavior. Source: Gash 2012. lives of the poor. With the increased interest in assets, power, or decision making at the house­ and emphasis on financial inclusion, stakeholders’ hold level. For example, if credit or crop insur­ interest has moved beyond increasing the number ance is concentrated on more profitable but risky of account holders to understanding if consumers cash crops mostly controlled by men, it is impor­ are benefiting from financial services and if those tant to assess the potential welfare effects of shift­ are provided using fair and prudent practices. ing resources away from crops that are controlled Traditional impact assessment measures the largely by women (Copestake 2004). developmental outcomes intended (and unin­ Historically, impact assessment was often con­ tended) by the use of financial services; it tries to ducted to determine if a particular provider’s ser­ identify links between product use and client vices or delivery were having any impact on its welfare.19 Impacts can be economic, sociopoliti­ clients. The purpose was to improve their prod­ cal, or cultural. Economic impacts include broad ucts and services based on findings from the changes in economic growth—for example, move­ assessments. While there are benefits to this ments from a barter to a monetized economy approach, the following section provides a (particularly in rural settings), business expan­ broader discussion on impact assessment and sion or transformation of enterprises, net gains in research methodologies, some of which may not income within subsectors of the informal econ­ be used extensively by individual providers (for omy, or a reduction in the vulnerability of poor example, RCTs; see box 5.13). people through consumption smoothing and risk management. Sociopolitical impact could include Research changes in policies that enhance the business environment or improvements in human devel­ Generally all research begins with an over­ opment indicators within a region (such as arching question that guides the focus, meth­ changes in nutrition or educational outcomes). odologies, and tools used to carry out the Cultural impact may include redistribution of research. The research question may be in the Measuring Financial Inclusion and Assessing Impact 131 Box 5.13  The Changing Focus of Impact Assessment The audience for microfinance impact assess- The need for cash to smooth consumption ments is diverse. The original stakeholder and provide working capital trumps all. group—providers, donors, and academics— Thus the tension persists between credi- has expanded to include investors, policy bility born of research rigor and useful infor- makers, and regulators. Yet despite stake- mation. The ongoing, rapid evolution of the holder diversity, the reasons to invest in industry has fed the need to prove impact. impact assessment have not changed that Rigorous approaches to research are seen as much. Proving impact was, and still is, needed essential to generating credible results, and, to justify the allocation of public and private consequently, interest in conducting RCTs resources. However, impact assessments has exploded. An important pool of knowl- can also play a role in market research because edge has thus been generated, albeit one that client data can help providers to improve their seems disconnected from the dynamics of products and services. These two agendas the industry or institutional practicalities of form the prove-improve continuum that delivering services. guides the design and use of assessment. Despite several recognized “good” and For those seeking to prove impact, the credible studies, the industry still has much methodological challenges of causality, selec- progress to make. While it is no longer a tion bias, and fungibility of money persist. In single-product industry focused exclusively on ­ the mid-1990s, these difficulties led some to working capital loans, the bulk of impact reject impact assessment, arguing that those assessments still addresses the effects of who want to prove the causal relationship microcredit. Recognition of market segmenta- between microcredit and poverty alleviation tion and product differentiation has yet to face an uphill battle. Instead, they proposed spawn products and services that respond to easier, more practical proxies. Early advocates clients’ changing life-cycle requirements. of commercialization, for example, argued Broader impact assessment and financial that repeat loans are a good indicator of the inclusion studies are needed. positive value that borrowers ascribe to micro- What has perhaps changed is how impact credit and can serve as a reasonable proxy for assessment findings have played out in the difficult-to-obtain impact data. In the interven- public arena. As the audience has grown, this ing years, both arguments have shown their information has, in some countries, become weaknesses, the welfare effects of access to more politicized, and the results of the new cri- credit have proven marginal, and repeat bor- tiques have been co-opted by politicians to the rowing reflects the scarcity of capital available detriment of providers and their clients. The to low-income populations more than the microfinance crisis in India between 2009 and appropriateness of the products they use. 2011 reflected this misalignment of interests. Source: Monique Cohen, Microfinance Opportunities. form of a hypothesis, which is a proposed will lead to a lower incidence of theft (Nelson explanation for a phenomenon or a presumed n.d.). A hypothesis can be confirmed, denied, correlation between cause and effect—for or proposed for further investigation via qual­ example, the provision of payment services itative or quantitative research. A research 132 The New Microfinance Handbook question can also be open ended. For example, • Sensitive. Capable of demonstrating changes research can be conducted (or commissioned) and capturing change in the outcome of inter­ by an investor to assess the financial landscape est (national per capita income is unlikely in an area to determine constraints and opportu­ to be sensitive to the effects of a single nities for funding, by a donor to determine the intervention) impact of a particular intervention, or by a pro­ • Timely. Possible to collect relatively quickly vider to better understand the needs of their cli­ ents or potential clients. • Cost-effective. Worth the cost to collect, pro­ cess, and analyze Indicator Selection • Ethical. Acceptable to those providing the Indicators are specific data that are linked to information. objectives and hypotheses (if applicable). These indicators allow defined changes to be measured Indicators help researchers to measure what or analyzed, help to develop an understanding of they believe to be affected; however, if the focus whether the hypotheses are correct, and highlight is only on measuring indicators, the research other unexpected changes or processes. Indicators may miss unintended or unanticipated impacts, need to relate closely to the changes that an orga­ both positive and negative. Ideally research nization or researcher hopes to observe. Wider efforts track indicators for consistency and impacts—those beyond the immediate financial accountability and pose a broader set of ques­ and social benefits for the individual or house­ tions for understanding wider or unanticipated hold—are difficult to identify and assess. Since impacts. many of the wider changes examined are difficult to measure directly, proxies are often used instead. Research Approaches In addition to being SMART (specific, measur­ The overall approach taken to proving the able, achievable, realistic, and time-bound), indi­ research hypothesis or answering the research cators ideally have the following characteristics question is influenced by the research objectives, (Dunn, Kalaitzandonakes, and Valdivia 1996): the quality of information required, the interests of various stakeholders, and the research bud­ • Valid. Measure what they are intended to mea­ get.20 Many decisions need to be made about the sure and capture effects due to the interven­ scope of the study, including size (number of tion rather than external factors individuals, households), time frame (a one-time survey or a longitudinal study), unit of study • Reliable. Verifiable and objective, so that, if (transactions, individuals, households, or enter­ measured at different times or places or with prises), and geographic coverage (local, national, different people, the conclusions will be the regional, or global). same Choices also include whether the research • Relevant. Directly linked to the objectives of should be an ongoing process of collecting infor­ the intervention mation for a period of time (such as financial diaries), a one-off survey, or a survey with two or • Technically feasible. Capable of being assessed more rounds, such as baseline or endline, that is and measured repeated after a period of time; whether the • Usable. Understandable and ideally providing research will study the financial sector as a useful information to assess performance and whole or will focus on an individual provider or inform decision making a particular product (or potential product); Measuring Financial Inclusion and Assessing Impact 133 whether it will look at demand or supply or the Quantitative Research overall financial landscape; and who will carry Quantitative research collects data to create gener­ out the research. A key decision is the balance alizable results from a sample of the population of between qualitative and quantitative approaches interest. It measures the reactions of many subjects or a combination of the two. Combining differ­ to a set of predetermined questions. The process of ent tools can increase the credibility and useful­ measurement is central to quantitative research ness of the research, but adds complexity and because it provides the fundamental connection cost. between empirical observation and mathematical expression of quantitative relationships. Thus Qualitative Research sampling (choosing which persons, households, or Qualitative research is undertaken to gain an enterprises) must be random and large enough to understanding of human behavior and the rea­ represent the population adequately. Properly sons for it. Qualitative methods investigate the designed quantitative studies can provide reliable why and how of decision making, not just the results because of the statistical validity of the find­ what, where, and when. Qualitative methods ings and the lack of bias in the sampling methodol­ capture what people have to say in their own ogy. But these approaches are not as flexible as words and describe their experiences in depth. qualitative methods, so they are best suited when Qualitative research helps us to discover what there is some idea of the situation on the ground. we do not know we do not know because it is Quantitative research commonly uses flexible and adaptable, which allows us to fol­ ­ surveys—predesigned and pretested question­ low up on interesting, unanticipated findings. naires administered in formal interviews. Surveys Hence, qualitative research uses small, focused contain questions with a limited set of answers so samples, whereas quantitative research uses that the results can be quantified, compared, and large samples. Sampling is generally purpo­ analyzed statistically. Because quantitative sive—that is, respondents are chosen because research is associated with statistical analysis of they have specific characteristics and can pro­ responses from a large number of clients, it is con­ vide information on the specific focus of the sidered a more “scientific” approach than qualita­ research. The type of information the researcher tive methods. Quantitative methods allow is looking for will determine the type of individ­ researchers to determine how extensive a phe­ uals chosen, the time spent with each individ­ nomenon is and if it exists with statistical cer­ ual or group, and the size of the sample. In cases tainty, but they are less able to measure unforeseen of very small samples, selecting “informa­ impacts or phenomenon. tion-rich” clients to interview is critical (Patton Quantitative research methodologies can be 1990). nonexperimental, quasi-experimental, or exper­ Qualitative research is generally carried out imental. Nonexperimental studies look at the using individual in-depth interviews, focus group differences in behavior between different peo­ discussions, or participant observation. These ple and relate the degree of access to variations interviews and discussions can form the basis in outcomes. Quasi-experimental and experi­ for case studies, which assess the needs, condi­ mental studies look at what changes take place tions, opportunities, and limitations of a small over time between a treatment group (who number of individuals. Participatory rapid accesses services) and a control group (who does assessment (PRA) expands on the traditional not access the service and who, otherwise, is focus group discussion, making it particularly believed to be identical to the treatment group). interactive (see box 5.14). Baseline and follow-up surveys are conducted 134 The New Microfinance Handbook Box 5.14  Participatory Rapid Assessment PRAs are derived from classic sociological and anthropological approaches in that they involve the use of semistructured interviews with key informants, participant observation, and the methodological principles of triangulation and open-endedness. However, compared to tradi- tional approaches, PRA techniques are more interactive. Workshop activities engage respon- dents by using drawings, stories, and theater, encouraging them to identify significant changes that have occurred in their lives as a result of access to financial services. PRAs use the following techniques: • Social mapping and modeling drawn by participants, indicating which institutions and struc- tures of their community are important in their lives • Seasonality maps or calendars, allowing communities to show how various phenomena in their lives vary over the course of a year • Daily time-use analysis to track how participants use their time, allowing participants and researchers to obtain a sense of responsibilities, challenges, and opportunities for structuring interventions • Participatory linkage diagrams, showing chains of causality • Venn diagrams, showing the relative importance of different institutions or individuals in the community • Wealth ranking • Product attribute ranking • Life-cycle needs analysis • Cash mobility mapping, providing an understanding of where the community goes to acquire or spend cash (markets, wage labor, cooperatives) and leading into a discussion of supply and demand. Source: Ledgerwood 1998. with both groups, and results are compared to the use of a financial service should affect both show what happened as a result of using the populations equally, so any difference in how financial services and what happened in the these populations change over time can be absence of using them. attributed to the effects of the financial services Quasi-experimental studies are nonrandom­ being studied. ized, while experimental methods, or RCTs, ran­ No one method is perfect, however, because domly assign groups or individuals to treatment various methodological challenges are inherent or control groups. While no one can ever know in research: what would have happened to a specific individ­ ual had they not participated in an intervention, • Attribution. The difficulty of attributing a random control group forms a counterfactual changes to a specific activity (access to or use (what would have happened in the absence of of financial services), given the complexity of whatever is being studied) for the group of indi­ environments shaped by an array of factors, viduals or households who use the service or including economic forces, social and cultural receive the benefit. Changes that are not due to norms, and the political climate Measuring Financial Inclusion and Assessing Impact 135 • Fungibility. The exchange or substitution of control and treatment groups are selected ran­ one thing for another—in this case, fungibility domly, the households in those groups should be means that money can be used for many pur­ equivalent, on average, on all observable (for poses, with changes in intention occurring example, education levels) and unobservable quickly. Assessing the impact of borrowing for (for example, an individual’s entrepreneurial a business, for example, assumes that the bor­ skills, organizational ability, or access to social rower used the loan capital for the business networks) characteristics (Bauchet and Morduch and that the borrower did not just reduce his 2010). Randomized designs make it possible to or her borrowing from other sources (that is, uncover the net impact of the intervention, free substitution) of selection bias.22 However, experimental methods only esti­ • Selection bias. The systematic differences in mate the average impact of accessing services or characteristics of people self-selecting to other interventions. They do not provide an participate in an intervention or access a finan­ understanding of the median impact, and in prac­ cial service and whether these characteristics tice they say little about the distribution of make them more likely to benefit from use of impacts. For example, if access makes one person the service (Gash 2012) much better off and all others a little worse off, an • Causality. The relationship between an event RCT might conclude that the average impact is (the cause) and a second event (the effect), positive if the positive impact for that one person where the second event is understood to be a is large enough to offset the sum of negative consequence of the first. The difficulty of iso­ impacts for everyone else (Bauchet and Morduch lating a variable causal impact is commonly 2010). That said, if the sample is large enough, referred to as a causality bias. data can be disaggregated into subcategories to While these challenges have persisted see the impact on certain groups. through decades of social research, some new Furthermore, spillovers (or leakage) can techniques are being used to address, in particu­ occur when randomiz­ing at the individual level, lar, issues of sampling bias and causality. Overall, for example, when someone transfers from the nonexperimental and quasi-experimental designs treatment group to the control group or vice are generally considered better at showing associ­ versa (leakage) or when mem­ bers of the control ation or correlation than at proving causation group are inadvertently affected by the treat­ (Gash 2012). By randomly assigning people to ment. This could happen, for example, when a treatment and control groups (experimental borrower gives part of her loan to a friend in the design), RCTs attempt to overcome the causality control group or when a client receiving train­ bias; since the selection bias is removed, it is pos­ ing shares some of the lessons with someone sible to attribute the impact to use of the service not assigned to the training (Bauchet and (see box 5.15). Morduch 2010). RCTs are very good at providing an estimate of Randomized Control Trials impact, but the results may be difficult to general­ At the time of writing, randomized control trials ize to other settings. This means they may have are relatively new in microfinance and thus are high internal validity (estimates are credible on described in more detail here.21 In addition to their own terms), but not external validity (con­ overcoming selection biases, RCTs are one of the clusions are applicable to a wider range of situa­ few methods (if not the only method) that can tions). For example, when conducting RCTs, account for unobservable factors. Because the researchers are sometimes forced to use a 136 The New Microfinance Handbook Box 5.15  The Difficulty of Proving Causation One significant issue to consider is the ability of a study design to prove causation or eliminate outside factors that could otherwise explain the results. A useful way to think about the link between methodologies and their ability to prove causation is to consider where the methodol- ogy would fall on a spectrum, as shown in figure B5.15.1. The farther the methodology is to the right-side arrow, the better it proves causality, and the farther it is to the left-side arrow, the less it proves causality and only shows association (or correlation). In general, the more rigorous the method, the more likely that cause can be attributed to the intervention. Figure B5.15.1  The Spectrum of Evidence ASSOCIATION CAUSALITY Field experience, anecdotes Interviews, case studies Client surveys Quasi-experimental with nonrandomized comparison group Randomized control trials Source: Gash 2012; provided by Kathleen Odell, Brennan School of Business, Dominican University. Quasi-experimental and nonexperimental studies indicate where impact may lie and help to identify important questions that can be answered more confidently with experimental studies. They are more flexible in terms of identifying unanticipated impacts and can sometimes more easily incorporate the context of the situation. Their results can also hint at the “why” of results that are not explained otherwise. The longer-term nonexperimental studies give us an idea of additional impacts that may emerge as participants use services for longer than the one- to three-year span of some RCTs. On a practical level, quasi-experimental and nonexperimental studies can be less expensive and easier to implement. Quasi- and nonexperimental studies, or even monitoring systems, can be used to check for similar results elsewhere. In essence, all three designs complement each other by filling in gaps and triangulating data. Source: Gash 2012. ­ n onstandard population, making the results intermediate outcomes and considering other less valid externally. While nonrandomized contexts to which the conclusions would apply approaches may collect data on larger geographic (or conduct multiple studies in different contexts). areas or diversified populations, thus having RCTs are sometimes considered unethical fewer problems with external validity, the because they require that a portion of the popula­ internal validity of these methods is often far less tion does not receive access to the intervention satisfactory. To reduce external validity prob­ being evaluated. Furthermore, the choice of who lems, well-designed RCTs try to understand the does or does not receive the intervention cannot “why” of impacts by gathering information on be made based on who needs it the most or who Measuring Financial Inclusion and Assessing Impact 137 deserves it the most. However, sometimes ran­ phenomenon and to verify something as more domly selecting participants can be “fairer” than likely to be true and not due to just one or a few other selection mecha­ nisms when, for example, respondents who could be biased. Similarly, sec­ funding is too limited to serve everyone who is ondary sources and desk reviews of existing find­ eligible. In this case, publicly randomizing who ings can supplement primary research. benefits and who does not can improve fairness Table 5.1 summarizes the various research (Bauchet and Morduch 2010). methods and their usefulness. Mixed Methods Poverty Assessment Tools A combination of quantitative and qualitative methodologies often provides more comprehen­ Poverty assessment tools (or calibrated income sive findings than one approach alone. Mixed proxy tools) are used to determine the poverty methods can be carried out simultaneously, using levels of groups or individuals being studied.23 different research teams or mixed methods in one While most often associated with social perfor­ study. For example, combining quantitative mance monitoring, they are discussed here household surveys to track changes with qualita­ because they are often used in various research tive focus group discussions and key informant efforts (for example, financial landscape studies interviews expands the understanding of contex­ or impact assessments) to assess the level of pov­ tual factors and may lead to unexpected ideas. erty of a group being studied. They allow A mixed approach can also be sequential. researchers (or providers or others) to estimate Qualitative work can inform what questions the rate of poverty incidence in a population should be measured with quantitative work or (or their clients) without having to measure explore unusual findings from quantitative stud­ income or consumption directly through time- ies. Different studies can build on one another in consuming household budget surveys. expected or unexpected ways. For example, qual­ Poverty assessment tools include short, coun­ itative studies indicate that SG members seem to try-specific surveys with indicators that have increase their saving rates from the first to the been identified as the best predictors of whether a second cycle because, by the end of the first cycle, given set of households is very poor, according to members have come to trust the model, under­ the legislative definition of extreme poverty standing that they are able both to save and to applicable to the country in question. Once the earn profits on their savings. However, comple­ gathered data are entered into a template, soft­ mentary quantitative data show that this increase ware can estimate the share of households living in saving from the first to the second cycle is much below the applicable poverty line. The construc­ stronger for the first group in the village than for tion of the tool relies on a set of indicators that are later groups in the same village. Having learned correlated most strongly with poverty in the from the experiences of the first group, later nationally representative expenditure surveys. groups understand better how the model works Each tool is meant to be administered by mini­ and tend to start out with higher saving rates and mally trained staff in 20 minutes or less. thus do not experience as great an increase Table 5.2 presents an overview of poverty (Cojocaru and Matuszeski 2011). assessment tools commonly used in microfinance All research benefits from triangulation— to measure absolute and relative poverty. Absolute that is, checking data with respondents and measures classify people as poor or nonpoor in cross-checking the information with others to relation to a defined poverty line (national or confirm different points of view of the same international, like purchasing power parity of 138 The New Microfinance Handbook Table 5.1  Research Methods and Their Usefulness Measuring Financial Inclusion and Assessing Impact Method Application Advantages Disadvantages Usefulness Randomized control Uses structured Regarded as the Difficult to design and administer if the Useful for measuring the effects of trials (RCTs) comparing surveys to measure most rigorous treatment group is self-selecting (that is, specific innovations where treatment and control variables and changes statistical method; buying a service). In the case of a self- randomization is possible and for groups attributable to the avoids “selection selecting treatment group, encouragement measuring the impact variables of steps in a bias” because the design can be used, which allows anyone to interest (for example, specific presuggested chain of treatment and take up the treatment, but randomly products or services such as results when samples control groups are assigns the encouragement. Study savings accounts, weather are sufficiently large identical on average questions cannot be changed mid-study insurance) Quasi-experimental Uses structured More approximate in Easier to implement than RCTs; results are Similar to RCTs, useful for research comparing surveys to measure that the control similar, but control group is not a perfect investigating specific interventions before and after changes attributable to groups method is counterfactual because it is not randomly and where the sample is characteristics in a step in the results not an exact control selected. The costs of the survey design, sufficiently large but, for treatment and control chain; could be useful implementation, and analysis are identical operational reasons, RCTs are groups (before-after for pilot projects for RCTs and for nonrandom control not feasible with control group; groups. Careful design and measurement also control variables are needed to ensure accuracy. Not valid before-after studies) when the control group is significantly different from the treatment group, especially with regard to underlying trends in both groups Participatory Used where the Might be the only Might be subjective, open to bias Useful for understanding access to approaches (for change in behavior way to show and use of financial services at the example, focus might have been attribution; can local level; complements RCTs in groups) caused by different uncover understanding causal pathways factors unanticipated impacts Opinions of key Might be used when Low cost Might be influenced by interviewer; open Especially useful for understanding informants and expert the key change is to subjective interpretation processes of policy change and interviews driven by one person where causes of market changes (for example, policy are being established (for example, change) demonstration effects) and are necessary for assessing development of rules and supporting functions Case studies analyzing Used where qualitative Low cost; can be a Might not represent the universe of Very useful at all stages of logic changes in behavior understanding is good indication of beneficiaries; can be time-consuming; model or results chain and and performance needed to interpret attribution, if well might be influenced by interviewers especially important for quantitative data designed and understanding changing patterns of executed use by clients 139 Source: Johnson 2009. Table 5.2  Main Poverty Assessment Tools Available for Microfinance Practitioners 140 Tool Purpose Description Implementation Pros Cons Grameen Estimates the % of poor Country-specific poverty Scorecard can be Good balance of ease of Makes no urban-rural Foundation clients, based on one or scorecard with 10 questions applied to a sample of use and accuracy; can be distinction;b not Progress out of two poverty lines and (socioeconomic indicators clients or to the entire used for targeting and available for all Poverty Index the probability of an that correlate with poverty); client base; for assessing changes in countries; validity of (PPI) individual falling below indicators are derived from implemented by field poverty levels; a results indicators changes the poverty line; large-scale nationally staff and can be used can be compared across over time measures absolute representative surveys before, during, or after regions poverty service delivery USAID poverty Estimates the % of poor Country-specific poverty Scorecard can be Good balance of Data cannot be assessment tool clients, based on one or scorecard of 16–33 questions applied to a sample of accuracy and ease of disaggregated and are (USAID PAT) two poverty lines; (socioeconomic indicators clients or to the entire use; results can be not available for all provides an absolute that correlate with poverty); clientele; implemented compared across countries; validity of measure of poverty indicators are derived from preferably after clients countries and regions indicators changes large nationally join the program over time representative surveys FINCA client Broad client assessment; A 130-question survey Surveys a sample of Provides a Relies on clients’ recall assessment tool allows classification of divided in sections: clients, interviewed comprehensive of past expenditures to (FCAT) the population according demographic and loan at periodic intervals assessment of clients’ measure poverty levels, to different poverty lines, information, household well-being and a fair which is prone to based on expenditure characteristics, expenditures, amount of information measurement errors data; provides an assets, access to facilities that can be used for absolute measure of (water, electricity, health management poverty care), business types, and client satisfaction and exit CGAP poverty Assesses the poverty Questionnaire includes a Surveys a sample of Uses multidimensional Lengthy survey; assessment tool levels of MFI clients range of indicators (adapted 200 clients and 300 definition of poverty demanding of technical (CGAP PAT) compared to nonclients to local context): nonclients; input (highly qualified within the operational demographic characteristics; implemented by staff) that does not The New Microfinance Handbook area of an MFI, based on housing quality; assets (type, external consultants build internal capacity a multidimensional number, and value); for future in-house index; provides a relative educational level and replication measure of poverty; can occupation of family use secondary data to members; food security and put relative measures vulnerability; household into a regional, national, expenditures on clothing or even international and footwear (poverty context benchmark) Measuring Financial Inclusion and Assessing Impact Housing index Identifies poor Uses a simple index that is MFI staff visit the Easy to verify; can be Limited definition of households in relation to adapted to the local communities and used for targeting, poverty; accuracy the community where conditions, in terms of apply the index to monitoring, and depends on the actual they live, based on the housing conditions identify potential assessment link between poverty structure and conditions clients; applied before status and housing of their dwelling; or after service conditions provides a relative delivery measure of poverty Means test Assesses the level of Uses household surveys Short interviews Combines simple Indicators may or may poverty of households with a small number of easily conducted by field indicators with short not be closely linked to based on a composite verifiable indicators; includes staff with all potential survey and standard poverty; accuracy is index; provides a relative asset ownership (land, clients; applied before scoring system, unknown measure of poverty livestock, radio, television), or after service simplifying sociodemographic delivery implementation; good characteristics, and others for targeting, monitoring, and assessing Participatory Identifies the poor in a Involves mapping the Participatory appraisal Provides a rich picture of Requires staff with wealth ranking community, based on community, ranking carried out in the livelihood strategies, strong participatory community perceptions individuals by level of wealth, community; facilitated nature, and causes of facilitation skills; of wealth (measures triangulating results, and by experts and MFI poverty; can be highly accuracy is unknown relative poverty) classifying individuals staff before or after correlated with national the program; 100–500 poverty lines households Source: Ines Arevalo, consultant to the Aga Khan Agency for Microfinance drawing from Social Performance Task Force (2009); CGAP (2003); IFAD (2006); Simanowitz, Nkuna, and Kasim (2000); SEEP Network (2008); www.progressoutofpoverty.org; www.povertytools.org; http://www.microfinancegateway.org/p/site/m/template.rc/ 1.11.48260/1.26.9234/ a. Does not establish causality. b. While the urban-rural indicator has been tested for power of prediction, it has never been included in a PPI. It was found that adding a rural-urban indicator did not improve the PPI accuracy as much as other indicators that are also correlated with the geographic location of the household (including ownership of agricultural land, type of dwelling, access to electricity). Geographic variation has also been accounted for by adjusting the poverty line that is used to construct the scorecard to the cost of living in different regions of a country (Grameen Foundation 2008, 13; personal communication with Mark Schreiner). 141 US$1.25 a day). Relative measures classify people robust relationship be expected. In general, in relation to other people of the same community this over-simplification of the definition of pov­ or geographic area. Absolute measures allow erty leads to less accurate assessments. Other comparisons across providers, countries, and so tools rely on a wider set of indicators (for exam­ forth and are useful for impact assessment (Zeller ple, participatory wealth ranking), but these are 2004). In general, tools that measure absolute derived subjectively, which means that the rate poverty perform better at the aggregate level— of poverty cannot be compared across regions. that is, they are more accurate when they mea­ An important caveat applying to most tools sure the rate of poverty in a group of people and included in table 5.2 is their validity over time. not the poverty status of an individual. If the pur­ As the underlying relationship between the set pose is to target beneficiaries, relative measures of indicators and poverty changes, the accuracy are a better alternative. However, the Progress of the tool is reduced. This means that tools need out of Poverty Index (PPI) of the Grameen to be updated (more recent national surveys Foundation, unlike the poverty assessment tool need to be conducted in the case of PPI and PAT (PAT) of the USAID or the client assessment tool or the participatory wealth ranking exercise (FCAT) of the Foundation for International needs to be conducted again) and extra effort Community Assistance (FINCA), which all made to allow inference of conclusions from the measure absolute poverty, can also be used for ­ application of the tools to different points in targeting because of the methodology used to time. derive the indicators. None of the tools included in the table uses income as an indicator of well-being, as con­ Notes sumption is generally considered a better indica­  1. http://www.cgap.org/p/site/c/template tor of welfare than income and is preferred as a .rc/1.26.14235/. poverty measurement.24 Of the tools presented in  2. www.theMIX.org. table 5.2, two attempt to measure expenditure as  3. www.finscope.co.za. well (FCAT and CGAP PAT). However, large  4. http://data.worldbank.org/data-catalog/ samples and advanced techniques that do not rely financial_inclusion. on recall over large periods of time are required to  5. For example, see http://www.themix.org/ reduce the error in estimations. To overcome this publications/microbanking-bulletin/2012/ issue, most tools use indicators that are correlated 02/over-indebtedness-and-investment- with poverty, such as household characteristics, microfinance. dwelling structure, ownership of assets, human  6. Regulated financial service providers are capital, and access to service facilities (Zeller required to report to central banks, but their 2004). reporting is not standardized across countries. The two tools whose set of indicators has The reporting of unregulated providers can be the strongest correlation with poverty are the especially complicated. Credit unions often report to their own apex body. Mobile money Grameen Foundation’s PPI and USAID’s PAT, providers are governed by specific legislation as they derive the final set of indicators from and thus may or may not be captured in large nationally representative income and reports from regulators. Further, there is no expenditure household surveys. Other tools systematic method for tracking outreach and such as a housing index rely on a single indica­ contribution to financial inclusion of NGOs tor to predict poverty; only when there is a very and non-bank financial institutions (Linthorst strong correlation with that one indicator can a and Gaul 2011). 142 The New Microfinance Handbook  7. AFI defines three levels of “formal” providers, US$1 or less per day. Profitability is measured each with implications for regulatory as “operating self-sufficiency,” which is income reporting: (a) registered institutions, such as divided by cash costs for a given period, with cooperatives or loan companies, that offer no standardization of loan loss provisioning financial services but are not required to and no adjustments for the effects of subsidies. provide information to a regulator, Operating self-sufficiency is self-reported by (b) institutions, such as remittance agents, the MFIs, unverified, and not reported that are authorized (or licensed) to offer publicly, although the Microcredit Summit financial services but are not actively independently verifies MFIs’ reported number supervised and have limited or no reporting of borrowers, where possible. obligations, and (c) institutions that are 11. http://www.microcreditsummit.org. authorized and directly supervised on an 12. http://www.mftransparency.org/. ongoing basis. This is the most restrictive definition, but is also the level at which 13. http://www.woccu.org/memberserv/ financial regulators have the most influence. intlcusystem.  8. The Global Partnership for Financial 14. http://www.wsbi.org/. Inclusion subgroup is proposing G-20 basic 15. www.finscope.co.za. financial indicators built on the AFI core 16. FinScope brochure, “From Data to Action,” set of indicators (Ardic, Chen, and http://www.finscope.co.za/new/scriptlibrary/ Latortue 2012). getfile.aspx?filename=FS workshop 2011_  9. Administrative unit is defined by each country brochureFNL.pdf&file=../module_data/ and could, for example, refer to municipality, 71e3e62d-1eeb-412e-893b-970e98f6a3fa/ township, county, or other (depending on the downloads/03bcf1fe-0fd2-40de-95f4-ffb73c country). Access points are defined as 12f1f0.file. regulated access points where cash-in 17. This methodology was developed for financial (including deposits) and cash-out transactions services by Susan Johnson, University of can be performed. This would include Bath. traditional bank branches and other offices of 18. The logic model, combined with the plan to regulated entities (such as MFIs) that perform assess progress toward expected outcomes, is these functions. Depending on the type of often expressed in a log frame analysis or a transactions permitted, this could include performance monitoring framework. agents of regulated entities and ATMs (only 19. Transactions-level analysis, for example, can those that perform cash-in as well as cash-out isolate unusually large household expenses transactions). Regulated entities are entities and study the transaction patterns that are prudentially regulated and surrounding them. When looking at the value supervised. Since regulations vary by country, and frequency of transactions, it is possible to a country should disclose which types of identify previously unseen trends and financial institutions are included in the opportunities to design and deliver improved calculation (for example, banks, cooperatives, financial services. MFIs). Adults refer to the population 15 years of age and older; if a different age is used 20. This section draws from Nelson (n.d.). because of country-specific definitions, a 21. This section was contributed by Alyssa country should disclose the age threshold Jethani and is summarized from Bauchet and used. See AFI (2011). Morduch (2010). 10. “Poorest” borrowers are defined as individuals 22. Some variations of quasi-experimental among the lowest half of individuals living research can approximate experimental below the national poverty line or living on methods, such as regression discontinuity Measuring Financial Inclusion and Assessing Impact 143 design, which relies on an arbitrary cutoff or Aga Khan Foundation. 2011. “Monitoring, rule to produce two populations that are Evaluation, and Learning Plan.” Internal essentially similar except that only one has document, Aga Khan Foundation, Geneva. access to or has used the service; natural *Ardic, Oya Pinar, Gregory Chen, and Alexia experiment, which is an RCT that occurs Latortue. 2012. “Financial Access 2011: An without any intent to create a research Overview of the Supply-Side Data Landscape.” situation; and encouragement design, which is Access to Finance Forum Reports by CGAP and a form of RCT that can be used when it is Its Partners 5, CGAP and IFC, Washington, DC, illegal or unethical to deny a service to May. participants. Here, the randomization pertains *Bauchet, J., and J. Morduch. 2010. “An to who gets extra “encouragement” to take up Introduction to Impact Evaluations with a service that everyone is free to join (Janina Randomized Designs.” Financial Access Matuszeski). Initiative, New York, March. 23. This section was contributed by Ines Arevalo, CGAP (Consultative Group to Assist the Poor.) consultant to the Aga Khan Agency for 2003. “Microfinance Poverty Assessment Microfinance. Tool.” Technical Tools Series 5, CGAP, 24. Income is widely believed to be inappropri­ Washington, DC. ate as a welfare indicator because, first, it CGAP and World Bank. 2009. Financial Access does not capture emergency coping strategies 2009: Measuring Access to Financial Services (for example, borrowing, selling assets, and around the World. Washington, DC: CGAP and consumption smoothing) and, second, it is World Bank. prone to large measurement errors—in ———. 2010. Financial Access 2010: The State of economies with large informal markets, Financial Inclusion through the Crisis. people might find it difficult to recall their Washington, DC: CGAP. earnings or might be unwilling to report parts of their income (Haughton and *Chaia, Alberto, Aparna Dalal, Tony Goland, Maria Khandker 2009). Jose Gonzalez, Jonathan Morduch, and Robert Schiff. 2009. “Half the World Is Unbanked: Financial Access Initiative Framing Note.” Report, Financial Access Initiative, New York. References and Further Reading Cojocaru, Laura, and Janina Matuszeski. 2011. * Key works for further reading. “The Evolution of Savings Groups: An Analysis *AFI (Alliance for Financial Inclusion). 2010a. of Data from Oxfam America’s Savings for “Financial Inclusion Measurement for Change Program in Mali.” Draft, Oxfam Regulators: Survey Design and America, Boston, November. Implementation.” Policy paper, Data Working *Collins, Daryl, Jonathan Morduch, Stuart Group, AFI, Bangkok. Rutherford, and Orlanda Ruthven. 2009. ———. 2010b. “Financial Inclusion Measurement Portfolios of the Poor: How the World’s Poor for Regulators.” PowerPoint presentation, AFI, Live on 2 Dollars a Day. Princeton, NJ: Kuala Lumpur. http://www.afi-global.org/sites/ Princeton University Press. default/files/fidwg_measurementoverview_ *Copestake, J. 2004. “Impact Assessment of porteous_0.pdf. Microfinance Using Qualitative Data: ———. 2011. “Measuring Financial Inclusion: Core Communicating between Social Scientists and Set of Financial Inclusion Indicators.” Data Practitioners Using the QUIP.” Journal of Working Group, AFI, Bangkok. http://www International Development 16 (3): 355–67. .afi-global.org/sites/default/files/afi%20 *———. 2011. “Microfinance Impact and Innovation fidwg%20report.pdf. Conference 2010: Heralding a New Era of 144 The New Microfinance Handbook Microfinance Innovation and Research?” IFAD (International Fund for Agricultural Enterprise Development and Microfinance 22: Development). 2006. “Assessing and Managing 17–29. Social Performance in Microfinance.” IFAD, Copestake, J., S. Johnson, and K. Wright. 2002. Rome. “Impact Assessment of Microfinance: Towards IMF (International Monetary Fund). 2011. “IMF a New Protocol for Collection and Analysis of Releases 2011 Financial Access Survey Data.” Qualitative Data.” Working Paper 23746, Press release 11/274, IMF, Washington, DC, Imp-Act, University of Sussex. July 11. *Demirgüç-Kunt, Aslı, and Leora Klapper. 2012. Johnson, Susan. 2009. “Quantifying Achievements “Measuring Financial Inclusion: The Global in Private Sector Development.” Centre for Findex.” Policy Research Working Paper 6025, Development Studies, University of Bath. World Bank, Washington, DC. Karlan, Dean S. 2001. “Microfinance Impact Dunn, Elizabeth, Nicholas Kalaitzandonakes, and Assessments: The Perils of Using New Corinne Valdivia. 1996. “Risks and the Impact Members as a Control Group.” Journal of of Microenterprise Services.” USAID, Microfinance 2 (3): 75–85. Washington, DC, June. Karlan, Dean, Nathanael Goldberg, and James. Duvendack, M., R. Palmer-Jones, J. G. Copestake, Copestake. 2009. “Randomized Control Trials L. Hooper, Y. Loke, and N. Rao. 2011. “What Is Are the Best Way to Measure Impact of the Evidence of the Impact of Microfinance on Microfinance Programmes and Improve the Well-Being of Poor People?” EPPI-Centre, Microfinance Product Designs.” Enterprise Social Science Research Unit, Institute of Development and Microfinance 20 (3): Education, University of London. 167–76. *FSD Kenya and Central Bank of Kenya. 2009. *Kendall, Jake. 2010. “The Measurement “Results of the FinAccess National Survey: Challenge.” Paper presented at the Global Dynamics of Kenya’s Changing Financial Savings Forum, November. http://www Landscape.” FSD Kenya, Nairobi. .gatesfoundation.org/financialservicesforthe­ *Gash, Megan. 2012. “Pathways to Change.” In poor/Documents/measurement-challenge.pdf. Savings Groups at the Frontier, ed. Candace Latortue, Alexia. 2012. “What Really Works for Nelson. Bourton on Dunsmore, U.K.: Practical Clients.” Part of the (virtual) conference Action. “Financial Inclusion: What Really Works for *Global Partnership for Financial Inclusion. 2011. Clients?” CGAP, Washington, DC. “Financial Inclusion Data: Assessing the Ledgerwood, Joanna. 1998. Microfinance Landscape and Country-Level Target Handbook: An Institutional and Financial Approaches.” Discussion paper, IFC, Perspective. Washington, DC: World Bank. Washington, DC. *Linthorst, Audrey, and Scott Gaul. 2011. *Grameen Foundation. 2008. Progress Out of “What Do We Need to Know about Financial Poverty Index™. PPI Pilot Training. Participant Inclusion in Africa?” SEEP Network, Guide. Washington, DC: Grameen Foundation. Washington, DC. Haughton, Jonathan, and Shahidur R. Khandker. Makanjee, Maya. 2009. “Financial Inclusion in 2009. “Inequality Measures.” In Handbook on Africa.” PowerPoint presentation at AFI Global Poverty and Inequality, 101–20. Washington, Policy Forum, September 14. http://www DC: World Bank. .afi-global.org/sites/default/files/GPF_Maya_ *Hulme, D. 2000. “Impact Assessment Makanjee.pdf. Methodologies for Microfinance: Theory, *MFO (Microfinance Opportunities). 2010. Experience, and Better Practice.” World “Financial Diaries as a Tool for Consumer Development 28 (1): 79–98. Research.” MFO, Washington, DC. Measuring Financial Inclusion and Assessing Impact 145 MIX (Microfinance Information eXchange). 2010. Identifying the Poorest Families.” http://www “Social Performance Indicators.” Report, MIX, .microcreditsummit.org/papers/povertypa­ Washington, DC, January 11. perH.pdf. *Nelson, Candace, ed. n.d. “Learning from Clients: *Social Performance Task Force. 2009. “Poverty Assessment Tools for Microfinance Targeting and Measurement Tools in Practitioners.” SEEP Network, Washington, DC. Microfinance.” SPTF User Reviews, vols. 8–9. Patton, Michael Quinn. 1990. Qualitative CGAP, Washington, DC, October. Evaluation and Research Methods. 2d ed. Stuart, Guy, Michael Ferguson, and Monique Newbury Park, CA: Sage Publications. Cohen. 2010. “Managing Vulnerability: Using Schreiner, M. 2010. “Seven Extremely Simple Financial Diaries to Inform Innovative Poverty Scorecards.” Enterprise Development Products for the Poor.” Report, Microfinance and Microfinance 21 (2): 118–36. Opportunities, Washington, DC, January. SEEP (Small Enterprise Education and ———. 2011. “Cash In, Cash Out: Financial Promotion) Network. 2008. “Social Transactions and Access to Finance in Malawi.” Performance Map.” Social Performance Microfinance Opportunities, Washington, DC, Working Group, SEEP Network, January. Washington, DC. World Bank. 2011a. “Household Financial Access: Simanowitz, Anton. 2000. “Making Impact Using Surveys to Understand Household Assessment More Participatory.” Working Financial Access: The Research Agenda.” Paper 2, Imp-Act, University of Sussex, June. World Bank, Washington, DC. ———. 2004. “Issues in Designing Effective ———. 2011b. “Living Standards Measurement Microfinance Impact Assessment Systems.” Study.” World Bank, Washington, DC. Working Paper 8, Imp-Act, University of Zeller, M. 2004. “Review of Poverty Assessment Sussex, January. Tools.” Report submitted to IRIS and USAID as Simanowitz, Anton, Ben Nkuna, and Sukor Kasim. part of the Developing Poverty Assessment 2000. “Overcoming the Obstacles of Tools project. 146 The New Microfinance Handbook PART II FINANCIAL SERVICE PROVIDERS CHAPTER 6 Community-Based Providers Candace Nelson “There are many devices for turning small savings Informal financial services tend to be flexible, into usefully large lump sums—the main money-­ convenient, and close to where the poor live; how- management task of the poor. Most of it is done in ever, they may not always be available when or in the informal sector” (Rutherford 2009). People the amounts needed. As discussed in chapter  1, often borrow from or save with a friend or a rela- informal financial service providers are referred tive to help smooth cash flow, take advantage of to as community-based providers (see figure 6.1). an opportunity, prepare for a life-cycle event, or Community-based providers offer flexible ser- address an emergency. Informal groups, formed vices that can accommodate uncertain cash flows for the purposes of mutual aid or savings and and provide discipline to encourage r ­ egular sav- credit, are also common. An early analysis of ings and loan payments. One of the greatest the Global Financial Inclusion (Global Findex) ­ benefits of community-based providers is acces- database 2012 reports, “Community-based sav- sibility, determined by both proximity and prod- ings methods such as savings clubs are widely uct features (for example, minimal administra­ tive used in some parts of the world but most com- procedures, no collateral requirements, low trans- monly in Sub-Saharan Africa. Among those who action costs, flexible terms) that suit the needs of reported any savings activity in the past 12 months, poor women and men. However, limited product 48 percent reported using community-­ based sav- offerings and potential unreliability are some of ings methods”; of these, 34 percent reported hav- their disadvantages. Somewhat more so than ing saved using only a community savings club institutional providers (discussed in chapter  7), (that is, not in addition to a formal account) community-based providers are vulnerable to (Demirgüç-Kunt and Klapper 2012). collapse or fraud, whether because of corruption, Community-Based Providers 149 Figure 6.1  The Range of Financial Service Providers Community-based providers Institutional providers Community-based groups Individuals Indigenous groups: Registered institutions Regulated institutions Moneylenders ROSCAs, ASCAs Financial cooperatives Deposit-taking MFIs Deposit collectors Burial societies SACCOs Savings and postal banks Pawnbrokers Facilitated groups: Suppliers, buyers State banks Traders CVECAs NGO MFIs Commercial microfinance banks Shop owners Savings groups Mutual insurers Non-bank financial institutions Friends, Family Self-help groups Money transfer companies Commercial insurers Financial service associations Mobile network operatorsa Level of formalization Note: ROSCAs = rotating savings and credit associations; ASCAs = accumulating savings and credit associations; CVECAs = caisses villageoises d’épargne et de crédit autogérées; SACCOs = savings and credit cooperatives. a. Mobile network operators are regulated as communication companies; most are not licensed to provide financial services. lack of discipline, or collective shocks—for exam- type of expense, such as a funeral). Group ple, a natural disaster or a bad harvest (Robinson members determine the rules that govern the 2001). Borrowing from family and friends can also group. be associated with stigma or loss of dignity, espe- Facilitated providers are groups (not individu- cially if borrowers become dependent on others als) that receive external training or assistance, or over-indebted (Ruthven 2002). typically provided by nongovernmental organiza- Informal or community-based financial ser- tions (NGOs) or government, to develop and vice providers can be divided into two broad implement a process for saving and lending. Many ­ categories: indigenous and facilitated. forms of facilitated groups have been introduced Indigenous providers, both individuals and over the years, but perhaps the largest, most well- groups, emerge within communities with no known are India’s Self-Help Groups (SHGs). external input or training. Individual providers Most facilitated groups follow a set of procedures such as moneylenders generally offer basic designed to help them to save regularly, pool their credit services using their own capital. As local savings, and make loans. Some operate solely residents, they offer convenience and a rapid ­ within their community; others federate, borrow response. Indigenous groups are different; from banks to on-lend to their members, and take their most common goal is to combine small on other development activities in addition to sums into bigger ones, the purpose of which financial services. Despite their diversity, facili- varies with the type of group. A rotating savings tated groups serve people who typically may not and credit association (ROSCA) pools money to have access to other financial services. They have circulate among the members in turn, while a a relationship with an external facilitator (often mutual aid society pools member contributions time-bound) that introduces an approach or to have funds available to respond to unex- model with procedures and systems to guide their pected or emergency expenses (often a specific financial activities. 150 The New Microfinance Handbook Indigenous Providers loans (Demirgüç-Kunt and Klapper 2012). In addi- tion to personal relations, individual community-­ Individual indigenous providers include money- based providers such as moneylenders or shop lenders, deposit collectors, informal traders, pawn- owners are common and operate either as licensed brokers, store owners, and informal money transfer providers or completely informally. providers. Some traders, processors, and input As part of the local community, moneylenders ­ suppliers also operate informally, while others are are not only easily accessible to borrowers, but more formal in nature (and thus are discussed often have personal relationships that enable briefly in chapter 7 as well). Indigenous groups them to evaluate the borrower’s repayment include ROSCAs, accumulating savings and credit capacity. These factors allow for fast transactions associations (ASCAs), and burial societies. Table 6.1 in locations convenient to the client. However, summarizes their key characteristics. moneylenders can be very expensive. For exam- ple, in many countries a standard loan from a Individual Providers moneylender is a “5/6 loan”—that is, for every Family and friends are the most common providers five units borrowed, six must be repaid. This of financial services in the informal sector in all amounts to a periodic (daily, weekly, monthly) developing-economy regions, but especially in interest rate of more than 20 percent (Helms Sub-Saharan Africa, where 29 percent of adults 2006). Individuals are often willing to pay high report friends and family as their only source of prices in exchange for receiving cash quickly and Table 6.1  Characteristics of Community-Based Financial Service Providers: Indigenous Groups Individual Community-based groups (money lenders, deposit Money transfer (ROSCAs, ASCAs, Characteristic collectors, traders) (hawala systems) burial societies) Legal form No formal legal form; No formal legal form, May be registered with adhere to local customs; adhere to local customs; local authorities or sometimes registered sometimes registered community leaders Regulation and Typically not regulated; Not regulated Not regulated oversight sometimes local oversight or registration Ownership Owner operated Owner operated Member owned Governance Self-governing Self-governing Self-governing; sometimes an elected committee Target market Poor and very poor needing Poor and very poor needing Poor and very poor needing credit or a place to save quick and accessible small amounts of credit and transfer services a safe place to save frequently Products Basic credit and savings; Informal money transfer No capital costs; user fees contractual savings with across geographic to cover operating costs some collectors distances and profits Funding Own capital; interest and No capital costs; user fees Member contributions or fees collected to cover to cover operating costs savings; sometimes external operating costs and profits and profits borrowing; interest and fees (no operating costs) Community-Based Providers 151 ­ onveniently, particularly in an emergency when c basis, while money guards generally expect there are no other options. clients to come to them (see box 6.1). Collection ­ Pawnbrokers are also characterized by a high normally occurs over a specified period of time, volume of small advances made for a relatively after which the depositor’s savings are returned short period. In contrast to most moneylenders, net of fees. Fees are charged either as a percent- pawnbrokers take physical possession of collat- age of the amount deposited or as a flat fee per eral when lending. In some countries this deposit. Research shows that the amount practice has become more formalized, with ­ charged is similar to the total cost, direct and rules, standards, and registration required. Loan indirect, of depositing directly with a bank or amounts are normally significantly smaller in saving in real assets (Ashraf, Karlan, and Yin value than the collateral pledged. Given the 2006). Clients may use deposit collectors for ­ necessary processing, valuing, and storing of various reasons, including convenience, lack of collateral, a pawnbroker’s transaction costs may connectivity, or cultural restrictions. Deposit seem high given the small amounts borrowed. collectors provide structure to accumulate sav- These transaction costs, however, are partly off- ings, offering both safety and discipline. Saving set by the fact that the pawnbroker does not take with a deposit collector is not without risk, how- time to evaluate the borrower or monitor the ever, as clients may not be able to access funds loan (Skully 1994). Loans are made strictly on when needed or the collector may disappear the basis of collateral, which can be sold to with their savings. recover the loan amount (most pawnbrokers Shop owners sometimes hold cash they receive also operate a retail store to sell goods that are from clients who want it out of the house; they not collected). also often provide credit to trusted clients who Deposit collectors or money guards—people take goods “on credit” and pay for them at a later who collect and store savings—are common- date. place in the developing world. They offer a con- Especially in agriculturally dependent rural venient way to put cash safely out of reach areas, traders may be important sources of infor- without having to spend money and time on mal credit for farmers. For example, credit may travel. Deposit collectors travel to their clients, be extended to purchase raw materials with the visiting their homes or businesses to collect a promise that they will sell the product back to the predetermined amount on a daily or weekly trader. Box 6.1  Ghana’s Susu Collectors Ghana is home to a large number of susu col- basis. The susu club is a variation on this col- lectors in the informal sector who go door to lection system, wherein members go to a door collecting savings for a fee, mostly from designated place on a scheduled day of the female market vendors and microentrepre- week to deposit their savings with the susu neurs. Susu collectors have an average of collector, who uses the group format to ser- 150–200 clients and collect deposits at vice a much larger number of clients. homes within the village on a daily or weekly Source: Gallardo 2001. 152 The New Microfinance Handbook While credit and savings are the most because they are discreet and involve little to no c ­ommon services associated with individual paperwork. They are also more accessible, espe- providers in the informal sector, money transfer cially for those without documentation in the providers—individuals specializing in transfer- sending country, and may seem more trust- ring money from one person to another—offer a worthy because they are underpinned by per- fast, usually safe, and cost-effective way to trans- sonal relationships (see box 6.2). fer funds domestically and internationally. Individual providers in the informal sector Informal fund transfer systems vary in structure offer advantages associated with operating inside and complexity. Hand carrying cash, usually by the community, including accessibility, conve- migrants who are often family or friends, is the nience, small transactions, and familiarity. They most basic system and especially common in provide direct cash-in, cash-out services, with all ­ situations of seasonal or circular migration, transactions taking place on a personal basis usu- when migrants frequently return to their homes. ally right in the village. This makes transaction Internationally, cash is physically transferred by costs relatively low, although the price of ser- couriers; domestically, it is transferred by bus vices is normally quite high. As individual pro- companies and taxi drivers (Isern, Deshpande, viders are often the only option available, the and Van Doom 2005). Many senders and poor are forced to accept both their costs and receivers prefer informal transfer mechanisms risks, including theft and fraud. Association with Box 6.2  Beyond Carrying Cash: Informal Money Transfer Systems More sophisticated informal systems exist the payment to the beneficiary upon sub- under different names around the world, mission of the code. ­including hundi (South Asia), fei-chen (China), After the transfer, hawaladars settle hui kwan (Hong Kong SAR, China), padala ­ accounts through payment in cash or in (the Philippines), phei kwan (Thailand), and goods and services. They are remunerated by hawala (the Middle East). Many of these systems,­ senders through a fee or an exchange rate such as those common in African mineral- spread. Hawaladars often exploit fluctuations exporting countries like Angola, evolved as in demand for different currencies, which mechanisms for financing trade and transfer- enables them to offer customers better rates ­ ring net funds against the movement of than those offered by banks (most of which goods. only conduct transactions at authorized rates The hawala system used in the greater of exchange). Since many hawaladars are also Middle East is representative of how such involved in ­businesses where money trans- systems work. Typically, a migrant makes a fers are necessary, such as commodity payment to an agent (hawaladar) in the coun- trading, transfer services fit well into their ­ try where he works and lives, and the existing activities. Remittances and business ­ ­ hawaladar provides a code to authenticate transfers are processed through the same the transaction. The hawaladar asks his bank accounts, incurring few, if any, additional counterpart at the receiving end to make operational costs. Source: Isern, Deshpande, and Van Doom 2005. Community-Based Providers 153 ­ ctivities is also a risk, even though most illegal a tontines (West Africa), chit funds (India), kibati people are not aware that they are taking place. (Tanzania), stockvel (South Africa), and esusu Informal providers require minimal documenta- (Nigeria). ROSCAs are the simplest form of finan- tion and, by definition, are not regulated. cial intermediation: several people form a group and contribute an agreed amount on a regular Indigenous Groups basis. At each meeting (or round), the money is Member-owned community groups have proven collected, and the total is given to one member on effective in providing basic financial services, a rotating basis. When the last member has especially in remote areas or urban slums char- received the lump sum, the group can choose to acterized by inadequate infrastructure and low start a new cycle or disband. savings and debt capacity. They provide mem- Easy to form and manage, ROSCAs are com- bers mutual encouragement to save and to use mon in many countries. A study by the Institute money wisely, as well as an economic safety net for Financial Management and Research in India to protect them in the event of sudden hardship. estimates that the registered chit fund industry In so doing, they promote savings discipline, could be as large as 10–50 percent of all lending to build social capital, increase assets, and decrease priority sectors; the unregistered chit fund mar- household vulnerability to financial and other ket could be as large as 15 times the registered shocks. market (Linder 2010). Poor women and men find these groups easily ROSCAs are structured to allow for financial accessible because they are local and offer few services overseen entirely by group members. barriers to entry. Members know each other and Since all members contribute the same amount at learn to rely on each other to achieve financial each meeting, each individual member accesses goals together that would be unattainable alone. the same sum of money at some point during the A common goal of community-based financial life of the ROSCA for use at her discretion.1 groups is accessing a lump sum of money, either Transactions take place only during regularly through saving or borrowing, where embedded scheduled meetings (often monthly) and are typ- social relations reinforce repayment. Some ically witnessed by every member. In addition, groups establish social funds to help members in since no money is retained by the group, often no times of crisis. This experience of managing records are required (other than possibly the list funds together and using their collective strength of who is to receive the funds when), and there is both to enhance household finances and to help no need to safeguard funds. The system further friends in need builds solidarity within groups— reduces risk to members because it is time one important reason why people often maintain limited—­typically lasting no more than 12 months. their membership in community-based groups This mitigates potential losses should a member even after they have gained access to formal take the funds early and stop contributing. These financial services. characteristics make the system transparent, There are three predominant types of indige- flexible, and simple, providing a financial service nous groups: ROSCAs, ASCAs, and informal well suited to poor communities with low literacy microinsurers. rates. At the same time, many people who are better-­off financially also join ROSCAs, both to Rotating Savings and Credit Associations save for a specific purpose and to take advantage ROSCAs exist in developing countries around the of the social capital that develops. While ROSCAs world and are known locally by many names: typically attract more women than men, mixed merry-go-rounds (Kenya), tandas (Mexico), ROSCAs also exist. 154 The New Microfinance Handbook However, a ROSCA’s simplicity is counterbal- save regularly, but the combined contributions anced by risk and lack of flexibility: are not distributed at each meeting; instead, sav- ings are pooled for the purpose of lending to • All ROSCA members receive the same amount members. While all members save, not everyone of money in a predetermined order. Each must borrows. Members borrow only when needed, in wait her turn regardless of need, and there is amounts that they and the rest of the members no flexibility to contribute more or less than are confident will be repaid. the agreed amount. Since members do not all transact in the same • The fund does not grow in value, as no loans way, ASCAs are more complex than ROSCAs. are made and no interest is paid. Members may borrow different amounts on different dates for different periods. Interest ­ • Those who are last in line risk not receiving ­ payments provide a return on savings that is their payout if the group disbands. When a shared fairly among the group. ASCAs may be ROSCA collapses, members who have not yet “time-bound,” with members saving, borrowing, received their proceeds have no recourse. and repaying for a predetermined amount of As a result of these limitations, informal sec- time, usually 6–12 months. However, given the ondary markets may be created, whereby one diversity of indigenous ASCAs, the cycle can member pays a premium to another member to vary in length, with some choosing to operate switch turns. These premiums sometimes indefinitely (see box 6.3). Depending on the time exceed 50 percent or more of the value of the frame and the simplicity of their structure, proceeds. ASCAs can operate without keeping any records by periodically dividing the accumulated funds Accumulating Savings and Credit Associations equally. However, more complicated ASCAs While still indigenous, an ASCA is a more flexible require bookkeeping, particularly those that and more complex group savings mechanism deal in large amounts or operate for long periods than a ROSCA. Like a ROSCA, group members of time. Box 6.3  Rural ASCAs in India In northern India, the good ASCA leaders • They take top-up contributions, often and bookkeepers are known in the commu- Rs100 per share, during start-up. nity, so setting up a new ASCA involves little • During lean seasons members can defer more than identifying reliable members contributions by converting the required with a shared need for financial services. savings amount into short-term loans of up Further­more, ASCAs have adopted several to two months. measures to address the seasonality of rural • They are much stricter about loan repay- cash flows: ment at the end of the cycle (usually another surplus season) than they are in ­ • They start operations during surplus the middle. seasons. Source: Abhijit and Matthews 2009. Community-Based Providers 155 Informal Microinsurers offer an important service at the community The third category of community-based financial level. The risk of fraud is potentially high, how- service providers focuses on the provision of ever, as leaders may abscond with the accumu- insurance. Community-based organizations that lated funds (Churchill and Frankiewicz 2006). provide insurance are owned and managed by Stretcher clubs are indigenous community their members. Their closeness to the market groups, often found in rural areas, that address enables them to design and market products more health emergencies. Members contribute small easily and effectively, yet they are disadvantaged amounts weekly or monthly, as determined by by their small size and scope of operations. They club rules and the structure of the group. When normally only operate in a limited geographic a member falls ill and needs to be transported to area, creating a high risk that the same misfortune medical care, the costs of transport and other will befall a large number of clients at the same ancillary fees associated with medical care are time (covariance risk). The resulting simultane- covered. In a few cases, members are literally ous claims can deplete the organization’s fund or carried on stretchers to the appropriate health substantially reduce individual payments. By def- center, but the club normally provides cash to inition, they are unlicensed and therefore cannot cover other relevant costs. Stretcher clubs are obtain reinsurance (see chapter 11). Some managed within the community, with leaders community-­ based microinsurers create federa- determining formation, rules, contributions, and tions with others, which can improve oversight benefits. and management, but this is not common. According to Roth, McCord, and Liber Facilitated Groups (2007, 24), “There are numerous [types] of infor- mal insurers throughout the poorest 100 coun- In many parts of the world, indigenous ROSCAs, tries, covering tens of millions of low-income ASCAs, and informal insurance schemes have people through hundreds of thousands of tiny been enhanced through facilitation (training and informal groups.” Two of the most common are capacity-building support), often provided by burial societies and stretcher clubs. nongovernmental organizations (NGOs) or other Burial societies assist members during bereave- external agencies. Training supports improved ment. They can consist of a few households or governance, recordkeeping, security, and, some- several thousand people from different neighbor- times, access to additional services. Examples of hoods in a large city. A burial society is managed facilitated groups in the informal sector include at the community level; members draw up a con- Savings Groups (SGs), SHGs, and community stitution specifying operations, contributions, associations (see table 6.2). participation, and benefits policies. Members SGs are essentially “time-bound distributing” make their payments monthly or weekly and— ASCAs. They have grown significantly since their similar to commercial insurance—do not receive emergence in Africa in the early 1990s. SHGs are benefits if their payments are not up to date. In generally not time-bound and are most often the event of death, benefits are paid to the mem- linked to banks for access to wholesale loans. ber’s family to cover funeral costs. Certain burial They exist in various forms in many countries, societies lend out the money they collect in but are most common in India. Less prevalent but order to generate additional resources. Burial more formalized groups include Financial Service societies offer financing in times of great eco- Associations (FSAs) and caisses villageoises nomic and personal uncertainty and, as such, d’épargne et de crédit autogérées (CVECAs). While 156 The New Microfinance Handbook Table 6.2  Characteristics of Community-Based Financial Service Providers: Facilitated Groups Community associations Characteristic SGs SHGs (FSAs, CVECAs) Legal form May be registered with local May be registered with local Registered with a authorities or community authorities or community central authority leaders leaders Governance Self-governing via an elected Self-governing via an Self-governing via an committee elected committee elected committee Target market Poor and very poor, requiring Poor and very poor, Poor and often rural small amounts of credit and requiring credit and a safe a safe place to save place to save frequently Products Basic savings and credit; Basic savings and credit; Basic savings and often insurance; sometimes sometimes nonfinancial credit products nonfinancial services services Management Self-managed with initial Often outsourced to literate Ongoing external and reporting technical assistance from members of the community support provided for a facilitating agency or to an SHG federation a fee Funding Member savings Member savings and often Member savings and external credit sometimes external credit Sustainability: Groups independent after Need minimum of three Varied sustainability overall 9–18 months years to function and independence independence independently; often federations provide ongoing support still community-based, they are larger and behave associated with costly life-cycle events. Regular more like financial cooperatives, remaining rela- meetings keep financial management at the front tively informal. They generally rely on ongoing of members’ minds, leading them to think criti- external management, unlike other community- cally about their fiscal behavior. In short, they based groups, where the facilitation process nor- learn by doing in a relatively safe and reliable mally ends (although SHGs may also require environment. Yet some advocates believe that ongoing assistance). facilitated financial groups can do more to By offering financial services to members, improve members’ financial capabilities and many of whom have had limited access to sav- thereby increase financial inclusion. Offering ings and loans, these facilitated groups support financial education to group members is a proac- financial inclusion. In the process, they also tive strategy that can enhance the benefits of build members’ financial capability. Through facilitated groups. Financial education intro- participation in groups, members have an oppor- duces people to good money management prac- tunity to save and borrow, to generate more sta- tices with respect to earning, spending, saving, ble cash flows, and to manage the challenges borrowing, and investing. Thus there is a ­natural Community-Based Providers 157 fit between the experiential learning linked to 12-month cycles. Members develop their own group participation and the content of financial rules for meeting frequency (usually weekly, but education. Financial education can help to sometimes fortnightly or monthly), savings achieve the following: requirements, and loan terms. In some variants of Savings Groups, every member saves the same • Increase members’ knowledge of how to man- amount, which the group can decide to vary dur- age money, especially as they have access to ing the cycle to reflect the seasonality of the local small loans and lump sums that were not avail- economy. In other variants, members save able to them prior to joining the group through the purchase of shares; the share price is • Enable members to plan for future expenses decided by the group and cannot be changed dur- ing the cycle. At each meeting, every member has • Allow members to compare products, an espe- the opportunity to buy one or more shares, usu- cially critical skill for those who use their ally to a maximum of five. Their pooled savings group experience to gain access to formal (the loan fund) are lent to members, with loan microfinance institutions (MFIs) and banks size often limited to a maximum multiple of sav- • Help members to understand the costs and ings, often three times. The circulation of capital benefits of the various forms of mobile money earns interest for the loan fund. and electronic wallets to which they will At the end of every cycle, the accumulated sav- increasingly have access (Ledgerwood and ings and earnings are shared among the members Jethani 2012). according to a formula chosen by the group. The “share-out” gives members access to lump sums for investment or other purposes. This end-of- Savings Groups cycle distribution simplifies accounting and Savings Groups began in Niger in the 1990s to serves as an “action audit,” providing members improve on traditional ROSCAs. They are now immediate verification that their savings are facilitated by numerous international and local intact and that the process is profitable. After NGOs, which mobilize groups, train members, each annual share-out, groups begin another and supervise their operations for a limited time.2 cycle of saving and borrowing. At this time, mem- These facilitating agencies introduce governance bers can leave and new members can join. They and recordkeeping systems designed to ensure can make changes, such as adjusting the share effective self-management. The methodology price, and may decide to make an exceptional promotes democratic participation with clear contribution (that is, a one-off contribution that and transparent procedures that foster members’ exceeds the normal limit for share purchase) to trust in the group as a safe place to save and bor- recapitalize the loan fund. As groups mature, sav- row. Minimal risk, maximum transparency, a ings can easily exceed tens of thousands of profitable structure for saving, access to small dollars. loans, and an annual lump sum of capital are the Groups elect officers annually, including posi- hallmarks of the SG methodology. Most SGs are in tions specifically to handle money and hold keys. Africa, but they are beginning to spread to Asia A treasurer or recordkeeper records member sav- and Latin America.3 ings and loans in passbooks, a central ledger, or both, often with a symbol to accommodate illiter- Savings Group Methodology ate or innumerate members. Some groups use Groups are composed of 15 to 25 self-selected memory-based systems that require no paper individuals and generally operate in nine- to records at all. 158 The New Microfinance Handbook Security and transparency are essential to suc- fund is set at a level that covers the minimum cess. Most SGs, but not all, keep their records and emergency needs of the group members and gen- any extra cash in a strongbox—typically locked erally is not intended to grow. with keys that are kept by separate group mem- bers who open the box only during meetings and Role of Facilitating Agencies in front of all the members present—the only time Facilitating agencies organize SGs and carefully that group funds are handled. Multiple locks and train and supervise them during their first cycle. multiple elected key holders minimize the risk Facilitators are trainers, not service providers. that records or money will be tampered with They do not manage the group’s activities and between meetings. Members report that they never touch its money or manage its recordkeep- trust the group because they see what happens to ing. Facilitators train the groups intensively at their money and receive it all back at the end of start-up, after which they simply supervise proce- the cycle. dures and routine operations as the group con- Many SGs also have an insurance fund (often ducts its business. The frequency of visits referred to as a social fund) that serves a variety of diminishes as the groups demonstrate their abil- emergency and social purposes according to rules ity to run organized, disciplined meetings and set by the group. Groups set their own policies for maintain accurate records. Facilitating agencies the social fund, notably how it is capitalized and are funded by donors and do not generate any rev- the terms of disbursement (for example, as a grant enue from the group. While SGs are sustainable in or no-interest loan). The insurance fund is sepa- and of themselves, facilitating agencies may con- rate from the loan fund, and normally all mem- tinue to provide groups with other development bers contribute the same amount. The insurance interventions (see box 6.4). Box 6.4  Savings Groups and Other Activities SGs are ultimately created to provide ­financial a ­ ctivity truly benefit members and constitute services. However, where launched, they an ­appropriate role for the NGO to play, or is have grown, through external facilitation and it a way for the NGO to attract additional spontaneous replication, into a visible net- funding?). Will it undermine the indepen- ­ work of rural groups that increasingly serve dence of Savings Groups? Additional costs, as a platform for other development (non- ongoing ­ dependency on external service pro- financial) services. They are natural vehicles viders, diversion of group funds to the “ex- for initiatives ranging from agricultural pro- tra” service(s), and spreading of group re- duction and crop marketing to training in sources (members’ time, energy, focus, and ­ business skills, literacy, and health. Yet the funds) too thinly are risks that practitioners addition of nonfinancial services to SGs is must consider. Furthermore, with limited not straightforward. It is important to ­ resources, facilitating agencies face the determine whether the “add-on” is truly ­ ­ difficult choice b­ etween strengthening exist- driven by demand and to examine the ing Savings Groups with additional program- incentives for adding it (that is, does the ­ ming or creating new ones. Source: Ashe and Nelson 2012; Rippey and Fowler 2011. Community-Based Providers 159 Facilitating agencies have assumed the respon- through community-based trainers (CBTs), also sibility for tracking SG performance using a known as village agents or replicating agents— ­ standardized management information system individual members whom the facilitator trains (see chapter 13). In addition, they report to the to operate independently. Eventually, the paid Savings Groups Information Exchange (SAVIX), facilitator shifts to a more supervisory role and an online database that provides transparent and CBTs are paid directly by the community, either standardized data on SG performance and out- through cash, shares, or in kind (such as free labor reach (see chapter 5). during planting season). This fee-for-service model is taking hold in many variations across Savings Group Sustainability and multiple SG programs. It significantly reduces Replication facilitation costs and establishes a market-based Sustainability and simplicity are key strengths of system for communities to promote new groups this model, enabling self-management and spon- and support existing ones after the facilitating taneous group replication. After an initial training agency leaves (see box 6.6). period, SGs manage themselves; early research While fee-for-service seems like the next log- indicates that most groups continue to operate ical step from a market development perspec- indefinitely. Furthermore, members introduce tive, it is not yet clear whether the market for the model to others, leading to the multiplication training services will be sufficient in the longer of groups; an investment in one group often term to support local trainers. If replication is results in the formation of two or three others robust, the most cost-effective option for sup- (Anyango et al. 2007; see box 6.5). porting the emergence of SGs may be to invest in Most facilitating agencies build into their building a critical mass of them and to rely on a methodology a system of purposeful replication combination of spontaneous fee-for-service and Box 6.5  Paths to Savings Group Replication Field research in Kenya found that SGs replicate “spontaneously” without any external facilita- tion in the following ways: • Fission of large groups. As groups add members, they get unwieldy and sometimes split into two or more groups. • Splinter groups. Members object to some aspect of their group and start a new one. • Social entrepreneurs. Dynamic group members form additional groups, usually as a civic service, but sometimes for a fee. • ROSCA upgrading. An SG member introduces the approach to her ROSCA or another group. • Natal village. Women who move to their husband’s village visit their families back home and introduce the SG model. • Inspired by. Neighbors carefully observe meetings and copy the procedures. • Clusters. Groups often meet at the same time and in the same place, forming a cluster of groups. The visibility and dynamism of clusters attract new members, encouraging the formation of new groups. Source: Rippey and O’Dell 2010; Digital Divide Data 2011. 160 The New Microfinance Handbook Box 6.6  Fee-for-Service: Variations on a Theme In India, the Aga Khan Foundation initially which they work are prepared from the begin- ­ operated its SG program through local partner ning for the eventuality that they will assume NGOs using paid staff. However, as the pro- responsibility for paying the private service gram matured, the local partners began using provider. CBTs to ensure continued expansion and sus- In western Kenya CARE piloted the use of tainability. CBTs are remunerated at a rate of independent contractors—both individual entre­­ Rs 1 per member per meeting and are paid preneurs and faith-based organizations— exclusively by members of the groups they ­ that contracted their own CBTs to mobi­ lize mobilize and train. The funds are deposited in and train SGs in return for a fee per successful a separate bag held in the cash box and may group trained. The pilot dramatically reduced be withdrawn by the CBT at any meeting. the cost per member trained, and the critical In Kenya, Uganda, and Tanzania, Catholic mass of SGs created under the project has Relief Services has built a private commer- raised their visibility, whereby communities cial system for training and supporting SGs. are slowly agreeing to pay the trainers to help It hires field agents who spend one year them to establish their own groups. Further learning to perform their duties. After a rigorous demand for CBT services comes from exist- certification process, these agents become ing groups seeking intermittent assistance private service providers. The communities in ­ even after graduation. Source: David Panetta, Aga Khan Foundation; Ferrand 2011. voluntary replication to spur group expansion lockbox, at significant risk.4 However, the need (Ferrand 2011). for formal savings vehicles to manage liquidity may exist throughout the cycle; according to Financial Linkages SAVIX, in the first quarter of 2012, globally, Although advocates of SGs have championed loans outstanding represented only 53.2 percent their simplicity—locally based, accessible, of total performing assets of SGs, indicating that transparent, autonomous financial service pro- there may be significant excess liquidity.5 viders that are free of debt obligations to exter- Innovations are emerging that will enable SGs nal lenders—as groups mature, access to formal to deposit excess liquidity through members’ financial services may be important. SGs do mobile phones (see box 6.7). not, nor are they designed to, meet all the finan- While SGs have been linked to other financial cial needs of their members, and some of their service providers for savings, credit, payments, limitations can be addressed by linking to for- and, in some cases, insurance products, the wis- mal financial service providers. Among the dom and benefits of doing so are still debated.6 most urgent needs is the ability to store cash Advocates suggest that such financial linkages assets safely; this arises primarily near the end put Savings Groups one step higher on the ladder of a cycle, when all loans are due in anticipation to formal financial inclusion, while others are of the share-out. At this time, groups have been concerned about elite capture, loss of autonomy, known to hold thousands of dollars in their and group sustainability, arguing that SGs are Community-Based Providers 161 Box 6.7  Bank Linkages through Mobile Phones A partnership between CARE, Equity Bank, and allows groups the same type of secure mobile Orange allows CARE Savings Groups in Kenya access. to open an Equity Bank account (pamoja) and The second feature, which was in the final deposit cash into an interest-bearing group stage of testing in 2012, is that all group mem- savings account without visiting a physical bers can register their cell phones enabling branch. This is made possible by the extensive them to receive a text message announcing network of Equity Bank and Orange agents any transaction made to the group account. throughout Kenya. This assures them that no one has tampered To ensure account security, CARE, Orange, with the group’s resources between and Equity Bank developed a first-of-its-kind meetings. security verification system that requires Equity Bank’s pamoja savings account of- three members to provide personal identifica- fers a safe place to save, a 2.5 percent annual tion numbers for every transaction—the elec- interest rate, no account maintenance or tronic equivalent of the three-padlock metal deposit fees, and minimal withdrawal fees. ­ lockbox that prevents any one person from SGs have 24-hour access to their accounts us- accessing the group’s cash. Although individu- ing the Eazzy 24/7 mobile phone platform. als have accessed bank accounts with mobile Using the same system, Equity will soon offer phones before, this is the first system that loans to SGs. Source: CARE 2012; www.savings-revolution.org. financial service providers in their own right and Self-Help Groups should be left alone. These debates center on the Initiated in India in the 1980s, SHGs are groups of following questions: 10–20 people—the vast majority of whom are women and marginal farmers or landless • Should linkages be created for the purposes of ­ agricultural laborers—who save and borrow savings, credit, or both? together. They are facilitated by a diverse set of • Should the focus be on linking individual external organizations that include NGOs, farm- members only to formal financial institutions ers clubs, government agencies, and even banks or on linking the whole group? (see box 6.8). These facilitators are collectively referred to as self-help promotional institutions. • Is there a way to preserve the original group Initially, SHGs function much like indigenous and its characteristics, while simultaneously ASCAs; members save regularly and use pooled fostering new relationships with other savings for loans. However, within a relatively providers? short amount of time (six to eight months), most • What are the roles and responsibilities of the access credit from banks. In fact, they are essen- facilitating agency in financial literacy and tially credit driven; they save primarily as a pre- consumer protection as it fosters formal requisite for a bank loan. They also serve as a linkages? community platform from which women become 162 The New Microfinance Handbook Box 6.8  Banks as Facilitators In a program of the Oriental Bank of Commerce loans to cover the costs of funds, support in India, the only role of the bank’s Rudrapur services, and overhead. Individual “facilitators” branch is to service SHGs. The branch’s two provide day-to-day transaction and bookkeep- officers oversee about 1,000 five-member ing services directly to groups. Each facilitator SHGs and perform most support functions. is contracted by about 200 SHGs and is paid The bank charges groups 11 percent a year on 1 percent of each group’s outstanding loans. Source: Isern et al. 2007. active in village affairs, stand for local election, tribes. Self-Help Groups are often single-caste or take action to address social or community groups. A study of 214 SHGs in four states found issues, such as the abuse of women, alcohol, the that two-thirds of the groups sampled are single dowry system, schools, and local water supply caste, reflecting both the practical advantages of (Sinha et al. 2010). neighborhood proximity and the greater ease of Self-Help Groups have achieved impressive organizing people by affinity (EDA Rural Systems outreach—by 2010, nearly 7 million groups and APMAS 2006). The formation of SHGs—in were serving more than 80 million members, which villages and with whom—is influenced by making them the dominant form of microfi- the targeting policies of the self-help promotional nance in India and perhaps the world. Although institutions. Some target only poor areas and poor pioneered by NGOs, the SHG model was taken people, some have a softer target of some poor to scale by the National Bank for Agriculture people, and some pursue a community-inclusive and Rural Development (NABARD), a govern- approach (EDA Rural Systems and APMAS 2006). ment wholesale lender, through its flagship Self-Help Group Bank Linkage Program, intro- Self-Help Group Methodology duced in 1992 (Lee 2010).7 The potential for Members join SHGs both to save (at least initially) this relationship was catalyzed by govern- and to access loans. During the initial months, ment-mandated, priority sector lending for members focus on building the group fund to banks (40 percent of all bank credit must be increase the amount available for internal lending lent to borrowers from priority sectors such as and, more important, to become eligible for larger, agriculture, microenterprises, and low-­ income external loans. Once the group has saved the populations). Banks, most of which are govern- amount that the bank requires to access whole- ment owned, maintain an active presence in sale loans, members often stop saving with the densely populated rural areas, facilitating group (Isern et al. 2007). access by rural clients.8 Since launching the An SHG typically qualifies for a bank loan program, NABARD has lent billions of dollars after it has deposited savings with the bank for a to hundreds of banks to on-lend to SHGs, sig- minimum of six months. Banks make one loan to nificantly expanding their number. the group, which on-lends to members. Initial SHG membership is open to all and covers all loans usually start at Rs 10,000 (about US$186 social groups, including scheduled castes and as of October 2012), with repayment within six Community-Based Providers 163 months to one year. Banks charge SHGs 8–10 Self-Help Group Formation and percent interest, and groups typically charge Technical Assistance members 24 percent. Subsequent loans can be Self-help promotional institutions train, moni- larger and longer term (three to five years). tor, and support SHGs and often help with Loan size is normally based on a ratio of the recordkeeping. Most are funded by government group’s savings on deposit, and the average is 4:1; banks to carry out this role, which varies greatly however, this ratio varies from 1:1 to as high as by institution; some are committed to grass- 20:1 (Isern et al. 2007; EDA Rural Systems and roots social mobilization and change, while oth- APMAS 2006; Srinivasan 2010). ers are more narrowly focused on establishing Because members’ savings are used as a permanent financial services at the village level. guarantee against funds borrowed from the Their diversity is reflected in the activities they bank, they have limited access to them. Generally, offer. In addition to training and facilitating SHGs “roll over” or retain some earnings at the bank linkages, they may offer services related to end of the cycle. That they do not “cash out” reproductive health, conflict resolution, school entirely allows them to have longer loan terms, construction, sanitation, watershed manage- but requires more sophisticated bookkeeping ment, and social initiatives to advance the dis- (Lee 2010). The fact that they are not time- enfranchised (for example, advocating for the bound also distinguishes them from other types rights of lower castes, against child marriage, of ASCAs. Yet with millions of SHGs, diversity is and for educating female child laborers).9 a given; some SHGs do cash out on a regular Similar to participation in an SG, participation basis, and many do not take external loans. An in an SHG sometimes leads to employment, as estimated 25 to 30 percent of SHGs are not individuals can also serve as facilitators for other linked to a bank (Lee 2010). groups (see box 6.9). Box 6.9  Individuals as Facilitators Sudesh is a “promoting individual” who works manager said that he needed a few groups, directly with more than 30 SHGs, most of so I gave him a few [in exchange for Rs 800 which she has “given” to a local bank manager for each SHG]; then DRDA [the District or a government program to contribute to their Rural Development Agency] needed some targets: groups, so I gave them some [also for Rs 800 for each SHG]. Now, DRDA’s targets I was leader of a group under the govern- are achieved, so they don’t need any more ment’s program. The staff asked me to groups, and the banker needs SHGs from form a few more groups in my village .  . .  time to time. I still have eight groups. I Since then, I have promoted more than charge each group Rs 20 a month for writ- 30 groups in neighboring villages. This is ing the records, which gives me a good my main job, since I am working with all income. these groups at the same time. The bank Source: EDA Rural Systems and APMAS 2006. 164 The New Microfinance Handbook In addition to forming SHGs, some promo- technical assistance (such as help with bookkeep- tional institutions contribute grants or revolving ing), and the lender often maintains a dedicated funds to member savings for internal lending staff for assisting SHGs. (EDA Rural Systems and APMAS 2006). Although most do not intermediate loan funds from the Challenges bank to the group, they can be instrumental in Well-managed SHGs can be profitable in their establishing the linkage; on average, SHGs rely on quest to bring financial services to the poor and their assistance for three years before being able marginalized. Their promotional costs compare to operate independently. favorably with those of other approaches to The government has encouraged SHGs to microfinance (Isern et al. 2007). Yet few are well ­ federate into larger organizations to ease the managed, and many perform poorly. Their withdrawal of promotional institutions from their recordkeeping systems are complex, partly due financial and nonfinancial roles. Such federations to the exigencies of external loans and partly due can also support banks that wish to on-lend to to the fact that most carry on their financial SHGs by serving as an intermediary and provid- activity from year to year without stopping peri- ing a single point of contact. In this role, some odically to distribute funds. Without full cash- federations intermediate funds, borrowing from out, SHGs need to have some level of transactional banks to on-lend to member groups (Srinivasan analysis to keep track of different terms and pay- 2010). They also build capacity, monitor perfor- ments, arrears (sometimes exceeding one year), mance, and provide policy guidance. and the complexity of liquidity and risk manage- Although several state governments actively ment (Lee 2010). The number of records, and the promote and fund SHG federations (there are amount of work to maintain them, prompts many 1,100 in Andhra Pradesh, 12,000 in Tamil Nadu, to rely on their promotional institution or feder- and 7,800 in Orissa) with the expectation that ation to keep their records. One specialized sup- banks will provide them with loans for on-­ port institution for SHGs—the Andhra Pradesh lending, federations face significant financial Mahila Abhivruddhi Society—reported in 2002 and, especially, organizational challenges that the records of only 15 percent of SHGs were (Srinivasan 2010; Lee 2010). Furthermore, some good, while the records of nearly 40 percent of question their added value, given that India has SHGs in Andhra Pradesh were grossly neglected the largest network of bank branches in the or nonexistent (Isern et al. 2007). Furthermore, world, and most villages are close to some type since external loans are linked to savings, SHGs of branch. Some have suggested that the ratio- have a strong incentive to overstate their savings nale for federating may be more social than and understate their losses (Matthews and Devi financial. Federating affords groups more visibil- 2010). Researchers have called recordkeeping ity and gives them experience with public inter- the “dark side of Self-Help Groups” (EDA Rural actions. Yet to achieve either financial or social Systems and APMAS 2006). goals, SHG federations require better gover- Other issues challenging the performance of nance, staffing, and organizational processes and SHGs include high default of intragroup loans systems (Sinha et al. 2010). (the repayment rates on internal loans within Thus SHGs receive organizational, opera- groups are reportedly as low as 35 to 40 percent) tional, and financial support from multiple and the equal distribution of bank loans among sources. The facilitating agency (NGO, govern- members, with those who receive more than they ment, or bank) usually employs a field agent to are able to invest lending the excess to others train and monitor the group, the federation offers (Srinivasan 2010). Community-Based Providers 165 However, the Indian SHG model remains financial service needs of the rural poor. In addi- unique for its sheer size and outreach to the poor; tion to providing access to credit, they are the entry SHGs are the link between individuals and rural point for many social activities (see box 6.10). regional banks, commercial banks, and coopera- tives. Although community based, they illustrate Other Facilitated Groups how the government, formal banks, and organized There have been dozens of other models for poor clients can work together to respond to the community-based groups whose purpose is to Box 6.10  Self-Help Groups: A Holistic View Several key factors, rooted in India’s banking large-scale employment guarantee scheme policies, explain how SHGs have flourished, delivers payments through them; social engaging more than 70 million people. First, campaigns by local leaders use them as the Reserve Bank of India mandates that their organizational base; and politicians of banks must have 40 percent of their portfolios all parties and ideologies woo them in an in a “priority sector,” and SHGs are one of the ­ effort to influence opinion and win elec- options for meeting these requirements. tions. From the top levels of government Second, a NABARD directive in 1993 ­ allowed policy and planning through to the local pan- informal, unregistered SHGs to be treated as chayat (village government), SHGs have “legal persons,” enabling banks to open become one of the most visible platforms ­ ­ accounts and transact business with them. for women’s development and empower- Overall, approximately 70 percent of SHGs ment; they are a household name for public are linked to a bank for loans, and more than and development programs alike. 16 percent of all bank lending to priority sec-  SHGs represent a counterpoint in the tors is done through them. microfinance world—a model that is owned ­ As one of India’s national flagship pro- and managed by the members themselves, grams, SHGs are a key government strategy encompassing a large set of small, decentral- for offering financial services to unbanked ized, informal cooperative organizations, communities and expanding financial inclu- ­ enabled, actively supported, promoted, and sion, particularly directed toward women. resourced by the state, with women as its Perhaps more important, they are increas- central focus. However, the realization of this ingly used to deliver many other develop- vision varies significantly: Some civil society ment schemes and programs. As a organizations and women’s initiatives empha- result, they have become much more than ­ size “self-help” and empowerment; others informal financial groups. Many are engaged focus on a more minimalist financial inclusion collectively in common livelihoods, market- numbers game, with greater emphasis on ing, and procurement activities. Health and ­ delivering loans. Capacity and performance nutrition workers use them to deliver ser- vary vastly. While the SHG model is relatively vices; SHGs often double as the local simple, its implementation has evolved in water management committee; schemes ­ complex ways, and the groups have become for low-cost housing, pensions, and group important institutions for social, political, and insurance are delivered through them; a economic participation. Source: Anuj Jain, Coady Institute. 166 The New Microfinance Handbook facilitate saving and lending for groups who expe- Membership requires a purchase of shares, which rience barriers (for example, distance, cost, trust) can be sold to other members but not withdrawn. to accessing more formal providers. Some are very FSAs are governed by a general assembly of share- small, limiting participation to 20–30 members; holders, which elects a board of directors and an others federate small groups in order to serve audit committee. Their legal form also varies from hundreds. Two examples are Financial Service country to country. In some countries they are not Associations (FSAs) and CVECAs (self-managed registered at all, while in others they are regis- village savings and credit banks) in Africa. tered with the relevant government ministry as community-based organizations or cooperatives. Financial Service Associations The original goal—to become self-reliant fol- Introduced in Benin in 1997 with support from the lowing initial training and oversight—has been International Fund for Agricultural Development, compromised by poor management and weak FSAs are member-owned and -operated institu- governance. Managers often lack the basic tions at the village level. With external technical capacity and experience needed to manage a support, they have been replicated in several financial institution; the absence of a clear sepa- countries—­Guinea, Mauritania, Kenya, Uganda, ration of responsibilities between management and Sierra Leone—producing variations to the and governance has led to problems such as model. Some leverage their equity base, built from disbursing loans to friends, relatives, or influen- ­ member shares, with loans from commercial banks tial board members who may not feel obliged to (Helms 2006). In Sierra Leone, some offer long- repay them. To counter these challenges, most term credit and group approaches to m ­ arketing FSAs have management contracts under which goods and produce (IFAD 2010). Membership can an external service company is hired to help to include groups and institutions, such as savings manage the operations (see box 6.11). Others, clubs, schools, churches, and health clinics. They particularly in Uganda, have transformed into range in size from 300 to 10,000 members. financial cooperatives. Box 6.11  Financial Service Associations in Kenya In Kenya, the K-Rep Development Agency KFS also assists with market research and (KDA) promotes FSAs; from 1997 until 2007, 77 product development, strategic planning, associations with a total of 34,000 members business development, branding, and mar- were established in 17 districts—including the keting. The aim is to achieve sustainable far north, where agro-ecological conditions are management and oversight. Marked improve- very challenging, livelihoods are predominantly ment in performance has led to increased livestock based, and population densities community confidence in and use of FSAs. In are low. With support from the Financial 2012 the KFS network included 44 FSAs, Sector Deepening Project, the KDA regis- totaling approximately 122,000 members. tered K-Rep Fedha Services (KFS), a ­ limited FSD Kenya estimates that there are an addi- liability company, to provide both manage- tional 80,000 members in 40 associations ment services and supervision to the associ- outside of the KFS network. ations for a fee. In addition to training, the Source: FSD Kenya 2007; communication with Felistus Mbole, Financial Sector Deepening Project, June 2012. Community-Based Providers 167 CVECAs  3. As of May 2012, SGs globally counted more than CVECAs are member-based organizations with 6 million members. http://savingsgroups.com. an emphasis on remote rural areas. Originally  4. Steps for managing this risk include dividing promoted by the French-based Centre Interna­ up the group funds among members until the tional de Développement et de Recher­ che, they share-out date or storing them in a govern- grew out of an interest in improving the tradi- ment office. tional model of cooperatives in West Africa.  5. This result is based only on SGs that are CVECAS are member-based microfinance inter- currently trained and monitored by facilitating agencies. Over time, the level of loan activity mediaries facilitated by external technical sup- varies significantly depending on local market port. They are designed to operate in rural areas opportunities and access to other financial with clients who are primarily subsistence service providers. At the same time, in a farmers, with minimal nonfarm income. While ­ research sample tracking 332 groups in most CVECAs have fewer than 250 members, 33 projects, loans as a percentage of outstanding they achieve flexibility and economies of scale assets were significantly higher, at 81 percent. by networking together into regional federations  6. This section draws from Ledgerwood and (Chao-Béroff n.d.). CVECAs were first devel- Jethani (2012). oped in the Dogon region of Mali in the late  7. The growth of SHGs has been most robust 1980s and have been replicated in other coun- in the south; more than 50 percent of such tries in Africa (Cameroon, The Gambia), adapt- groups in the NABARD program are found in ing the original model to suit the local the state of Andhra Pradesh, where environment. In The Gambia, they are known as 72 percent of households belong to one. village savings and credit associations. Their pri- Here, the State Credit Plan allocated mary role is to provide safe and easy access to 24 percent of credit for lending to SHGs, possibly the highest level of support savings, offering both current accounts and term available to any type of community-based deposits, as well as loans. Some of these groups group in the country. As much as 65 percent also take on external credit, distorting the sav- of the total loan exposure of some branches ings incentives and creating another set of chal- was to SHGs (Srinivasan 2010). lenges around repayment, ownership, and  8. In a study of 214 SHGs in nine districts vitality of the groups. Many also suffer from in India, the average distance to a bank was weak governance, a common issue for many 3.5 kilometers (EDA Rural Systems and financial service providers (Secka 2011). APMAS 2006).  9. A study of 214 SHGs found that 62 percent were engaged by their promotional institution Notes in a “microfinance plus development” model; in Andhra Pradesh, the proportion rose  1. Many ROSCAs form expressly to help to 90 percent (EDA Rural Systems and members to purchase the same item—for APMAS 2006). example, mattresses, cookware, solar lamps, or iron roofing sheets.  2. At the time of writing, well-known interna- References and Further Reading tional NGOs including CARE, Catholic Relief Services, Oxfam America, Freedom from * Key works for further reading. Hunger, the Aga Khan Foundation, Plan Abhijit, Sharma, and Brett Hudson Matthews. International, and World Vision were 2009. “Village Financial Systems in Northeast facilitating SGs. India.” Focus Note 21, MicroSave India, July. 168 The New Microfinance Handbook Anyango, Ezra, Ezekiel Esipisu, Lydia Opoku, Ferrand, David. 2011. “Keynote Paper 1: Susan Johnson, Markku Malkamaki, and Chris Strengthening Financial Service Markets.” Musoke. 2007. “Village Savings and Loan PowerPoint presentation at M4P Hub conference Associations: Experience from Zanzibar.” Small “Developing Market Systems: Seizing the Enterprise Development Journal 18 (1): 11–24. Opportunity for the Poor,” Brighton, U.K., *Ashe, Jeffrey, and Candace Nelson. 2012. November 7–9. http://www “Introduction.” In Savings Groups at the .m4phub.org/userfiles/file/David%20 Frontier, ed. Candace Nelson. Washington, DC: Ferrand%20Empress.pdf. SEEP Network, November. FSD (Financial Sector Deepening) Kenya. 2007. Ashraf, Nava, Dean Karlan, and Wesley Yin. 2006. Annual Report. Nairobi: FSD Kenya. “Deposit Collectors.” Advances in Economic Gallardo, Joselito. 2001. “A Framework for Analysis and Policy 6 (2): Article 5. http://www Regulating Microfinance Institutions: The .bepress.com/bejeap/advances/vol6/iss2/art5. Experience in Ghana and the Philippines.” Ballem, A., and R. Kumar. 2010. “Savings Financial Sector Development Department, Mobilisation in SHGs: Opportunities and World Bank, Washington, DC, November. Challenges.” Focus Note 44, MicroSave India. Helms, Brigit. 2006. “Access for All: Building http://www.microfinancegateway.org/gm/ Inclusive Financial Systems.” CGAP, document-1.1.6347/IFN_44_Savings_ Washington, DC. Mobilisation_in_SHGs.pdf. Helms, Brigit, and Douglas Pearce. 2001. CARE. 2012. “CARE, Equity Bank, and Orange “Financial Service Associations: The Story So Launch Partnership to Connect Community Far.” CGAP, Washington, DC. Savings Groups to Banks Using Mobile Phones.” Press release, CARE, Nairobi, March 16. IFAD (International Fund for Agricultural Development). 2010. “FIDAction in West Chao-Béroff, René. n.d. “Cooperatives and and Central Africa.” IFAD Newsletter Community-Based Financial Systems.” 18 (October). CGAP, Washington, DC. http://www.cgap .org/gm/document-1.9.2310/africaday_ Isern, Jennifer, Rani Deshpande, and Judith Van Theme4.pdf. Doom. 2005. “Crafting a Money Transfers Strategy: Guidance for Pro-Poor Financial *Churchill, Craig, and Cheryl Frankiewicz. 2006. Service Providers.” Occasional Paper 10, CGAP, Making Microfinance Work: Managing for Washington, DC. Improved Performance. Geneva: International Labour Organization. *Isern, Jennifer, L. B. Prakash, Syed Hashemi, Robert Christen, and Gautam Ivatury. 2007. *Demirgüç-Kunt, Aslı, and Leora Klapper. “Sustainability of Self-Help Groups: Two 2012. “Measuring Financial Inclusion: The Analyses.” Occasional Paper 12, CGAP, Global Findex Database.” Policy Research Washington, DC. Working Paper 6025, World Bank, Washington, DC. Johnson, S., M. Malkamaki, and K. Wanjau. 2005. Digital Divide Data. 2011. “Results of Study of “Tackling the ‘Frontiers’ of Microfinance in Post-Project Replication of Groups in COSALO Kenya: The Role for Decentralized Services.” I.” FSD Kenya, Nairobi. Decentralised Financial Services, Kenya. *EDA Rural Systems and APMAS (Anhdra Pradesh *Ledgerwood, Joanna, and Alyssa Jethani. 2012. Mahila Abhivruddhi Society). 2006. “Self-Help “Savings Groups and Financial Inclusion.” In Groups in India: A Study of the Lights and Savings Groups at the Frontier, ed. Candace Shades.” EDA and APMAS, Gurgaon and Nelson. Washington, DC: SEEP Network. Hyderabad. http://www.edarural.com/ Lee, Nanci. 2010. “Community-Based Financial documents/SHG-Study/Executive-Summary.pdf. Services: African Savings Groups vs. Indian Community-Based Providers 169 Self-Help Groups.” Unpublished report, Aga World’s 100 Poorest Countries. Appleton, WI: Khan Foundation. MicroInsurance Centre. Linder, Chris, with contributions from Denny *Rutherford, Stuart, with Sukhwinder Arora. 2009. George. 2010. “Who Says You Can’t Do The Poor and Their Money. Updated version. MicroSavings in India? Part 1: Community- Bourton on Dunsmore, U.K.: Practical Action Based/Owned.” Focus Note 45, MicroSave Publishing. India, July. Ruthven, O. 2002. “Money Mosaics: Financial Matthews, Brett H., and Trivikrama Devi. 2010. Choice and Strategy in a West Delhi Squatter “SHGs Should Balance or Break.” Focus Settlement.” Journal of International Note 19, MicroSave India. Development 14: 249–71. *Rippey, P., and B. Fowler. 2011. “Beyond Financial Secka, Ndegene. 2011. “Economic Challenges Services: A Synthesis of Studies on the Impending Gambian Entrepreneurship.” Integration of Savings Groups and Other Today—The Gambia’s Quality Newspaper, Development Activities.” Aga Khan February 1. http://microfinanceafrica.net/tag/ Foundation. www.akdn.org/publications/2011_ visaca/. akf_beyond_financial_services.pdf. *Sinha, Frances, Ajay Tankha, K. Raja Reddy, and Rippey, Paul, and Marcia O’Dell. 2010. “The Malcolm Harper. 2010. Microfinance Self-Help Permanence and Value of Savings Groups in Groups in India: Living Up to Their Promise? CARE Kenya’s COSAMO Programme.” Savings London: Practical Action Publishing. Groups Learning Initiative, Aga Kahn Skully, Michael T. 1994. “The Development of the Foundation. Pawnshop Industry in East Asia.” http://library Robinson, Marguerite. 2001. The Microfinance .wur.nl/way/catalogue/documents/FLR21.pdf. Revolution: Sustainable Finance for the Poor. *Srinivasan, N. 2010. Microfinance India: State of Washington, DC: World Bank. the Sector Report 2010. New Delhi: ACCESS *Roth, Jim, Michael McCord, and Dominic Liber. Development Services and Sage Publications 2007. The Landscape of Microinsurance in the India. 170 The New Microfinance Handbook CHAPTER 7 Institutional Providers Joanna Ledgerwood Chapter 1 provides an overview of the types of financial services to poor women and men include financial service providers within the core of the nongovernmental organization (NGO) microfi- financial ecosystem. Chapter 6 focuses on nance institutions (MFIs), financial cooperatives, ­community-based providers that operate primar- formal commercial microfinance banks, special- ily in the informal sector. This chapter focuses on ized MFIs and other non-bank financial institu- institutional providers—those that are more for- tions (NBFIs) such as insurance and leasing mal in nature; that is, they generally have brick companies, as well as payment service providers. and mortar branches (but not always), incur They can be found on the right side of figure 7.1. operating expenses, generate revenue, maintain These institutions differ in their organiza- financial accounts (including producing financial tional structure and governance, the types of statements), and are usually registered and often products and services offered, their legal form, regulated. and the associated supervision by authorities. A financial institution is a collection of Although they may lack the flexibility and prox- assets—human, financial, and other—combined imity of community-based providers, they often to perform activities such as granting loans, can offer a broader variety of products and ser- underwriting insurance, or mobilizing deposits. vices. The types of financial products and services Projects are not institutions—institutions serve that a provider offers are influenced by its legal a permanent function within the core of a mar- structure and related regulation (if applicable), ket system. Financial institutions that provide capacity, mandate, and target market. Most, but Contributions to this chapter were made by Julie Earne and Peter McConaghy. Institutional Providers 171 Figure 7.1  The Range of Financial Service Providers Community-based providers Institutional providers Community-based groups Registered institutions Individuals Regulated institutions ROSCAs, ASCAs Financial cooperatives Moneylenders Deposit-taking MFIs Burial societies SACCOs Deposit collectors Savings and postal banks Savings groups Suppliers, buyers Pawnbrokers State banks Self-help groups NGO MFIs Traders Commercial microfinance banks Financial service Mutual insurers Shop owners Non-bank financial institutions associations Money transfer companies Friends, family Commercial insurers CVECAs Mobile network operatorsa Level of formalization Note: ROSCAs = rotating savings and credit associations; ASCAs = accumulating savings and credit associations; CVECAs = caisses villageoises d’épargne et de crédit autogérées; SACCOs = savings and credit cooperatives. a. Mobile network operators are regulated as communication companies; most are not licensed to provide financial services. not all, financial service providers provide while microfinance banks tend to take a few years credit—either to their members, as with financial to break even because they need to invest in infra- cooperatives, or to the public at-large, as with structure and develop their market. To date, banks and NGOs. Most nonregulated institutions microinsurance providers have found it very diffi- and even some regulated NBFIs (finance compa- cult to reach sustainability. nies, insurance companies) are generally not This chapter discusses the types of institutions allowed to mobilize and intermediate savings that provide financial services to poor women from the public. However, financial cooperatives and men. Institutional management issues, such can normally intermediate deposits within their as human resource management, product devel- membership. Although some banks, MFIs, and opment, social performance monitoring, and cooperatives sell insurance, this product is largely financial reporting and risk management, are dis- restricted to insurance companies, as is insurance cussed in chapters 14 and 15. underwriting. In some countries, banks, regu- lated MFIs, and some mobile network operators, Characteristics of Financial in addition to institutions licensed as money Institutions transfer companies, provide payment services and other transaction accounts. Institutional pro- A financial institution’s structure is determined viders generally require more sophisticated oper- by its legal form, its ownership and governance ations than informal providers, which often mean structure, the degree to which it is supervised by professional staff and relatively more complex the state, and the types of clients it serves. These, systems. The financial sustainability and inde- in turn, influence an institution’s product offer- pendence of different providers vary primarily in ing, financial management, reporting needs, relation to time and, in some cases, objectives. funding sources, and overall financial sustainabil- NGO MFIs and transforming MFIs take time to ity and independence. Table 7.1 summarizes the reach sustainability, depending on their target key characteristics of institutional financial ser- market, support provided, and overall mission, vice providers. 172 The New Microfinance Handbook Table 7.1  Characteristics of Institutional Financial Service Providers Institutional Providers Regulation Management Sustainability Type of and and and provider Legal form oversight Ownership Governance Client type Products reporting Funding independence Financial Registered Credit unions Owned by Board of A range of Basic savings Professionally Equity Medium to high cooperatives with central may be members directors or clients, and credit, managed to provided depending on authority regulated; management depending although varying from member capacity of oversight by committee on members inherently degrees; contributions; management specialized elected by savings led report to deposits and and governing body members supervisory some body authorities external debt NGO MFIs Registered Not No owners, Board of Poor, Traditionally Professionally Grants and Low to medium and as an NGO, regulated; strong directors, “unbanked” credit led; managed to debt from (high costs and multipurpose not-for-profit may be ownership appointed by clients; for multipurpose varying development lack of NGOs institution, or subject to characteristics founders and multipurpose NGOs degrees; may institutions, separation of company government among funders NGOs, generally add need to report foundations, activities can limited by oversight founders and various financial to registration socially delay or prevent guarantee board target clients services to body responsible sustainability of and other investors, or financial beneficiaries activities aggregators activities) Deposit- Licensed as Regulated Mostly private Board of Unserved or Credit, Professionally Mix of equity Varied, costs to taking MFIs a bank or and shareholders; directors underserved savings, managed; and debt transform can other form as supervised some appointed by individuals or insurance, report to financing be high; per by central development shareholders micro or payment central bank from both ongoing costs regulatory bank, banks as small services; or supervisory private and of regulatory requirements ministry, or a initial businesses terms may be authority public requirements specialized shareholders modified for sources, can be high body client needs deposits NBFIs: credit Licensed as Regulated by Mix of public Board of Clients vary Range from Professionally Mix of equity Medium to high; companies, an NBFI or central bank and private directors depending credit only, managed; and debt initial support insurance modified or specialized shareholders; appointed by on type of leasing, report to financing may be required companies, financial body or by sometimes shareholders products (for insurance; supervisory from both depending on leasing institution one or more other financial example, normally not authority private and target market companies (determined government institutions or credit or able to public by country- units other insurance) intermediate sources specific legal companies deposits charter) (continued next page) 173 174 Table 7.1  (continued) Regulation Management Sustainability Type of and and and provider Legal form oversight Ownership Governance Client type Products reporting Funding independence Suppliers, Registered Credit Varies; can be Varies Rural Basic credit Little formal Funding from High wholesale as a services owner farmers embedded in structure, working sustainability buyers, company generally not operated or purchases provider capital; may processors under regulated part of larger driven have debt primary company business Rural, Licensed as Regulated by Shareholders, Board of Broad target Primarily Professionally Equity and Medium to high savings or a bank central bank government directors group: poor savings; wide managed to debt postal banks or specialized and/or private appointed by and nonpoor; distribution varying financing, body or by shareholders generally network degrees; generally one or more rural leveraged for report to from public government payment regulators sources and units services savings State banks Licensed Normally Shareholders, Board of General Varied; some Professionally Public Varied; medium with the regulated generally directors population; offer a full managed, but funding; debt (benefits from central and government, appointed, government variety of may be largely public subsidies authorities; supervised some private influenced by sometimes financial politically sourced from in certain cases incorporated by the government mandates services, influenced; deposits due to often as either a central bank poor or rural others focus normally rural distribution parastatal or focus on agriculture report to network) shareholding lending regulators company Commercial Licensed as Regulated Private Board of Commercial Credit, Professionally Equity and High; with microfinance a commercial and shareholders directors micro, small, savings, managed; debt from greenfields, banks bank supervised and some appointed by and medium payments, report to institutional some initial by central development shareholders enterprise sometimes central bank investors; support The New Microfinance Handbook bank banks clients, insurance deposits required, then urban, fewer independent poor clients Money Licensed as Regulated by Private Board of Poor and Transfers and Professionally Private Generally high transfer a money local financial shareholders directors nonpoor; payments managed funders sustainability companies transfer services appointed by rural and between due to user fee provider authorities shareholders urban people, structure government, businesses Note: MFI = microfinance institution; NBFI = non-bank financial institution; NGO = nongovernmental organization. Financial Cooperatives weathered the storm relatively well because local deposits proved a much more stable source of Financial cooperatives are member-owned finan- funds than external investments (Christen and cial service providers, also called savings and Mas 2009). credit cooperatives (SACCOs), savings and loan Financial cooperatives are essentially a for- associations, credit unions, or building societies (a malized version of a large accumulating savings special form of cooperative that mobilizes mem- and credit association (ASCA) that is legally regis- ber savings to finance housing). Financial cooper- tered (see chapter 6). They vary in size from very atives are organized and operated according to small (dozens of members) to very large (thou- basic cooperative principles: There are no exter- sands of members). They are subject to the coun- nal shareholders; the members are the owners; try’s laws and pay taxes if required. Cooperatives each member has the right to one vote. Members are usually governed by a volunteer board of of financial cooperatives are usually affiliated directors elected by and from the membership. In through geography, employment, or religion. To smaller cooperatives, management may also be become a member, each person is required to pur- voluntary. As with the microfinance sector, gover- chase a share and is generally restricted in the nance is one of the greatest challenges facing the number of shares he or she can own. The share cooperative sector. purchase value is set by the cooperative and is the Cooperatives, particularly smaller ones, may same for all members, although it can change focus on rural markets, facilitating access to both over time. In addition to holding shares redeem- savings and credit services and circulating able at par, members may deposit money with the resources within a community. With both wealthy cooperative or borrow from it. Although financial and poor members depositing funds, excess cooperatives traditionally provided simple sav- liquidity of one household can provide credit for ings and credit products, many are introducing a another. However, cooperatives can be subject to greater variety of products, such as contractual power imbalances, with elected board members savings and housing loans; if properly licensed, or management taking advantage of their position they sometimes provide money transfer or pay- to borrow excessively or extend credit to their ment services and insurance (Branch 2005). supporters (see box 7.1). Well-managed cooperatives often provide Individual financial cooperatives often choose loans at lower interest rates than MFIs. If profit- to be affiliated with an apex institution, which able, they either reinvest excess earnings in the represents the cooperative at the national level, cooperative or return them to members in the provides training and technical assistance to affil- form of dividends, usually based on their average iated cooperatives, acts as a central deposit and savings balances or share ownership. These mea- interlending facility (central financing facility), sures sometimes translate to more affordable and, in some cases, channels resources from loans for members or higher returns on savings external donors to the national cooperative sys- than are available from other institutional provid- tem. Being a member of an apex institution can ers (WOCCU 2011). also mean that individual cooperatives benefit Member savings and shares, the primary fund- from economies of scale for purchasing or other ing mechanism for cooperatives, constitute a sta- services. Affiliation involves purchasing share ble and relatively low-cost funding of funds from capital and paying annual dues to the national which loans are made. During the 2008 financial or regional apex institution. Membership pro- crisis, for example, local financial cooperatives vides the right to vote on national leadership and Institutional Providers 175 Box 7.1  Reflections on Member-Owned Financial Service Provision Member-owned and -managed financial ser- system to their own advantage (Johnson vice providers offer several features that 2004). This arises from a more general set of appeal to poor people. First, their survival “principal-agent problems” in which the inves- depends on the degree to which they tors in the organization or the shareholders respond to their members’ need for financial (the principals) elect a board or committee (the services. Second, a high degree of client agents) to represent their interests (fiduciary ownership and participation is present: responsibility). But when these organizations Users have a direct influence in determining become large and monitoring the performance the financial services provided, including the of the board becomes more difficult, the board interest rates charged. (However, flexible may tend to protect its own interests and terms and conditions require more detailed those of management rather than those of reports to monitor performance and hence shareholders and the organization as a whole. higher levels of management skill and stron- This results in the all-too-familiar situation of ger governance mechanisms.) People assist escalating costs and bad loans to board mem- one another and offer social support, and bers, which become particularly problematic when a member has a genuine repayment when board members are net borrowers problem, the member can appeal for more whose savings cannot cover the loan losses. time to repay (Johnson 2004). This flexibility These problems are compounded in poorer means that members are not as frightened areas where people are less well educated of taking loans from these systems as they and poorly equipped to understand and moni- would be from other systems; and unlike tor management. Where these systems are in MFI group-solidarity systems, members most successful, it is often because board are not forced to make repayments on the members are skilled, such as retired civil defaulter’s behalf. servants and professionals, and sufficiently However, the very nature of these advan- concerned about the well-being of the orga- tages leads to the problems facing user-owned nization. Members often trust community systems. The element of “negotiability” leaders more than unfamiliar staff at another allows powerful individuals to manipulate the institution. Source: Johnson, Malkamaki, and Wanjau 2005. policies and to participate in nationally sponsored have the requisite skills to supervise financial services and programs. intermediaries. This general lack of financial As institutions that intermediate member sav- oversight coupled with weak governance can ings, larger cooperatives are normally supervised. compromise the safety and soundness of The level and structure of supervision varies sig- ­ financial cooperatives, which is especially prob- nificantly from country to country (see chapter 17). lematic when poor people’s savings are at risk. In many countries, the authorities charged with Although many still struggle with poor manage- overseeing cooperatives of all kinds—agricultural, ment, financial cooperatives are significant marketing, transport, and others—also supervise ­ providers of financial services in many develop- financial cooperatives. These entities may not ing countries. 176 The New Microfinance Handbook NGO MFIs save and borrow, providing a guarantee for each other’s loans; see chapter 9). Although some Nongovernmental organizations are nonprofit NGOs require compulsory savings, they cannot be organizations that provide social and economic legally intermediated (that is, on-lent to another services, which may include health or education client). Many NGOs have broadened their prod- or microfinance, among other services. They dif- uct offerings in an effort to enhance access to fer from financial cooperatives or community- financial services, offering credit for uses other based groups in that they are not member owned than productive investment, such as housing or and managed. NGOs are a diverse group, includ- education. ing large multipurpose organizations such as The funding structure of NGO MFIs varies. BRAC in Bangladesh, international NGOs such as Traditional NGO MFIs are generally funded by a ACCION or Opportunity International that have mix of grants, debt, and accumulated equity, how- fostered a network of local NGOs, and small inde- ever, with the professionalization of and demand pendent local organizations. for sustainability among NGO MFIs, revenue The level of formality of NGOs varies signifi- from daily operations is expected to cover overall cantly, depending on the mission, funding, and costs and provide capital for growth, while grants vision of the organization. NGOs are typically reg- are increasingly spent on technical assistance and istered under national laws, which permit a range product and channel development. The equity of of activities and determine the tax treatment of NGO MFIs includes grants provided by donors incoming donor money and revenue generated for loan capital and retained earnings (excess rev- from operations. NGO MFIs have no owners. enue over expenses). NGOs often have fairly Rather, they have boards with members appointed weak leverage (the amount of debt relative to by the founders or funders, which are the func- equity) because their lack of formality can limit tional equivalent of shareholders. NGO boards their ability to borrow commercially, although are responsible for overseeing the collective they are increasingly accessing various kinds of activities of the NGO and providing input on stra- debt. Where traditionally they were required by tegic activities. NGO governance structures are funders to hold cash collateral or pledge their generally not suited for bearing fiduciary respon- loan portfolio as collateral, well-performing sibility because board members do not represent NGOs are able to borrow with guarantees and shareholders or member-owners with money at lower or no physical collateral requirements. stake. NGO MFIs may receive oversight from a Debt for NGOs is largely in the form of term government body or international network, but loans; however, a few NGO MFIs have been able they are typically not regulated or supervised by a to issue bonds supported by partial credit guaran- country’s central bank or financial system regula- tees (see chapter 16). tory authorities. NGO MFIs benefit from less onerous report- As financial service providers, NGO MFIs are ing requirements and less formalized structures limited in the services they can provide (for than regulated institutions and thus may be able instance, only credit); some may also operate as to operate more informally in response to client agents for a bank or insurance company. They tra- needs; however, management is often weak, par- ditionally offer a standard microenterprise loan ticularly as the NGO expands, which may lead to for investment in productive activities, either to difficulty maintaining stability and growth. NGO individuals or to groups, often using peer guaran- MFIs were early, if not the first, providers of tees, group solidarity, or village banking methods microfinance in areas underserved by formal (between 5 and 30 neighbors meet regularly to financial institutions. Over the years, however, Institutional Providers 177 NGOs have become less prominent in microfi- retained through earnings and deposits, as well as nance largely because of their inability to provide various forms of debt. Deposit-taking MFIs are savings services and difficulty covering their costs often able to borrow from a broad range of lend- and funding growth. Although thousands of mul- ers as well as the capital markets. The ability of a tipurpose NGOs offer microcredit, they serve a deposit-taking MFI to borrow is determined by relatively small number of clients. Given these its performance. limitations, some NGO MFIs become regulated Deposit-taking MFIs are a form of NBFI, institutions. Larger multipurpose NGOs may spin which can be an interim step to obtaining a off their financial services to a separate entity bank license or an end in and of itself. As with (ideally self-sustaining), while other activities other shareholding institutions, deposit-taking continue to require subsidies. MFIs need to balance the need for shareholder value and returns with the need to serve poor women and men. Furthermore, if transforming Deposit-Taking MFIs from a nonprofit organization with no owners Deposit-taking MFIs have the institutional struc- into a for-profit company with return-seeking ture and regulatory approval required to mobilize shareholders, a tremendous amount of work and intermediate deposits. They may be licensed and strong leadership is required. The cultural and regulated as banks or operate under a special changes—from frontline staff, to all levels of category for deposit-taking MFIs created by the management, to the board—are very difficult to regulatory authorities. For example, the Bank of manage and require substantial commitment Uganda created a special “tier 3” category of and involvement of the board and senior man- financial institutions, called micro-deposit-taking agement. Transformation takes money, strong institutions, that intermediate deposits but do not visionary leadership, institutional ownership, qualify as banks. These institutions have lower and time (see box 7.2). minimum capital requirements and cannot pro- vide all the services banks can. The ability of an Other Non-Bank Financial MFI to accept deposits contributes to financial Institutions inclusion by providing clients with a secure place to save. By facilitating savings, these institutions In addition to specialist deposit-taking MFIs, better respond to client needs and can expand which are generally not licensed as banks, other services to nonborrowers. NBFIs are beginning to increase their depth of Deposit-taking MFIs can be set up as green- outreach to poor women and men. NBFIs include field institutions or be transformed from an NGO insurance companies (discussed in a separate MFI into an institution licensed and regulated by section below), leasing companies, specialist the central bank. Accepting deposits provides credit companies such as finance companies, both a much valued service and an important consumer credit companies, and others. NBFIs resource base with which to fund loans. Accepting are restricted by law in the range of services they deposits also enhances the MFI’s sustainability can offer and the financial infrastructure they and places it in a better position to access com- can access. NBFIs cannot normally intermediate mercial sources of funding to fuel growth and deposits (unless specifically licensed to do so) expand outreach. Given their regulated status, and may not be allowed to participate in pay- deposit-taking MFIs are usually shareholding ment and settlement systems (see chapter 18). institutions, with a mix of funding sources, From a legal and regulatory perspective, it is including equity raised from shareholders and often easier to obtain a license to operate as an 178 The New Microfinance Handbook Box 7.2  Transformation from an NGO to a Deposit-Taking Institution Many NGOs have taken different routes over Numerous institutional incentives are the past decade, with some of the larger and associated with becoming a deposit-taking more professional organizations transforming institution. Client satisfaction is improved into deposit-taking institutions. The transfor- when the range of products is broad; and mation process is difficult and has proven to deposits offer a stable base of local currency be extremely time-consuming and expensive. funding. In addition, rigorous reporting to a Thus it is not for the majority of NGO MFIs. regulator facilitates increased transparency Assuming that the proper regulatory frame- and increased access to diversified investors work is in place, an NGO MFI must modify its and funding sources. There are trade-offs, governance structure, develop savings prod- however. Many institutions target large depos- ucts, and design new operating processes its, which are generally less expensive to and procedures. These processes include mobilize but can be less stable than small both front-office operations—those that inter- local deposits and may undermine the original face with clients—as well as back-office oper- purpose of transforming; however, mobilizing ations, including accounting, reporting, and only small deposits generally entails high treasury. In addition, upgrading infrastructure costs and therefore is not feasible. Some such as banking halls and vaults to comply institutions struggle for years to implement with banking regulations, developing manage- appropriate information systems to facilitate ment information services capable of accepting deposits, and many underestimate reporting to regulators, and capturing data ­ competition in the formal sector. In addition, associated with savings products are all formal reporting to investors, regulators, and a crucial activities for a successful transforma- ­ board of directors is substantially greater for tion. Furthermore, MFIs must hire and train deposit-taking institutions. Many MFIs find it new staff for savings products, and they often difficult to keep up with the volume of report- hire new senior management with experience ing and level of detail required of regulated managing a regulated institution. financial institutions. Source: Ledgerwood and White 2006. NBFI than as a bank, because minimum capital are licensed and regulated by the banking requirements are lower and because there is less authorities and are generally privately owned. systemic risk as there is no (for the most part) Although most leasing companies do not focus intermediation of deposits. on the poor (there are few microleasing compa- nies), many types of providers are beginning to Leasing Companies add leasing products. Because the lease is Leasing companies and hire-purchase compa- granted based on cash flow with the asset itself nies finance fixed assets such as equipment or as security, leasing provides entrepreneurs with heavy-duty vehicles and mostly provide credit financial resources to start a business on a lim- under financial lease contracts. Under a leasing ited budget or to increase productivity through model, the leasing company retains ownership of new capital investments. Leasing requires pro- the leased asset, which is generally used as col- cesses and systems that accommodate asset lateral for the transaction. Leasing companies ownership and residual value, specific taxation, Institutional Providers 179 and accounting and legal requirements. Leasing credit is their first experience and first access to products are discussed in chapter 9. the financial system. Customers build up a credit history, start saving, and start using the financial Finance and Consumer Credit Companies system. Consumer finance stimulates the penetra- Finance companies or financiers are NBFIs that tion of financial services in society, and a well- provide small, short-term loans, which are fre- developed consumer finance delivery system quently unsecured and used to purchase con- leads to a better overall financial structure (banks sumer durable goods and services. Finance and non-banks), better competition, and more companies are often associated with consumer access to credit for all income groups and, last but credit and installment contracts. They are nor- not least, at better credit terms” (FMO 2006). mally not allowed to mobilize savings; however, Asset finance companies, which were espe- their activities vary by their charters, and excep- cially popular in North America in the 1950s, have tions are found. For example, some may be able to been replaced largely by finance divisions of large mobilize time deposits, but not demand deposits retail chains, but they can help the working poor (see box 7.3). to buy household assets such as furniture and Organizations that provide consumer credit appliances. This financing is similar both to leas- include specialized consumer finance companies, ing, where the purchaser is able to use the asset payday lenders, supplier credit, and retail stores. during the lease agreement, and to consumer For example, some large retail outlets are applying financing, where the retailer sells on “lay away” for licenses to provide financial services, such as and the purchaser pays a certain amount periodi- Grupo Elektra in Mexico (see box 7.4). Some pro- cally until he or she owns the asset. However, vide short- to medium-term consumer loans to financing costs can be quite high. employees that are repaid through payroll deduc- tions. Similar to MFIs, consumer credit compa- Suppliers and Buyers nies often serve low-income households and Private companies such as input suppliers, microentrepreneurs, and they are becoming more buyers, wholesalers, exporters, and processors ­ and more significant in many emerging and devel- sometimes provide financial services, primarily oping markets: “For most customers, consumer credit, to low-income markets. Supplier credit is Box 7.3  NBFIs in India Many MFIs in India operate as for-profit NBFIs. and cannot issue checks, and (3) deposit insur- Under Indian law, an NBFI is a company regis- ance facilities are not available. NBFIs regis- tered under the Company’s Act of 1956 and tered with the central authorities are classified engaged in the business of loans and advances as an asset finance company, an investment and the acquisition of shares, stocks, bonds, company, or a loan company. An asset finance debentures, and securities issued by the gov- company, the most common type of NBFI, is ernment or a local authority. a financial institution whose principal business Banks differ from NBFIs: (1) NBFIs cannot is the financing of physical assets such as accept demand deposits, (2) they are not a automobiles, tractors, lathe machines, or gen- part of the payment and settlement system erators to support productive activities. Source: India Microfinance Editorial Team 2009. 180 The New Microfinance Handbook Box 7.4  Grupo Elektra and Banco Azteca in Mexico In March 2002 one of Mexico’s largest retail- which were previously issued by Elektrafin, ers for electronics and household goods, the financing unit of Grupo Elektra’s retail Grupo Elektra, received a banking license. In stores. These loans averaged US$250. October 2002 it launched Banco Azteca, open- Although tied to merchandise, they could be ing 815 branches in all Grupo Elektra stores. used for business purposes such as the pur- From the outset, Banco Azteca targeted chase of a new sewing machine or a refrigera- low- and middle-income customers, histori- tor that could be used to start or sustain a cally underserved by the traditional banking microbusiness. In 2003 Azteca started offer- industry. Azteca began offering savings ing US$500 consumer loans not tied to mer- accounts that could be opened with as little chandise. These amounts were comparable in as US$5. Within the first month, 157,000 size to loans offered by several microfinance accounts were opened, increasing to 250,000 organizations, which in 2002 amounted to accounts by the end of December 2002. At its about US$360 on average. Toward the end of opening in October 2002, Banco Azteca also 2003, Azteca also expanded into the mort- took over the issuance of installment loans, gage and insurance business. Source: Bruhn and Love 2009. ­ rovided by input suppliers and wholesalers, who p back to the supplier. Value chain finance is dis- provide in-kind credit or cash in return for either cussed in detail in chapter 10. installment payments over a period of time or a Private companies that provide credit are nor- lump-sum payment at the end of the term. For mally not regulated or supervised by banking example, seed suppliers may provide seeds to authorities because they generally do not pose farmers during the planting season with the systemic risk (and may not be licensed at all to expectation that the seeds will be paid for at the provide financial services). Although volumes are time of harvest. Financing costs are built into not tracked, private companies often provide a the price of seeds. substantial amount of credit, particularly in rural Credit provided by input suppliers and buyers areas. is often embedded in another transaction and In addition to supplier credit, other private therefore is not provided without it. Credit is built companies embed financial services within their into existing business relationships through a normal business operations. For example, value chain. A value chain is a path that a product Patrimonio Hoy provides financial services to follows from raw material to consumer, from increase access to housing (see box 7.5). input supplier to producers, and through various actors who take ownership of the product before Banks it arrives at its final condition and location (Jones and Miller 2010). The fact that actors are within Many types of banks are engaged in microfinance, the same value chain provides incentivized lend- including rural banks, postal and savings banks, ing by input suppliers, processors, wholesalers, state banks, and commercial banks. Banks are and others to, for example, guarantee the sale of normally licensed and regulated by the central inputs or commit producers to sell the product bank or other government agency or ministry, Institutional Providers 181 Box 7.5 Patrimonio Hoy: Housing Microfinance That Addresses Market Opportunities CEMEX, a Mexican cement manufacturer Participants in Patrimonio Hoy pay about with a US$15 billion market capitalization, US$14 a week for 70 weeks and receive developed an innovative corporate social consultations with CEMEX architects and responsibility program called Patrimonio Hoy scheduled deliveries of materials that coin- (Patrimony Today). The program aims to cide with the building phases. Prices on all reduce the Mexican housing deficit—which building materials are kept stable for the life has left more than 20 million people with of the project, which shields consumers ­ inadequate shelter—while stimulating con- from sudden price hikes and supply short- sumer demand for housing materials in the ages that are common in free markets. low-income urban slums of Mexico. And if needed, participants can store their For more than a year, CEMEX employees materials in a secure CEMEX facility. and consultants immersed themselves in the Participants found the program enabled urban slum of Mesa Colorada in the state of them to build homes more cheaply and Jalisco, where they conducted a series of learn- three times faster than they could on their ing experiments and in-depth interviews. They own. discovered that a significant barrier to building From 2000 to 2011, Patrimonio Hoy pro- homes was the inability to save enough money vided affordable solutions to more than 1.3 to purchase the required materials. The families million people throughout Latin America and explained that committing to long-term projects enabled more than 265,000 families—251,000 was difficult because employment in the area in Mexico and 15,000 in other countries—to was unstable. Moreover, even when they tried build their own homes. Patrimonio Hoy oper- to purchase construction materials, Patrimonio ates through more than 100 centers in Hoy participants had nowhere to store them. Mexico, Colombia, Costa Rica, Nicaragua, and Theft is common in such impoverished neigh- the Dominican Republic. Of these 100 offices, borhoods, and weather conditions often spoil 85 are in Mexico and 93 are completely the products before they can be used. self-sustaining. Source: Segal, Chu, and Herrero 2006. which ensures that the term “bank” is reserved owned, member owned, or privately owned and for certain types of financial institutions. Although are normally licensed and supervised by the bank- microfinance banks share features of standard ing authorities. They are relatively small institu- commercial or retail banks, lending and outreach tions, but large enough to support professional are targeted to customers not normally reached management and staff. They are normally by traditional formal financial institutions. restricted to a certain geographic area and may be limited in the products they can offer. They gener- Rural and Community Banks ally provide products similar to commercial banks, Rural and community banks operate in rural areas, including short- and long-term savings products providing primarily savings services and agricul- (sometimes with overdraft facilities) and invest- tural loans, reflecting the main economic activity ment and consumption loans, often focused on in rural areas. Rural banks can be government agriculture and trading. Rural banks may also be 182 The New Microfinance Handbook licensed to provide money transfers and pay- services, some rural banks are also allowed to dis- ments. Given their small size, rural banks are tribute microinsurance (BSP 2011). often part of an association or apex institution and may benefit from technical support includ- Savings Banks ing, for example, capacity building, fund mobili- Savings banks are regulated financial institutions zation, and treasury management. In Ghana the with a retail focus that extends across broad geo- Association of Rural Banks also performs impor- graphic areas. In Europe and North America, sav- tant supervisory functions delegated to it by the ings banks originated as early as the eighteenth Bank of Ghana (see box 7.6). century, with the objective of providing easily Rural and community banks exist predomi- accessible savings services to a broad range of nantly in Indonesia, Ghana, Nigeria, India, China, populations. and the Philippines. In these countries rural banks The universe of savings banks is very diverse; were often established as part of rural develop- no “prototype” savings or socially committed ment strategies implemented by national govern- retail bank exists.1 However, most savings banks ments. For example, in Indonesia rural banks were set up to reach clients who are not served by were established during the 1960s in an effort to commercial banks. Typically their objective is not foster the growth of financial services. Rural banks to maximize profit (Christen, Rosenberg, and in Indonesia are largely owned by provincial gov- Jayadeva 2004). ernments and used to support regional economic Savings banks are regulated by the banking policies. In India regional rural banks have a man- authorities and are both publicly and privately date to improve access to financial services, owned. They often have a broad decentralized including savings, in underserved, primarily rural, distribution network, providing local and areas and are heavily involved in credit-linked regional outreach. Research conducted by the programs to Self-Help Groups (Linder 2010a, World Savings Banks Institute in 2006 showed 2010b). The Philippines has both rural banks, that savings banks hold three-quarters of the which are owned and organized by individuals 1.4 billion accessible accounts provided by living in a given community, and cooperative rural double-bottom-line financial institutions (De banks, which are owned and organized by cooper- Noose 2007).2 Furthermore, data from 2000 to atives and other farmer associations. In the 2003 show that non-postal savings banks rep- Philippines, in addition to savings and credit resent close to 20 percent of total banking Box 7.6  Rural and Community Banks in Ghana As a network, rural and community banks are and 680,000 borrowers. Although the service the largest providers of formal financial ser- delivery of the network has been strong, its vices in Ghana’s rural areas. By the end of financial performance has been mixed. The 2008, Ghana had 127 rural and community profitability and net worth of the network have banks, with 584 service outlets, representing grown, but the financial performance of some about half of the total banking outlets in the members has been poor, and a small number country, reaching about 2.8 million depositors are insolvent. Source: Nair and Fissha 2010. Institutional Providers 183 assets (Christen, Rosenberg, and Jayadeva directly by the postal bank, if licensed to interme- 2004). Because of their large branch networks, diate deposits, or on behalf of a commercial bank in many countries, such as Kenya and Chile, that partners with the post office acting as an the geographic proximity of ­ savings banks agent. Postal banks are ­ primarily wholly or enables greater access than some other types ­ majority owned by governments directly or of providers. As well, savings banks offer prod- through government-owned and -managed post uct terms that make them accessible; their offices. They are normally supervised by a special- standard passbook savings account has low ized unit of the central bank or by a separate gov- minimum balance requirements and low or no ernment agency altogether (Christen, Rosenberg, fees. Finally, savings banks can also contribute and Jayadeva 2004). to developing financial capabilities because, in In 2010 post offices worldwide had an exten- addition to introducing financial services to sive retail distribution network with more than many unbanked individuals, they often provide 660,000 points of sale, above twice the number of financial education programs. For example, in commercial bank branches; many of these are Thailand the Govern­ ment Savings Bank has a located in periurban, rural, or remote areas, pre- school-based savings program in which stu- senting immense opportunities to offer entry- dents create a savings bank in their class and level banking services to the public (WSBI 2010; acquire the basic principles of personal finan- see box 7.8). cial management (De Noose 2007). State Banks Postal Savings Banks State banks include agriculture banks, develop- A large proportion of savings banks are postal sav- ment banks, postal banks (discussed above), and, ings banks, often established by governments in some cases, even commercial state banks. The originating from the postal network. In addition to primary institutional feature is that they are their core postal activity—collecting and distribut- owned and controlled primarily by the govern- ing mail and parcels—postal branch networks can ment and, as such, are considered public or semi- provide financial services. Postal financial services public entities. State banks often have a large traditionally include payment and money trans- number of savers and extensive branch networks. fers as well as savings services, generally in small In line with their ownership structure, they are amounts (see box 7.7). In some countries services funded largely by investment of public funds as also include credit or insurance products, either well as deposits. Box 7.7  Post Office Banks in India Of the 155,000 post office branches in India for Rs 3.4 trillion in deposits (more than US$75.6 reported in March 2008, more than 98 percent billion, 42.9 percent of what banks held). Even offer some type of savings services. The post more encouraging for financial inclusion is that, office controlled 174.7 million savings accounts unlike banks, 89.8 percent of all post offices are (or 40.7 percent of what banks held), accounting located in rural areas. Source: Linder 2010a. 184 The New Microfinance Handbook Box 7.8  Increased Financial Inclusion through Postal Savings Banks The large branch and agency networks of payment systems, thus leveraging the postal postal banks offer valuable channels for inter- banks’ networks. The Kenya Post Office national and domestic money transfers. Savings Bank has partnered with Citibank and Using a postal bank’s network, the govern- Stanbic Bank to do this. The network could ment and other institutions can pay salaries also provide valuable outlets and agencies for and pensions and individuals can pay school insurance products, as insurance companies fees and transfer allowances to pupils in increasingly examine the low-income mass remote areas that are not being served by market and develop products for it. However, commercial banks. For example, in Kenya the challenges of successful linkages and about 55 percent of the allowances for uni- strategic alliances should not be understated; versity students in public universities and to date, few examples have reached signifi- 50 percent of government pensions are paid cant scale. through the Kenya Post Office Savings Bank As postal banks start the process of reengi- (Robinson and Anyango 2003). Postal banks neering themselves and their business, the often attract young people and students— threat of brand confusion with the post office either as parents seek to open a low-cost will grow in importance. The Kenya Post Office bank account for their children or as govern- Savings Bank suffered damage to its reputa- ments seek to pay student allowances across tion as a result of being confused with the post the country. office and its poor service quality. Postal banks Significant opportunities exist for postal often also suffer from serious overstaffing, banks to become profitable, modern, partly as a result of their manual operations ­ client-responsive organizations. Postal banks and past politicization of appointments. This have large networks of branches, giving them phenomenon means that, at some levels, a comparative advantage over commercial postal banks not only have too many staff, but banks and creating the potential for offering also do not have the appropriate skills to man- e-banking solutions. The postal bank networks age cash balances and the treasury, with the also have a comparative advantage over shops result that savers must often travel to larger or other agent locations. They are permitted to centers to withdraw cash. Furthermore, most accept deposits and utility bill payments, are postal banks are required by their enabling acts used to handling remittances and manage or laws to invest mainly in government instru- money, and in many cases have greater liquid- ments. Often state corporations cannot ity than shops with limited turnover. Indeed, in borrow without the approval of the share- ­ some countries, the central bank authorities holder—the government—which guarantees do not permit shops or others to offer even a the amount borrowed. This can result in bud- basic withdrawal service. Strategic alliances getary constraints. Fluctuating interest rates with other banks can allow postal banks to on treasury bills have meant significant vari- offer withdrawal and deposit services through ances in annual profits and in the capacity to point-of-sale devices or mobile phone–based carry out major projects. Source: Wright, Koigi, and Kihwele 2006. Institutional Providers 185 Many government-owned banks are estab- to close or restructure state-owned financial lished to serve the agriculture sector. Their pri- institutions (ADB 2007; see box 7.9). mary activities include extending credit and However, not all state banks suffer from gover- savings services to promote small-scale farming nance and management problems and fail to production, cottage and village industries, and become profitable. Bank Rakyat Indonesia pro- other rural livelihood activities. Individual farm- vides a good example (see box 7.10). ers and merchants, cooperatives, or associations are the primary target market. In many cases agri- Private Commercial Banks culture development banks are the only formal Commercial banks have the most robust product financial service provider in rural areas. offering of all financial service providers, typically State banks have often been established to providing a full menu of payments, credit, and correct market failures and provide resources to savings services.3 Although they are beginning to underserved or high-priority sectors of the econ- reach lower-income markets, private commercial omy. As a result, they may be susceptible to the banks generally operate in urban areas and serve political priorities of ruling governments and to a wealthier clientele than alternative financial political influences that may not serve the insti- institutions specifically targeting low-income tutional objectives. Beyond politics, some aspects populations. of government ownership threaten the long- Commercial banks tend to be more highly term sustainability of state banks: An implicit leveraged than other providers given their access government guarantee creates a safety net, limit- to different sources of funding enabled by their ing their motivation to operate profitably, and formality, regulated status, and, by definition, poor collection practices and frequent forgive- commercial orientation. Equity is raised from ness schemes enable a weak credit culture, shareholders either through private placements undermining the ability of the private sector to or through capital markets. Debt is raised through operate in rural markets (Young and Vogel 2005). commercial sources, including borrowing from State banks may be reluctant to operate under other commercial banks, development finance prudent financial management and accounting institutions, and microfinance investment vehi- practices. For example, they may not write off cles, and through capital markets. delinquent loans, frequently understate provi- In general, commercial banks engage in micro- sions for portfolios at risk, and overstate profits finance in three ways: (1) by expanding their and assets. Political ties may compromise full product offering to microclients—referred to as transparency of financial positions. State banks downscaling—either through the creation of a may not be “accountable” to the regulators in the separate internal unit or through a new subsidi- same way that a private bank or financial services ary, (2) by creating a new institution—referred to company should be. Furthermore, board mem- as greenfielding—for the specific purpose of offer- bers may be appointed based more on political or ing regulated formal financial services to the poor, other criteria than on professional skills or busi- or (3) by establishing an agency relationship with ness rationale, limiting effective governance and an experienced microfinance organization or perpetuating the challenges of fiduciary respon- other provider. sibility. Governments have often been willing to subsidize continuing losses, weakening manage- ment discipline (Christen, Rosenberg, and Downscaling Jayadeva 2004). Faced with an often massive When a commercial bank creates a separate inter- budgetary burden, some governments have had nal unit or establishes a microfinance subsidiary, 186 The New Microfinance Handbook Box 7.9  Privatization: The Experience of Khan Bank in Mongolia Khan Bank was established in 1991 from the the loan portfolio grew from US$9 million to assets of the former state bank with the spe- US$149 million. In 2006, 76 percent of the cific goal of serving the rural sector. In 1999 the loan portfolio was in rural areas, business World Bank made reforming Khan Bank a con- loans accounted for 45 percent, consumer dition of its Financial Sector Adjustment Credit loans for 28 percent, and agricultural loans for Program for Mongolia, and the U.S. Agency for 26 percent. The portfolio at risk over 30 days International Development agreed to fund was only 2.5 percent. During the initial transi- external support to manage Khan Bank. tion period, Khan Bank focused on simple, Management’s mission was to (1) restore standardized products in rural areas. It piloted financial soundness to Khan Bank, (2) bring new products in selected urban branches, financial services to the country’s rural popula- only rolling them out once they proved viable. tion, and (3) prepare Khan Bank to operate Over time Khan Bank increased its range of independently as a precursor to privatization. products and now offers a wide range of loan, After being placed in receivership in 2000, deposit, and money transfer services. Loan the bank was recapitalized, put under a products range from express micro loans and restructuring plan, and successfully privatized small and medium enterprise loans to crop in 2003. From December 2001 to June 2006, and herder credit. Source: DAI 2007; ADB 2007. Box 7.10  Bank Rakyat Indonesia In 1983 Bank Rakyat Indonesia (BRI) began shares of BRI to the public in an initial public the transformation from a dispenser of subsi- offering. Listing on the Indonesian Stock dized agricultural credit to a self-financed Exchange brought a new level of reporting microbanking network with ever-growing and transparency as well as a true double bot- deposits, loan portfolios, profits, and outreach tom line, with public investors expecting a to the lower segment of the market. In 1997 return on their shares, while the government and 1998 the Asian financial crisis destroyed maintained majority ownership as protection much of the commercial sector in Indonesia against purely commercial motives. and almost wiped out the country’s banking BRI became the most profitable bank industry. However, BRI was one of the state- in Indonesia in 2007 and the largest bank in owned banks exempted from closure. It was terms of loan portfolio size in April 2008. In restructured through a massive recapitaliza- 2010 it purchased Bank Agroniaga in an effort tion effort in 2000, and in 2003 the govern- to expand its footprint in the agribusiness ment of Indonesia offered 40 percent of the sector. Source: Seibel and Ozaki 2009. Institutional Providers 187 it needs to change its organizational structure, brand. The culture and brand of the commercial lending methodologies, staffing, processes, and bank will not necessarily carry through appropri- procedures to facilitate smaller transactions ately to the microfinance arm. appropriate for microclients. For example, loan If a subsidiary is created, it must be licensed officers, who traditionally meet prospective cli- and regulated separately, with its own manage- ents at the bank branch, must usually visit clients ment team and staff. The parent bank is a partial in their home, marketplace, or village. Loan prod- owner (usually majority) in the new microfinance ucts must be modified to reflect the reality that subsidiary. Other investors (equity shareholders) most microclients do not have collateral, official bring microfinance experience, and specialized accounts, or financial statements; instead, loan consulting firms often take a role in setting up and officers must focus on business and household managing the new subsidiary (see box 7.11). cash flows. Savings services need to be modified to have lower or no minimum balances. Pricing Greenfielding may need to be adapted to reflect higher operat- While transforming NGO MFIs and downscaling ing costs and lower balances. Similarly, auditing existing commercial banks can be effective for and accounting procedures need to be modified increasing financial inclusion, greenfielding—the to analyze a portfolio with numerous small trans- start-up and creation of new microfinance actions. Cultural and operational changes of this banks—is another approach whereby a formal magnitude require a distinct management struc- bank is created with financial services dedicated ture to ensure, first and foremost, that the new entirely to the micro, small, and medium-size microfinance unit or subsidiary offers a value enterprise markets. The banks are licensed and proposition for clients under its own image and formally regulated institutions with professional Box 7.11  Subsidiary Model in Practice: ACCION-Ecobank Partnership Ecobank is a full-service regional banking insti- Company (EASL) in Ghana—an institution tution employing more than 11,000 staff in jointly owned by Ecobank (70 percent shares) 746 branches and offices in 29 West, Central, and ACCION (30 percent shares) through its and Southern African countries. In an effort to investment company, ACCION Investments. move down-market and provide banking ser- The new entity received its license from the vices to lower-income clients, it partnered Bank of Ghana in March 2008. Since its launch, with ACCION to form subsidiaries in Ghana EASL has experienced significant growth, and Cameroon. As part of the agreement, ­ serving clients through a network of six ACCION brings its technical expertise and branches and two satellite kiosks based in mar- leadership in the microfinance sector, and kets throughout Accra. EASL provides the Ecobank offers the opportunity to leverage its working poor with access to credit and savings infrastructure and extensive network of banks products, along with debit cards for use across to help to standardize and deliver high-quality the country. In particular, EASL has successfully financial services to low-income clients. launched six savings products addressing a vari- At the end of 2006, Ecobank and ACCION ety of client needs. In May 2010 EASL opened launched Ecobank-ACCION Savings and Loans its first two branches in Douala, Cameroon. Source: Ecobank-ACCION website (http://www.accion.org/page.aspx?pid=2067). 188 The New Microfinance Handbook management teams and unique methodologies Holding companies provide standardized ser- for deploying small-scale savings accounts, credit, vices to their affiliated subsidiaries such as sup- and other financial services. port for fundraising, help negotiating loan and Greenfielding of new microfinance banks has shareholder agreements, and backup support for grown rapidly since 2006 with the creation of information systems, product development, audit- numerous commercial microfinance networks. ing, and training programs for middle and senior These networks are structured as holding com- management. The commercial microfinance net- panies in which the sponsor or primary share- work model is founded on the principles of social holder provides the technical expertise while responsibility, transparency, efficiency, and sus- other like-minded investors, including develop- tainable profitability. Banks owned by the same ment finance institutions and bilateral donor holding company are integrated into a worldwide institutions, provide various forms of funding. In network in which ideas and experience are addition to investing equity, shareholders nor- exchanged and synergies are exploited. All net- mally provide grant funding to the technical work institutions are co-branded and adhere to a partner, often a foreign network, to develop the common set of ethical, environmental, and pro- capacity of the institution as well as related fessional standards (see box 7.12). products and channels, support a critical analy- Creating a new institution entails three stages: sis of the financial needs of target beneficiaries, • Foundation stage. A greenfield MFI is estab- and hire and train local staff. Over time, local lished, the license is obtained, initial capacities employees are trained to take over virtually all are developed, and operations are launched. At functions of the new banks. Box 7.12  Microfinance Networks and Commercial MFIs ProCredit, the first commercial microfinance microfinance banks through a combination of network, started operations in Central and equity and management services rendered by Eastern Europe. In 2011 the ProCredit group its technical partner LFS Financial Systems consisted of 21 banks operating in transition GmbH, concentrates on start-up and early- economies and developing countries in Eastern stage greenfield banks. Together with other Europe, Latin America, and Africa. Building on partners, it establishes new and transforms the success of the network model, numerous existing non-bank microlending institutions into other commercial microfinance networks were full-service microfinance banks. Over time, created between 2005 and 2007, including AcessHolding will transform from a holding AccessHolding, MicroCred, and Advans. These company of associated MFIs into a controlling networks have focused largely on filling market parent company of a global network of microfi- gaps in some of the most underbanked coun- nance banks with a common brand identity. As tries. Among all the networks, more than of December 2011, AccessHolding had assets 20 microfinance banks were greenfielded in of €479.8 million and had invested in seven Africa between 2006 and 2010, largely sup- microfinance banks in Azerbaijan, Liberia, ported by the International Finance Corporation Madagascar, Nigeria, Tajikistan, Tanzania, and and Kreditanstalt für Widenraufbau. Zambia. All investments are regulated entities AccessHolding, a commercial microfinance operating under full commercial bank or special holding company dedicated to investing in microfinance licenses. Source: Access Holdings (http://www.accessholding.com); ProCredit (http://www.procredit-holding.com). Institutional Providers 189 this stage management consists largely of staff Microfinance organizations acting as agents seconded from the technical partner or share- for banks can offer the physical presence, expe- holder. The new bank receives continuous rience, and agility to reach low-income popu- training and capacity building from the techni- lations and assess them efficiently, whereas cal partner. Ideally a local partnership is also banks offer longer-term, lower-cost sources of established at this stage. funds. For MFIs, agency relationships can sup- port increased income, while expanding finan- • Institutional development stage. The branch cial services to their clients (Miller 2011). Some network is gradually expanded, and opera- agency relationships originate with the micro- tional breakeven is expected by the third or finance organization rather than the commer- fourth year of operations. Funding for techni- cial bank, while others are hybrid, with only cal assistance is maintained but reduced as some services being managed by the agent local management and staff personnel have institution. been trained and adequate systems have been Agency relationships can also include differ- rolled out. ent financial service providers (most often banks • Sustainability and further advancement. A sec- or money transfer companies), to allow clients to ond injection of capital is foreseen during the process transactions when they cannot access fifth or sixth year of operations to sustain the their primary provider; this is referred to as bank’s growth. Local staff now assume most “correspondent banking,” where a bank per- managerial positions, and the bank absorbs the forms services for another bank located in a dif- costs of senior expatriate staff, if applicable. ferent city or country. A correspondent bank usually conducts business transactions, accepts deposits, and gathers documents on behalf of Agency Relationships and Partnerships another bank or other financial institution. The third method for engaging in microfinance is Other correspondent banking services may to provide services through an agency (rather include treasury management, credit services, or than directly). Agency relationships occur when a foreign exchange. commercial bank partners with a microfinance Correspondent banking services can help a organization or other financial service provider to financial institution to extend its geographic cov- provide services to microfinance clients on behalf erage, while lowering transaction costs for clients of the bank. using the existing infrastructure of partner insti- In this model the microfinance clients do not tutions. Correspondent banking can be used to engage directly with the bank, but rather with the offer services to clients without having to invest partner organization acting as its agent. The agent in physical infrastructure, which may prove too undertakes marketing, sales, and service (most costly for a smaller provider. For example, money direct client contact), while loans and savings are transfer companies such as Western Union or booked on the balance sheet of the bank. Often MoneyGram often arrange to have a kiosk or win- operating on a fee-for-service basis, the agent is dow located within the branch of a bank (or MFI). paid by the bank for each new loan; incentives are Normally each of the partners continues to run its in place to ensure loan quality. When an agency businesses separately but benefits from the ability relationship is used, the primary changes in the to share branch costs and to access a greater num- bank occur at the senior management level to ber and type of customer. Another example is integrate microfinance assets into the bank’s where many smaller providers such as MFIs or overall strategy and cost structure. SACCOs partner with a larger bank or group of 190 The New Microfinance Handbook banks to negotiate access to the larger provider’s part because funding for health insurance is pop- network of automated teller machines (ATMs) ular among donors. (see box 7.13). Mutual Insurers Mutual insurers are nonprofit organizations that Insurance Companies are often owned by credit unions or cooperatives Microinsurance is a relatively new area within and are nonprofit, member-based organizations. microfinance and is still very much in the learn- They are distinct from other community-based ing stage. Chapter 11 provides a thorough discus- groups such as burial societies (see chapter 6) sion of microinsurance products and services and because they have professional management and addresses some of the issues and challenges fac- are typically supervised under regulations other ing the delivery of microinsurance. This section than the insurance act. They have the advantage describes the main types of insurance providers of operating in low-income areas and are experi- active in microinsurance.4 enced in financial activities, disbursements, and confirmation of events. After commercial insur- NGO Insurance Providers ers and NGOs, mutual insurers are the third larg- NGO insurance providers include development est provider of microinsurance (Roth, McCord, organizations, trade unions, federations, and and Liber 2007). MFIs that provide microinsurance (Roth, Takaful insurers are insurance organizations McCord, and Liber 2007). They interact directly that operate according to Islamic financial princi- with poor communities and are therefore close to ples; a takaful insurer can invest only in non- the market. Most operate without the benefit of interest-bearing assets and, as such, operates an insurance license and are outside the regula- essentially as a nonprofit mutual. However, very tions to which commercial insurers must adhere. few takaful insurers provide microinsurance. They are not driven by profits, which gives them more flexibility and propensity to experiment in Commercial Insurance Providers providing new microinsurance products. NGO Commercial insurers are for-profit insurers regu- insurance providers have traditionally been the lated under various country-specific insurance largest provider of health microinsurance, for acts. They are professionally managed and example, in part because demand exists and in required to maintain reserves in accordance with Box 7.13  Linking Different Types of Institutions SACCO Link is a partnership in Kenya that has access their cash through Co-Operative Bank of increased linkages within the formal financial Kenya’s ATMs as well as any Visa-branded ATM. sector. The SACCO Link service has helped It links many rural cooperative members with SACCOs to enhance the sophistication of finan- the larger financial sector. The SACCOs pay for cial services they offer to members. The SACCO connectivity, software upgrades, and a bridge Link debit card enables SACCO members to to connect to the bank’s system (integrator). Source: Co-Operative Bank of Kenya 2008. Institutional Providers 191 regulations. Commercial insurers provide a vari- manages the customer relationship, handling ety of insurance products through established sales, premium collection, policy administration, sales and delivery structures and have the poten- claims assessment, and settlement, while the tial to distribute microinsurance on a very large microinsurance provider is responsible for the scale. However, in addition to modifying products design and development of the products (Roth, to make them both appropriate for low-income McCord, and Liber 2007). In some cases a third- clients and cost-efficient, a specific challenge for party service provider (such as a health care delivering insurance is establishing trust between provider) is also involved. the insurer and the client. Commercial insurers, MFIs with strong processes and systems can especially, may not be accustomed to the extra administer policies for insurers. However, weak- effort required to ensure that clients understand nesses in these areas can be exacerbated by the the service and see the value of microinsurance. responsibility for administering microinsurance Microinsurance providers need to understand policies (Roth, McCord, and Liber 2007). These the risk profiles of clients as well as the tolerance relationships require much expenditure of time and mitigation measures of poor people, which on building trust and capacity and providing make the provision of microinsurance signifi- support. cantly more challenging than traditional Commercial insurers also have access to rein- insurance. surance. Reinsurance is a risk management tool Unlike general credit and savings products, whereby one insurance company purchases insurance products typically involve more than insurance from another insurance company. one organization—the insurer and the delivery Reinsurers provide insurance to insurers for cata- channel. The insurer carries the risk, finalizes the strophic risk or excessive losses and are becoming premium and product design, and ultimately pays increasingly common with microinsurance, claims. The delivery channel sells the product although to date, they do not play a very large role and provides after-sales service (Roth, McCord, because the size of claims is so small (Roth, and Liber 2007). McCord, and Liber 2007). Selling insurance, collecting premiums, and supporting policyholders to settle claims may be Payment Service Providers performed by the insurer’s direct sales division or by others serving as the delivery channel, includ- Payment services refer to the electronic transfer ing MFIs, financial cooperatives, independent of funds, sometimes called money transfers, agents, churches, post offices, governments, transfer services, transactions, mobile money funeral parlors, and retailers. Depending on the (when using a mobile phone), or simply pay- country, regulation may affect different delivery ments. Although nonelectronic payment services channels differently. exist (for example, paying a fee to a human cou- For example, although an MFI may not have rier to transport cash to another person, as dis- the capacity or regulatory approval to offer insur- cussed in chapter 6), for institutional providers ance, it can act as an agent for a large insurance these terms refer to the electronic transfer of company, offering direct access to customers (see funds between two parties. box 7.14). Responsibilities are separated in such Electronic money or e-money products (elec- partnerships, with the insurer specializing in tronic or mobile payment services) are offered by product design and risk management and the numerous types of providers, including money MFI leveraging its geographic footprint and cli- transfer companies, post offices, banks, or other ent relationships. In these cases, the MFI formal financial institutions as well as, more 192 The New Microfinance Handbook Box 7.14  Allianz in West Africa To reach out to the low-income market, Allianz, may not have identity cards, do not know their a commercial insurance company, looked for rights, and could not enforce them even if partners with established networks in rural ar- they did. In a “cascade of trust,” Allianz relies eas. It teamed up with PlaNet Guarantee, an on PlaNet Guarantee’s knowledge of local international organization that promotes micro- MFIs and ability to manage microinsurance; insurance across Africa. PlaNet Guarantee PlaNet Guarantee trusts the reliability of has brokered nine partnerships for Alli­ anz in Allianz; CAURIE trusts the advice of PlaNet different African countries. Part­ners are MFIs Guarantee; the loan officers trust CAURIE; that secure their cre­ dits with standard credit and the women in the village banks trust their life insurance. CAURIE, Allianz’s partner in loan officers. Information about insurance and Senegal, provides credit to 21,000 women in Allianz products in particular is handed down 275 village banks. Within each village bank, the this cascade. women split up into solidarity groups of be­ To provide even better service in the tween 3 and 10 women. To avoid the burden future, PlaNet Guarantee and Allianz initiated that the death of a member can put on the dialogues with 300 micro­ credit clients through whole group, the MFI added compulsory local NGOs. Cus­ tomers help loan officers to credit life insurance to its product. under­stand their needs beyond individual life With this new service, CAURIE’s loan offi- insurance—such as coverage for the death of cers had to learn how to explain microinsur- a family member and the associated funeral ance. They found that the benefit of insurance costs or health expenses. This information is much harder to convey than the benefit of helps Allianz to develop new products that will credit, because customers pay up-front for a create additional va­lue for these customers. In specific future event that may or may not Senegal Allianz added a livelihood component ­ happen—for example, the death of the to its life insurance pro­ duct. The insurance insured. If that event does not happen, there pays out a fixed sum for each day a borrower is no payout. Moreover, customers have to is unable to work to cover lost income. trust that the insurer will keep its promise. Although not yet a full-blown health insur- Formal contracts are worth little in villages ance, the daily allowance is large enough to where people often do not have addresses, cover smaller medical expenses. Source: Allianz 2010. recently, through Internet networks or mobile internationally for people who are unbanked or network operators (MNOs) and other third-party for people who prefer not to use either the formal providers. These payment services typically banking system or informal systems. They trans- require the use of a cash-in, cash-out location fer funds through electronic funds transfer (EFT) whereby the customer making the transfer brings networks. The sender visits the company’s retail cash to the office of the provider or the location of or affiliated agent’s location, submits the transfer an affiliated agent. amount, and pays the fee, at which point the funds Money transfer companies are commercial are transferred and the recipient is informed by networks that transfer funds domestically and telephone or text message. The recipient is then Institutional Providers 193 able to collect the transfer amount by showing Post offices offer electronic cross-border pay- appropriate identification at any retail or agent ments referred to as giro transfers. To make the location representing the money transfer com- transfer, clients must do so from a post office loca- pany. Each major money transfer company oper- tion; the receiver can receive the transfer into a ates in a similar manner, with a central database postal account, a bank account, or in cash. Giro linking all staff or company agents who are dis- transfers take advantage of the cash float in the bursed widely in various locations, including postal system, and although transfer times may be branch offices (generally their own) and exten- relatively long (two to four days), the fees are gen- sive networks of partner banks, postal agencies, erally lower than with banks (Frankiewicz and MFIs, travel agents, change bureaus, grocery Churchill 2011). stores, convenience stores, and other retailers. Banks most often conduct transfers and pay- The provision of money transfer services was a ments through current accounts (see chapter 12). highly profitable industry long before the advent Current account transactions may be carried out of the Internet and mobile phone networks (see using negotiable instruments such as checks or box 7.15). Although the profit margins for these money orders and, like other financial products, services have shrunk as innovations in telecom- can be accessed through various delivery chan- munications have created other options for cus- nels such as debit cards, ATMs, or mobile phones. tomers, transfer service companies remain an Commercial banks also facilitate electronic fund important financial service provider. The service transfers to another bank account; this is gener- points are widely accessible, and the service is ally expensive and not available to persons with- efficient and convenient without much paper- out a bank account. work. Although expensive, money transfer ser- Although traditional providers of electronic vices are often the only option for an unbanked transaction services are regulated financial insti- customer who cannot or does not wish to rely on tutions, credit unions, post offices, or commercial informal systems or is not comfortable with money transfer companies, over the past decade transferring money using a mobile phone. more than 100 mobile money deployments (that Box 7.15  Western Union and MoneyGram Two of the largest players in the money transfer Both Western Union and MoneyGram industry are Western Union and MoneyGram. have increasingly offered retail and agent loca- In 2012, Western Union had approximately tions in developing countries, while at the 510,000 agent locations in 200 countries and same time targeting members of diaspora territories, allowing consumers to send money communities who frequently send money worldwide through retail or agent locations, back to their home countries. Migrant workers including convenience stores, kiosks, and the seeking economic opportunity in urban areas postal service. Similarly, in 2012 MoneyGram away from home also provide a natural target had more than 275,000 locations in 194 coun- market because many migrant laborers do not tries. Each company earned significant profits. use banks. Source: Isern, Deshpande, and Van Doom 2005; Wikipedia.org/wiki/moneygram; corporate.westernunion.com/ news_media_corporate.html. 194 The New Microfinance Handbook is, money transfers using mobile phones) have References and Further Reading launched in developing countries, which suggests * Key works for further reading. there is significant commercial interest among ADB (Asian Development Bank). 2007. “Proposed MNOs in offering payment services using mobile Loan. Mongolia: Khan Bank. Report and phones.5 Mobile network operators are becoming Recommendation of the President to the Board important players within the financial ecosystem, of Directors.” Project 41911, ADB. as a channel both for delivering financial prod- Allianz. 2010. “Learning to Insure the Poor.” ucts and services through mobile phones as well Microinsurance Report. Allianz, Munich. as for providing money transfer services in their Branch, Brian. 2005. “Working with Savings and own right. As experience is gained and the sector Credit Cooperatives.” Donor Brief 25, CGAP, evolves, they are poised to become increasingly Washington, DC, August. more relevant. Bruhn, Miriam, and Inessa Love. 2009. “The Although the regulations in Kenya permit an Economic Impact of Banking the Unbanked: MNO to offer payment services to clients without Evidence from Mexico.” Policy Research Paper a bank account, the central banks in other coun- 4981, World Bank, Washington, DC. tries (India, Pakistan, and Bangladesh, for exam- BSP (Bangko Sentral ng Pilipinas). 2011. “BSDP ple) require the deployment of all mobile payments Grants Microinsurance License to Two Rural to be led by banks; in other words, the users of Banks.” Press release, BSP, December 22. mobile money are customers of the bank, and the *Christen, Robert Peck, and Ignacio Mas. 2009. mobile device is the delivery channel for transact- “It’s Time to Address the Microsavings ing through accounts held at the bank (see chapter Challenge, Scalably.” Enterprise Development 12). Related to this are third-party providers that and Microfinance 20 (4): 274–85. are neither financial institutions nor MNOs that *Christen, Robert Peck, Richard Rosenberg, and are also emerging as payment service providers, Veena Jayadeva. 2004. “Financial Institutions for example, bKash in Bangladesh and Sub-K in with a ‘Double Bottom Line’: Implications for the Future of Microfinance.” Occasional Paper India. While they do provide direct interface with 8, CGAP, Washington, DC, July. clients, they are discussed in chapter 12 because it Co-Operative Bank of Kenya. 2008. “Africa is hard to differentiate them as providers or as Technical Workshop.” PowerPoint delivery platforms; by definition they need to part- presentation, November 26. ner with other providers to deliver services. DAI. 2007. “Khan Bank: Bank Management Support.” http://dai.com/our-work/projects/ Notes mongolia%E2%80%94khan-bank-bank- management-support.  1. www.wsbi.org. *De Noose, Chris. 2007. “Bringing the Hidden  2. Double-bottom-line financial institutions Giants to the Footlight: The Role of Savings and target the mass market, such as MFIs, credit Retail Banks in Increasing the Level of Access unions, cooperatives, agricultural and to Financial Services.” Microbanking Bulletin 15 development banks, and savings and postal (Autumn). savings banks (De Noose 2007). FMO (Entrepreneurial Development Bank of the  3. This section was contributed by Julie Earne. Netherlands). 2006. “Guidelines for Consumer  4. This section is summarized from Roth, Finance.” Memo, FMO, July 6. McCord, and Liber (2007). *Frankiewicz, Cheryl, and Craig Churchill. 2006.  5. GSMA Mobile Deployment Tracker (http:// Making Microfinance Work: Managing for www.wirelessintelligence.com/mobile-money). Improved Performance. Geneva: ILO. Institutional Providers 195 ———. 2011. Making Microfinance Work: Managing Nair, Ajar, and Azeb Fissha. 2010. “Rural Banking: Product Diversification. Geneva: ILO. The Case of Rural and Community Banks in *Helms, Brigit. 2006. “Access for All: Building Ghana.” In Innovations in Rural and Agriculture Inclusive Financial Systems.” World Bank and Finance, ed. Renate Kloeppinger-Todd and CGAP, Washington, DC. Manohar Sharma. Focus 18, Brief 5. Washington DC: International Food Policy Research Institute India Microfinance Editorial Team. 2009. and World Bank. “NBFC—Frequently Asked Questions—RBI.” India Microfinance Business News (Delhi), Ritchie, A. n.d. “Typology of Microfinance Service Financial Inclusion, Social Entrepreneurship, Providers.” Version 1.3. World Bank, and Mobile Money Blog, April 7. Washington, DC. Isern, Jennifer, Rani Deshpande, and Judith Van Robinson, Marguerite, and Ezra Anyango. 2003. 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Inc., Maryland. 196 The New Microfinance Handbook PART III FINANCIAL SERVICES AND DELIVERY CHANNELS CHAPTER 8 Savings Services Joanna Ledgerwood Voluntary savings mobilization from the pub- and operations that improve productivity and lic is not a matter of adding a few products to contribute to higher incomes. Savings also help to a microcredit organization. If successful, it manage shocks through providing resources dur- inevitably and irreversibly changes the insti- ing times of crisis (figure 8.1). In recent years the tution, though not its mission. Those that are volume of demand and consumer preference for not prepared for such changes should not safe and convenient savings services has been undertake to collect savings from the public. increasingly acknowledged, outdating a previous, However, those that are willing and able to widely held view that the poor do not save. make the changes needed to overcome the “The poor need savings services that allow risks can profitably attain wide outreach as them to (1) deposit small, variable amounts fre- financial intermediaries and can serve as quently and (2) access larger sums in the short, models of the industry for other institutions. medium, or long term (Rutherford 2009). Like —Robinson (2006) everyone else, they demand a portfolio of savings products that offer differing terms of access and Demand for savings services is diverse and robust. generate differing returns” (CGAP 2005, p. 3). In A small amount of savings in a secure place can some cases, poor people need highly liquid ser- provide resources to manage consumption needs, vices, for example, to cope with emergencies or to smooth irregular income, cover expenditures for take advantage of an investment opportunity. For health and education, or provide the capital nec- other purposes, they prefer illiquid options to pro- essary to invest in household assets or new tools tect their savings and instill discipline, particularly Contributions to this chapter were made by Cheryl Frankiewicz. Savings Services 199 Figure 8.1  How Savings Can Improve the Lives of the Poor (a) Enhance productivity Income (b) Smooth consumption (c) Protect against shocks Income Income Time Time Time Source: Christen and Mas 2009. Note: Dotted line denotes cash flows when people have access to savings services. if they are saving to purchase an asset or pay an save in small amounts, making the transaction upcoming expense such as school fees. Savings costs proportionately even higher. Products may services also help to keep savings secure, espe- have complicated procedures and requirements cially when receiving lump sums such as at har- that are difficult for poor people to meet, such as vest time or through a remittance (CGAP 2005). minimum balances or formal identification; ­ This chapter provides an overview of savings intimidating banking facilities and procedures services, primarily from an institutional perspec- can potentially make poor savers feel disre- tive focusing on the institutional capacity spected (Frankiewicz and Churchill 2011). required, the range of clients served, the added Although informal saving mechanisms have complexity to operations when mobilizing depos- drawbacks, because of the difficulties in access- its, and a brief discussion of savings products. It ing formal providers, many poor women and will be of interest to practitioners, donors, and men continue to save informally (see box 8.1; see regulators, particularly those interested in adding also chapter 2). savings services for the poor. Saving in cash at home or with neighbors or friends is the most liquid and accessible form of savings but also the most vulnerable to pressure Savings Services in the for unintended or unnecessary expenditures and Community at the most risk of theft. To avoid such risk, many Poor people often rank convenience, access, and choose to save in kind—storing value in grain, ani- security over interest earnings, with proximity mals, or jewelry—or through savings clubs or being key. For these reasons, poor savers have deposit collectors found in the local community. persistently chosen to save in the informal sec- Often women will save a store of food (such as tor. Banks typically have limited rural infrastruc- rice) with a neighbor for use at a time when food ture, and many find it difficult to serve small, is scarce. These arrangements are generally recip- often isolated savers profitably. Furthermore, for rocal between households and build on the trust clients, accessing savings services from formal and social capital within communities. Saving in institutions often requires time and high trans- livestock is common as well and can provide action costs such as transportation, identifica- short-term income from the sale of products such tion, registration, and opportunity costs. As well, as milk, eggs, or wool. In addition, selling animals given low and irregular incomes, poor people can support the need for medium-term lump 200 The New Microfinance Handbook Box 8.1  Savings Patterns in India A study by MicroSave and the International transaction time/money listed as hindrances), Finance Corporation of savings patterns in and lengthy procedures to open accounts. As India showed that challenges to saving can such, the vast majority of excess liquidity include cash flow volatility, unplanned expen- remains in the informal sector. ditures, and unanticipated events such as ill- When respondents were asked why they ness and natural disasters. Examining the do not save, volatility in cash flows was the supply and demand of savings options for reason cited most often. Unplanned expendi- poor people in India, the study highlighted reg- tures, unanticipated events such as illness or ulatory and operational challenges and oppor- natural calamity, and the lack of a proper place tunities for financial institutions and mobile to save were all also frequently cited. banking platforms serving the low-income Opportunities for individuals to save on a market. It found that nearly 75 percent of structured, regular basis were highly valued. opportunities to save are unplanned and The researchers concluded with seven key remain in the informal sector because of ease attributes that influenced the performance of and access. Although bank branch density in service providers who mobilize deposits: India is reasonable, usage is low because of security, interest, proximity, liquidity/ability to bad personal experiences with banks, mis- withdraw, acceptance of small savings, trust of the banking system, inaccessibility deposit term, and the opportunity to save in (specifically with affordability of travel and small amounts on a regular basis. Source: Sadana et al. 2011. sums. Yet saving in kind is not always safe and also be inflexible (for example, ROSCAs) and often not very liquid as market demand and val- result in a negative return (for example, deposit ues fluctuate. There are also costs associated with collectors),1 and money may not be accessible saving in livestock because animals require food, when needed (for example, ASCAs). water, grazing land, and shelter—costs that add to household financial pressures. Saving in jewelry Institutional Savings Services is popular in many cultures because it is transfer- able into cash and can be used to maintain value Formal providers are beginning to make impor- during a period of inflation. However, jewelry can tant progress in reaching lower-income markets also fluctuate in value and poses a high risk of with savings services. When savings services are theft and fraud (Robinson 2004). offered by institutional providers, they are gener- Saving clubs such as rotating savings and credit ally referred to as deposits. Savings is a more gen- associations (ROSCAs), accumulating savings and eral term used when discussing a broad set of credit associations (ASCAs), deposit collectors, activities related to holding assets stored by oth- and others in the community are used frequently ers; deposits are the portion of savings held in (see chapter 6). These offer more security than financial institutions (CGAP 2005). Mobilizing keeping cash or other assets at home and instill deposits is very different from providing credit discipline with mandatory regular deposits (daily, and much more difficult. Whereas lenders must weekly, biweekly, or monthly). However, they can select borrowers whom they trust to repay the Savings Services 201 loans, the situation is reversed with savings: It is chapter 17).2 They also require careful oversight the customers who must trust the service pro- by a competent, committed governance structure vider (Robinson 2006). knowledgeable about financial intermediation, Savings services from formal providers can and strong institutional capacity including skilled improve upon informal services and, in some management and appropriate systems and cases, support increased incomes (see box 8.2). ­ processes to manage the complexity of both lending and mobilizing savings, and to facilitate ­ Institutional Capacity a relationship of mutual trust (see chapter 15). For financial institutions to offer deposit services Infrastructure is required that provides easy access to the public, they must be licensed to do so (see for clients (see chapter 18) as well as the capacity to Box 8.2  Savings Constraints and Microenterprise Development: Evidence from Kenya “Does limited access to formal savings ser- take-up and usage of the account was high vices impede business growth in poor coun- among market vendors, especially women— tries?” In search of an answer, Pascaline 40 percent of female market vendors took up Dupas and Jonathan Robinson conducted a the savings account. The fact that these field experiment in which a randomly selected women voluntarily saved in accounts earning sample of small informal business owners in a negative returns suggests that access to a for- village in rural western Kenya received access mal savings account was highly valued. to an interest-free savings account. By directly The research found that having an account expanding access to bank accounts, they had a substantial positive impact on levels of tested the impact of these accounts on overall productive investments among market ven- savings mobilization, business investment, dors and within six months led to higher income (measured using expenditures), and income levels, determined through a proxy health expenditures, among other variables. of expenditures. The authors found sugges- The sample was composed primarily of mar- tive evidence that the account made market ket vendors. Dupas and Robinson relied on a women less vulnerable to health shocks. The data set collected from 279 daily logbooks logbook data indicated that over the period of kept by individuals in both the treatment the study, market women in the control (those with access to the account) and control group were forced to draw down their work- (those without access) groups. The logbook ing capital in response to health shocks, data were supplemented by bank account whereas women in the treatment group did activity information, making it possible to not have to reduce their business investment examine the impact of the accounts along a levels and were better able to smooth their variety of dimensions that typically are not labor supply over illness. It seems that Dupas easily measured. and Robinson’s initial hypothesis was cor- The bank charged substantial withdrawal rect: Limited access to formal savings ser- fees, and as such, the de facto interest rate on vices can impede business growth in poor the account was negative. Despite this, countries. Source: Dupas and Robinson 2011. 202 The New Microfinance Handbook ­anage liquidity throughout a network of m intermediary. The institution should have a branches, outlets, or agents (see chapter 14). demonstrated track record of high-level per- Additional (and sometimes substantial) reporting formance and transparency. It should have requirements and compliance issues (for example, effective and efficient operations, maintain a strong rooms and safes, teller windows) to satisfy high rate of loan recovery, and regularly earn the regulatory body imply increased personnel good returns. It should be financially self-­ costs and the need for expanded information sys- sufficient, with considerable outreach. tems and infrastructure. According to Robinson e. Preparation for far-reaching changes. Before (2006), five main conditions need to be met for a becoming regulated and undertaking deposit financial institution to mobilize public deposits: mobilization, the institution’s owners, govern- a. The political economy. Mobilizing voluntary ing board, managers, and staff, as well as the public deposits requires at least a moderately licensing authorities, need to understand that enabling macroeconomy and some degree of substantial changes in the institution’s organi- political stability. zation, leadership, infrastructure, information, and operations will be required—many of b. The policy and regulatory environment. A rea- them in a relatively short period. sonably adequate policy and regulatory envi- ronment is needed—or if not immediately In order to be financially self-sufficient, insti- possible, at least consistent nonenforcement tutions that mobilize deposits from the poor must of inappropriate policies and regulations. also attract large deposits; transaction costs are Institutions licensed to take savings from the too high to collect savings in very large numbers public and to intermediate these funds need to of small accounts. Providing large numbers of operate in an environment characterized by small savers with deposit services is labor inten- liberalized interest rates and regulations sive and therefore costly—even if no interest is appropriate for commercial microfinance. paid below a minimum balance. By attracting larger deposits, the overall costs are lowered and c. Public supervision. For the protection of their liquidity risk is reduced, especially when low-­ customers, especially savers, institutions that income clients need to withdraw their savings at mobilize deposits must be publicly supervised. the same time, such as when school fees are due This generally means that their governments or in preharvest months. If large numbers of cli- must be willing to modify their standard bank- ents withdraw savings at the same time, the insti- ing supervision practices so that the rules are tution can easily run into liquidity problems. suitable for their activities. Appropriate super- When savings are collected from a range of clients vision does not mean relaxing standards; It of different income levels, including organiza- means applying high standards in ways that tions and institutions, this is unlikely to occur are relevant for financial service providers except in special circumstances such as hyperin- serving the poor. It also means ensuring that flation, regional shock, or loss of trust in the pro- the supervisory body has the capacity to mon- vider (Robinson 2006). itor effectively the performance of such licensed providers. Management Skills d. A strong institutional performance record. An Managing a financial intermediary, that is, an institution mobilizing deposits must have institution that takes savings and lends those sav- high-quality governance and management ings to others, is far more complex than managing capacity that is appropriate for a financial credit services only. Financial intermediation Savings Services 203 requires significant management skills, in partic- Managing Operations ular, strong financial capabilities, as well as Most providers that mobilize deposits have orga- knowledge of the opportunities and risks of pro- nizational structures that are both extensive and viding financial services to the poor. This can be decentralized. Locations close to deposit custom- difficult to achieve. Well-qualified managers are ers reduce transaction costs for both the provider hard to find and generally command high salaries and its clients and are an important part of estab- (Robinson 2006). lishing a permanent relationship built on mutual When mobilizing deposits, managers and staff trust, which is key to successful savings mobiliza- need to understand how local markets operate, tion. “People will deposit their savings with an how to locate potential savers, and how to design institution only if they perceive it to be reliable, instruments and services for that market. They trustworthy and professional” (Frankiewicz and also need to understand basic finance and the Churchill 2011, p. 89; see box 8.3). importance of an adequate spread between lend- Because of this extensive and decentralized ing and deposit services. They need to be trained structure, savings operations can be more vul- in developing savings products and services nerable to fraud and errors than credit opera- appropriate for all types of savers, and adapting tions. Institutions must manage the liquidity products when necessary. Both classroom and associated with larger amounts of cash and risks ­ on-the-job training are needed in market the unpredictability of the size and timing of research, including monitoring and evaluation, deposits. Effective asset liability management ­ product costing and pricing, and operational (see chapter 14) and internal controls (see procedures (Robinson 2006). ­ ­ chapter 15), for example, as well as adequate premises are crucial. Accounting, reporting, and Box 8.3  Inspiring Trust To ensure depositors develop a trust relationship with the institution, providers must do the following: • Deliver on promises, even if they seem insignificant or have no direct connection to a savings product; failure to deliver will create the impression the provider is unreliable. • Serve customers in an efficient, friendly, and responsive manner. • Provide well-defined and transparent services. • Create a secure, attractive, and professional appearance. • Hire and promote managers who demonstrate professionalism and are perceived by clients to be strong, risk-conscious, and trustworthy. • Make withdrawals simple and easy to access. • Develop marketing campaigns and promotional materials that communicate safety, reliability, transparency, and a long-term commitment to the community. • Make public relations an important component of the institution’s marketing strategy. • Provide financial counseling or financial education to increase clients’ understanding of the benefits of saving and the measures the provider is taking to ensure the safety of their funds. Source: Frankiewicz and Churchill 2011. 204 The New Microfinance Handbook audit ­systems must normally be approved by the term and the larger the amount, generally the ­ regulator as well as internal controls, and often higher the interest rate paid. Fees are often levied physical premises. Deposit mobilizing institu- for withdrawals and transfers that exceed the tions must ensure that the product terms do not number of allowable free transactions per month, increase interest rate and liquidity risk and that and for balances that fall below a predetermined the deposits mobilized are invested in assets that minimum. With deposit collectors or money match their term and pricing structure. There guards, fees are charged for collecting savings, must be sufficient reserves, capital, and operat- resulting in negative returns. ing funds to cover any operating losses or losses The interest rate paid on deposits is generally due to catastrophic events without using client based on the prevailing deposit rates of similar deposits. Internal controls must be sufficient to products in similar institutions, the rate of infla- protect savings from fraud and mismanagement tion, and market supply and demand. Risk factors and to ensure the physical security of funds. The such as liquidity risk and interest rate risk must physical premises must provide adequate pro- also be considered based on the time period of tection, accommodate clients, and inspire their deposits. Because highly liquid accounts are trust. Additional security measures are likely costly to administer, they pay lower interest. Most needed as well as reporting and information sys- savers who select a liquid account are more inter- tems. Systems must be able to handle an ested in greater access to their savings than to increased number and type of transactions asso- higher interest earnings. Fixed-term deposits pay ciated with mobilizing deposits and provide a higher rate of interest because the funds are information that is sufficient, accurate, timely, locked in and provide a more stable source of and transparent. Finally deposit-taking institu- funding than more liquid savings products. tions need a profitable place to invest mobilized In addition to interest paid on deposits, provid- deposits beyond those that are used for lending ers incur numerous other costs, including staff (CGAP 2005; McKee 2005). and branch costs to mobilize and administer Altogether, financial institutions that mobilize deposit accounts. Deposits do not generate reve- deposits generally have significantly more savings nue for providers; rather, they provide capital, accounts than loan accounts. It is necessary that which is used to fund loans or other investments institutions know how to design and deliver prod- for a return. As discussed in chapter 9, credit prod- ucts, including loans, for a wide variety of clients ucts are priced to cover all operating costs, loan and that they have realistic business plans that loss provisioning costs, and the cost of capital. The demonstrate ongoing profitability. Revenues and cost of capital includes the costs of deposits and costs need to be detailed, and plans must also con- other debt and equity. A provider needs to earn a sider the cost of capital in addition to the admin- spread between what it pays for savings and what istrative and financial costs of deposits. it earns from lending services. This spread is then used to cover other costs, namely, operating costs, Pricing Savings Products provisioning costs, and other capital costs. Credit Some savings services pay interest (or a share of and savings products should therefore be designed earnings if savings are on lent) to the saver; others and priced together to enable both appropriate do not and, in fact, may result in negative earnings coverage and institutional profitability (Robinson (the value of savings declines) because of fees 2006). Determining the rate of interest to pay on charged. The interest rate paid on savings prod- deposits is complicated and must be considered as ucts is often tied to the balance and length of time part of the overall cost structure of providing the savings are held on deposit; the longer the financial services (see chapter 15). Savings Services 205 Some providers organize their branches or funding within the system, it will then access field offices as profit centers and employ a method external funding and on-lend it to its branches for of transfer pricing, ensuring full-cost coverage a set price. throughout the branch network (if applicable). The transfer price charged to branches (or Transfer pricing refers to the pricing of services paid to branches for excess deposits) is set either provided by the head office to the branches on a close to the interbank lending rate or at a rate cost-recovery basis. For example, costs incurred somewhat higher than the average costs of funds in the head office to manage the overall organiza- of the provider. This provides incentives for tion are prorated to the branches based on a per- branches to mobilize savings locally rather than centage of assets (loans) or liabilities (deposits) relying on the excess liquidity of other branches held at the branch. Funding costs are apportioned within the network. It can also result in addi- as well. A branch that disburses a larger volume of tional revenue at the head office level to cover loans than the deposits it collects needs to receive overhead. Transfer pricing ensures transparency funding from the head office (or another branch) and instills accountability and responsibility in to fund those loans. The head office (or a regional the branches. office) acts as a central funding facility to ensure that any excess deposits in one branch are “sold” Savings Products to another branch to fund their loans. The branch that has excess deposits receives payment (inter- In general, an institution providing deposit ser- est revenue) for those funds, while the branch vices does not need a large number of products receiving them pays a fee (interest expense). If (see box 8.4). A savings account permitting the head office determines that there is no excess unlimited transactions, a time deposit account Box 8.4  Savings Services—Not Only about Products “For many years, product design was clients; information systems, space use, neglected in microfinance. Now the pendu- asset-liability management, liquidity, and lum has swung, and product design is too cash management; efficiency of operations often overemphasized by managers who (for example, short waiting periods for savers sometimes appear to think that the race is who want to deposit or withdraw); quality of won by the provider with the largest number administration; quality of the loan portfolio; of products. Well-designed savings products trustworthiness of the institution; and many are essential, but they are only one element other factors are crucial to capturing and in a much larger set of requirements for suc- maintaining public savings. Getting the struc- cessful mobilization of savings from the ture and operations of these interlinkages public—many of which tend to be overlooked ­ right—which requires experienced, skilled as increasing emphasis has been placed on management at all levels—is far more impor- designing multiple products. Product deliv- tant than a wide range of products. The race ery is far more difficult than product design. is generally won by the institution that dem- Convenience of branch location and opening onstrates the best delivery of a few well-­ hours; attitudes of managers and staff toward chosen products.” Source: Robinson 2006. 206 The New Microfinance Handbook (which includes options for relatively short transactions are restricted). For example, for sav- maturities), potentially a contractual savings ings accounts with no minimum balance require- account to support education, retirement, ment, to compensate for the small balances housing, or upcoming ceremonies, and, if neces- generally held in these accounts, providers may sary, one or two other deposit products are suffi- restrict the number of monthly transactions and/ cient. They must be carefully designed through a or limit withdrawals to lower-cost access points balance of product features, security, conve- such as automated teller machines or mobile nience, and price to allow them to be used in dif- phones. Passbook savings generally offer clients ferent combinations for different purposes by all interest on the funds deposited, although many types of savers—poor and nonpoor, individuals providers also charge transaction and other fees and institutions (Robinson 2006). associated with services. Deposit products available from regulated pro- The main advantages with passbook accounts viders include current accounts, savings accounts, are liquidity and higher interest rates compared to contractual savings accounts, time deposits, and current or transaction-based accounts. Generally long-term savings or micropensions.3 passbook savings accounts are used for short-term savings for cash flow management or for emer- Current Accounts gencies or unexpected opportunities. Interest paid Current accounts are generally considered to be is normally lower than that paid on time deposits. more of a transaction account than a savings account (see chapter 12). They provide the Contractual Savings Accounts account holder with the ability to manage daily Contractual savings accounts (also called com- cash flows and transfer funds and make pay- mitment savings or target savings) require clients ments. Also called checking accounts or demand to commit to regularly deposit a fixed amount for or site deposits, current accounts are fully liquid a specified period to reach a predetermined date accounts in which the depositor may deposit and or amount. Clients are prohibited from or penal- withdraw any amount at any time with no ized for withdrawals before the maturity date. advance commitment or notice. Current accounts After the maturity date, the client can withdraw may be set up with automatic transfers, for exam- the entire amount plus the interest earned. ple, to pay bills each month or to transfer to Contractual savings accounts help clients another account. accumulate funds to meet specific expected Customers often must deposit a minimum needs, such as school fees or to pay for an upcom- amount to open a current account and maintain a ing celebration such as a marriage (see box 8.5). minimum balance to keep it active. Generally cur- Generally the interest paid on contractual savings rent accounts do not pay any interest but charge is similar to other savings accounts, the primary clients fees either on a monthly or a transaction benefit being the discipline they provide. basis or both. If clients overdraw from their cur- Contractual savings products can be used as a rent accounts, they may be charged a penalty or first entry point for youth in microfinance. Often the payment may be rejected outright. only small modifications are needed to tailor a regular product for youth, including, for example, Passbook Savings Accounts low or no minimum balances or a link to a finan- A basic savings account or passbook savings is an cial education program. account that is fully liquid (that is, money can be An innovative savings product similar to con- freely deposited and withdrawn by the account tractual savings is borrowing for the purpose of holder) or semiliquid (that is, the number of saving (see box 8.6). Savings Services 207 Box 8.5  Saving for Education Opportunity Bank Malawi offers a savings agreement between the parents and the account designed for parents and guardians bank to use the savings to pay for their chil- with school-age children called Tsogolo dren’s education. Parents can open the Langa. The account allows parents to more account and voluntarily deposit money into easily pay school fees and other related it if the beneficiary child is a student at any expenditures and to keep their money safe of the bank’s approved schools. The account until the fees are due, ideally allowing chil- offers no service charges and makes fee dren to go to school continuously. The payments directly to the school on behalf of account features include a minimum bal- the depositor. Interest is paid on a monthly ance of MK 300 (US$1.85) and a contractual basis. Source: Opportunity Bank Malawi, http://www.oibm.mw/index.php/deposit-products/62-tsogolo-langa-account. Box 8.6  Borrowing to Save P9 is a savings-and-loan service offered to Jipange Kusave (JKS) builds off of the low-income households by SafeSave in same concept, offering a savings-and-loan Bangladesh that builds on Stuart Rutherford’s service through Kenya’s hugely popular pioneering work on understanding how the mobile money service M-PESA. The first loan poor manage their financial lives. P9 “lends to is usually small, about US$20. Half of it is save” by advancing only a portion of the loan deposited into the client’s M-PESA account to amount and holding the remainder (40–50 use as they please, and the other half goes percent) in escrow as “savings.” Over time, into a savings account in a regulated bank. the client pays the entire loan amount and JKS encourages clients to set “savings goals” retains the savings. For example, if a client and commit to a number of smaller wants to save US$5, she borrows US$10 and commitments—a goal of US$50 for example, ­ immediately has use of US$5 to do with what- could involve five rounds of US$20 each. ­ JKS ever she wishes. The remaining US$5 is charges an origination fee of 2–5 percent, an locked away as savings. She cannot touch it early savings withdrawal fee of 5 percent, and until she repays the US$10 in full, at which a charge from M-PESA of K Sh 10 (approxi- point, she has accumulated US$5 in savings. mately US12 cents) per transaction. Repay­ The client is able to borrow increasing ments for both P9 and JKS can be made as amounts in subsequent tranches, building up often as desired and in any amount. significant savings within a short amount of However, the products are not without time. P9 has an initial registration fee of 200 their challenges. The variable costs to clients takas (approximately US$3), a disbursement can be quite high, and securing appropriate fee of 3 percent, no interest, and allows banking licenses and satisfying regulatory top-ups. requirements will be key to their growth. Source: Ashriul Amin. 208 The New Microfinance Handbook Time Deposits micropensions, and savings combined with Time deposits—also called fixed deposits, term insurance products. deposits, or certificates of deposit—are savings prod­ucts in which a client makes a one-time Pensions deposit that cannot be withdrawn for a specified Although not highly prevalent among poor com- period or term without penalty. At the end of the munities, pensions are a type of savings product term, the client can withdraw the entire amount that provides a regular flow of payments from with interest or roll over the deposit for another retirement to death. Sometimes these payments term. Financial institutions offer a range of possi- transfer to a surviving spouse. Pensions are pri- ble terms and usually pay a higher interest rate on marily provided by employers. Benefits accumu- time deposits than on passbook or contractual late based on earning level and years of service; savings accounts because these accounts offer the the more years of service and the higher the institution larger amounts of money for longer employee’s earnings, the greater the amount of periods of time at lower costs (see box 8.7). payments. Pension funds can be internally man- aged by the company or outsourced to an invest- Long-Term Savings and Micropensions ment manager and can be fully funded by the Poor people are vulnerable because low and employer (defined benefit pension) or a defined irregular incomes combined with insufficient contribution pension funded by both the financial tools often leave them with little to no employer and employee, with the employer savings as they age. In many developing coun- matching the employee’s contributions using a tries, particularly in poor communities, children formula such as 2:1 or 0.5:1. and grandchildren will take financial responsi- Even less prevalent—and, in fact, so far there is bility for older family members and provide very little long-term experience to draw from— them shelter and financial resources. In addi- micropensions provide a form of income security, tion to family support, there are financial ser- enabling voluntary savings for old age and aimed vices that facilitate savings for long-term goals at lower income populations (Sterk 2011). They and/or retirement, including long-term savings, require fixed contributions over time, which are Box 8.7  Nicaragua—Promoting Agriculture Savings The Central de Cooperativas de Ahorro y farmers receive. Credit unions work with Crèdito Financieras de Nicaragua (CCACN) farmer members to open a savings account is a second-tier network of Nicaraguan and deposit the proceeds from each harvest credit unions. CCACN developed a time and then work with each farmer to identify deposit product called “Agriculture Salary” his or her individual expenses and deter- with a twist. Rather than receive all the pro- mine an appropriate “salary”—a portion of ceeds of an annual or semiannual harvest harvest proceeds on deposit combined with as a lump sum all at once, the goal of the interest—to be withdrawn from the credit product is to smooth the flow of income union each month. Source: WOCCU 2003. Savings Services 209 invested in term savings accounts, group term small regular deposits over time and then with- savings accounts, or physical assets such as prop- draw either the lump-sum amount or, like erty, land, and livestock, to create a consistent micropensions described above, with an annu- flow of income when the micropension holder ity allowing a regular stream of payments over can no longer generate income. Micropensions time after a certain age (see box 8.8). Although offer an option to invest in a financial asset over clients appreciate the illiquid nature of LTCS time that produces a flow of income—either as a products as well as the benefits of discipline lump sum, on a periodic basis, or through the pur- (like other contractual savings products), they chase of an annuity—beginning at a predeter- necessarily compare the options of investing mined age (Sterk 2011). Micropensions can also elsewhere and the associated risks. In particu- be informal whereby money is invested in the lar, if available, clients need to consider the businesses or education of family members in ­ benefits of saving long term versus buying exchange for future income or subsistence sup- insurance. The risk of LTCS products is that the port (Rutherford 2008). person may die before the savings goal is reached. This risk is addressed with retirement Long-Term Contractual Savings and life products offered by insurance compa- Similar to micropensions, long-term contrac- nies (Frankiewicz and Churchill 2011). tual savings (LTCS) products can be used to Finally, retirement planning can also involve the prepare for retirement and to build resources combination of savings and insurance products, for life-cycle events anticipated in the future. specifically, savings completion insurance, endow­ LTCS products work much like other contrac- ment plans, or annuities. This is discussed under tual ­savings products whereby clients make insurance products in chapter 11. Box 8.8  Grameen’s Deposit Pension Scheme (GPS) In 2001 Grameen Bank began to offer long- Deposits are made during the weekly term savings products for the poor. Terms are meetings that all Grameen members are 5 or 10 years, and equal monthly deposits are obliged to attend. Grameen thus uses its own made in sums as little as US$1. Interest on the “agents,” because the agents are also credit 10-year term is paid at 12 percent per annum. officers. After five years, in 2005 GPS had This is about 8 percent in real terms and gener- attracted more than 3 million accounts holding ous compared with rates offered by commer- approximately US$83 million. By the end of cial banks for similar products. (This has led to October 2011 the balance was Tk 38.87 billion increased demand from nonpoor households (US$513 million). to obtain Grameen membership and brings Understanding precisely why the product into question the profitability of the product.) is so popular is complicated by the fact that all The depositor gets almost twice the amount borrowers with a loan of more than US$125 of money she saved at the end of the period. are required to hold a minimum-value GPS The matured sum may be taken in cash or as account. Nevertheless, many savers hold monthly income. Savers may also transfer the more than one account, suggesting that the sum into one of Grameen’s fixed deposits. product is valued for its own sake. Source: Frankiewicz and Churchill 2011, adapted from Roth, McCord, and Liber 2007; http://www.grameen-info .org/index.php?option=com_content&task=view&id=26&Itemid=0. 210 The New Microfinance Handbook Notes Innovations for Poverty Action, New York and New Haven, CT.  1. The willingness of poor women and men to *McKee, K. 2005. “Prerequisites for pay for deposit collection demonstrates the Intermediating Savings.” In Savings Services for value of saving services and the overall need the Poor, ed. Madeline Hirschland, 27–42. for both the ability and discipline to save small Bloomsfield, CT: Kumarian. amounts frequently. Robinson, Marguerite. 2004. “Mobilizing Savings  2. This section is summarized from Robinson from the Public: Basic Principles and (2006). Practices.” USAID, SPEED Network, and  3. This description of products draws substantially Women’s World Banking, Kampala, Uganda. from Gilsovic, El-Zoghbi, and Foster (2010). *———. 2006. “Mobilizing Savings from the Public.” In Transforming Microfinance Institutions: Providing Full Financial Services to the Poor, ed. References and Further Reading Joanna Ledgerwood and Victoria White. * Key works for further reading. Washington, DC: World Bank. Ashraf, Nava, Dean Karlan, and Wesley Yin. 2006. Roe, Alan, Robert Stone, Stephen Peachey, and “Tying Odysseus to the Mast: Evidence from a Abigail Carpio. 2008. “Increasing the Number of Commitment Savings Product in the Philippines.” Deposit Accounts: A White Paper for Quarterly Journal of Economics 121: 635–72. Discussion.” Oxford Policy Management, Oxford. *CGAP (Consultative Group to Assist the Poor). Rosenberg, Rich. 1996. “Microcredit Interest 2005. “Microfinance Consensus Guidelines Rates.” CGAP Occasional Paper 1. CGAP, Developing Deposit Services for the Poor.” Washington, DC. CGAP, Washington, DC. Roth, Jim, Michael McCord, and Dominic Liber. *Christen, Robert Peck, and Ignacio Mas. 2009. 2007. The Landscape of Microinsurance in the “It’s Time to Address the Microsavings World’s 100 Poorest Countries. Appleton, WI: Challenge, Scalably.” Enterprise Development MicroInsurance Centre. and Microfinance 20 (4): 274–85. Rutherford, Stuart. 2008. “Micropensions: Old Age Dupas, Pascaline, and Jonathan Robinson. 2011. Security for the Poor?” In New Partnerships for “Savings Constraints and Microenterprise Innovation in Microfinance, ed. Ingrid Development: Evidence from a Field Matthäus-Maier and J. D. von Pischke, 241–64. Experiment in Kenya.” NBER Working Paper Berlin: Springer. 14693. NBER, Cambridge, MA, October 27. *———. 2009. The Poor and Their Money: An Essay *Frankiewicz, Cheryl, and Craig Churchill. 2006. about Financial Services for Poor People. New Making Microfinance Work: Managing for Delhi: Oxford University Press. Improved Performance. Geneva: International Sadana, Mukesh, et al. 2011. “Deposit Assessment Labour Organization. in India.” IFC, MicroSave, and Ministry of *———. 2011. Making Microfinance Work; Managing Foreign Affairs, March. http://www.microsave Product Diversification. Geneva: International .org/sites/default/files/research_papers/ Labour Organization. Microsave_IFC.pdf. *Gilsovic, Jasmina, Mayada El-Zoghbi, and Sarah *Sterk, Boudewwijn. 2011. “Micro Pensions: Foster. 2010. “Advancing Saving Services: Helping the Poor to Save for the Future.” Aegon Resource Guide for Funders.” CGAP, Global Pensions, The Hague, May 31. Washington, DC. WOCCU (World Council of Credit Unions). 2003. *Karlan, Dean, and Jonathan Morduch. 2009. “The “A Technical Guide to Rural Finance: Exploring Economics of Saving. Access to Finance: Ideas Products.” Technical Guide 3. WOCCU, and Evidence.” Financial Access Initiative and Madison, WI, December. Savings Services 211 CHAPTER 9 Credit Joanna Ledgerwood and Julie Earne Credit products offer clients the ability to bor- requirements (to ensure repayment). The core row money in exchange for an agreement to components of a loan are size, term, repayment repay the funds with interest and/or fees at some terms, lending methodology, collateral or secu- future point(s) in time. Credit products range rity, and pricing. from working capital loans, emergency and con- Loan sizes vary depending on need and can be sumption loans, to leasing products and housing as low as US$5 from a community-based pro- loans. They are found at the core of the financial vider to upwards of US$20,000 or more for an market system. individual business loan or housing loan. Loan This chapter provides a brief overview of sizes can increase over time based on client lending products including product characteris- needs, debt capacity, and credit history; loans tics, pricing, methodologies for determining the should not increase simply as a function of con- effective cost of borrowing, and the most preva- tinued borrowing. lent credit products accessed by poor people Loan term (or tenor) refers to the length of today. It will be of interest to practitioners, time the loan is intended to be outstanding. Most donors, and others wanting to support outreach microfinance loan terms range from three months of credit to the poor. to one year, although terms can be up to three years or longer. Group loans tend to have short Characteristics of Credit Products maturities given they are normally small and Loans are structured based on client demand, sometimes provided to clients without a credit capabilities of the provider, and risk management history. Agriculture loans may have longer terms Contributions to this chapter were made by Liz Case. Credit 213 to match the planting and harvest period, while individuals and, in some cases, whether they housing loans may be even longer due to their must adhere to Islamic banking principles. The larger size and purpose. Given the higher risk lending methodology chosen greatly influences associated with a longer term, loan terms can product design, client selection, the application increase as clients establish a track record. and approval process, loan repayment, and mon- Repayment terms affect the credit risk, trans- itoring and portfolio management. Lending action costs, and accessibility of loan products. methodology also impacts the institutional Loans are usually designed to be repaid in peri- structure and staff requirements, including odic (often equal) installments over the loan term training and compensation. or at the end as a lump sum, ideally matched to the borrowers’ cash flows. Loan payments (usu- Group Lending ally comprising principal plus interest but can be Group-based approaches lend either to the group interest only if the principal is paid all at the end) itself as one loan, to individuals who are members can be made in weekly, biweekly, or monthly of a group, or to groups who then on-lend individ- installments depending on the loan structure, or ually to the members. Group lending reduces can be a lump-sum payment at the end of the transaction costs and risks to providers and often term. The frequency of loan payments depends facilitates greater access to financial services for on the needs of the client and the ability of the those who are difficult and expensive to reach, provider to ensure repayment and manage liquid- including remote, rural populations, those with ity. A grace period (period of time between the low debt capacity, and those who have no collateral disbursement and first repayment) may also be or credit history. The group mechanism effectively provided, especially with agriculture loans to shifts the bulk of the responsibility for screening, allow for planting. monitoring, and enforcement from the provider to More frequent repayments serve to reduce the borrowers, and thus some of the costs. credit risk but in turn can increase the transaction Some of the most well-known group lending costs and may make loans less accessible for bor- methodologies include the following: rowers in remote areas or those with infrequent cash flows. Depending on how, when, and where • Grameen—five-person subgroups, six of which payments are made, the risk of default may make up a center of 30 individual borrowers; increase if the borrower is not able to manage the subgroups guarantee each other’s loans, larger installments or a final lump sum. and the center provides a secondary guarantee. Loan products must be well structured to meet client needs and provided in a safe, transparent • Solidarity groups—three to 10 people per manner. For example, it is imperative that provid- group, each guaranteeing each other’s individ- ers effectively assess debt capacity to ensure that ual loans. clients borrow amounts they can afford to repay • Village banks—15 to 50 people who form a “vil- on time. When clients are unable to repay, provid- lage bank” that makes individual loans to the ers should have policies that support delinquent members of the village bank. In some cases borrowers and limit further harm while still pooled member savings may be loaned to ensuring a strong repayment discipline. members within the group; such loans are referred to as “internal account” loans. Lending Methodology Lending methodologies differ with respect Disadvantages of the group approach include to whether loans are made to groups or to higher transaction costs for clients due to time 214 The New Microfinance Handbook spent in group meetings (and away from produc- officers’ cash flow analysis. These worksheets tive activities or household responsibilities), a rel- enable a loan officer to create a basic balance atively limited product offering, a lack of privacy, sheet and income statement based on revenues, and of course the risk a fellow group member will expenses, turnover, and value of stock and sup- default. Covariance risk—the tendency of group plies in the household or enterprise. members to be affected by the same risk at the A cash flow analysis can be supplemented same time as a result of similar production activi- with other tools such as credit ratings, credit ties or event—can also exist, resulting in higher scoring, and psychometric evaluations, depend- risk for both the provider and borrowers. Group ing on their availability in a given market. A training costs can be high because of the impor- credit rating is obtained from a credit bureau tance of quality group formation and related con- and provides information on a borrower’s his- sumer education. Furthermore, group members tory of repayments and delinquencies from all sometimes feel pressure to borrow even if they do providers participating in the credit bureau (see not need a loan or are unsure of their ability to chapter 18). repay. This may also happen in Savings Groups or For clients without a credit history and with- Self-Help Groups even though loans are made by out formal employment, providers use other data the group to individuals. to better assess risk and help currently unbanked clients develop a formal credit history. Such data Individual Lending can include the following: Individual lending requires greater up-front anal- ysis of clients and their cash flows, sometimes • Bill payments (electricity, gas, or water) physical collateral, and frequent and close contact • Phone bills (mobile and fixed, post- and with clients during the term of the loan. Loan prepaid) approvals and amounts are based on an appli- cant’s eligibility and debt capacity, which in turn • Rental payments are dependent upon a number of factors, includ- • Transaction data (remittances, withdrawals, ing personal and business characteristics, for deposits, or transfers).1 example, age, gender, or reputation, sources and amount of income, age of business (if applicable), These data are sometimes put into a credit cash flow, and available collateral. Historically scoring that uses historic payment data to math- many providers also considered the purpose of ematically predict the probability of a client the loan as part of the loan approval decision, but defaulting. Instead of conducting extensive this is less and less common as providers begin to analysis of financial statements, credit scoring understand client cash flows, their needs, and the uses simple predictive variables, such as length fact that money is fungible within households and of time in business, bill payments, and length of microenterprises. time with the financial institution, to generate a Cash flow analysis is used primarily for indi- score that represents the probability of future vidual loans and focuses on the overall cost struc- repayment (Frankiewicz and Churchill 2011). ture of the household or microenterprise, The increasing use of electronic channels by including all revenues flowing in and expenses lending institutions (for example, mobile bank- flowing out, anticipated cash flows during the ing, ATMs, or banking agents) increases the abil- term of the loan, and the absorptive debt capacity ity to track and utilize clients’ payment and of the borrower. Many individual providers have transaction histories to predict payment capac- designed streamlined worksheets that guide loan ity and creditworthiness. Credit 215 Psychometric testing is a newer form of client creditors. Other Islamic banking principles state evaluation and is in the early stages of develop- that (1) all financial transactions must be linked ment. Psychometric evaluations involve asking a to a “real” economic activity involving tangible series of questions that evaluate the potential bor- assets and (2) funds may not be invested in activ- rower’s attitude and outlook, ability, and charac- ities inconsistent with Sharia (alcohol, pork, or ter in an effort to predict creditworthiness.2 These gambling). Furthermore, contracts must reflect tests are processed by specialized companies and mutual agreement; all parties must have precise attempt to measure credit risk without depending knowledge of the product or service being on formal financial accounts, business plans, or bought or sold (Karim et al. 2008). collateral. There are various types of Islamic microfi- nance lending contracts. Murabaha sale is a Islamic Lending cost-plus-markup sale contract that requires the ­ Islamic banking requires special lending method- financial service provider to purchase the asset, ologies.3 Islamic (or Sharia-compliant) financial as requested by the client, and sell it to them at a principles strictly prohibit giving or receiving any predetermined markup to pay for the service fixed, predetermined rate of return on financial provided (see box 9.1). Contracts can also be transactions (Karim et al. 2008). Because Islamic developed as profit and loss sharing schemes: law forbids gains on lending money, Islamic Musharaka refers to equity participation in a loans are often treated more like equity than debt business with parties sharing the profits or losses with lenders considered investors rather than according to a predetermined ratio. Musharaka Box 9.1  Islamic Finance in Practice Akhuwat was established in 2001 in Pakistan Islamic microfinance services in Pakistan with the aim of providing interest-free micro- using murabaha-based financing principles to credit to the poor. Akhuwat dispenses small individuals, based on a combination of per- interest-free charitable loans (qard al-hasan) sonal guarantors, group savings accounts, with an administration fee of 5 percent. cosigners, and community recommenda- Administrative procedures and activities are tions to ensure repayment. In 2009 Islamic coordinated through mosques and the com- Relief partnered with HSBC Amanah, the munity. There are no independent officers; Islamic finance arm of the commercial bank rather, loans are disbursed and recovered in HSBC, to provide financing to its microfi- the mosque. The Islamic provider relies on nance projects in Rawalpindi. HSBC Amanah ­ collateral-free and individual financing based also assists in developing the Sharia structure on mutual guarantees. Anecdotal evidence for financing models and contracts and pro- suggests that disbursing loans in a mosque viding Islamic finance training to Islamic attaches a religious sanctity to borrowers’ Relief staff. In turn, Islamic Relief staff man- oaths to repay them on time. age the microfinance projects, including set- Islamic Relief, a Muslim international relief ting out eligibility criteria, screening potential and development organization, provides beneficiaries, and reporting to HSBC Amanah. Source: Allen and Overy LLP 2009. 216 The New Microfinance Handbook can be used to fund assets and/or for working means that the entire group no longer has access capital. Mudaraba is trustee financing in which to credit. one party provides funding while the other party Character-based lending: Some providers lend provides the managerial expertise in managing to people based on a good reputation. Before the business, and they share in the profit or loss. making a loan, the credit officer visits various Profit-and-loss sharing schemes require vigilant establishments in the community and asks about reporting and a high level of transparency for the potential client’s character and behavior. profits and losses to be distributed fairly (Karim Frequent client visits: Provided the branch or et al. 2008). credit officers are within a reasonable geographi- cal distance from their clients, frequent visits help Loan Collateral to ensure that the client is able and willing to Low-income clients often have minimal assets to repay the loan. Frequent visits also allow the pledge for loans; property, land, machinery, and credit officer to understand his or her clients’ other capital assets are often not available. cash flows and the appropriateness of the loan Because of this, collateral substitutes and alterna- (amount, term, frequency of payments, and so tive collateral are used to reduce the risk to the forth). Visits also contribute to developing mutual lender. respect between the client and the credit officer as they learn to appreciate and understand each Collateral Substitutes other’s commitment to their work, which can One of the most common collateral substitutes is lead to stronger relationships that benefit both peer pressure, either on its own or jointly with the clients and providers. However, more fre- group guarantees. quent client visits entail additional costs that Group guarantees: Many providers facilitate need to be considered. the formation of groups whose members jointly guarantee each other’s loans. Guarantees are Alternative Forms of Collateral either implicit guarantees, with other group Commonly used alternative forms of collateral members unable to access a loan if all members include compulsory savings and personal are not current in their loan payments, or actual guarantees. guarantees, with group members liable if other Compulsory savings: Many providers require group members default on their loans. clients to hold a balance (stated as a percentage of Some providers require group members to the loan) in savings (or as contributions to group contribute to a group guarantee fund, which is funds) for first or subsequent loans (or both). used if one or more borrowers fail to repay. Use of Compulsory savings differ from voluntary savings the group guarantee fund is sometimes at the dis- in that they are not generally available for with- cretion of the group itself and sometimes decided drawal while a loan is outstanding. In this way by the provider. If it is used at the group’s discre- compulsory savings act as a form of collateral. tion, the group will often lend money from the By being required to set aside funds as savings, guarantee fund to the group member who is borrowers are restricted from utilizing those unable to pay. The member who “borrows” from funds. Usually the deposit interest rate paid (if the group fund is then responsible for paying the any) on the savings is lower than the return earned fund back. If use of the group guarantee fund is by the borrowers if the savings were put into their managed by the provider, the fund is seized to the business or other investments. This results in an extent of the defaulted loan, with other group opportunity cost equal to the difference between members making up any shortfall. Failure to do so what the client earns on compulsory savings and Credit 217 the return that could be earned otherwise. This be fixed for the term of the loan. The effective needs to be considered in calculating the cost of price is increased when a fee is charged in addi- the loan for the borrower. Compulsory savings, tion to interest. Fees are generally charged on the however, also provide a means of building assets initial amount of the loan disbursed and may be for clients; not all providers view compulsory sav- expressed as a percentage of the loan amount or ings as strictly an alternative form of collateral. an absolute amount to cover the cost of making A variation of compulsory savings is for bor- the loan. Other costs to the client such as trans- rowers to pay additional interest each month and, port costs to visit the provider, costs to obtain provided they have made full, on-time payments documentation such as identification or property each month, the additional amount is returned to rights, child care, and time away from business all them. For example, at the Bank Rakyat Indonesia, contribute to the total cost of credit for the bor- this is referred to as a “prompt payment incentive” rower but are generally not expressed in the price and results in the borrower receiving a lump sum of the loan and do not generate revenue for the at the end of the loan term. This benefits the bor- lender. rower and provides a concrete incentive to repay the loan on time, thus benefiting the bank as well. Calculating Interest Rates Personal guarantees: If borrowers do not have Interest rates can be stated using a declining bal- the ability to guarantee their loans, they are some- ance method or a flat-rate method. The declining times able to enlist friends or family members to balance calculates interest as a percentage of the provide personal guarantees (sometimes referred amount outstanding during the loan term. As the to as cosigners). This means that in the event of amount of principal declines with each periodic the inability of the borrower to repay, the person payment, the interest is calculated only on the who has provided a personal guarantee is respon- remaining amount owed. The flat-rate method sible for repaying the loan. calculates interest based on the original disbursed amount (sometimes net of fees). The flat-rate Loan Pricing method is sometimes preferred by providers for Revenue on loans is, for the most part, generated the sake of simplicity in calculation; because the from interest and fees, including in some cases interest payment is the same amount each repay- penalties for late payments. Revenue needs to ment period, some providers argue that using the cover various expenses, including operating costs, flat-rate method is easier for staff and clients to loan loss provisions, and the cost of capital, ideally understand (see box 9.2). leaving a surplus (profit). Pricing requires a bal- Although many providers use the flat-rate ance between the need to cover costs through method because it is simple to calculate, it results revenue with the need for simplicity, transpar- in higher effective rates of interest (and thus ency, and affordability for clients. For community- higher costs for the borrower) for the same based lenders who have minimal if any costs, the stated rate compared to interest calculated on a price for loans is usually set based on demand and declining balance. For example, by month 6 of a supply. If the price is set too high, there will be 12-month loan for 1,000, the borrower will owe little demand and therefore minimal returns; if it only 500 (approximately) if he or she has paid in is set too low, demand will exceed supply. regular weekly installments. At that point, if the The price of loans is normally stated as a nom- loan price were to be calculated using the declin- inal interest rate—a percentage of the loan ing balance method, interest would be charged amount. Interest rates can be flexible and change on only 500 rather than 1,000. (Note that with depending on market conditions, or, more often, interest paid on the declining balance, a greater 218 The New Microfinance Handbook Box 9.2  The Flat-Rate Method The flat-rate method calculates interest as a percentage of the initial loan amount rather than the amount outstanding (declining) during the loan term. Using the flat-rate method means that interest is always calculated on the total amount of the loan initially disbursed, even though periodic payments cause the outstanding principal to decline. To calculate interest using the flat-rate method the interest rate is simply multiplied by the initial amount of the loan. For example, if a provider charges 20 percent interest using the flat- rate method on a 1,000 loan, the interest payable is 200. For example, loan amount: 1,000; 12-month loan term; monthly loan payments: 100; interest rate: 20 percent. Outstanding Month Payments Principal Interest balance 0 — — — 1,000.00 1 100 83.33 16.67 916.67 2 100 83.33 16.67 833.34 3 100 83.33 16.67 750.01 4 100 83.33 16.67 666.68 5 100 83.33 16.67 583.35 6 100 83.33 16.67 500.02 7 100 83.33 16.67 416.69 8 100 83.33 16.67 333.36 9 100 83.33 16.67 250.03 10 100 83.33 16.67 166.70 11 100 83.33 16.67 83.37 12 100 83.33 16.67 0.00 Total 1,200 1,000.00 200.00 — Source: Ledgerwood 1998. portion of the monthly payment is paid in inter- However, providers should realize that regard- est during the early months of the loan and a less of the nominal rate quoted, it is important greater portion of principal is paid toward the that all interest calculations are transparent. end of the loan. This results in a slightly larger The examples in boxes 9.2 and 9.3 illustrate amount than half of the principal remaining out- that with all other variables the same, the amount standing at the midpoint of the loan. In the of interest paid on a loan with interest calculated example in box 9.3, in month 6, 524.79 is still out- on a declining balance is much lower than that on standing, not 500.) a loan with interest calculated on a flat-rate basis, The declining balance method is a fairer way for the same stated rate. To compare rates of to price loans but more difficult to calculate interest calculated by different methods it is nec- and may be confusing to borrowers (box 9.3). essary to determine what interest rate would be Credit 219 Box 9.3  Declining Balance Method To calculate interest on the declining balance, a financial calculator is required. On most financial calculators, present value and payment must be entered with opposite signs; that is, if present value is positive, payment must be negative, or vice versa. This is because one is a cash inflow and one is a cash outflow. Financial calculators allow the user to enter different loan variables as follows: PV =  Present value, or the net amount of cash disbursed to the borrower at the beginning of the loan i = Interest rate, which must be expressed in same time units as n below n = Loan term, which must equal the number of payments to be made PMT = Payment made each period. In the example above, a one-year loan of 1,000 with monthly payments and 20 percent interest calculated on the declining balance is computed by entering the following: PV = –1,000 (enter as negative amount, as it is a cash outflow) i = 20 percent a year; 1.67 percent a month n = 12 months Solve for PMT: PMT = 92.63. Total payments equal 1,111.56 (12 months at 92.63). Total interest is 111.56. Loan amount: 1,000; 12-month loan term; monthly loan payments: 92.63; interest rate: 20 percent. Month Payments Principal Interest Outstanding Balance 0 — — — 1,000.00 1 92.63 75.96 16.67 924.04 2 92.63 77.23 15.40 846.79 3 92.63 78.52 14.21 768.29 4 92.63 79.83 12.81 688.46 5 92.63 81.16 11.48 607.30 6 92.63 82.51 10.12 524.79 7 92.63 83.88 8.75 440.91 8 92.63 85.28 7.35 355.63 9 92.63 86.70 5.93 268.93 10 92.63 88.15 4.49 180.78 11 92.63 89.62 3.02 91.16 12 92.63 91.16 1.53 0.00 Total 1,111.56a 1,000.00 111.76a — Source: Ledgerwood 1998. a. Difference of 0.2 is due to rounding. 220 The New Microfinance Handbook required when interest is calculated on the Calculating Effective Rates declining balance to earn the same nominal amount of interest earned on a loan with a flat- The total cost of a loan is often expressed as the rate basis calculation (see box 9.4). “effective interest rate.” The effective rate of interest refers to the inclusion of all direct finan- cial costs of a loan in one rate. Effective interest Fees and Other Service Charges rates differ from nominal rates by incorporating In addition to charging interest, many providers interest, fees, the interest calculation method, and also charge a fee or service charge when disburs- other loan requirements into the financial cost of ing loans. Fees or service charges increase the the loan. The effective rate also includes the cost financial costs of the loan for the borrower and of compulsory savings or group fund contribu- revenue to the provider. Fees are often charged as tions because these are financial costs to the bor- a means to cover initiation costs or to increase the rower. Other transaction costs, both financial and yield to the provider instead of charging higher nonfinancial, incurred by the borrower to access nominal interest rates. the loan, such as opening a bank account, trans- Fees are generally charged as a percentage of portation, child-care costs, or opportunity costs, the initial loan amount and are collected up- are not included when calculating the effective front rather than over the term of the loan. rate because these can vary significantly by bor- Because fees are not calculated on the declining rower. The effective rate of interest is useful for balance, the effect of an increase in fees is greater determining whether the conditions of a loan than a similar increase in the nominal interest make it more or less expensive for the borrower rate (if interest is calculated on the declining than another loan and the effect of changes in balance). pricing policies. Box 9.4  Equating Declining Balance and Flat-Rate Methods A 1,000 loan with 20 percent interest calculated on a declining balance for one year with monthly payments results in interest of 112 (rounded from 111.56). The same loan with interest calculated on a flat-rate basis results in interest of 200. To earn interest of 200 on a loan of 1,000 with interest calculated on the declining balance, the interest rate would have to increase by 15 percentage points to 35 percent (additional interest revenue of 88 based on interest on a 1,000 loan at 35 percent declining balance results in a total interest cost of 200, rounded from 199.52). Interest 35% Interest 20% Interest Interest declining declining balance 20% flat Difference 20% flat balance Actual costs 112 200 88 200 200 Source: Ledgerwood 1998. Credit 221 When interest is calculated on the declining Given all the possible variables when structur- balance and there are no additional financial costs ing loans, numerous examples could be provided to a loan, the effective interest rate is the same as and the permutations are many. Various sources the nominal interest rate. Many providers, how- are available that explain in more detail how to ever, calculate the interest on a flat-rate basis, calculate effective rates, including Rosenberg charge fees as well as interest, or require borrow- (1996), Ledgerwood (1998), and mftransparency. ers to maintain savings or contribute to group org. In particular, mftransparency.org provides a funds (guarantee or insurance funds). downloadable Excel spreadsheet called the Variables of microloans that influence the “Calculating Transparent Pricing Tool.”4 effective rate include the following: In reality, it is possible for all providers, even without sophisticated systems, to calculate the • Nominal interest rate declining balance interest rate and communicate • Method of interest calculation: declining bal- the effective interest rate to clients. Using several ance or flat-rate widely available tools, a provider can amortize the loan repayment so that each installment is the • Payment of interest at the beginning of the same, thus maintaining simplicity for clients who loan (as a deduction of the amount of principal want to pay the same installment each period. It is disbursed to the borrower) or over the term of used by most, if not all, formal financial institu- the loan tions. Also, if all providers used the declining bal- • Service fees either up front or over the term of ance method, it would enable price competition the loan based on transparency.5 • Contribution to guarantee, insurance, or group fund Loan Products • Compulsory savings or compensating balances As we now know, poor women and men have a and the corresponding interest paid to the bor- multitude of financial service needs. In addition, rower either by the provider or another insti- more and more providers acknowledge that tution (bank or credit union) money is fungible; that is, loans intended for a • Payment frequency specific purpose may be used for something else within the household or business. In response • Loan term providers have expanded their credit product • Loan amount. offerings to include more than the standard microenterprise loan for working capital or When all variables are expressed as a per- fixed assets. Loans are beginning to be made centage of the loan amount, a change in the available for different purposes, including the absolute amount of the loan will not change the following: effective rate. Calculation of the effective rate demonstrates • Cash flow management (working capital and how different loan product variables affect the consumption loans) overall costs and revenues of the loan. Box 9.5 • Risk management (emergency and top-up illustrates the effect that a change in the loan fee loans) and a change in the loan term have on the effec- tive rate (the examples are calculated on both a • Asset building and productive investment flat-rate and a declining balance basis). (fixed asset loans, leasing, housing loans). 222 The New Microfinance Handbook Box 9.5  The Effect of a Change in Loan Fees and Loan Terms With all other variables the same, the effective rate for a loan with interest calculated on a flat- rate basis will be higher than the effective rate for a loan with interest calculated on a declining balance basis. Fees also increase the effective rate, and if fees are charged, the effective rate is further increased when the loan term is shortened. This is because fees are calculated on the initial loan amount regardless of the length of the loan term. If the loan term is shortened, the same amount of money needs to be paid in a shorter amount of time, thus increasing the effec- tive rate. (This difference is greatest when a fee is charged on a loan with interest calculated on the declining balance. The shorter loan term increases the relative percentage of the fee to total costs.) Similarly, a fee that is based in currency (such as US$25 per loan application) will change the effective rate if the loan amount is changed; that is, smaller loan amounts with the same fee (in currency) result in a higher effective rate. Calculation Effective 20% annual Service Loan term cost per Fee/Term rate fee (%) (months) month (%) Change (%) 3% fee; 12-month Flat-rate 3 12 3.5 term Raise fee to 8% Flat-rate 8 12 4.3 ↑ 0.8 Lower term to Flat-rate 3 3 4.0 ↑ 0.5 3 months 3% fee; 12-month Declining 3 12 2.1 term balance Raise fee to 8% Declining 8 12 2.9 ↑ 0.8 balance Lower term to Declining 3 3 3.2 ↑ 1.1 3 months balance Note that the effect of an increase in the fee by 5 percent (to 8 percent) has the same effect (an increase of 0.8 percent per month in effective rate) whether the loan is calculated on a declin- ing balance or flat-rate method. This is because the fee is calculated on the initial loan amount. Source: Ledgerwood 1998. Cash Flow Management repay both principle and interest at predeter- Working capital loans for microenterprises were mined intervals. Working capital loans are, for the among the first microcredit products to be devel- most part, used for cash flow management to sup- oped during the industry’s initial growth phase in port productive investment. the 1970s. Working capital loans (often termed Lines of credit are often used for working capi- microenterprise loans) are provided to either tal and/or household cash flow management. start or expand enterprises with the assumption Rather than receiving a set amount of a loan that that additional business revenue will be used to is then repaid, lines of credit allow the borrower Credit 223 to access credit as needed up to a certain amount. regular income and assets, and in some cases, Repayment is often very flexible as well. Interest payment may be delayed until schooling ends. and fees (if applicable) are paid on the amount Education loans are increasingly linked with borrowed (or “drawn down”) for as long as it is financial education for youth with the view to outstanding. Lines of credit, however, require develop financial capable consumers. management systems that accurately track with- As more stakeholders begin to acknowledge drawals and payments of the line of credit as well the need for education funding, innovative prod- as the ability to ensure adequate liquidity at all ucts are being developed (see box 9.6) times; they are typically available only from com- mercial providers. Risk Management Consumption loans: Many households face Emergency loans provide funds on short notice cash management challenges related to both daily for unanticipated events. They are generally consumption and larger expenditures for life- offered by community-based providers but are cycle events such as marriages and funerals, or to becoming more prevalent with institutional pro- address emergencies or education needs. These viders. Banks sometimes make emergency loans needs are often best addressed through savings, to clients with whom they have long-term rela- but if not available or if cash flows are insufficient, tionships, often by adding to existing loans As consumption loans with appropriate loan with any loans, the debt capacity of the borrower amounts and repayment terms can be useful. The must be ensured. primary purpose of these loans is to help house- Top-up loans: Many providers, both formal and holds to smooth cash flows so that daily con- informal, offer “top-up” loans where the out- sumption becomes less dependent on income, standing loan amount can be increased if the particularly when income is erratic (Frankiewicz amount requested is relatively small. Top-up and Churchill 2011). Consumption loans may not loans were introduced to provide flexibility to tra- be available if providers are used to assessing ditional working capital loans and are generally microenterprise cash flows to determine debt processed very quickly with decisions largely capacity. Frequently when consumption loans are based on a borrower’s repayment history. not readily available, borrowers will take a work- ing capital loan and use it for consumption. Asset Building and Productive Investment Salary loans are made to clients with a regular Fixed asset loans are used to finance a specific source of income through salaried employment. asset such as a sewing machine or motorcycle; The borrower’s salary provides collateral for the generally the assumption is the asset will con- loan, and repayments are usually debited directly tribute to an income-generating activity or through the employer at the time of payroll. Salary enterprise, increasing the borrower’s cash flow loans may or may not be required to be used for and, thus, capacity for debt. However, as men- specific investments or purchases and are often tioned above, stated and actual use may vary used for consumption. Salary loans, however, are fundamentally. It is impor­ tant thus to assess relatively rare for low- and very low-income pop- cash flows and debt capacity without the asset in ulations because most do not have salaried case the loan proceeds are not used to purchase employment. the asset. Acknowledging that this sometimes Education loans are used to finance primary or happens and that altogether the poor may want secondary education. These loans can have more to purchase assets that are not productive, some flexible repayment schedules and collateral providers are beginning to make loans to pur- requirements to accommodate students’ lack of chase household assets as well. 224 The New Microfinance Handbook Box 9.6  Financing Education through Human Capital Contracts Education finance has long been an area of affordable payments upon graduation regard- interest for financial service providers. One less of their level of income. Graduates are not new tool—the Human Capital Contract required to make payments when unem- (HCC)—provides an innovative approach to ployed, and they make smaller payments dur- some of the key challenges associated with ing periods of underemployment, reducing lending for higher education. the risk of unmanageable debt servicing asso- More like equity then debt, the HCC is not ciated with traditional student loans. technically a credit product. Participants apply Although the HCC lowers risk for students, for and receive a given amount of funding to lenders must cope with variable repayment help cover costs associated with higher educa- streams, income verification, and legal barri- tion. In exchange, each student commits a ers to implementation. One Latin American fixed percentage of their income for a fixed firm, Lumni, is successfully overcoming these period of time after graduation. There is no set and other challenges. Lumni smoothes the principal associated with the transaction—the risk inherent in such variable repayment student’s obligation ends after the designated schemes by pooling student contracts and number of payments (generally defined as a bringing actuarial and labor market expertise percentage of their income over a set number to bear in its fund design and contract pricing of years paid monthly) have been made work. To ensure success for both parties, regardless of the total sum paid. The percent- students have access to career development age of income commitments never exceeds services and networking activities. 15 percent and is set for each individual based By 2012, Lumni had financed over 3,000 on the expected earnings for his or her degree. students with operations in Chile, Colombia, As a result, some students will ultimately Mexico, and the United States and is currently repay more than others, but all students face planning expansion into Peru. Source: Noga Leviner, education finance specialist and former CEO, Lumni USA. Leasing agreements, financial and operating, with some Leasing is a form of financing that allows variations. ­businesses or individuals to make use of equip- Financial leases are leases in which the risks ment and other assets without having to own and rewards associated with ownership of the them or purchase them outright at the begin- leased equipment are substantially transferred ning. The user (the lessee) pays specific from the lessor to the lessee. A financial lease has ­ regular amounts to the owner (the lessor). the following common aspects: Commonly leased assets include machinery • Amortization of the asset price—includes a (such as plows or shovels), vehicles, farming purchase option for an agreed amount of pay- equipment, and livestock. Separating the use ments or at the end of the lease period and ownership of an asset eliminates the need for a business or household to commit scarce • Maintenance—lessee is responsible for main- capital to purchase assets (Wakelin et al. 2003). tenance and all risks usually associated with Broadly there are two different types of lease ownership without actually owning the asset Credit 225 • Noncancellation—the agreement is generally A variation on financial leases are sale and lease- fixed at the time of the contract (Kloeppinger- back leases; the asset is sold initially to the lessor, Todd and Sharma 2010). with the agreement that the lessee will purchase back the asset over the life of the lease agreement For farmers or enterprises constrained by a (Deelen et al. 2003). lack of assets for collateral, financial leases over- Operating leases are structured so the respon- come this constraint, and in some cases, the lessee sibility associated with ownership of the leased owns the asset outright at the end of the lease asset rests with the lessor who owns the asset. period (see box 9.7). Generally operating leases are for terms substan- Financial leases are often beneficial to provid- tially less than the economic life of the asset, and ers who may not have specific knowledge about the lessee pays to use it for a finite period of time. the equipment being leased. Under a financial An example of an operating lease includes the use lease, the lessor takes the financial risk of the of livestock or a vehicle for a few days in exchange leased product without having to assume the for payment. With operating leases, the lessor technical risk associated with product perfor- takes responsibility for the upkeep and ongoing mance. Financial leases are sometimes called operations of the asset. capital leases, lease to purchase, or hire-purchase Leasing can also be provided under Islamic leases (with a hire-purchase lease, part of the banking. Ijarah is a leasing contract typically used ownership of the asset is transferred with each to finance small equipment. The term of the lease payment, and upon payment of the last install- and the payment schedule must be determined in ment the lessee becomes the full owner). advance to avoid speculation and comply with Box 9.7  Cow Leasing K-Rep Development Agency in cooperation the microleasing company and the farmer’s with Swisscontact developed a cow-leasing family are covered. In the event of death of product. Under the lease, a farmer is loaned either the farmer or the cow, the leasing a pregnant cow and a chaff cutter used for company is paid the outstanding amount of producing milk. Various alternative forms of the loan. collateral and risk mitigation mechanisms Under the microleasing contract, the are used to protect the provider and the farmer has the benefit of a grace period of up farmer. First, as a lease, the asset itself is to three months. After this period, the farmer collateral, because the provider may take the has to begin repaying the cost of the cow plus cow back if the farmer does not make the interest. The farmer can also choose to repay agreed payments. Second, the farmer must in 9, 12, or 18 months. The farmer uses income belong to a group with other farmers who from milk sales to repay the loan. When the cross-guarantee each other. Third, the farmer farmer completes payment for the cow and has to take insurance coverage for the cow the chaff cutter, he owns both outright and and for himself. The attached credit life prod- reaps double benefit; because the cow is uct, the cost of which is built into the amount already pregnant, the farmer owns the cow of the lease, ensures that all the risks to both and its calf. Source: Baumgartner and Kamau 2010. 226 The New Microfinance Handbook Sharia principles. For the transaction to be con- collateral. Interest rates are often lower than for sidered Islamic (and not a sale camouflaged with microenterprise loans. Like other microcredit interest), the ijarah contract must specify that the products, housing loans make use of group guar- ownership of the asset, and responsibility for its antees, localized collection efforts, and minimal maintenance, remain with the funder. An ijarah collateral, often other than the house or land contract may be followed by a sales contract, itself; providers generally do not require a land whereby the ownership of the asset is transferred title to guarantee the loan, making products more to the lessee (Karim et al. 2008). accessible to low-income borrowers. Even where To date, however, leasing services have not specific housing finance products are not avail- been readily available given the difficulties of able, there is evidence that up to 20 percent of all offering leasing products and the need for special microfinance loans intended for working capital licenses and expertise. is used for housing and upgrading purposes (Ferguson 2008). Housing Loans Housing support services, such as expertise Housing loans have become more popular in the from architects, engineers, and construction last decade as providers acknowledge the need supervisors, are sometimes offered with housing for adequate shelter and the value of building loans. For example, Prodel in Nicaragua and the assets.6 Housing loans differ from traditional Patrimonio Hoy program of Cemex in Mexico mortgages in that mortgage finance refers to long- offer specific technical assistance to both ensure term loans to purchase real estate where the high-quality results and confirm that loan funds property acts as collateral. Mortgages are gener- are used for housing improvements or construc- ally offered by commercial banks and mortgage tion. Although many argue they help ensure qual- companies at market interest rates; however, up ity housing (Ferguson 2010; Vance 2010), these to 80 percent of the global population cannot services can be costly and complicated to deliver access conventional mortgage finance because of (see box 9.8). affordability issues, informal incomes, lack of The vast majority of housing loans have so far clear land ownership, insufficiently deep financial focused mainly on progressive building improve- markets, and/or weak housing finance institu- ments, where individual households take a series tions (Daphnis and Ferguson 2004). The World of loans to improve their homes incrementally Bank estimates that only 3 percent of the popula- given the costs involved and low incomes. tion of Africa can afford a mortgage (Centre for Furthermore, the poor do not show much appe- Affordable Housing Finance in Africa 2011). tite for larger loans with terms beyond five CGAP (2004) defines housing microfinance as years;7 they are well aware they will have other “loans to low-income people for renovation or needs—for education, weddings, funerals—that expansion of an existing home, construction of a will require their resources. Lastly, few provid- new home, land acquisition and basic infrastruc- ers show significant appetite for providing ture.” Some institutional providers have begun, finance for new house construction for the poor, most notably over the past 5 to 10 years, to develop or slum-upgrading financing overall, because of housing loans for low-income populations. These increases in risk and costs that this kind of larger products combine elements of both conventional project entails. Incremental lending, and the mortgage finance and microcredit. Housing housing improvements that go with it, are an eas- microfinance provides relatively larger loans ier “fit” into the existing delivery models of most (up to US$5,000) and longer terms (one to eight providers seeking financial viability (Ferguson years) and may require compulsory savings as 2010; McLeod and Mullard 2006). Credit 227 Box 9.8 Affordable Housing in Ghana In 2007 UN-Habitat, supported by the govern- on the ground floor that delivered cross- ments of Sweden, Norway, and the United subsidy. Financing and funding arrangements Kingdom, established a local finance facility included a commercial loan that was guaran- institution in Tema-Ashaiman, near Accra, teed by TAMSUF, community down pay- which was designed to provide credit ments, subsidy from partner nongovernmental enhancement (in this case, cash-collateral organizations, subsidy from government, and guarantees) and technical support to develop the commercial cross-subsidy being gener- “bankable” low-income housing or slum ated by the shops and the toilets and show- upgrading projects, that is, projects that are ers. Thus far, the community, all of whom are able to secure and repay commercial housing informally employed, have been paying the loans. The TAMSUF institution has now deliv- commercial loan with a 100 percent repay- ered on a challenging but thus far successful ment rate. project that resulted in the construction of a Although a complex project, which required mixed-use low-income housing project in the significant structuring and negotiation, the heart of the informal settlement of Amui Djor. Amui Djor building has served as a positive The three-story building, constructed on land example that communities can repay com- provided by the Tema Traditional Council, has mercial loans and can ensure and manage 32 residential units on the upper floors, which group repayment. TAMSUF is working on fur- were sold to low-income residents at a ther phases of this project, which received an reduced rate. This was made possible through award of excellence in December 2011 for the construction and operation of 15 shops innovation in social housing from ConsultASH and a commercial toilet and shower operation and the UK Charted Institute of Housing. Source: Liz Case, UN-Habitat. Notes References and Further Reading  1. CGAP Technology—Alternative Data to * Key works for further reading. Develop a Credit Score, http://www.cgap *Allen and Overy LLP. 2009. “Islamic .org/p/site/c/template.rc/1.26.2144/. Microfinance Report.” Report for the  2. The Entrepreneurial Finance Lab, http://www International Development Law Organisation, .efinlab.com. February. http://loganswarning.com/wp-  3. Adapted from Karim et al. (2008). content/uploads/ 2010/12/Islamic-  4. See http://www.mftransparency.org/resources/ Microfinance-Report.txt. calculating-transparent-pricing-tool/. Baumgartner, P., and P. Kamau, eds. 2010. “How  5. Contributed by mftransparency.org, October Can a Farmer Get a High Yielding Cow?” 2011. Organic Farmer no. 56, January, Nairobi, Kenya.  6. This section was contributed by Liz Case. Centre for Affordable Housing Finance in Africa, FinMark Trust. 2011. “2011 Yearbook.” FinMark  7. Pierre Giguere, private communication with Trust, Parkview, South Africa. http://www Liz Case, Manager, Housing Finance, .housingfinanceafrica.org/wp-content/ Développement International Desjardins, uploads/2011/09/2011-Housing-Finance-Year- Canada, June 2010. book.pdf. 228 The New Microfinance Handbook CGAP (Consultative Group to Assist the Poor). Emerging Market Niche.” Focus Note 49, CGAP, 2004. “Helping to Improve Donor Effectiveness Washington, DC. http://www.cgap.org/gm/ in Microfinance: Housing Microfinance.” document-1.9.5029/FN49.pdf. Donor Brief 20, CGAP, Washington, DC. Kloeppinger-Todd, R., and M. Sharma. 2010. Daphnis, Franck, and Bruce Ferguson, eds. 2004. “Innovations in Rural and Agricultural Housing Microfinance: A Guide to Practice. Finance.” Focus Note 18, World Bank, Bloomfield, CT: Kumarian Foundation. Washington, DC. *Deelen, Linda, Mauricio Dupleich, Louis Othieno, Ledgerwood, Joanna. 1998. Microfinance Olivier Wakelin, and Robert Berold, eds. 2003. Handbook: An Institutional and Financial Leasing for Small and Micro Enterprises: A Perspective. Washington, DC: World Bank. Guide for Designing and Managing Leasing McLeod, Ruth, and Kim Mullard, eds. 2006. Schemes in Developing Countries. Geneva: Bridging the Finance Gap in Housing and International Labour Organization. Infrastructure. Urban Management Series. Ferguson, Bruce. 2008. “A Value Chain Framework Rugby, Warwickshire: Practical Action for Affordable Housing in Emerging Countries.” Publishing. Global Urban Development Magazine 4 (2), Vance, Irene. 2010. “Housing Support Services in November. http://www.globalurban.org/ Central America: Status and Challenges.” GUDMag08Vol4Iss2/FergusonValueChain Presentation at the conference Sustainable .htm. Housing Microfinance in Sub-Saharan Africa: ———. 2010. “Financing Slum Upgrading and Slum Turning Loans into Homes, April 12–15, Nairobi. Prevention for the Poor.” Presentation at the Wakelin, Oliver, Louis Otheno, and Kirugumi conference Sustainable Housing Microfinance Kinuya. 2003. “Leasing Equipment for in Sub-Saharan Africa: Turning Loans into Business: A Handbook for Kenya.” Report, Homes,” April 12–15, Nairobi. Enterprise Development Innovation Fund, *Frankiewicz, Cheryl, and Craig Churchill. 2011. September. http://practicalaction.org/microle- Making Microfinance Work: Managing Product asing/leasing.htm. Diversification. Geneva: International Labour *Wright, Graham A. N. 2010. “Designing Savings Organization. and Loan Products.” Report, MicroSave, *Karim, Nimrah, Michael Tarazi, and Xavier Nairobi. http://www.microsave.org/research_ Reille. 2008. “Islamic Microfinance: An paper/designing-savings-and-loan-products-0. Credit 229 CHAPTER 10 Agricultural Finance Calvin Miller Rural finance refers to financial services provided specific to agriculture. This chapter focuses pri- in rural areas for agricultural as well as nonagri- marily on credit products for agriculture and will cultural purposes. Agricultural finance, primarily be of interest to practitioners, policy makers, and a subset of rural finance, is dedicated to financing regulators who want to understand the financial agriculture-related activities such as inputs, pro- service needs of individuals and businesses work- duction, storage, processing, and marketing of ing in the agriculture sector and to develop appro- goods. In addition to funding for working capital, priate products for addressing those needs. agricultural finance also funds investment and infrastructure, such as irrigation systems, storage The Context of Agricultural facilities, and machinery. It includes a variety of Finance products including credit, savings, insurance, and transfer payments. Agricultural finance is pro- Governments have tended to promote agricul- vided in various forms (cash and in-kind) to tural finance, providing credit to low-income agroenterprises and farmers operating small, farmers through government-owned agricultural medium, and large farms. It also includes finan- banks and special agricultural loan programs. cial services such as warehouse receipts systems, After relatively dismal results of agricultural savings or other capitalization mechanisms, as credit programs due to systemic or covariant risks well as insurance and forward contracts that are (risks that affect many at the same time, such as The author thanks Linda Jones and Emilio Hernandez for their contributions. The views expressed here are those of the author(s) and do not necessarily reflect the views of the Food and Agriculture Organization of the United Nations, for which the content of this chapter was written. Agricultural Finance 231 droughts), high costs of operations, and unsus- time, higher food prices improve the profitabil- tainable subsidies, the focus of financing changed ity of agriculture and the returns to investment from agricultural credit to financial services ser­ in the sector, thus creating demand for agricul- ving other rural activities in addition to agricul- tural financial services. ture. Financial services were more efficient by In addition to the rise in prices and long-term serving the entire rural population, while reduc- growth prospects in agriculture, an even more ing risk by moving beyond a sole focus on agricul- fundamental change has been occurring in how ture. However, without incentives, many private agriculture is organized and operates. Agriculture and even public financial institutions have grown has become more commercial, catalyzing more increasingly hesitant to fund agriculture due to integration between buyers and sellers to meet the difficulties involved in managing an agricul- higher consumer demand. The relationships tural portfolio. Given the shift of government between buyers, sellers, and other participants in financing away from agriculture, significant gaps agricultural value chains have changed in an now exist in the availability of both rural and agri- effort to improve efficiency, meet tighter stan- cultural financial services. dards of agroindustries, and satisfy market Since many microfinance institutions (MFIs) demand for consistent quality, timely delivery, were founded to serve the poor and agriculture is and differentiated products. These changes have a critical source of rural employment, income, had a major impact on how the agriculture sector and food security, addressing the financial needs is or could be financed. of poor agricultural households fits within their New technologies in information and commu- mission. However, due to the typical nature and nication have opened new opportunities for cost of their services, MFIs have tended to pro- improved financial and value chain services. All vide rural financial services that are most appro- types of financial institutions, including most priate for nonagricultural purposes. While MFIs, now have management and information product innovation has allowed MFIs to reach systems that can handle multiple, customized impoverished rural households with savings and credit, savings, and payment products, including loan products and, in many cases, with training point-of-sale transactions and direct transfers. and other services, financial services for agricul- They also have improved communication with tural finance have generally remained a small agricultural clients. Furthermore, improved portion of their portfolios. access to information facilitates pricing, direct Today, development concerns and market sales, and deliveries as well as forward buying and potential are driving renewed interest in both selling of contracts and lowers the transaction agriculture and agricultural financial services. costs of doing business, making agricultural Recognizing that the majority of poor people in enterprises good clients. developing countries reside in rural areas and One aspect of agricultural finance that has not depend on agriculture for their livelihoods, changed is the effect of political intervention, many governments and development agencies which in some countries can be significant. have specifically included increased access to Governments often intervene in agricultural prices, agricultural finance in their national develop- either through price controls or through import ment strategies. Furthermore, a drop in global and export restrictions or regulations that affect food reserves has raised concern for food secu- market prices for agriculture and hence repayment rity; short-term increases in food prices are capacity of agricultural borrowers. In addition, causing unrest, while growing demand increases governments and even donors are often tempted to vulnerability over the long term. At the same control interest rates for lending to agriculture, 232 The New Microfinance Handbook especially to smallholder farmers, which can be risks, making it hard for financial service provid- disruptive for those lending to the sector. Policy ers to hedge them. Consequently, providers find makers in some countries may also directly inter- it difficult to finance agricultural activities. vene in agricultural finance with policies to pro- The nature of the flow of capital is a further vide subsidized credit through a variety of channels challenge to both borrowers and lenders. or loan write-offs at election time or after poor har- Because agricultural production (crops and live- vests. Such programs often create more problems stock) in general has a slower turnover than than they solve and make private financial institu- other microenterprise ventures traditionally tions wary of lending to the sector. The provision of funded by MFIs, agricultural credit generally subsidized funding to farmers or cooperatives requires longer loan terms and is vulnerable to often creates disincentives for private providers to unpredictable and potentially lower returns on get involved (van Empel 2010). For example in capital. Consequently, it entails higher risk and India, the government provided an agriculture is much more sensitive to interest rates than tra- debt waiver scheme for smallholder farmers in ditional microfinance (Miller 2011). 1990 and again in 2008, adding to the banks’ reluc- Agricultural credit requires adjustments that tance to lend to these farmers (Das 2012). differentiate it from a typical microenterprise One reason for political and development loan. Because cash outflows for inputs, capital, intervention in smallholder agriculture financing and some labor occur at the beginning of the sea- is that it is often perceived as agriculture rather son and cash inflows occur primarily at harvest than agribusiness or agroenterprise. However, for time, agricultural loans often require the loan financing, especially lending, agriculture must be principal to be paid at maturity rather than treated as a business. “Credit is not appropriate, throughout the loan period. Interest may also be nor viable, for subsistence farming, although paid at maturity, at the beginning of the loan, or some financial services such as savings for income periodically (either at fixed or flexible intervals) ‘smoothing’ and insurance can be useful. Despite throughout the loan period. both the important development role of aiding In agriculture, land is often used as collateral. smallholders as they transition from subsistence However, there are frequent problems with land farming into the market economy and the social title and property rights for smallholder families, emphasis of many microfinance organizations, it especially women-headed households that often is not the role of a financial services provider to do not have title to land (in some cultures women lend where there is not a market-linked business are not allowed, either formally or informally, to case to do so” (Miller 2011, 4). own land). Furthermore, small loans rarely justify the legal costs to process a land claim. Movable assets such as livestock and equipment are also The Challenge of Agricultural fairly high risk, as farmers often have no proof of Credit ownership or insurance coverage for them. Farmers often live in areas that are hard to reach Personal and group guarantees have weaknesses, with traditional financial services. In addition, since group members often are also farmers and they face climatic and price risks, seasonal likely to face the same risks. Therefore, such guar- demand for products, and fluctuating labor and antees work best when the group or its members capital. Many of these risks and challenges such do not depend on similar sources of income such as droughts, floods, pests, or diseases are beyond as crop agriculture. Poor financial literacy rates of the control of farmers; within a region, they are farmers also contribute to inefficient agricultural often subject to the same weather and climate finance markets. Agricultural Finance 233 The following factors apply primarily to rural their respective contexts. These extend well and agricultural markets and constrain both the beyond loans, savings, and other financial ser- supply of and demand for financial services vices to include insurance, hedging, embedded (Christen and Pearce 2005): finance from nonfinancial entities, and invest- ment finance. There are also guiding principles of • Generally lower population density, dis- agricultural finance that can be considered uni- persed demand, low literacy rates, and inad- versal better practices. equate transportation and communication Agricultural risk assessment includes both the infrastructure risks of the particular client or group of clients • Limited economic opportunities for local themselves and their relationships with the per- populations sons or groups with whom they buy and sell. Thus the assessment goes well beyond what is common • High risks faced by potential borrowers and in microfinance. The emphasis of microfinance is depositors due to the variability of incomes, placed on knowing the clients, their character, and exogenous economic shocks, and limited tools their capacity, demonstrated, in part, by their for managing risk repayment history. Assessment is quick but gener- • Seasonality of crops and production sched- ally only provides a cursory overview of the ules, leading to spikes in loan demand and household or enterprise activity. In traditional shortages in both funding and labor in certain banking, collateral is the most important and often periods determining factor for lending. As long as the loan is secured, often with a collateral value much • Heavy concentration on agriculture and higher than the loan amount, there is little interest ­ agriculture-related activities, exposing clients in fully understanding the business or household. and providers to multiple risks, both idiosyn- Collateral requirements are often prohibitive for cratic (one household) and covariant (entire agricultural borrowers, who generally do not have region or country) the type of mortgage collateral most banks request. • Women farmers, who are constrained by lack When financing agriculture, fully under- of land, loss of land when the husband dies, or standing the needs and risks of the client, busi- inability to borrow without the husband’s ness activity, and sector is crucial. Lending permission solely on the basis of the client’s character or the group’s track record is inadequate, as is the • Lack of reliable information about borrowers traditional collateral-based banking approach. • Lack of market information and market access Each of the 5 Cs of loan analysis—namely, char- acter, capacity, collateral or capital, conditions, • Weak institutional capacity, including poor and cash flow—must be well understood for governance and operating systems and insuffi- each borrower as well as for their agricultural cient skills among staff and management of activity. It is important to assess the capacity service providers of the borrower and, if relevant, the strengths and weaknesses of his or her agribusiness • “Crowding out” effect of subsidies and directed partners with regard to their financial, mana- credit. gerial, and technical capacity. There must also While there is no one simple solution to suc- be a level of confidence in both the character cessful agricultural finance, an array of proven of the borrower and his or her relationship processes, approaches, and tools work within with the various participants in the value 234 The New Microfinance Handbook chain. And while character and collateral Agricultural Value Chain Finance remain important, agricultural credit places much greater weight on cash flows and condi- Agricultural lending requires risk assessment tions (Miller and Jones 2010). well beyond the agricultural borrower to include Cash flow analysis is the most important C for an analysis of market dynamics that determine determining the amount and timing of loans, the fluctuations of prices and production in the repayment schedules, and repayment capacity. agriculture sector. This is because the ability of The diversity of agricultural activities on even a farmers to produce, sell their products, and profit small farm makes it seem complicated, but the from their farming activities is influenced by the cash flow of a household or agribusiness must be economic performance of individuals or busi- assessed. The lender can assess cash flow either nesses from whom they buy and sell. Farmers’ directly or indirectly using information from the cash flow is linked to the competitiveness and farmer’s buyers or sellers. Some of the farm’s cash reliability of their suppliers, buyers, and service flow will be regular, while some will be irregular; providers. These farmers, businesses, and indi- for agricultural producers, most production-­ viduals are interdependent actors participating in related cash flow is irregular—that is, seasonal in the transformation of agricultural products, each nature (Heney 2011). one of them adding value through their efforts to Conditions are a second critical factor. produce products that the end consumer will Conditions are not simply the conditions of the purchase. The total set of interactions between all loan, which must work well for the borrower, but of these actors to produce a specific agricultural the short- and long-term conditions of the entire product is often referred to as a value chain. value chain and sector. Collateral remains impor- A value chain is the path that a product follows tant, but the emphasis shifts from reliance on from raw material to consumer, from input sup- mortgage collateral and toward collateral based plier to producer, and on through the various on products, contracts, and processes. actors (private or public) that take ownership of These characteristics of agricultural lending the product before it arrives at its final condition require a deeper assessment and understanding and location. The path may be very short—from for planning and monitoring loans and thus are farmer to household—or may follow a complex prohibitively costly for small loans, which is a path of value addition and geographic movement major reason why MFIs and banks are typically from farmer to aggregator or cooperative, to raw not interested in them. However, the changing materials processor, to value added production, to nature of agriculture is providing ways to use the retailer (Miller and Jones 2010). In the expanded agricultural value chain to accomplish much of definition of the term, a value chain and its analy- this risk assessment and monitoring. For this, a sis also embody support service providers, socio- new approach—agricultural value chain finance— cultural constraints, enabling environment, and has emerged to address finance in agriculture. It relationships among stakeholders. is not new in its elements or new to those who Value chain finance refers to the flow of funds to have taken a comprehensive approach to agri- and through, or among, the various actors in a value cultural lending, but it is quite new to many. It is chain. It uses an understanding of production, an approach that seeks to reduce costs and lower value added, and marketing processes to deter- the risks of lending by understanding risks and mine financial needs and provide financing to structuring financing (that is, fitting the condi- those involved. The strength of value chain finance tions) to fill the needs of participants within a lies in understanding the risks of the business by value chain. understanding the risks and competitiveness in Agricultural Finance 235 the value chain, using that information for invest- chain finance. However, if the same provider ment decisions, and then providing financial ser- lends to coffee producers so they can purchase vices tailored to current and potential clients inputs—because they are known to be part of a within the value chain. Competitive agriculture is viable coffee value chain with a reliable buyer and connected a ­griculture—linking participants in a market—this is value chain finance. These rela- sector or within a value chain in which everyone tionships often give external financiers the confi- involved has a vested interest (Miller 2011). dence to extend credit to those who would not be Lenders need to understand the nature of able to obtain credit on their own. Additionally, relationships and the capacities and limitations medium or large firms may be able to obtain of the persons and companies participating in a financing for their partners farther down the particular value chain in order to assess the chain. For example, a bank may not be geared to level of risk that may affect the ability of a spe- serving small-scale producers and agroenter- cific client to repay a loan. With this awareness, prises, but might provide a loan to a large buyer lenders also need to consider the cash flow and with the understanding that the large buyer will interests of the other participants within the on-lend to those in their value chain. Such value chain or chains of the borrower (Miller on-lending could enable these smaller producers and da Silva 2007). In addition, providers need and agroenterprises to purchase inputs so that to improve their data management to capture they can produce or manufacture goods and sell and use production and marketing data for the them to the large buyer. Knowledge of a value most important agriculture sectors of their cli- chain and how it operates can improve repay- ents and region. ment and reduce risk. Value chain finance can be either internal or The interplay between a value chain and the external to a value chain. For example, when a financial market strengthens both the value dealer supplies inputs on credit to a producer, or a chain and the financial market system. Access to wholesaler makes an advance payment to a trader credit helps participants in the value chain to for the purchase of raw materials, these consti- overcome bottlenecks and supports the smooth tute internal value chain finance. Internal financ- functioning of the value chain. The existence of a ing between value chain actors is often viable value chain reduces risk and instills confi- “embedded” with other services. Common forms dence in lenders, thereby deepening outreach. of embedded finance are trader credit, input sup- However, agricultural value chains often are plier credit, marketing company credit, and lead poorly organized, lack transparent pricing, and firm financing. The flow of funds from an outside are fragmented—all of which results in higher provider to a business or a category of businesses transaction costs. In many cases, the market is (producers, traders, input suppliers) in the value distorted by stakeholders, including donors, gov- chain is defined as external value chain finance. ernments, and development banks, that regard For example, when a bank lends money to a buyer agriculture as a social problem rather than as an for production purchases, or when a provider economic activity. extends credit to a farmer using a warehouse Value chain financing not only analyzes the receipt as collateral, these are examples of exter- flow of funds between participants in the value nal value chain finance. chain and financial institutions, but also is cog- If a provider, for example, offers general loans nizant of the support services1 that are pro- to rural and agricultural borrowers, and some of vided and those that are needed in order to them use the funds to generate income related to strengthen the weakest links in the chain, as specific crops or value chains, this is not value shown in figure 10.1. 236 The New Microfinance Handbook Figure 10.1  Using the Value Chain for Agricultural Financing Financial service Support Value chain actors institutions services Exporters / wholesalers Bank Technical training Processors Non-bank financial institutions Business training Local traders & processors Private investors & funds Producer groups Specialized Cooperatives / services associations Farmers Local MFIs / Governmental community certification / grades organizations Input suppliers Product flows Financial flows Source: Miller and Jones 2010. Value Chain Business Models often envision this model as the most desirable because it gives producers the greatest power. The nature of the product, cash flow dynamics, But this model generally brings greater exposure type of relationships, and risks associated with a to risk, requires greater productive and manage- value chain are influenced by various business rial capacity of farmers, and entails the need to models defined by who is the “driver” of the value access more sophisticated financial services. chain. There are several types of models: Many, and in some countries a majority, of small • Producer-driven producer organizations do not have the capacity • Buyer-driven and market knowledge for sustainable success • Facilitated and growth without some support. One disad- • Integrated. vantage is that market demand is driven by con- sumers, who are the farthest from the producers In producer-driven models, the producer in the value chain. However, for producer orga- organization is the driver and the principal deci- nizations with good capacity and value chain sion maker. Producers and even governments partners, the model can be successful. Agricultural Finance 237 In buyer-driven models—for example, contract since this model depends on subsidies from non- farming—buyers contract producers to supply the governmental and governmental development product and offer them direct or indirect credit to agencies, it must be conceived as a catalytic short- enable them to meet delivery requirements. to medium-term model. The facilitator does not Financing conditions are set to fit the producer’s become directly engaged in product flows or cash flow schedule. For smallholders and their transactions in the value chain (see box 10.1). producer organizations, contract farming or the In integrated models, the lead agribusiness has less formal arrangements called outgrower full control over and responsibility for coordina- schemes are becoming the most common form of tion. This is common with larger conglomerate buyer-driven model today for linking finance to agribusiness firms and can allow them to lower the value chain and securing inputs, technical their financing and business risks. This model is assistance, and market access. much less inclusive of small producers and agroen- Facilitated value chain models use outside trepreneurs, making it harder to reach the poor. support agencies (generally development agen- In summary, understanding business models cies acting as facilitators) to build capacity and and how they are organized helps lenders to know broker partner relationships, thereby reducing how best to provide credit to value chain partici- the costs and risks for those involved. However, pants, with the financing often coming through or Box 10.1  The DrumNet Project The DrumNet Project in Kenya establishes re- transfer. DrumNet serves as the intermediary lationships with key actors along a supply in the flow of payment to ensure that credit is chain—a buyer, a bank, and several retailers of repaid before earnings reach the farmers’ ac- farm inputs—and links them to smallholder counts. A master contract governs the entire farmers through a dedicated transaction plat- process, and DrumNet’s information technol- form and a fully integrated finance, p­ roduction, ogy system monitors compliance. delivery, and payment process. The t ­argeted The process creates an enabling environ- use of information and communication tech- ment for agricultural finance in several ways. nologies across the platform makes the pro- ­ending First, banks are assured at the time of l cess efficient, cost-effective, and practical in that farmers have a market for their produce the African context. and the means to serve that market—two The process begins when farmers (orga- building blocks of a healthy revenue stream. nized into farmer groups) sign a fixed-price Second, banks minimize the problem of loan purchase contract with an agricultural buyer. diversion by offering in-kind credit to The contract allows farmers to approach a farmers for inputs and directly paying certi- partner bank, obtain credit, and receive farm- fied (and monitored) retailers after the ing inputs from a local, certified retailer. At har- inputs are distributed. Finally, cashless pay- vest, the contracted produce is collected, ment through bank transfers reduces strate- graded, and sold to the buyer at designated gic default, since farmers cannot obtain collection points. A successful transaction revenue until their outstanding loans are triggers a cashless payment through a bank ­ fully repaid. Source: Campaigne and Rausch 2010 238 The New Microfinance Handbook in coordination with the value chain driver, who advance (with interest as agreed) from the pur- can then pass on funding through to its partners. chase price. A supplier may offer a producer However, many agribusiness firms that buy or sell inputs on credit, with the understanding that the products prefer not to manage credit and look to producer will pay the supplier once the crop is outsource credit management, thus creating an sold. In some cases, these arrangements can opportunity for financial service providers. By involve a third party such as when a buyer pays working in partnership with input suppliers and the supplier for inputs and deducts the cost from buyers, they can provide financial services with the price paid to the producer. lower market risk and greater efficiency, as loans Marketing companies and lead firms that can often be repaid at the point of sale through aggregate products from producers often advance coordination with warehouse managers and payment for goods prior to production, which is a ­ processors. Working with specialized financial form of trade credit embedded in the value chain. institutions (rather than suppliers and buyers Similarly, contract farming exists when a whole- doing it themselves) often improves the delivery saler provides credit to producers based on a con- and lowers the cost of financial services to the tract specifying that the farmer must provide a value chain partners. Agribusinesses finance their specific volume and quality of produce to the suppliers or buyers as a way to secure products or wholesaler at a specific time. While there may not markets, but they are often less equipped to man- be an explicit interest rate, a discount on the sell- age financing and find it more efficient to concen- ing price is usually built into the contract. With trate on their core business and let financial contract farming arrangements, the wholesaler institutions manage loans. At the same time, these may also offer technical assistance to ensure qual- participants in the value chain often have more ity products. knowledge about agricultural inputs, markets, Traders are most often members of the rural and the persons and organizations they work community or from within the region. They not with than external financial institutions. This only have capital and have or can arrange trans- gives them a comparative advantage. portation, but, which is most important, often also have specialized knowledge of markets and Trade Finance contacts that enable them to operate effectively in Trade and product-related finance refers to credit their region. Traders are therefore able to advance provided by traders, input suppliers, and agribus- funds with the guarantee that the crop to be har- iness processors and buyers. Trade finance has vested will be available to them for resale accord- traditionally been the most prevalent form of ing to a price that is fixed at the time of financing. agricultural financing, especially for small pro- In regions where there is little competition, prices ducers. It is common in both well-structured offered by traders are often low to compensate for agricultural value chains and in informal and risk, costs of embedded interest, and profit; trad- fragmented ones. These farmer-trader or ers may be opportunistic and take advantage of buyer-trader relationships play a critical role in ­ smallholder farmers who need cash. connecting farmers to markets. They provide For financial institutions, especially MFIs and farmers with funds for inputs, harvest, or other government banks, it is often assumed that needs such as family consumption and emer- financing must be provided directly to the micro gencies. In more organized value chains, a trader and small agricultural producers and households. or buyer may give an advance to a producer so the This may or may not be the most feasible way to producer can purchase inputs and cover costs ­ finance agricultural activities due to the costs and until harvest. The trader then deducts the risks involved. Hence, financing institutions also Agricultural Finance 239 need to consider alternative ways to finance sup- accounts receivables (that is, invoices) at a dis- pliers, traders, and agribusiness buyers who can count. Both are forms of credit, which allows a advance the supplies or funds needed by those business to obtain immediate cash without wait- producers. For example, when sufficient compe- ing for invoices to be paid. This cash advance tition among traders or buyers helps to keep their credit is especially important for small enterprises prices realistic in relation to market prices, then that need operating capital for purchasing goods indirect financing of smallholder farmers through or advancing cash or inputs to their clients. such traders and buyers may be the most cost-­ Factoring is a special form of bill discounting effective manner of financing them. that works through specialized factoring agen- cies (see box 10.2). Buyers and wholesalers or Bill Discounting and Factoring input suppliers sell their invoices at a discount to Input suppliers that sell on credit as well as agri- the factoring agency, which provides a credit businesses or producer organizations that sell advance (for example, 80 percent of invoice products on consignment or on delayed payment value) to the business or producer organization. (for example, 60 days) often struggle with liquid- The agency collects the receivables when due and ity. This limits the amount of sales they can make makes a final settlement payment to the business, on credit, which, in turn, limits the ability of minus a factor discount (administrative fee and smallholder farmers to obtain inputs on credit to interest). Factoring speeds the turnover of work- be paid upon delivery of their harvest. Bill dis- ing capital and provides services such as accounts counting and factoring can help to improve cash receivable bookkeeping and bill collection. In flow without requiring additional collateral addition, it provides some protection from credit (which is often not available). Bill discounting and risk in that the factoring agency conducts a due factoring are both financial transactions whereby diligence assessment of the buyer from whom it a business or producer organization sells its must collect. Box 10.2  Factoring to Support Agriculture In Kenya, De Derby Green Ventures Capital amount of the invoices from the buyers. On (DGV) is a limited-liability company, whose fo- the due date, the buyers pay DGV the full cus is value chain financing through factoring, amount of the invoice, and DGV discounts its both in agriculture and in manufacturing. Its fees and pays the remainder to the supplier as mission is to facilitate business linkages by previously agreed (Obara 2011). eliminating the financial stress experienced by In Guatemala, the MFI Summa provides businesses. DGV gives priority to the agricul- short-term bridge financing to producer orga- ture sector, which represents 80 percent of its nizations and their members while they wait portfolio. for buyers to pay them. Even more important, DGV allows agricultural suppliers to con- it also collects the accounts receivable, which vert approved invoices and delivery docu- can be very difficult and costly for producer ments into instant cash by discounting them organizations to handle directly, especially at an agreed fee. DGV then collects the face when they operate far from cities. Source: Miller 2011. 240 The New Microfinance Handbook Factoring differs from credit in three main credit that originated during the nineteenth cen- ways. First, the emphasis is on the value of the tury among European farmers. Warehouse receivables, not the creditworthiness of the agri- receipts involve a tripartite agreement between business or producer organization. Second, (a) producers (or often producer organizations ­ factoring is not a loan; it is the purchase of an operating on behalf of farmers), who borrow using asset—the receivables. While not directly financ- stored produce as collateral; (b) local financial ing producers, it allows input suppliers or buyers institutions, which lend to producers or organiza- to access funding, which can benefit farmers who tions; and (c) a warehouse manager, who provides receive advances. The factoring agency provides storage services. The stored produce is then sold the collection service, which can even make other when prices are generally highest and potential financial service providers more willing and able revenue can be maximized. Agribusinesses also to extend inputs on credit or provide advances to can use warehouse receipts as long as the goods farmers. Also, producer organizations who sell to are stored securely by an independently con- supermarkets or other buyers on consignment trolled warehouse. Farmers or other participants not only have to wait for payments, but often find in the value chain receive a receipt from the ware- that collection is difficult. Due to their location house stating that they have deposited goods of a and collection experience, it can be more effective particular quantity, quality, and grade, which they to have a factoring agency manage this. then pledge as collateral to access a loan from a third-party financial service provider, such as a Warehouse Receipts Systems cooperative or an MFI (see figure 10.2). Warehouse receipt systems (sometimes called Warehouse receipt systems can help to warrants or warrantage) are a form of inventory smooth seasonal price variations throughout Figure 10.2  The Warehouse Receipts Financing System Lender Borrower Warehouse 1. Lender and Borrower enter into a credit agreement 2. Borrower places goods in warehouse 7. Buyer pays lender for goods 3. Warehouse issues receipt 8. Lender releases receipt Buyer 4. Borrower offers receipt as 9. Buyer redeems receipt at collateral to lender warehouse for goods 5. Lender grants borrower a loan 10. Lender applies buyer’s 6. Borrower sells stored goods payment to the loan to buyer Source: Höllinger, Rutten, and Kiriakov 2009. Agricultural Finance 241 the year, as they help consumers and sellers to federations use a “warrantage” system (Miller know that supply is available in warehouses. 2011; see box 10.3). This can help to forecast demand and revenue, leading to a more stable and developed market Agricultural Leasing overall. However, for products and commodi- As discussed in chapter 9, a financial lease, also ties for which prices do not generally rise in a called a lease-purchase agreement, is a viable predictable, seasonal fashion, there is little loan alternative for financing equipment and incentive or need to store and use warehouse durable assets. Leasing uses the agricultural receipts. equipment and machinery acquired as its own While many warehouse receipt programs are collateral, thus providing an alternative for cli- formally structured, informal credit systems ents who do not have the traditional collateral involving village granaries or regional storage needed to purchase directly. Leasing is a specific centers are common in many developing coun- financial product governed by distinct legisla- tries. In Latin America, MFIs have begun using tion. Leasing and micro leasing have become “micro-warrants” as a form of warehouse common in some countries, but are still rela- receipt financing for their agricultural microen- tively new. Leasing is sometimes available from trepreneurs, and in Africa, credit cooperative banks or MFIs, but quite often is available from Box 10.3  Warehouse Receipt Systems: Lessons from Niger In Niger, local farmer organizations and MFIs opportunities, the enabling regulatory frame- have adapted the warrantage concept. Since work, the existence of proper storage man- its beginnings in the mid-1990s, the warran- agement and facilities, and sound governance tage system has created a relatively popular within producer organizations. Lessons from financial product offered by all MFIs in the Niger highlight the relative importance of country. Producer organizations provide their these conditions. The constant demand for members with storage facilities and also han- cereal imports from neighboring Nigeria has dle their loan transactions. The loans enable created stable business opportunities for farmers to finance several of their household’s farmers in Niger. Through their organizations, income-generating activities during the stor- farmers have taken advantage of these oppor- age period, allowing for smoother cash flows. tunities by building storage facilities and Revenues from the activities financed often requesting joint loans backed by cereal stocks. enable farmers to pay back the loan without Lenders understand the worth of these stocks using revenue from the eventual sale of the and accept them as collateral. Even though stored produce. the court system in Niger makes credit con- Several conditions need to be met for tracts difficult to enforce, the combination of warehouse receipt financing to work. Some stable agribusiness opportunities, strong important ones include detailed lender knowl- farmer organizations, and lenders familiar with edge of the dynamics of the agricultural value agricultural markets makes warehouse receipt chain, the stability of borrowers’ agribusiness financing work in the country. Source: Interview with Emilio Hernandez, May 2012. 242 The New Microfinance Handbook specialized leasing companies, which may or • Yield-based insurance. Indemnity payments may not be linked with banks or MFIs. are made when the client’s yield is below a predefined level, independent of the damage that is measured after the defined loss event. It Addressing Client Risk through is suited to perils where individual attribution Financial Services to the crop loss is difficult to measure. Agriculture is subject to production, price, and • Crop-revenue insurance. The timing and marketing risks. These can affect all clients in a amount of indemnity payment are defined region. While these risks are determined by based on a predefined combination of yield uncontrollable factors, their effects on income and commodity prices, set according to histor- and loan repayment can be mitigated. Financial ical norms in a subarea. service providers working with low-income cli- ents, like any financial institution, must mitigate • Index-based insurance. A predefined index is these systemic risks through portfolio and sector used to estimate the timing and value of losses diversification and, where possible, regional suffered by the insured client. The index is cal- diversity and insurance. In addition, MFIs can culated based on historical meteorological and also make better agricultural lending decisions production data. Examples include some com- when they improve their management of data to bination of temperature, rainfall, wind speed, capture and use production and marketing data yields, and mortality rates averaged over a sub- for the most important agriculture sectors of their area. Use of an index avoids the need to verify clients and regions. the value of losses, and its deviation from a specified level defines the value of the indem- nity payment. Examples of indexes include (a) Agricultural Insurance a specified minimum temperature for a mini- Weather and related natural events affecting mum period of time (for frost); (b) a specified agricultural production are unpredictable, and amount of rainfall in a certain period of time risks are increasing with climate change. (for excess or lack of rain); and (c) a certain Insurance can reduce these risks. While various wind speed (for hurricanes). types of insurance described in chapter 11 are important for farm households and enterprises, Although agricultural insurance is quite insurance products are available specifically for ­ ommon in developed countries, it is much less c agricultural risk. so in the developing world. The institutional Agricultural insurance products can be classi- mechanisms to obtain relevant data, verify losses, fied as four principal types (Kang 2007; Roberts develop appropriate indexes, or distribute insur- 2007): ance products are limited in many countries, making it costly for insurance companies to • Damage-based insurance. Indemnity payments provide services and difficult for them to offer ­ are triggered by the occurrence of a specific prices that farmers are willing to pay. However, if type of damaging event, such as hail, fire, or a proper index can be determined, delivery costs death of animals. These products tend to be can be significantly reduced because payment for used when there is a low correlation between damage does not have to be verified but is auto- events occurring within a given area and pay- matic according to the index. The use of an index ment is subject to the value of the loss. also avoids the risk of moral hazard. This is Agricultural Finance 243 because neither the insurer nor the client can conjunction with loans through links with insur- influence the index measurements, usually col- ance providers. lected by a third party such as a government min- istry. However, like all types of insurance, Forward Contracts index-based insurance depends on reliable, his- Forward contracts commit the issuer to sell a torical data. While data collection is improving, it product with delivery at a future date, such as at remains a major drawback for insurance in harvest. The sale price is fixed at the time of the developing countries. A related challenge is contract. Forward contracts are useful for small- building indexes that represent losses and avoid holder farmers, traders, and agroenterprises to the risk of not providing payment when it is due mitigate or “hedge” the price risk, which helps to or of providing payment when it is not due (IFC mitigate the risk for lenders, since future income 2010; see chapter 11 for more on index-based is more secure. Forward contracts can also be insurance). used as collateral for loans (see box 10.4). In addition, agricultural households face lim- ited market opportunities and have little access to Guarantee Funds complementary services such as credit, savings, In some countries, governments, donors, or com- agricultural inputs, or communication infrastruc- mercial companies offer guarantee funds for agri- ture. Insurance services bring little additional culture or for specific sectors or target groups of value to these households, and their willingness farmers or agroenterprises. These are meant to to pay for them tends to be low, even if subsidies reduce the risk of lending. A typical example is a are provided. fund that guarantees approximately 50 percent of For agricultural insurance for smallholder the loan in the event of default (either shared farmers, it is useful to bundle insurance with equally or the first loss) for a fee of 3 to 5 percent other financial products like loans and savings annually. Lowering the risk gives the lender an products. Bundling greatly reduces the transac- incentive to lend to new or risky sectors and to tion costs of delivering payments, deposits, and lend more. The loan guarantee fund manager also premiums. Insurance product management is provides an additional risk review as part of its often beyond the capacity of most MFIs, but it due diligence. The weakness of loan guarantee can be delivered effectively through them or in programs is the cost, which is unsustainable Box 10.4  Crop Receivables The government of Brazil created the rural ­ ommits the farmer to deliver a specific that c finance note, called the cedula produto rural, quantity and quality of product at a given for loans to agribusinesses and producers. The future date and location. In exchange, the note is not a typical forward contract; it is a buyer pays in advance a certain amount of hybrid of forward contracts and warehouse money that corresponds to the quantity of receipts. Its mechanism is very simple—­ product specified. In effect, the buyer provides farmers issue a rural finance note to a buyer an unsubsidized loan backed by the note. Source: Miller and Jones 2010. 244 The New Microfinance Handbook unless subsidized by the government or a donor The Role of MFIs in Agricultural (Zander, Miller, and Mhlanga 2012). Finance All financial institutions that provide agricultural Lending for Livestock financial services need to understand agriculture While much of the previous description has and related small and medium agroenterprises in focused on crop agriculture, attention must also order to be effective. Inclusive finance acknowl- be given to animal husbandry. Providing financial edges the role that agriculture plays in the lives of services for small animals as well as livestock is the rural poor. Agricultural finance requires an common in microfinance and does not pose the array of financial and nonfinancial services. MFIs same risks as crop financing. Small animal raising alone cannot deliver the breadth of financial ser- and dairy are often carried out by women. Animals vices and nonfinancial technical support needed provide a means to increase women’s assets, in the agriculture sector. It is thus more effective while also being relatively liquid in times of emer- for them to work with other service providers to gency or need. In addition, raising animals can deliver the comprehensive financial services that diversify income and risk to farmers and make agricultural households need. For MFIs, under- them more creditworthy. standing the agricultural needs of their clients Credit for livestock and other animals is not and linking with partners that complement their without risks, however. Small animals such as services are keys to making a significant contribu- chickens, pigs, or cows are often raised at a very tion to livelihoods. small scale under rustic conditions without Continual innovation is important if financial proper care. Poor animal hygiene, lack of proper institutions are to succeed in reaching small- pasture and feed, as well as lack of disease con- holder farmers and agroentrepreneurs in a trol can lead to animal losses, sickness to the cost-effective and sustainable manner. MFIs have family, or exclusion from markets (animals that been successful in applying innovative products are sick or do not meet quality requirements are and approaches to reach the needs of the poor; difficult to sell). In addition to capital, farmers they can and are innovating to serve agricultural raising livestock could benefit from other inputs clients better. For example, in Bolivia FONDECO (see box 10.5). (Community Development Fund), an MFI, has Box 10.5  Heifer International Heifer International and BRAC have long rec- ­asture improvements, para-veterinary train- p ognized that promoting animal husbandry may ing, vaccination campaigns, and other services. require more than finance. Heifer International To increase the success of its many clients gives loans in kind, with recipients repaying raising chickens, BRAC instituted hatcheries to the loan with offspring. Its success over 60 supply day-old chicks and supported access to years around the world has been intricately improved feeds. linked to its support for group formation, Source: Miller 2011. Agricultural Finance 245 Box 10.6  FONDECO: Microfinance Innovations along the Value Chain • Contract (farming) guarantees—cassava and wood • Product-backed loans—livestock and forest products, whereby the product serves as guarantee • Agricultural insurance • Micro-warrants (warehouse receipts)—rice, maize, dehydrated peaches, almonds, quinoa, and alpaca wool • Bill discounting finance—input and service suppliers • Micro factoring—hot peppers and school breakfasts • Micro leasing—agricultural machinery • Buyer guarantees—small coffee producer organizations • Guarantee funds—input and service suppliers • Risk fund—potatoes and grapes. Source: Adapted from Vargas 2010. moved beyond simply lending for agricultural Agricultural finance depends on the success production to offering multiple financial prod- of the agriculture sector as a whole and the com- ucts for different parts of the value chain, as petitiveness and risk profile of the client and the shown in box 10.6. value chain. Long-term investments are needed In summary, new approaches to agricultural to improve production and quality as well as to finance reduce costs and risks. Some of these have build human capacity (skills and relationships) been facilitated by increased value chain linkages and physical infrastructure (irrigation, storage, and improved management, communication, and equipment, and technologies). All are required technology systems. Even so, the three Rs of for a healthy agriculture sector capable of gener- finance remain critically important for agricultural ating economic growth and higher incomes for finance: the risk of clients and their agricultural farmers. businesses, generation of sufficient returns to capi- tal of the clients, and repayment capacity. There is Note no substitution or shortcut for assessing clients and their businesses accurately. Cash flow analysis,  1. These support services are market-based, product value chain assessment, and tailoring of supporting functions within the market loans with the appropriate conditions are critical. system, not facilitation. Even with the best assessment, agricultural credit should be accompanied by insurance and safety cushions. While insurance products can References and Further Reading help to mitigate losses, the most important Becerra, N., M. Fiebig, and S. Wisniwski. 2010. insurance is built through savings and accumula- “Agricultural Production Lending: A Toolkit tion of assets, which can be liquidated easily in for Loan Officers and Loan Portfolio times of need. Easily accessible savings services Managers.” Rural Finance Learning Center, support farmers. FAO, Rome. 246 The New Microfinance Handbook Campaigne, Jonathan, and Tom Rausch. 2010. commissioned for the 2011 Global Microcredit Bundling Development Services with Summit, Valladolid, Spain, November 14–17. Agricultural Finance: The Experience of Miller, Calvin, and Carlos da Silva. 2007. DrumNet. Innovations in Rural and Agriculture “Value Chain Financing in Agriculture.” Finance Focus 18, Brief 14. Washington, DC: Enterprise Development and Microfinance 18: International Food Policy Research Institute 95–108. and World Bank, July. Miller, Calvin, and Linda Jones. 2010. Agricultural Christen, Robert P., and Douglas Pearce. 2005. Value Chain Finance. Rugby: FAO and Practical “Managing Risks and Designing Products for Action Publishing. Agricultural Microfinance: Features of an Obara, Beatrice. 2011. “De Deby Green Ventures Emerging Model.” Occasional Paper 11, CGAP, Capital in Kenya.” In Agricultural Value Washington, DC. Chain Finance, ed. Rodolfo Quirós. Rome Das, P. K. 2012. “Agricultural Credit Policy in and San José: FAO and Academia de India.” Unpublished research paper, Centroamérica. Bhubaneswar, India. Roberts, R. A. J. 2007. “Livestock and Aquaculture Heney, J. 2011. “Loan Appraisal: Agricultural Insurance in Developing Countries.” Bulletin Lending; Self-Study Guide for Loan Officers.” 164, FAO, Rome. Rural Finance Learning Center, FAO, Rome. Van Empel, Gerard. 2010. “Rural Banking in Höllinger, Frank, Lamon Rutten, and Krassimir Africa: The Rabobank Approach.” In Kiriakov. 2009. “The Use of Warehouse Receipt Innovations in Rural and Agricultural Finance, Finance in Agriculture in Transition ed. R. Kloeppinger-Todd and M. Sharma. Countries.” Working paper, FAO Investment Focus 18, Brief 4. Washington, DC: Centre, FAO, Rome. International Food Policy Research Institute IFC (International Finance Corporation). 2010. and World Bank. “Indexed-Based Agricultural Insurance: A Vargas, Edwin. 2010. “Innovaciones financieras en Product Design Case Study.” IFC Advisory la cadena productiva.” PowerPoint presentation Services, Washington, DC. at the conference “Agricultural Value Chain Kang, M. G. 2007. “Innovative Agricultural Finance,” FAO and Academia de Insurance Products and Schemes.” Agricultural Centroamérica, Rome and San José, Costa Rica. Management, Marketing, and Finance http://www.academiaca.or.cr/presenta- Occasional Paper, FAO, Rome. cion2010/presentaciones/edwin_vargas.pdf. Miller, Calvin. 2011. “Microfinance and Crop Zander, Rauno, Calvin Miller, and N. Mhlanga. Agriculture: New Approaches, Technologies, 2012. Credit Guarantee Systems for Agriculture and Other Innovations to Address Food and Rural Enterprise Development. Rome: Insecurity among the Poor.” Workshop paper FAO. Agricultural Finance 247 CHAPTER 11 Insurance Craig Churchill Low-income people live in risky environments, for the poor. Over the past decade, however, vulnerable to numerous perils—illness, acciden- microinsurance has been on a steep growth and tal death and disability, loss of property due to learning curve, in part because of work by the theft or fire, agricultural losses, and disasters of Microinsurance Network and the International both the natural and manmade varieties.1 They Labour Organisation’s Microinsurance Innovation are also the least able to cope when a crisis does Facility. Thanks to their efforts, the experiences of occur. For example, an estimated 150 million microinsurance providers around the world have people are adversely affected by out-of-pocket been documented and analyzed, creating new spending on health care services each year. waves of lessons and guidance. More than 90 percent of these individuals live This chapter describes the need for insur- in low-income countries. For approximately ance and key product design issues that need to 100 million people, out-of-pocket payments for be considered to make insurance relevant for health services are so financially devastating low-income households. It provides an over- that they are pushed below the poverty line view of the types of products, including life, (Xu et al. 2007). health, property, and agriculture insurance, and Microinsurance is much younger than other describes how insurance can be integrated into financial services for the poor. In the original the financial inclusion agenda. It will be of Microfinance Handbook (Ledgerwood 1998), it interest to practitioners, funders, and other received only a passing mention, two paragraphs stakeholders interested in understanding how and a box. At the time, there was very little expe- microinsurance can help poor women and men rience or innovation around insurance services better manage risk. Insurance 249 The Need for Microinsurance Microinsurance is emerging as a comple- mentary tool to help low-income people man- Stakeholders in microfinance often focus their age risks more effectively. It provides protection attention and resources on the productive side of against specific perils including death, disabil- finance, particularly micro- and small enterprise ity, hospitalization, or crop failure, in exchange lending. Yet any development gains achieved— for regular payments proportionate to the like- such as increased incomes, assets accumulated, lihood and cost of the risk occurring. Often the and jobs created—can quickly be lost if the term “insurance” is used loosely to refer to gen- entrepreneur’s business or household experi- eral risk-prevention and management tech- ences a peril. Consequently, productive invest- niques. For example, savings set aside for ments must be balanced with similar attention emergency purposes might be referred to as an and resources on promoting protection. insurance fund. This book, however, uses a nar- Although people in different countries are con- rower definition in which microinsurance, like cerned with different risks, low-income house- traditional insurance, involves a risk-pooling holds consistently identify the loss of an income element, which allows large groups of insured earner and sickness of a family member as their entities to share the losses resulting from the greatest concerns (Cohen and Sebstad 2006). The occurrence of an uncommon event (see box 11.1 dominance of illness is not surprising, especially for definitions of key insurance terms). because of its double impact. An inability to work The insured entities—such as persons, results in lower income opportunities and addi- ­ businesses, households, communities, or even tional expenses to cover health care costs. For countries—are therefore protected from risk in families with sick children, small expenses can exchange for a fee known as a premium. The pre- quickly mount and have a large financial impact. mium amount is determined by an estimation of Accidents, as well as chronic illness such as the frequency and severity of the event occurring. malaria and HIV/AIDS, require relatively large Those in the risk pool who do not suffer a loss sums. These overwhelming financial pressures during a particular period essentially pay for the frequently fall on women, many of whom assume losses experienced by others. Insurance reduces primary responsibility for the welfare of their vulnerability as households replace the uncertain families. prospect of peril with the certainty of making Although poor households may have infor- small, regular premium payments and receiving a mal means to manage risks, these strategies payout if the peril occurs. This risk-pooling func- generally provide insufficient protection. Many tion makes insurance more complicated than sav- risk-management strategies, such as spreading ings, credit, or payment services. financial and human resources across several Despite features similar to those of traditional income-generating activities, result in low insurance, microinsurance requires a fundamen- returns. Informal risk-coping strategies, such as tally different approach to be relevant for the borrowing from friends and family, tend to low-income market and viable for providers. cover only a small portion of the loss, so the The products generally available from insurers poor have to patch together support from a vari- are not designed to meet the specific characteris- ety of sources. Even then, informal risk protec- tics of the working poor, particularly the irregu- tion does not stand up well against a series of lar cash flows of households with bread winners perils; before the household has a chance to in the informal economy. Other key product fully recover from one crisis, they are often design challenges include inappropriate insured struck by another. 250 The New Microfinance Handbook Box 11.1  Key Insurance Terms Actuary: A person who calculates insurance and annuity premiums, reserves, and dividends. Adverse selection: The tendency of higher-risk individuals to seek out more insurance cover- age on average in anticipation of a greater probability of experiencing the insured event(s). Agent: An insurance company representative who solicits, negotiates, or effects insurance con- tracts, and provides service to the policyholder for the insurer, usually for a commission on the premium payments. Basis risk: The chance that an insurance payout does not match the loss experienced by the policyholder. This is a particular concern with index insurance, which pays out based on a measurable indicator, such as too much or too little rain, but that indicator may or may not correlate well with the policyholders’ actual losses. Beneficiary: The person or financial instrument (for example, a trust fund), named in the policy as the recipient of insurance money if an insured event occurs. Benefits: The amount payable by the insurer to a claimant or beneficiary after the occurrence of the insured event. Capitation: Method of payment whereby a physician or hospital is paid a fixed amount for each person in a particular plan regardless of the frequency or type of service provided. Claim: A request for payment of a loss that may come under the terms of an insurance contract. Claim verification: The process whereby the microinsurer verifies and processes claims for payouts. Copayment: Mechanism used by insurers to share risk with policyholders and reduce moral hazard, which establishes a formula for dividing the payment of losses between the insurer and the policyholder. For example, a copayment arrangement might require a policyholder to pay 30 percent of all losses while the insurer covers the remainder. Covariant risk: The tendency for either (1) many households to be affected by a risk at the same time or (2) several risks to consistently occur together. Coverage: The scope of protection provided under a contract of insurance, and any of several risks covered by a policy. Deductible (or excess): Mechanism used by insurers to share risk with policyholders and reduce moral hazard, which establishes an amount or percentage that a policyholder agrees to pay, per claim or insured event, toward the total amount of an insured loss. Endowment: Life insurance payable to the policyholder if living, on the maturity date stated in the policy, or to a beneficiary if the insured dies before that date. Lapse: The termination or discontinuance of an insurance policy due to nonpayment of a premium. Moral hazard: A risk that arises when people with insurance engage in more dangerous behaviors or use more services because they know they are protected. An example might include failing to take preventative health care measures or making unnecessary visits to a doctor. Preexisting conditions: These are health conditions that are often excluded by insurance policies as a means of controlling adverse selection. To control for this, insurance programs may (continued next page) Insurance 251 Box 11.1 (continued) require a health checkup before enrollment, or ask prospective policyholders to answer a health questionnaire. Premium: The sum paid by a policyholder to keep an insurance policy in force. Rider: An amendment to an insurance policy that modifies the policy by expanding or restricting its benefits or excluding certain conditions from coverage. Risk pooling: The spreading of losses incurred by a few over a larger group, so that in the process, each individual group member’s losses are limited to the average loss (pre- mium payments) rather than the potentially larger actual loss that might be sustained by an individual. Risk pooling effectively disperses losses incurred by a few over a larger group. Self-administration: Maintenance of all records and assumption of responsibility by a group policyholder for those covered under its health insurance plan. Responsibilities include preparing the premium statement for each payment date and submitting it with a payment to the insurer. The insurance company, in most instances, has the contractual prerogative to audit the policyholders’ records. An alternative is third-party administration, whereby a specialized company performs the administrative function. Underwriter: (1) A company that receives the premiums and accepts responsibility for the fulfill- ment of the policy contract; (2) the company employee who decides whether or not the company should assume a particular risk; or (3) the agent that sells the policy. Waiting period: The period whereby policyholders cannot access certain benefits for some time after they enroll. A waiting period has essentially the same effect as excluding preex- isting conditions except the insurer does not have to incur the claims verification costs. Source: Adapted from Roth et al. 2007. amounts, complex exclusions, and indecipher- and encourage salespersons to focus on larger able legal policy language, all of which conspire policies and more profitable clients. against effectively serving the poor. Microinsurance is just one of several risk- Another major challenge in extending insur- management tools available to low-income ance to the poor is educating the market and households, and so organizations truly con- overcoming its bias against insurance. Many cerned about helping the poor to manage risks poor persons are skeptical about paying premi- should assess whether the provision of microin- ums for an intangible product with future bene- surance is the most appropriate response. For fits that may never be claimed. Insurance risks that result in small losses or for risks with a providers are seen as quick to take one’s money, high likelihood or high frequency of occurrence, but slow to pay it out. In fact, this bias goes in savings and emergency loans would be more both directions. People who work for insurance appropriate risk-managing financial services. companies are usually unfamiliar with the needs Savings and credit are also more flexible than and concerns of the poor. In addition, the culture insurance because they can be used for a variety and incentives in insurance companies reward of different risks (and opportunities). Insurance, 252 The New Microfinance Handbook on the other hand, provides more complete cov- Group or Individual Insurance erage for large losses than poor households could The primary feature distinguishing group insur- provide on their own. For these larger risks, par- ance from individual insurance is that under ticipating in a risk pool is a more efficient means group insurance, many people are insured under of accessing protection than if households try to one master policy. The group policyholder protect themselves independently. decides what type of coverage to buy for the Like other financial products, insurance pro- members of the group and is responsible for grams for the poor have to balance three compet- enrolling members, collecting premiums, dissem- ing objectives: (1) provide coverage to meet the inating certificates of insurance and product needs of the target population, (2) minimize information, and assisting members to file claims. operating costs for the insurer, and (3) minimize The policy describes and defines the eligible the price (including transaction costs) for clients members of the group. to enhance affordability and accessibility. The Underwriting guidelines for group insur- goal is to strike a balance between broad inclu- ance generally begin by specifying the funda- sion, sufficient benefits, low premium rates, and mental requirements that define a group. The sustainability. main criterion is that the group must have been formed for reasons other than to obtain insur- ance. This mechanism should limit the scope Product Options for adverse selection and allow for easier When designing insurance products, various underwriting and risk management; particular options need to be considered. Will the insurance care needs to be made to implement it properly, be offered to groups or individuals? Will it be as illustrated in box 11.2. Examples of groups mandatory or voluntary? What are the coverage suitable for group insurance include employees terms and prices? How will premiums be col- in a company, labor union members, borrowers lected? And how will benefits be paid? of a microfinance institution (MFI), and affinity Box 11.2 AKAM’s Experience with Village-Based Health Microinsurance in Pakistan In 2006 the Aga Khan Agency for Microfinance Based on thorough market research, micro- (AKAM) launched a microinsurance program insurance experts designed a remarkable in Pakistan to test an innovative health micro- product and innovative processes. The product insurance to protect low-income families from covered not only inpatient hospitalization cost the often ruinous effects of catastrophic health (up to US$400 per year), including a follow-up care expenditure. The program attempted to visit and medication needed after discharge, make insurance possible among villagers in but also one outpatient consultation for every the rugged Northern Areas by dramatically insured person and life insurance for the fami- reducing transaction costs through group poli- ly’s bread winner. The product had few exclu- cies and designing insurance products that sions and no age limits, waiting periods, meet the target market’s needs. copayments, or deductibles. Both normal and (continued next page) Insurance 253 Box 11.2 (continued) complicated maternity was covered from day In addition, insurance utilization greatly one. The general intention was to provide cov- exceeded expectations; claims exceeded pre- erage for US$5 per year that addressed miums by several hundreds of thousands of people’s needs in a way that would allow them dollars between 2007 and 2011. The main rea- to understand, appreciate, and embrace for- son was an erroneous assumption regarding mal insurance. membership in village organizations, which Because cases of catastrophic health was neither universal nor static. Although the costs of one villager can affect the entire insurance design assumed that every person community, the insurance purchase was was already a member of a village organization intended to be a community decision. when they were offered insurance, instead Applying the principles of group insurance to people who intended to use the insurance villages would allow AKAM to insure larger because of current pregnancies or preexisting numbers by selling the product through vil- illnesses could choose to join one village orga- lage organizations—thereby reducing the nization or another specifically to access insur- transaction cost per person—and protect the ance. Market research confirmed the program against the risk that only unhealthy opportunistic attitude. When asked why she people would buy insurance. had not renewed her policy, one woman Market research indicated, however, that answered, “Last year I was pregnant, but this the insurance purchase could not be imposed year I don’t plan to have a baby, so why insure?” on every person in a village: Some were too Other factors aggravated this behavior: Not poor, and the initial assumption that the better all of a family’s children were insured, insur- off would subsidize the premium of their ance was bought after the sales window was neighbors proved unrealistic. So departing officially closed, and claims control could have from one fundamental principle of group insur- been more rigorous. Given that much larger ance, the minimum take-up rate was reduced premium volumes and much larger numbers from 100 percent (everybody is insured) to of insured persons were needed to cover 50 percent of households in a village organiza- expenses and reduce the cost per person, tion, but with the additional condition that those management’s main focus for several years households that decided to buy the coverage was on increasing scale. It was expected that had to include every household member. by insuring more people, automatically more The outcome of this careful design was not healthy people would be insured, reducing the as expected. Fewer people than anticipated unsustainable utilization rates. But this did not bought the coverage, and the families who did happen, and in the end restrictive product were smaller than the average household size. redesign was necessary to contain losses. Source: Peter Wrede. groups such as professional or community financially sustainable. Individual insurance is associations. often twice as expensive as group coverage Individual microinsurance requires a high because of higher sales, underwriting, adminis- participation rate among the potential target mar- tration, and claims costs. The cost for individual ket to make the provision of individual insurance insurance claims can be reduced through more 254 The New Microfinance Handbook rigorous underwriting, such as medical screening Voluntary or Mandatory Insurance (because bad risks are identified and filtered out Mandatory insurance is the most common type of or are limited to lower coverage). However, for microinsurance and refers to a situation in which microinsurance additional screening may not an organization requires all of its clients to pur- make economic sense because coverage amounts chase insurance or it is provided as a loyalty are very low; moreover it may run counter to the incentive to customers (see box 11.3). Mandatory social agenda of the microinsurer. participation ensures a broad cross section of A key advantage of individual insurance is people participate and can help to limit adverse that the coverage can continue with the individ- selection. To be demand driven and client ual once group membership ceases, for exam- focused, one would expect that voluntary cover- ple, for MFI borrowers who no longer require age would be the most appropriate. Yet in the field loans. Group coverage can be converted into of insurance—microinsurance in particular individual policies using continuation options. where affordability is so important—a strong case To the extent that the group coverage relies on can be made for mandatory coverage because it infrastructure supporting the group (such as performs the following: using an MFI for premium collection), continu- • Enables insurers to reach scale, which increases ation policies may require additional charges the accuracy of predicting future claims and administration. Box 11.3  IFFCO-Tokio’s Bundled AD&D Coverage In India the Sankat Haran Policy sold by IFFCO- insurance premium, so there is no need for Tokio provides accidental death and disability the insurer to collect premiums from the cli- (AD&D) coverage, which is obtained when cli- ent or, indeed, from the retailer. ents buy a 50 kg fertilizer bag of IFCCO and On the face of it, in a competitive market Indian Potash brands. The receipt for the fertil- for fertilizer and AD&D insurance, it is hard to izer bag acts as proof of payment, and the pol- imagine what value is offered to the consumer icy document is printed on the fertilizer bag. by this type of embedding. Any consumer The amount of coverage is US$90 in the event who wanted either fertilizer or AD&D insur- of an accidental death and US$45 for certain ance could buy it separately in the required categories of dismemberment and disability. quantities without needing to buy the two The insured is the purchaser of the fertilizer together. However, the rural Indian market is bag, and a single person can hold multiple pol- not competitive, and this may be the only icies up to a maximum of US$2,260 in means of distributing such insurance. It is also coverage. More than 3.5 million farmers are possible that the addition of AD&D insurance covered by this program. provides an incentive to purchase a particular Essentially the program sells prepaid insur- brand of fertilizer (in much the same way some ance, in the sense that the retailer buys the Visa cards come with similar coverage linked fertilizer, including its insurance component, to travel). The insurance is compulsory, which from a wholesaler. The retailer prepays the in theory should control adverse selection. Source: Adapted from Roth and Chamberlain 2006. Insurance 255 • Reduces costs due to higher volumes and member selection to reduce the risks of overusage lower enrollment, administration, collection, and moral hazard, but as shown in box 11.2, such and underwriting costs an approach is not always successful. • Improves claims ratios because it brings in lower-risk individuals, which is known as pos- Terms of Coverage and Pricing itive selection, who may otherwise opt out or Many microinsurance products have terms of postpone their participation and 12 months or less. Short-term policies are gener- ally preferred by insurers because long-term insur- • Reduces vulnerability to staff fraud because it ance involves longer-term commitments and thus reduces the chance for agents to sell policies higher risk—it is easier to predict the likelihood of and keep the premiums. an insured event in the next year than in the next Community groups, such as women’s associa- 10 years. For the insured, however, the opposite is tions and other community-based organizations, true: The advantage of long-term coverage is that financial cooperatives, MFI borrowers, and small he or she will have protection over the long term business associations, can be leveraged as distri- without having to reapply for insurance every year. bution channels and as a mechanism to protect To address the need to balance long-term risk against adverse selection. One of the biggest disad- with client preferences for long-term coverage, vantages of mandatory coverage, besides the fact short-term policies can have a renewable term that people are required to buy something that arrangement whereby the policyholder can con- they may not want, is that the distribution system tinue to have coverage up to a maximum age tends to overlook the consumers’ need for infor- without the need to reapply, as long as premium mation. Such products generally have excessively payments are made. Renewable terms combine low claims ratios, seemingly the result of people the advantages of short- and long-term coverage. not knowing that they are covered. As one rural The insured are guaranteed to receive continued banker in Ghana noted, “If we tell people all about coverage, yet the insurer can adjust the pricing, the cover, we’d be flooded with claims.” When up or down for each renewal term, depending on offering mandatory coverage, microinsurers its experience. (or their agents) need to ensure that clients are Although insurance companies tend to exclude constantly educated about buying an intangible high-risk persons, or charge them higher rates service that provides security and peace of mind to than others, microinsurance programs generally ensure that they can appreciate the benefits, and strive to be inclusive. Because the sums insured thus lead to the creation of an insurance culture. are small, the costs of identifying high-risk per- Microinsurance providers can combine the sons, such as those with preexisting illnesses, may advantages of mandatory and voluntary coverage be higher than the financial benefits of excluding by making insurance mandatory for all members them in the first place. Consequently, instead of of an existing group (which minimizes adverse pricing products for an individual’s risk profile, selection), while providing two or three options to microinsurance generally uses a group pricing choose from. This allows members to opt for the method. Limiting the number of exclusions and coverage level they would prefer and increases the restrictions lowers administrative costs and likelihood they will receive sufficient information increases efficiency, and the group provides some to make informed decisions. Some microinsurers means of controlling insurance risk. use groups more effectively than conventional Besides using groups, insurance plans incorpo- insurers by enlisting the support of the groups in rate various mechanisms to protect against 256 The New Microfinance Handbook adverse selection and overusage, including deduct- premium payment to a loan is a good example of ibles, copayments, and benefit ceilings. With a this strategy; when clients receive a loan, they deductible, all claims below a specified amount are have cash to pay the premium. This strategy is paid by the insured. Copayment arrangements also one of the easiest ways to achieve high mean a portion is paid by the insured and a portion renewals. Its downside is that only clients who by the insurer and are normally structured as a receive a loan can obtain insurance coverage. fixed fee, usually a specific amount per office visit. Alternatively, a link between savings and insur- Benefit ceilings limit the overall amount of cover- ance provides more continuous coverage than the age to a specified amount, normally on a per per- credit-insurance link, and it can significantly son basis over a fixed period. Instead of using reduce the transaction costs. This can be done by waiting periods or screening for high-risk persons, deducting the premium from a savings account microinsurance programs often will include grad- (although there is a public relations risk that uated benefits that start small during initial depositors may not be aware that the money is months of coverage and increase over time, which being deducted). Another more innovative link also creates an incentive to renew. between savings and insurance is to establish a fixed deposit account and allow the interest to pay Premium Payment Mechanisms the insurance premium. One challenge with this Methods for paying premiums must minimize method is for the poorest clients to save up enough administrative costs for the insurer and transac- money to deposit in the account. From a manage- tion costs for clients. In general, the best time to ment perspective, there is the risk the interest collect premiums is when policyholders have rates that are payable on the account may change cash, for example, at harvest time, or when they and not be sufficient to pay the premiums. receive a loan or a government cash transfer. More recently, insurance is being linked to To streamline premium payments, a com- other financial transactions, such as buying gro- mon strategy is to “piggyback” the premium on ceries or cell phone minutes or paying an electric- top of another financial transaction. Linking the ity bill (see box 11.4). The emergence of more Box 11.4  Collaborating with a Utility Company in Colombia In response to increased competition, accident, funeral, home, and vehicle insur- CODENSA, the largest electricity distribu- ance. As an equal partner with a significant tion company in Colombia, has developed a investment in the project’s success, CODENSA customer loyalty program to strengthen its is committed to maximizing profitability and customer base. A core component of the developing an effective microinsurance busi- strategy is to offer alternative, nonelectricity ness model. Because of aligned interests products, including insurance, which can be and good project management, the project paid through the electricity bill. With this has enabled more than 300,000 families to objective, CODENSA entered into a partner- manage risk more efficiently by paying ship with MAPFRE Insurance in 2003 and insurance premiums together with their currently offers five products: life, personal electricity bill. Source: Adapted from Smith et al. 2012a. Insurance 257 effective payment services, for example, through it is preferable to require family coverage where smartcards and point-of-sale devices or by mobile possible. phones themselves, creates a new platform for Even more important than defining which premium collection and dramatically expands dependents are eligible is to identify them in potential outreach. advance. To minimize claims fraud, each person covered by the policy must be individually identi- fied using official documents (where possible) Eligibility and/or with photographs. It is not sufficient to When designing an insurance product, it is also specify which persons are covered without necessary to determine who is eligible to be cov- explicit identification of the additional persons. It ered. Generally it is better to have more people is also important to control movements of depen- covered by one product, and therefore a family dents on or off the policy. For example, to control benefit approach, which may include spouses, adverse selection, clients may have an option of dependents, and even parents, creates a number adding newborn children on to the policy within of advantages for microinsurers: a specified time frame, but not subsequently. • A family is a group of sorts, and consequently family coverage carries many of the same Claims advantages as group coverage, including larger The best opportunity to demonstrate the value of numbers and lower adverse selection risk. All insurance is to pay claims. When the benefits are other things being equal, the price for a family paid is equally as important as how they are paid. unit is generally lower than the sum of individ- Some products pay benefits in phases rather than ual premiums. in one lump sum to cover ongoing expenses. The provision of benefits over a period of time after • Family coverage can have a positive selection the insured event may have greater development effect by purposefully enrolling very low-risk impact than a lump-sum payment because persons. demands on the receiver of the payment can be significant; if the insurance payout is spent, for • Family coverage often has a better marketing example, on an elaborate funeral, it is no longer effect because the claims are more frequent, available to help the household cope with the loss and thus there are many more examples to of income from the deceased. demonstrate the value of microinsurance. Generally claims are paid only when the • Lenders concerned about protecting their loan claim has been verified through a claim verifica- portfolio realize that borrowers have repay- tion process. Policyholders have the right to ment problems when death or illness strikes efficient claim processing to ensure they receive family members. tangible benefits for the premiums paid. A claim verification process consists of (1) an insured The downside of family benefits is that not event leading to a notification of loss, (2) collec- everyone has a family, or that some people have tion of required documents, (3) presentation of larger families than others. To deal with the size the claims application to an intermediary or the of the family, microinsurers either ask the policy- insurer, (4) claim adjustment to verify the claim holder to identify a specific number of depen- and the amount, and (5) claim settlement. dents who are covered by the policy or they offer In general there must be enough checks and different prices for different sized households. To balances to ensure that fraudulent claims are not ensure that women and children are not left out, paid. Effective controls center on ensuring the 258 The New Microfinance Handbook information being supplied by the policyholder is more substantive benefits would be a strong indi- accurate and verifiable, and that all associated cator of customer satisfaction and loyalty. documents submitted with the claim are original Insurance is designed to be risk specific. and demonstrate no indication of fraud. Controls Microinsurance products can be broadly classi- must be strong but cost effective and reflect the fied into five primary categories: life, health, ability of clients to furnish the required informa- property, agriculture, and composite.2 Islamic tion. For example, death certificates are often insurance, called takaful, centers on the con- required for life insurance policies, but if they can cept of mutual insurance whereby multiple par- be easily purchased from corrupt officials, then ties contribute to a fund used to support groups they are not very effective controls. Alternatively, in times of need such as death, crop loss, or if the costs of securing the documentation, includ- accidents. Paid premiums are invested in a ing time and travel, are high, then the product will Sharia-compliant manner to avoid interest. not provide clients with particularly good value. Life Basic life insurance is the easiest insurance to Insurance Products provide. It is generally in high demand, relatively Insurance products should be largely designed easy to price, most resistant to fraud and moral based on demand research. What is it that people hazard, and not dependent on the existence and want coverage for? The general lesson is that efficient functioning of other infrastructure such microinsurance should be kept as simple as possi- as clinics or hospitals (Roth et al. 2007). Life ble for several reasons. First, to keep the premi- insurance involves a contract whereby the insurer ums low, the administrative costs have to be kept promises to pay a designated beneficiary a sum of low; and it is easier to accomplish that objective if money upon the death of the insured person. In the benefits are straightforward. More compli- certain instances, other events such as critical ill- cated products could be managed cost effectively ness or permanent disability may also trigger pay- if the provider has an excellent management ment. Life insurance includes a range of variations information system, although this is not an area in such as credit life, term life, and funeral insurance which microinsurers have yet excelled. as well as coverage that accumulates value such Second, the target market for microinsurance as endowment policies and annuities. often lacks exposure to insurance and may not Credit life insurance is life insurance linked to trust providers. Complicated benefit packages a loan. In its most basic form, the benefit or sum are difficult and time consuming to explain to insured is the outstanding balance of the loan and clients. If it is not easy for policyholders to the beneficiary is the lender. Many credit life pro- make a claim or to fully understand what grams require life insurance from borrowers. For expenses are eligible, then the proposed benefit the most part, credit life does not offer much ben- will not be particularly beneficial. Although the efit to clients; rather, it really protects the lender. benefits should be simple and “claimable,” However, to provide better value to clients, credit microinsurers should also consider offering life products can also cover the lives of spouses different benefit levels so that the low-income and/or other persons, or cover other risks, such as market can experiment with a very basic and permanent disability or fire damage (for more inexpensive product. If they come to believe that details, see Wipf et al. 2012). insurance provides good value for their money, With term life the benefit is payable only if the they might be enticed into higher benefit levels. insured dies during a specified period. No benefit This graduation from entry-level products to is payable if the insured is alive at the end of that Insurance 259 period. Term life is relatively simple to price has been in effect and the total of the premium and manage the risk. Although term life is less payments. expensive than other types of life insurance, The attraction of endowment policies is that low-income households may feel they have they enable the policyholder to build assets wasted limited resources by paying premiums if through a contractual savings component, which they do not receive any benefits. enables the poor to have something to show for Funeral insurance is essentially a term life their premium payments if the insured event does product with a cash or in-kind benefit such as the not occur. The difficulty with this product is that funeral service itself. This product is unique a significant portion of the premiums are used to because in some places, such as South Africa, cover administrative expenses including the there is significant demand, and therefore it can agent’s commission. Also, inflation and low be sold or marketed through passive channels, investment returns can reduce the benefits, and if such as a retailer. Funeral insurance may even be the policy lapses, contributions are forfeited. sold by the funeral parlor itself and may or may Consequently this product may provide policy- not be underwritten by a regulated insurance holders with limited value, especially if the client company. Funeral insurance is sometimes more is unable to make the regular premium payments attractive to low-income populations than other and the policy lapses, which happens frequently term life products because the benefit—the with low-income clients who have irregular funeral service—is tangible and represents a sig- incomes. Efforts to overcome the limitations of nificant expense for low-income households. To endowment policies are underway, particularly increase the value of these products to beneficia- by insurers in India, as evidenced by the examples ries, some funeral products offer a schedule of in table 11.1. benefits after the funeral, such as paying school With life annuities, the policyholder pays regu- fees and electricity bills or providing groceries for lar premiums until a specified date, usually a 12 to 24 months to assist households that have lost retirement date, after which he or she receives a bread winner to cope with the funeral costs and regular benefit payments until death. Often life loss of income (for more details, see Hougaard annuities are referred to as pensions, although and Chamberlain 2012). they do not have to be linked to retirement. Like Accumulating value products, such as endow- other insurance products, life annuities work on a ment plans and life annuities, include life insur- pooling principle. A population can be expected ance and a savings element over a longer period to have a distribution of life spans around the of time, and therefore they are much more com- population average, so those dying earlier will plicated financial instruments than basic term support those living longer. To design such a life products. Endowment policies combine ele- product, the insurer needs accurate data for the ments of a contractual savings product and insur- target population’s age and mortality tables as ance. An endowment policy accumulates value well as actuarial expertise to predict future over a period, typically 5, 10, or 15 years, through trends. Consequently the pricing of annuities is regular premium payments. If the policyholder very difficult, especially in developing countries, survives the term, he or she receives a lump sum. and therefore such products are generally not If the policyholder dies during the term, his or available for low-income markets. her beneficiaries receive a payment called the Savings completion insurance combines con- sum assured. Endowments can also be surren- tractual savings with insurance. In the event of dered early for a surrender value, the amount of death, savings completion insurance covers the which varies depending on how long the policy difference between the amount saved and the 260 The New Microfinance Handbook Table 11.1  Two Long-Term Insurance and Savings Products in India Max Vijay Grameen Shakti Insurance Max New York Life Insurance Company, Ltd SBI Life Insurance Company, Ltd Term 10 years 5 or 10 years Premium First payment from Rs 1,000 to 2,500 Annual payment of Rs 301 for a sum (approximately US$22–55); subsequent assured of Rs 25,000 (approximately premiums of Rs 10 (US$0.20) to Rs 2,500 US$6.50 for US$532 of coverage); grace per day are voluntary period of 30 days from the premium payment due date Sum Five times premiums paid subject to a limit Rs 5,000 to 50,000 (in multiples of 5,000); assured of Rs 50,000 to 100,000 (limit depends on group decides the sum it wishes to assure amount of first premium payment) Maturity Maturity = (sum of premiums paid + 5-year term = 50% of premium paid net of benefit investment return − account fees) service tax guaranteed; 10-year term = 100% of premium paid net of service tax guaranteed Death Natural death = account value plus sum Sum assured benefit assured; accidental death = account value plus two times sum assured Withdrawal/ Surrender and partial withdrawals possible Surrender possible after 3 years surrender after 3 years Source: Adapted from Rusconi 2012. target savings amount. A major difference Health between the endowment and savings completion Health insurance is one of the most highly insurance is that with the latter, the insurer does demanded insurance products and among the not hold the savings—rather, the financial service most difficult to provide to low-income house- provider does. From the insurer’s perspective, holds. It is in big demand because health risks this is a very simple product: just basic term life occur frequently and costs can be catastrophic. with a declining benefit amount. However, it may Health problems cause expenses for treatment but be less attractive to insurers than an endowment also result in the loss of income due to reduced policy because insurers generally prefer to hold productivity. The benefit of having health insur- the savings so they can invest and earn additional ance is that people do not have to delay care revenue. Alternatively, savings completion insur- because they cannot pay, which in turn can reduce ance may provide better value to clients, because the loss of income and lead to better health out- their savings are not used to pay an agent’s com- comes. If subsidies are not available, to make the mission (see box 11.5). coverage affordable to the poor, benefits are often For all long-term insurance products, policy- rationed to a limited range of treatments. The holders need to trust that the insurer will exist effectiveness of health insurance is highly depen- 10, 20 or 30 years later when benefits are dent on the health care system and the availability expected to be paid out. Insurers thus need to of quality services, whether public or private. be managed (and supervised) so they continue Health insurance can be complicated and difficult to operate and can fulfill their commitments, to price and manage given the involvement of a especially in times of inflation and currency third party (health care providers) and the number devaluations. of potential risks, including over-usage and fraud. Insurance 261 Box 11.5  Savings Completion Insurance Offered by TUW SKOK TUW SKOK, the primary provider of insur- coverage. In the event of the member’s ance to Polish credit unions, offers savings accidental death, TUW SKOK pays the bene- completion insurance to encourage credit ficiary the difference between the savings union members to save regularly. The mem- target and the savings balance at the time ber determines a savings goal and time of death. This insurance product is of partic- period, up to a maximum of 10 years. The ular interest to credit unions because it is credit union then calculates the amount of closely integrated into their core business the member’s required monthly deposit to and helps them achieve their own goals by achieve his or her savings target. It also cal- making the contractual savings product culates the monthly premium for insurance more attractive. Source: Adapted from Churchill and Pepler 2004. Health insurance benefits are often paid on a sometimes an additional payment for transporta- reimbursement basis; the policyholder pays for tion. Such a product is also not linked to the actual the health care and then submits the receipts for medical expenses, and therefore claims process- reimbursement. Such an arrangement is gener- ing does not require medical expertise. Such a ally less appropriate for poor clients who do not product is particularly relevant where the poor have regular cash flows. Some health insurance have access to good quality care in government or programs use a third-party or cashless payment other low-cost hospitals (see box 11.6). system whereby the microinsurer pays the health Inpatient coverage pays for the actual costs of care provider directly so the insured does not being in the hospital and is linked directly to the experience any out-of-pocket expenses, except medical costs incurred. Hospitalization is a good perhaps for a copayment or transportation, which example of an insurable risk because it is a large is sometimes also reimbursed by the insurer expense that occurs infrequently, so it is possible (for more details see LeRoy and Holtz 2012). for the risk pool to function effectively. However, As with life insurance, there are several differ- inpatient-only coverage does not typically include ent ways of structuring health insurance benefits, preventative care and early treatment, encourag- and not all of them actually cover health care ing the insured to wait until an illness is so serious costs. that it requires hospitalization before seeing a The most basic version, critical illness cover- doctor when the illness may have been treated age, is essentially a life insurance policy that pays more effectively if it had been addressed earlier. benefits early, that is, before the person dies, if the Pharmaceutical coverage pays for medicine policyholder is diagnosed with a specified critical either on its own or as an additional benefit to or terminal illness. In the context of microinsur- other health insurance. ance, this benefit is unlikely to cover the cost of Outpatient coverage pays for outpatient visits treatment, but would assist with the financial to the doctor or clinic. Because it occurs fairly hardship of not being able to work. often and is not a major expense, risk pooling Hospital cash pays the insured a daily rate for does not work as well. Consequently, some the number of days in the hospital, as well as organizations experiment with health savings 262 The New Microfinance Handbook Box 11.6  Microfund for Women’s “Caregiver” Product In situations where health care costs are low their spouse or a child is hospitalized, Caregiver compared with opportunity costs in the event pays out a lump-sum benefit for each night a of hospitalization, benefits sometimes take borrower or one of their immediate family the form of a per diem payment, which policy- members spends in the hospital. Clients can holders can use as they please. In Jordan the use the funds to cover costs such as transpor- Microfund for Women’s Caregiver product was tation, child care, and medical fees, as well as designed as a hospital cash-type product, but lost income. Borrowers are automatically cov- with a gender-focused twist. Recognizing that ered when they take a new loan; they do not women are their family’s primary caregiver, need to have a medical exam, and there are no and they are likely to have to leave their work if exclusions for preexisting conditions. Source: Adapted from Frankiewicz and Churchill 2011. accounts for outpatient expenses, with possible market basis, sometimes it is completely subsi- links to insurance for hospitalization. The advan- dized by governments, and often the reality lies tage of covering outpatient expenses in an insur- somewhere in between. ance product is that policyholders are likely to use the benefits and thus appreciate the value of Property renewing their policies. With inpatient coverage, Property insurance provides coverage for tangi- in contrast, generally fewer than 5 percent of ble assets such as housing and contents as well as policyholders are likely to experience a claim, machinery and other equipment. For low-income and therefore many may feel they have wasted households and businesses, such coverage can be their money. difficult to underwrite and verify claims, because In many countries, both developed and devel- ownership may not be clear and actual losses can oping, there is ongoing debate about the role of be difficult to verify. With the exception of agri- government in providing health insurance bene- culture insurance, there are few examples of fits to the public, particularly the poor. Although stand-alone property coverage for the low-in- universal health insurance coverage is certainly come market, although it is included in some an ideal objective, governments that cannot afford composite products. Perhaps the most common it may have to ration benefits in some way, per- type of property microinsurance is a rider on a haps by limiting coverage to the poor, or by subsi- credit life policy that would pay specified benefits dizing health care providers to lower costs for if a borrower’s business burns down. Such a risk is consumers. In some developing countries, includ- common among MFI clients who work as ven- ing Rwanda, Ghana, and India (see box 11.7), the dors in large markets. government is providing leadership in efforts to extend health insurance coverage to workers in Agriculture the informal economy (Leatherman et al. 2012). In rural areas, concerns about drought, death of Indeed, microinsurance lies at the crossroads livestock, and other agricultural risks tend to be between financial inclusion and social protection; high for low-income households. Without pro- sometimes it is offered by insurers on a purely tection against agricultural risks, financial service Insurance 263 Box 11.7  Public-Private Partnerships and Health Microinsurance in India What is particularly interesting about health to aggregate huge numbers, these programs microinsurance in India is the emergence of are transforming health microinsurance by state-driven mass programs. These programs addressing key challenges such as data cre- are considered under the broad heading of ation, investment in identification technology, microinsurance, even though they are heavily and setting industry standards for health care subsidized, because they generally involve provision. some sort of user fee and they are often imple- For RSBY, the successful implementation mented by the insurance industry through on such a scale can be attributed to the public-private partnerships. ­ public-private partnership and the use of tech- From 75 million people covered under nology. Whereas Aarogyasri and Kalaignar col- such programs in 2007, it is estimated that laborated with one insurer, Star Allied 302 million people had health microinsurance Insurance, RSBY in its first year worked with in 2010. Three of these programs—Aarogyasri eight insurers and 16 third-party administra- in Andra Pradesh, Kalaignar in Tamil Nadu, tors to implement the program. To control and the national Rashtriya Swasthya Bima fraud, RSBY uses biometric cards that are Yojana (RSBY) program—reportedly insured issued in “real time,” which improves cus- 54 million families by the end of 2010 (PHFI tomer service and controls any rent-seeking 2011). Backed by political will and the ability behavior by the card-issuing agency. Source: Adapted from Ruchismita and Churchill 2012. providers may be unwilling to lend for agricul- loss or pay off the claims adjuster), and expen- tural inputs. Even if poor farmers have funds to sive claims verification processes, especially for pay for seeds and fertilizer in one growing season, smallholder farms. a crop failure may ruin their ability to plant the As described in box 11.8, an innovation to over- following season. These risks tend to be covari- come these problems is index-based insurance ant, affecting many farmers in the same region at whereby policyholders in a particular geographic the same time, causing particularly large risks for area receive a benefit regardless of whether or not local lenders. When an entire community is they experience a loss if a predetermined measur- affected, this also limits the ability of farmers to able outcome occurs, such as too much or too lit- help each other. tle rain, temperatures above or below certain Agriculture insurance generally covers crop thresholds, or excess wind speeds. The big advan- failure and the death of livestock. However, it is tage of an index approach is that it helps to elimi- wrought with challenges, particularly moral nate fraud and moral hazard and minimizes the hazard (for example, having insurance may costs of claims processing. A key limitation, how- give the farmer an incentive not to follow ever, known as basis risk, is that farmers may appropriate farming practices), covariant risk experience a loss even though the index is not (for example, a natural disaster affects many of triggered, or alternatively do not experience a loss an insurer’s policyholders at the same time), and still receive a benefit (for more details, see fraud (for example, the farmer may fake crop World Bank 2011). 264 The New Microfinance Handbook Box 11.8 Index Insurance and Technology: The Case of Kilimo Salama, Kenya Kilimo Salama is an index-based agriculture insurance product that was piloted in March 2009, initially covering only 200 maize farmers and drawing on data collected by two weather stations. The project has since grown and now uses 30 weather stations and covers 22,000 farmers who grow maize, sorghum, cotton, beans, and coffee. Kilimo Salama (which means “Safe Agriculture” in Kiswahili) is a partnership between the Syngenta Foundation, Safaricom, the largest mobile network operator in Kenya, and UAP, a large general insurance company. The product covers farmers’ agricultural inputs (for example, fertil- izer, seed, and pesticides) in the event of drought or excessive rainfall. The product is index based, meaning that payouts are triggered by rainfall amounts. During the planting season, actual rainfall is measured using a solar-powered weather station in each area. If rainfall is below or above predetermined thresholds, a payout is made. The value of the payout is a function of how much the recorded rainfall deviates from the threshold. To distribute the product, Syngenta involves agro-dealerships and an innovative technol- ogy system. The administrative backbone of Kilimo Salama is a fully automated, paperless technology that uses mobile phones with tailor-made Java software as registration devices at the points of sale. The mobile phones transmit customer information to a central server, and the server in turn communicates with the insured farmer via SMS (text messaging). The “backbone” technology is linked to Safaricom’s M-PESA mobile payments platform to facili- tate payment of premiums and settlement of claims. The following steps highlight how technology supports enrollment: • Farmers visit a local agro-dealer who offers Kilimo Salama for a premium related to their expected harvest or the cost of inputs purchased from the agro-dealer. • If a farmer decides to buy Kilimo Salama, the dealer scans a bar code on the bag of seeds using a specially designed mobile phone application. • The application then informs the dealer of the premium the farmer should pay, which is cur- rently between 5 and 15 percent of the cost of inputs. • The agro-dealer captures the farmer’s details—name, mobile number, and coverage amount—on the dealer’s mobile phone and transmits this information via GPRS to the insurer through a central communications server. • The farmer then receives a text message with the policy number and coverage details. Provision has been made for farmers who do not have mobile phones: The policy number and coverage details are sent instead to the dealer’s phone, and the dealer then passes them on to the farmer. Kilimo Salama uses the amount of rainfall as a trigger for claims. During the planting season, weather stations send the precipitation data via a general packet radio service connection to UAP. The insurer enters it into a weather-index application that outlines the rainfall requirements for each crop. The application calculates the claim percentage, if any, and then UAP transfers the claim amount to the M-PESA account of the farmer or dealer. Although reasonably effective, the use of technology has posed certain challenges. The weather station technology allows for the design of a viable insurance product, but it also makes (continued next page) Insurance 265 Box 11.8 (continued) the product more complex to understand. Farmers are on average 20 kilometers away from the nearest station, which could lead to a misunderstanding by farmers as to whether they are enti- tled to a payout if the rainfall recorded on their farms differs from the local weather station. This basis risk increases the need for appropriate and extensive client education. Multiple technologies are required to minimize the error margin in constructing weather indices. Reliance only on weather station data is unlikely to provide an accurate picture of the rainfall patterns experienced in a particular area. This is all the more difficult if weather stations are few and far apart. To overcome this challenge, Kilimo Salama is experimenting with satellite mapping systems and devising better ways to collect and track yield data. This will allow for the cross-validation of weather data and the selection of more accurate product parameters. Source: Adapted from Smith et al. 2012b. http://kilimosalama.wordpress.com/about/. Composite Insurance counter to a primary tenet of microinsurance: Offered in some low-income markets, composite simplicity. A related issue is the potential lack of insurance combines multiple benefits into one transparency. The contribution of each individual integrated insurance policy. Benefits can come benefit relative to the total price may not be com- from two or more different insurance companies municated, nor are clients normally allowed to and are bundled together into one comprehensive choose the specific benefits they want. Because product. The rationale is that composite insur- different risks may be managed by different com- ance delivers a more comprehensive risk protec- panies, a potential problem also exists when the tion package at a lower cost (that is, it would be service provided by one component of the prod- more expensive to sell three separate products). uct is inadequate and negatively affects the per- The marginal cost of adding benefits to many ception of the entire product. insurance products is minimal. In addition, when selling the product, a cost-effective solution to Microinsurance and Financial diverse risk-management needs can be offered. Inclusion For example, VimoSEWA, the insurance arm of the Indian trade union the Self-Employed A unique aspect of microinsurance is the willing- Women’s Association (SEWA), offers life, hospi- ness to be broadly inclusive. The method by talization, and property coverage for individuals which commercial insurers typically limit their and families all in one product. However, because exposure by excluding high risks, such as older insurance regulations require companies to have persons or those with preexisting conditions, nat- separate licenses for life and general insurance, urally excludes large numbers of vulnerable peo- the risks are underwritten by two different com- ple. The microinsurance challenge is to find ways panies, the Life Insurance Corporation of India to inclusively serve vulnerable households at for life insurance and the New India Assurance affordable rates over the long term. for non-life insurance. Broader inclusion means lower operating costs A challenge with composite insurance is that by reducing the costs of screening, while accept- the benefits can be complicated, which runs ing higher-risk persons and their accompanying 266 The New Microfinance Handbook claims costs. However, significant scale is required • Controlling covariant or catastrophe risk, to justify this approach. High-risk individuals can for example, riots or weather catastrophe be included if the benefits are limited or, alterna- exclusions tively, if premiums are correspondingly higher • Reducing the extent of initial underwriting, for risky members than for the rest of the for example, one-year HIV/AIDS exclusions group. Both of these approaches reduce the applied to life coverage to eliminate the need cross-subsidization of the higher-risk individu- for testing. als by the rest of the members to support broader inclusion on a sustainable basis. There Microinsurers, however, may adopt a different is a solid economic rationale at play as well: approach to exclusions than traditional insurers. The costs of monitoring and enforcing complex Although the moral hazard exclusion is justifiable exclusions must be weighed against the claims regardless of the type of insurance, a microin- avoided; the small sums insured and premiums surer may allow typically excluded conditions for of microinsurance products cannot support covariant risk and certain adverse selection risks complex screening and claims validation. in the spirit of social protection. Where covariant Another challenge in getting broader microin- risks are taken on, it is essential that appropriate surance inclusion is that in developing countries, risk management strategies exist, such as reinsur- information for actuarial calculations, such as ance. Otherwise, the only consequence of drop- mortality and morbidity rates, is at best unreliable ping the catastrophe exclusion will be the and generally not available. Garand et al. (2012) insolvency of the program in the event of a propose some solutions for actuaries to price catastrophe, which benefits no one. insurance products with limited data, but only The argument against exclusions for preexist- once programs have sufficient experience can ing conditions is not quite as clear. If a microin- they accurately predict claims incidents and surer offers voluntary individual insurance, then costs. the high-risk people are most likely to sign up; if Although programs may be willing to accept only high-risk people join, the insurer cannot high-risk members, they might not be so inclined effectively pool the risk. However, if it is group to keep older policyholders. Most have age ceil- coverage, especially if it is mandatory, or the ings whereby members may be asked to leave the microinsurer recruits large volumes of policy- program just when they really need the benefits. holders, then it can be more inclusive with In these cases, some microinsurers provide a regard to preexisting conditions. This additional withdrawal payout. Insurers may use exclusions risk is highest at product launch. If renewal rates for a number of reasons: can be kept high as the program matures, the risk associated with preexisting conditions becomes • Controlling adverse selection, for example, more manageable because new insured mem- preexisting condition exclusion bers become a smaller proportion of the entire • Reducing moral hazard, for example, suicide portfolio. exclusions A microinsurance-friendly alternative to exclu- sions is the waiting period where benefits are not • Reducing the cost of insurance by removing accessible for some time after enrollment. For high-frequency or common claims and target- example, HIV/AIDS-related adverse selection is ing only specific causes of claims, for example, managed using six-months to one-year acci- accident-only coverage, which excludes death dent-only waiting periods. If the insured event due to illness occurs during the waiting period, the claim is Insurance 267 rejected; the insurer does not have to check with • Improve efficiency: Administrative costs for doctors and review medical records to determine microinsurance continue to be high for many if the policyholder already had the problem, as it products, making it difficult for sufficient pre- has to do with exclusions for preexisting miums to return to policyholders as claims. To conditions. support scale, insurers need to efficiently pro- Another alternative to exclusions which is cess huge volumes of data. At the same time, more in line with the spirit of microinsurance front-office technology, from handheld and is to offer benefit schedules with gradually point-of-sale devices to mobile phones, are increasing benefits. For example, if the insured beginning to improve sales, premium collec- event occurs in the first year, the benefit is tion, and even claims settlement. There are small; but if it occurs after the first year, the great expectations that technology will facili- benefit is much larger. Such an approach is an tate paperless insurance processes that will effective way to control adverse selection while streamline systems and provide greater value creating an equitable microinsurance program to policyholders. that encourages long-term participation and • Innovate with voluntary products: Much of the renewal. scale that has been achieved to date can be attributed to mandatory coverage or automatic Moving Forward benefits. The next step is to experiment with voluntary products and sales mechanisms to The rapid growth of microinsurance means that better understand how to unlock the latent many more low-income households have insur- demand for microinsurance. ance coverage, but it does not necessarily mean that they have quality coverage. A growing body • Engage new players: Insurance companies of evidence shows that it is possible to design and have been increasingly attracted to microin- deliver insurance services to low-income house- surance, but outreach has dramatically holds and enterprises, and it can be viable for pro- increased in part because of the involvement viders, but the next step is to increase the value of new players, such as governments, mobile that those products provide to the insured and phone companies, retailers, and banking cor- their beneficiaries. In this context, the concept of respondents. Greater competition does not value includes a range of dimensions, including automatically lead to better quality products, affordability, accessibility, covering risks that are but these new entrants are likely to contribute relevant, paying claims quickly, and a substantial to both scale and client value. portion of the premium paid by policyholders coming back to the risk pool in the form of claims • Develop better data: Insurance is a data- (see Matul et al. 2011). To achieve these objec- intensive industry, and one of the drawbacks tives, critical issues need to be addressed, includ- inhibiting the expansion of microinsurance is ing the following: the lack of data, including information about mortality and morbidity for people and ani- • Improve insurance literacy: Low levels of insur- mals, property loss, and weather. Institutional ance literacy make it difficult for clients to performance data are also limited. Where understand policies and use them properly, microinsurance is not considered a business which undermines client value. Financial edu- line for insurance companies, they often can- cation is especially important with mandatory not assess their own performance in the insurance and subsidized offerings. low-income market segment. 268 The New Microfinance Handbook • Enter new markets: Various countries, includ- Institutions: A Technical Guide to Developing ing India, South Africa, and the Philippines, and Delivering Microinsurance. Geneva: can boast about significant microinsurance International Labour Organization. accomplishments. But for every developing Churchill, C., and M. Matul, eds. 2012. Protecting country that is experiencing significant growth, the Poor: A Microinsurance Compendium, Vol. II. there are at least three or four that are stagnant Geneva and Munich: International Labour or have limited microinsurance activity. Organization and Munich Re Foundation. Churchill, C., and T. Pepler. 2004. “TUW SKOK, A patient approach is required for microin- Poland.” CGAP Working Group on surance because the demonstration effect will Microinsurance, Good and Bad Practices Case take some time to sink in. The findings from Study 2, ILO Social Finance Programme, Matul et al. (2011) illustrate that products Geneva. mature over time, and as they do they become Cohen, M., and J. Sebstad. 2006. “The Demand for more efficient and provide better value. A criti- Microinsurance.” In Protecting the Poor: A cal challenge in building a market is to create Microinsurance Compendium, ed. C. Churchill, conditions that encourage low-income house- 25–44. Geneva and Munich: International Labour Organization and Munich Re Foundation. holds to turn to insurance naturally as part of their risk-management toolkit. In environments Frankiewicz, C., and C. Churchill. 2011. Making Microfinance Work: Managing Product where microinsurance is prevalent, and provid- Diversification. Geneva: International Labour ers are cultivating the trust of that market Organization. through efficient claims payments, such condi- Garand, D., C. Tatin-Jaleran, D. Swinderek, and tions are emerging. However, microinsurance M. Yang. 2012. “Pricing of Microinsurance providers need to continue to recognize that Products.” In Protecting the Poor: A their most important function is to pay claims, Microinsurance Compendium, Vol. II, ed. and build on the emerging demonstration effect. C. Churchill and M. Matul, 464–83. Geneva and Munich: International Labour Organization and Munich Re Foundation. Notes Hougaard, C., and D. Chamberlain. 2012. “Funeral  1. This chapter draws heavily from Churchill Insurance.” In Protecting the Poor: A (2006), especially chapters 1.1 and 3.1, and Microinsurance Compendium, Vol. II, ed. various chapters in Churchill and Matul (2012). C. Churchill and M. Matul, 217–36. Geneva and  2. One might also consider accident and disability Munich: International Labour Organization insurance, but they could also be considered as and Munich Re Foundation. subsets of life and/or health. They are perhaps Leatherman, S., L. J. Christensen, and J. Holtz. most useful as part of a composite product or 2012. “Innovations and Barriers in Health as a rider on a life insurance product. Microinsurance.” In Protecting the Poor: A Microinsurance Compendium, Vol. II, ed. C. Churchill and M. Matul, 112–30. Geneva and References and Further Reading Munich: International Labour Organization Churchill, C., ed. 2006. Protecting the Poor: A and Munich Re Foundation. Microinsurance Compendium. Geneva and Ledgerwood, Joanna. 1998. Microfinance Munich: International Labour Organization Handbook: An Institutional and Financial and Munich Re Foundation. Perspective. Washington, DC: World Bank. Churchill C., D. Liber, M. J. McCord, and J. Roth. LeRoy, P., and J. Holtz. 2012. “Third-Party 2003. Making Insurance Work for Microfinance Payment Mechanisms in Health Insurance 269 Microinsurance.” In Protecting the Poor: A A Microinsurance Compendium, Vol. II, ed. Microinsurance Compendium, Vol. II, ed. C. Churchill and M. Matul, 176–96. Geneva and C. Churchill and M. Matul, 132–55. Geneva and Munich: International Labour Organization Munich: International Labour Organization and Munich Re Foundation. and Munich Re Foundation. Smith, A., H. Smit, and D. Chamberlain. 2012a. Matul, M., C. Tatin-Jaleran, and E. Kelly. 2011. “New Frontiers in Microinsurance “Improving Client Value from Microinsurance: Distribution.” In Protecting the Poor: A Insights from India, Kenya, and the Microinsurance Compendium, Vol. II, ed. Philippines.” Microinsurance Paper Series 12, C. Churchill and M. Matul, 486–502. Geneva International Labour Organization, Geneva. and Munich: International Labour PHFI (Public Health Foundation of India). 2011. Organization and Munich Re Foundation. A Critical Assessment of the Existing Health Smith, A., E. Gerelle, M. Berende, and G. Chelwa. Insurance Models in India. New Delhi: PHFI. 2012b. “The Technology Revolution in Roth, J., and D. Chamberlain. 2006. “Retailers as Microinsurance.” In Protecting the Poor: A Microinsurance Distribution Channels.” In Microinsurance Compendium, Vol. II, ed. Protecting the Poor: A Microinsurance C. Churchill and M. Matul, 528–47. Geneva and Compendium, Vol. II, ed. C. Churchill and Munich: International Labour Organization M. Matul, 439–51. Geneva and Munich: and Munich Re Foundation. International Labour Organization and Munich Wipf, J., E. Kelly, and M. J. McCord. 2012. Re Foundation. “Improving Credit Life Microinsurance.” In Roth, J., M. J. McCord, and D. Liber. 2007. The Protecting the Poor: A Microinsurance Landscape of Microinsurance in the World’s Compendium, Vol. II, ed. C. Churchill and 100 Poorest Countries. Appleton, WI: M. Matul, 197–256. Geneva and Munich: MicroInsurance Centre. International Labour Organization and Munich Ruchismita, R., and C. Churchill. 2012. “State and Re Foundation. Market Synergies: Insights from India’s World Bank. 2011. Weather Index Insurance for Microinsurance Success.” In Protecting the Agriculture: Guidance for Development Poor: A Microinsurance Compendium, Vol. II, Practitioners. Washington, DC: World Bank. ed. C. Churchill and M. Matul, 427–60. Geneva Xu, Ke, D. B. Evans, G. Carrin, A. Mylena and Munich: International Labour Aguilar-Rivera, P. Musgrove, and T. Evans. Organization and Munich Re Foundation. 2007. “Protecting Households from Rusconi, R. 2012. “Savings in Microinsurance: Catastrophic Spending.” Health Affairs 26 (4): Lessons from India.” In Protecting the Poor: 972–83. 270 The New Microfinance Handbook CHAPTER 12 Payment Services and Delivery Channels Joyce Lehman and Joanna Ledgerwood Payment services refer to the electronic trans- mobile phone) and the channel (for example, fer of funds, sometimes called money transfers, when the mobile handset is connected to a bank transfer services, transactions, mobile money, account, referred to as mobile banking, discussed or simply payments. Although nonelectronic under delivery channels below). These distinc- payment services exist, in this chapter these tions are important to note when discussing elec- terms refer to the electronic transfer of funds tronic money. between two parties, whether either party con- Payment services involve both a provider of sists of an individual person, a business, a gov- the services and the service or product itself. ernment, or any other organization. Referring The provider can be any one of a variety of finan- to electronic money rather than using the more cial service providers, including money transfer common terminology of mobile money reflects companies, banks or other formal financial insti- the fact that most, if not all, payment services tutions, post offices, and now mobile network can be accessed using devices other than a operators (MNOs) (see chapter 7). The product mobile phone. can be a remittance from one individual to With electronic payment services, it can be dif- another, a social welfare payment from a govern- ficult to distinguish between the product (for ment to an individual, a bill payment by an indi- example, when a transfer is conducted on a vidual to a business, a salary deposited directly Contributions to this chapter were made by Joakim Vincze and Geraldine O’Keeffe. Payment Services and Delivery Channels 271 into a bank account, or a payment for goods pur- Payment Services chased from a merchant. The term “payment services” is used in this chapter when discussing Payment services or electronic transfers can occur the product. between two people, between a person and a busi- A payment service is not the same as a ­payment ness (or vice versa), or from the government to a system. Also known as a clearing or settlement person (or vice versa).1 Transfers can be made system, a payment system is the infrastructure using a negotiable instrument such as a check, a that enables the transfer to occur. Clients initiate direct debit through a bank account, an electronic payment services but are not involved in payment funds transfer (EFT), a POS device, an ATM, or a systems, which are discussed in chapter 18. mobile phone. The terms commonly used are P2P Delivery channel refers to the mechanism by for a person-to-person transfer, P2B or B2P for which financial services are delivered to clients transfers between a person and a business, and and is distinct from both the product and the pro- G2P for transfers from the government to a person. vider. For example, a money transfer (the prod- Although these terms are most commonly used in uct) can occur over a mobile phone (the delivery the context of mobile money, they can also apply to channel) through a service offered by an MNO payments using POS devices and other channels. (the provider). Or a client can make a deposit (the All electronic transactions generally involve a product) by giving cash to a savings officer in the fee levied by the provider doing the transfer. For field with a point-of-sale (POS) device (the deliv- example, banks charge fees for drawing a check ery channel) connected to the back-end technol- on a current account or sending a wire transfer. ogy of a bank (the provider). Services can be priced as a percentage of the In the developed world, individuals with bank transaction amount or on a sliding scale based on accounts have the ability to conduct most finan- the transaction size, with a fixed fee assigned to cial transactions electronically. In the developing each size range or simply a flat fee. world, most poor people are trapped in a cash- only world and pay a high cost in both time and Person-to-Person Transfers money to conduct financial transactions. As more The bulk of money transfers in the low-income alternative delivery channels develop to allow sector consist of remittances from migrant or sea- poor women and men to access services through sonal workers sending money back home to fam- agents in their own community, the cost to con- ily and friends.2 Many of these are domestic duct personal financial transactions, whether remittances as a family member migrates to an deposits, withdrawals, payments, or transfers, urban area and sends money back to family in the can be greatly reduced. rural village. International transfers are also com- This chapter describes various payment ser- mon but require a provider with cross-border set- vices used by the poor followed by a discussion of tlement capabilities. Money transfers can also the channels available to deliver all financial occur between two private parties for general products. And whether they are MNOs, financial purposes. Taxi drivers in Nairobi, for example, institutions, or independent third parties, a key prefer to be paid with M-PESA electronic money part of many delivery channels is a network of rather than with cash to reduce the risk of theft. agents who conduct transactions on the behalf of Because the senders and receivers of remit- providers and brand the network accordingly. tances are often low-income people and the The issues and operational challenges involved in amounts remitted are small, the price of the ser- setting up an effective and efficient agent network vices, which can be quite high, is a major consid- are also discussed. eration (see box 12.1). 272 The New Microfinance Handbook Box 12.1  Trends in the Average Cost of Remittance Services Remittances Prices Worldwide (RPW), a World Bank initiative launched in 2008, monitors the costs of cross-border remittances, measuring the progress of a 2009 G-8 goal to reduce the global average cost by 5 percent in five years. By 2011 RPW was monitoring prices in 213 remit- tance corridors to and from 31 sending countries and 91 receiving countries. The findings here are based on an analysis of third-quarter 2011 data. Commercial banks charge about 14 percent of the amount remitted and are the least trans- parent in disclosing exchange rates. Post offices are less costly at 7.1 percent, but transparency is also an issue. Money transfer companies, at 7.4 percent, are similar in cost but notably more transparent, with 99 percent of those in the RPW database disclosing full price information to their clients. The cost of remittances also varies depending on where the money is being sent. South Asia (6.2 percent) and Latin America and the Caribbean (7.7 percent) are the least costly, whereas Sub-Saharan Africa (12.4 percent) and East Asia and Pacific (9.8 percent) are the most expensive. These variations are likely due to the level of competition as well as contextual factors such as local costs of doing business. A comprehensive analysis of the average price by product found the following results: • Cash products are available at an average price of 7.6 percent. • Account-to-account services are very costly at 14.5 percent, but the price drops to 6.5 percent­ if the two accounts are in the same or a partner bank. • Online services cost on average 8.8 percent but are generally not available to the senders. • The least expensive services are prepaid cards and account-to-cash products, at 4.2 and 2.9 percent, respectively. Source: World Bank 2011. Although most P2P transfers have tradition- through a POS device and a card or a mobile phone. ally been through money transfer companies or Some organizations allow customers to pay for ser- transacted through informal channels, this is vices such as health care premiums using mobile beginning to change with the advent of mobile money (see box 12.2). The agreements for P2B money. transfers typically do not entail a fee to the con- sumer; instead, the business or merchant pays the Transfers between Individuals and provider an agreed amount per transaction. Businesses Throughout the developing world, numerous P2B transfers include bill payments made by an financial service providers are experimenting with individual to a business such as a utility or tele- having their credit clients repay loans or make phone company as well as payments to a merchant deposits using mobile money rather than transact- for goods purchased. Depending on the arrange- ing with cash at a branch. ments made between the utility, telephone com- B2P transfers are increasingly used by compa- pany, or merchant receiving the payment and the nies to pay salaries to their employees. These sal- bank or MNO, the transfer can be made either ary payments are made through direct deposits to Payment Services and Delivery Channels 273 Box 12.2  Mobile Money Innovations in Microinsurance in the Philippines Health care financing is one of the biggest weekly or monthly basis, as opposed to constraints to improved health care around quarterly or half-yearly. Participation has the world. In the Philippines, a national increased as convenience has increased health insurer enables clients to pay micro- and costs (financial and opportunity costs) insurance premiums though a mobile have decreased. The ability to make small phone and receive claims into the mobile payments through a mobile phone gives financial services account. They can also individuals greater opportunities to manage use text messages to pay premiums on a insurance payments. Source: Gencer and Ranck 2011. the employees’ bank account, if they have an value (see box 12.3). And although it has the poten- account, or onto their mobile phones. Some credit tial to put formal savings options within reach, providers are beginning to use mobile payments to there are little or no data demonstrating a clear make loan disbursements as well, although the size correlation between agent proximity and an of the disbursement may exceed the maximum increase in both the uptake of savings accounts and size of transaction allowed. deposit balances over time (Alvarez 2010). From the government’s perspective, however, Government Transfer Payments upgrading G2P payment mechanisms can sub- G2P payments include government employee sal- stantially reduce administrative costs as well as aries, pensions, health and social welfare limit opportunities for fraud and leakage. In benefits, and one-off payments for emergencies. Brazil, switching just one financial institution to Such government transfers are increasingly being electronic benefit cards helped to reduce the cost linked to bank savings accounts or to mobile of delivering Bolsa Familia grants from 14.7 to 2.6 phones, facilitating access to the financial system percent of the grant value disbursed. Moreover, and encouraging recipients to save a portion of there is growing recognition that financial the funds received. The recipient can then choose ­ inclusion efforts, particularly if driven by pro- when and how much of the money received to moting access to savings, can be highly comple- take as cash (through an agent, ATM, or branch mentary to a range of social protection objectives office). As the entire electronic ecosystem devel- (Almazan 2010). ops and more governments, businesses, and mer- chants begin to use electronic technology, Value of Payment Services customers have an opportunity to keep an Some payment service products are more appeal- increasing amount of value in electronic form ing than others. The price of services is impor- rather than converting it to cash. tant, perhaps more so than for other financial Proximity of the cash outlet (an agent, for exam- services; particularly when small amounts are ple) to the recipient clearly leads to both time and involved, fees can represent a significant cost. As cost savings for receiving and making payments, technology develops, the price of payment ser- transferring and withdrawing money, and storing vices will decline, particularly as competition and 274 The New Microfinance Handbook Box 12.3  Mobile Money in Papua New Guinea Improvement in mobile money networks in and nurses are the largest groups of govern- Papua New Guinea contributes to improved ment employees, but the education and health health care and education by reducing the care systems are some of the weakest, in need for nurses and teachers to travel to cash large part because of absenteeism. Teachers, points to collect their pay. The government and for example, have a 15 percent absentee rate, private sector, often based in urban areas, primarily because of the need to travel to col- employ thousands of individuals across the lect wages. The opportunity cost is children in country, most often in rural areas. The difficulty school with no teachers or patients in hospi- of transferring money from urban to rural areas tals with no nurses. Mobile money reduces can have real consequences for the country’s absenteeism and improves federal and private education and health care systems. Teachers services, particularly in rural areas. Source: Bruett and Firpo 2009. efficiency increase; however, this will require a clients may be less likely to use the service. The level of scale not yet reached. risk of losing money or having the receiver claim An important feature of payment services is it never arrived is a concern, especially for new the time it takes to effect the payment or transfer. users. These risks need to be mitigated as much Generally the shorter the time, the higher the as possible by the provider, enabling clients to price, but this is not always the case, depending trust the service and see value in using it. on the service used. Transfers can be instanta- neous, within a few hours, or take several days. Delivery Channels Depending on their needs, clients may be willing to pay additional fees to ensure a quick transfer. Transactions can occur over a range of channels Convenience is also important—both for the either in person at a branch or with technology-­ sender and the receiver. If either needs to incur enabled alternatives. Financial service providers substantial costs for transport, identification, or traditionally operate through branch networks, time away from home or business, these addi- requiring face-to-face meetings with clients tional costs need to be considered. In addition, either at the branch or in the field. As discussed although security of cash is likely increased in chapter 1, to reduce costs, increase conve- through electronic money, particularly with new nience, and reach more clients, providers are delivery channels, using technology, agent net- exploring alternative channels such as ATMs, works, or both may lack the level of confidence mobile branches, agent networks (using POS and trust embedded in more traditional services. devices and mobile phones), and Internet bank- Clients need to be sure that the money they are ing. In most alternative channels, the “face-to- sending will get to the right person at the right face customer experience” with the institution time and in the intended amount. If conducting changes significantly, a factor that may alter the transfer themselves is too complicated—for ­products and how they are marketed or designed. example, on their mobile phone—or is prone to Box 12.4 provides a glossary of terms related to errors, with no checks and balances in place, alternative delivery channels.3 Payment Services and Delivery Channels 275 Box 12.4  Glossary of Terms Related to Alternative Delivery Channels • Agent. Any third party acting on behalf of a bank or other financial service provider (including an e-money issuer or distributor) in its dealings with customers. The term agent is commonly used even if a principal-agent relationship does not exist by law in the country. Agents may (if permitted under local law) engage subagents to carry out the activities on behalf of the financial service provider. A financial service provider may also engage an agent network manager to help select, train, manage, and oversee agents. • Automated teller machine. An unattended electronic machine usually located in a public place, connected to a data system, and activated by a client with an electronic payment card connected to an account; it is used to make cash withdrawals or deposits and conduct other banking services. • Branchless banking. The delivery of financial services outside conventional bank branches, using ATMs, mobile branches, agents, or other third-party intermediaries as the principal inter- face with customers and relying on technologies such as card-reading POS devices and ATMs, mobile phones, or Internet-connected computing devices to transmit the transaction details. • Cash-in. In the context of e-money, the exchange of cash for electronic value. • Cash-out. In the context of e-money, the exchange of electronic value for cash. • Credit card. An electronic payment card allowing the holder to purchase goods and services on credit. • Debit card. An electronic payment allowing the holder to deposit or withdraw funds to or from a bank account; it may be used with an ATM or in conjunction with a POS device. • Electronic funds transfer or e-payment. Transfers initiated through an electronic terminal, telephone, computer, or magnetic tape for the purpose of ordering, instructing, or authorizing a financial institution to debit or credit a consumer’s account. • Electronic money (e-money). A type of stored-value instrument or product generally under- stood to have the following attributes: (1) issued upon receipt of funds, (2) consisting of electronically recorded value stored on a device (for example, a chip, prepaid card, mobile phone, or computer system), (3) accepted as a means of payment by parties other than the issuer, and (4) convertible into cash. • E-money account. An account of a holder of e-money held with the e-money issuer. If the e-money issuer is a bank, the account could be a “regular” transactional bank account; if the e-money issuer is a non-bank, then the account is a recording of the e-money issued by the issuer and held by the customer. The funds backing the amount may be pooled with other customers’ funds of the same non-bank e-money issuer and held in a bank account or accounts. In some cases, a trust account is established for such customers. • E-money issuer. An entity that initially sells or issues e-money against the receipt of funds; some countries permit only banks to issue e-money; other countries also permit non-banks to issue e-money. • E-wallet. Electronic money held on a mobile phone, smartcard, or the Internet. • Internet banking (e-banking). The use of an Internet browser to perform financial transactions over the Internet, via the provider’s website. • Interoperability. The ability of diverse information technology systems to work together so that services can be provided across multiple providers. (continued next page) 276 The New Microfinance Handbook Box 12.4  (continued) • Mobile banking. The use of a mobile phone to access financial services and execute financial transactions connected to a bank account. This covers both transactional and nontransac- tional services, such as viewing financial information on a customer’s mobile phone (Chatain et al. 2011). • Mobile branches. Sometimes referred to as mobile vans or as minibranches, vehicles equipped with a portable ATM that are staffed by a teller equipped with a small laptop, mobile phone, or POS device linked to the provider’s core banking system that travels to remote areas at spec- ified times to conduct financial transactions, primarily cash-in, cash-out services. • Mobile financial services. The use of a mobile phone to access financial services and execute financial transactions. Mobile financial services can also include mobile branches. As mobile branches are relatively few, the term most often refers to accessing financial services and executing transactions via a mobile phone. • Mobile money. A type of e-money that can be transferred by an MNO. As with other e-money issuers, the issuer of mobile money may (depending on the local law and the business model) be an MNO, a bank, or a third party. • Mobile network operator. A company that has a government-issued license to provide a mobile phone service. • Mobile payment. An e-payment made through a mobile phone. • M-wallet. A mobile-based account for storing electronic money on the mobile device. • Payment terminal. A stand-alone terminal similar to an ATM, providing retail cash-in access points, but not cash-out capabilities. • Point-of-sale device. A small, portable device that facilitates an electronic financial transaction. • Prepaid cards. Also called stored-value cards, plastic cards that are preloaded with value and used for purchases or payments where they are accepted. They typically do not require a bank account, and they can be reloaded with funds. • Smartcard. A payment card with a machine-readable embedded chip that stores information about the customer and his or her accounts. • Smartphone. A highly portable personal computer that has a built-in mobile phone. • Third-party provider. Agents and others acting on behalf of a financial service provider, whether pursuant to a service agreement, joint-venture agreement, or other contractual arrangement. Source: CGAP, draft glossary of mobile financial services terms; Center for Financial Inclusion 2010; CGAP 2011. Branches telecommunications access. Operationally there In a branch, a teller or customer service officer are staff costs, security provisions, and backup conducts transactions, including cash-in, cash- power sources, as well as internal controls and out services. These brick and mortar branches are other risk management and monitoring costs. the most expensive channel to operate. A­ Because of the high costs of setup and operations, properly functioning branch needs accessible branch networks are not generally conducive for roads, electrical power, Internet connectivity, and reaching­remote, rural areas or lower-income Payment Services and Delivery Channels 277 consumers in urban areas. For customers in rural to the branch. This is changing as field officers areas, visiting a branch can involve traveling long take advantage of technological innovations and distances, paying for transportation, and often facilitate transactions on behalf of clients via waiting in long lines once they reach the branch. handheld devices (mobile phones, POS devices, As technology continues to transform the core tablets, or laptop computers) to increase effi- brick and mortar bank functions, the relative space ciency. Although more expensive, sometimes allocated to front- and back-office functions is field officers are able to provide other services in changing, with branches becoming primarily sales the field such as information or technical support offices, while alternative delivery channels are that can help both clients to increase productivity increasingly being used to conduct transactions. and providers to decrease risks (see box 12.5). Some providers address cost issues by estab- lishing minibranches or outlets that are staffed Automated Teller Machines only one or two days a week or by setting up ATMs perform many of the same functions as a kiosks in marketplaces equipped with POS cashier or teller at a branch, but customers carry devices or laptop computers that allow access to out transactions using the ATM and a card. ATMs the provider’s core banking system for entering are generally located in high-traffic areas close to client transactions and generating ministate- clients and function 24 hours a day, providing ments. In this way, outreach is increased without convenient access points for basic transactions, incurring the costs of operating a full branch. For including withdrawals, transfers, and bill pay- example, Kshetriya Gramin Financial Services ments. In some cases they accept deposits as well. (KGFS) branches in India are set up to be wel- ATMs increase convenience through better loca- coming meeting points for villagers (bright col- tions or, in some cases, inside or next to the ors, an awning, and benches in front to encourage branch, which reduces congestion in the branch people to linger and chat) and are powered in the and results in shorter wait times. However, they back by a technology infrastructure. In some way, are still relatively scarce. In 2009 there were only KGFS branches are similar to branch innovation 8 bank branches per 100,000 adults in developing in the United States and Europe, where branches countries versus 24 in developed countries. There sometimes double as Internet cafes. were only 23 ATMs per 100,000 adults in devel- oping countries versus 78 in developed countries Field Officers (Mylenko et al. 2009). As part of their outreach strategy, financial ser- Although most ATMs guide clients through vice providers often send staff to the field to meet the steps of a transaction using written instruc- clients (either individually or in groups) close to tions displayed on the device’s screen, some their place of business or residence. Using field ATMs developed for populations with minimal officers is a common practice, often associated literacy use pictures or spoken instructions for with early initiatives in microfinance such as this purpose. Some ATMs have also incorporated Grameen, solidarity group lending, or village biometric technology to either replace cards or banks. The model has proven resilient in many verify client identity. As soon as the machine rec- countries but is still relatively inefficient and ognizes the client’s identity and retrieves the expensive compared to some of the newer chan- account information, the client can conduct a nels being developed. Field officers traditionally range of transactions. record transactions with paper and pen, and each Although less expensive than a branch, ATMs transaction is later entered into the provider’s can still be relatively expensive for providers to core banking system when the field officer returns own and operate. In addition to infrastructure 278 The New Microfinance Handbook Box 12.5  Expanding Rural Finance in Sri Lanka The Hatton Nation Bank (HNB) of Sri Lanka is effectively—customer service centers, micro- a well-established commercial bank that was finance units, ATMs, and mobile vehicles. forced to embark on rural and agricultural The bank also invested in a large network of finance in the mid-1970s when the govern- field officers, hiring qualified people who not ment restricted private commercial banks only understand finance but also have exper- from opening more branches in urban areas. tise in agriculture and creating a network of 250 By the late 1980s, HNB had implemented a “barefoot bankers” who work in the villages strategy for serving the largely underserved and normally come from the community. They rural market. It had downscaled its regular act as field officers and also mentor, guide, and operations, established a dedicated rural provide technical assistance to clients, encour- banking division, and offered extension ser- aging and guiding farmers to become commer- vices to its new rural clientele. To support the cially viable. With the barefoot bankers new strategy, HNB invested in new delivery providing technical expertise and guidance channels to reach rural customers more close to clients, the bank has reduced its risk. Source: Lahaye 2011. costs (machines, cards, vehicles for moving cash), MasterCard, which gives clients the ability to use they require appropriate theft-proof installation them at ATMs or with an agent. structure, data network connectivity, reliable The electronic cards store customer informa- power, and regular service to replenish or collect tion on a magnetic stripe or an embedded chip. cash. Furthermore, regulations also mandate that Cards with an embedded chip are referred to as rigorous information management and internal smartcards. Although not an access point in and control systems are in effect and may restrict the of themselves, smartcards facilitate access to dif- use of ATMs by providers such as MFIs that may ferent transaction points and increase the secu- be lacking in those systems. rity of information. Chips enable detailed transaction records to be stored offline and to Electronic Payment Cards perform transactions without a real-time link to Clients access ATMs through electronic payment the customer’s account. They can also store bio- cards using a password or personal identification metric information. Smartcards can function as number (PIN) that allows personal information debit cards, credit cards, or prepaid (or stored- to be verified and transactions carried out. Cards value) cards. can be debit cards, where the amount available Prepaid cards differ from traditional debit for withdrawal depends on the amount of acces- cards in that they are preloaded with value (and sible funds in the corresponding bank account, or can be reloaded) and typically do not require a credit cards, with a maximum amount of credit bank account. Prepaid cards come in various for- available to the holder, which, if used, is repaid at mats and can be single- or multiple-use cards. a later date with interest. They can also be They are cheaper to issue and to host than branded with merchant or other organization conventional debit or credit cards. They are ­ logos or a card association such as Visa or increasingly used for government transfer Payment Services and Delivery Channels 279 payments and can be issued by banks or retailers. maintain. Data network connectivity, reliable For example, UBL in Pakistan issued cards to power sources (some have solar panels where recipients of government payments after realizing regular power is unstable), and cash handling all that many low-income women beneficiaries did result in substantial costs for terminal operators. not have their own mobile phone (see box 12.6).4 Similarly, some terminals necessitate that clients Smaller providers without sufficient capital have electronic cards. Cards may be purchased and technical capacity can enter into partner- only with proper identification, and in most cases ships to give their clients access to the ATMs of a registration is required. larger, more established provider. This arrange- Regulatory supervision of payment terminals ment is referred to as a “white label” arrangement varies by country as well as by specific terminal in which the smaller institution obtains specially functions. Some terminals accept cash deposits, printed bank cards, PIN mailers (sealed enve- an activity that requires a banking license or part- lopes with the client’s assigned PIN), and access nership with a bank. In some countries, simple to a telephone-based customer support center bill payments require regulatory supervision. that deals with ATM issues (for example, unread- able cards). Point-of-Sale Devices Some ATMs do not require users to have an POS devices are small special-purpose portable electronic payment card, but rather are linked to computing devices that facilitate payments, mobile phones as cash points, allowing customers deposits, withdrawals, money transfers, voucher with or without a bank account to use e-wallets to distributions, account balances, and printing of access cash through the ATM (see box 12.7). For mini-statements. Unlike an ATM, transactions on this to work, the ATM needs to be placed in a a POS device are performed in conjunction with location with Global System for Mobile (GSM) an agent or retailer or a mobile field officer who network coverage and the client must have access supports the successful completion of the trans- to a GSM phone with a charged battery, a sub- action, provides cash-in, cash-out services (if scriber identity module (SIM) card, and airtime applicable), and provides a printed receipt with credits.5 the client’s card once the transaction is complete. POS devices generally include a facility to read Payment Terminals information from a card (magnetic strip or smart Payment terminals are retail cash-in access points card),7 which allows the device to work with pre- located in local shops and markets or in stand- paid or stored-value cards. These can be used to alone kiosks along streets, often two to three on a pay for goods or services, withdraw cash, and, if single city block.6 Customers use payment termi- used with an agent or field officer, deposit cash. nals to pay bills for services such as electricity, POS devices are generally located at fast-­ Internet, and water. Where utility company main moving consumer goods retail outlets where a offices or branches may be located far from a cus- retailer acts as the agent for an MNO or bank. tomer’s home or place of work, terminals are par- Retailers are often affiliated with a bank card ticularly convenient. Depending on the license brand (for example, Visa, MasterCard, or Maestro) granted to the terminal operator, payment termi- and can serve clients from any financial institu- nals can also be used to top up mobile airtime as tion that is also affiliated with the bank card well as facilitate domestic and international per- brands that the retailer represents. son-to-person transfers (see box 12.8). Although the cost of a POS device is higher Like ATMs, payment terminals can be rela- than a mobile phone, the device offers a larger tively expensive for operators to install and screen, higher-quality keyboard, superior data 280 The New Microfinance Handbook Box 12.6  World Food Programme Card Pilot, 2009 United Bank Limited (UBL), one of Pakistan’s largest private banks, has a branchless banking channel called Omni, which launched in early 2009 and was fully rolled out in April 2010. In 2009 several million residents of the Swat Valley in Pakistan were displaced from their homes follow- ing a period of intense conflict between security forces and militants, making them dependent on emergency supplies and cash transfers from the World Food Programme (WFP). UBL approached the WFP with an offer to pay out the cash transfers of Rs 4,000 (US$47) in each of two monthly payments using a prepaid card as a means of piloting this way of paying cash. The WFP designated 12,000 beneficiaries to participate, and UBL staff issued the cards. A total of 24,000 cash payments were made, amounting to just over US$1 million using a network of 15 Omni agents. The WFP transferred the funds in bulk to the UBL, which cred- ited each of the underlying limited-mandate bank accounts set up for each beneficiary. Thereafter, beneficiaries could withdraw their money by presenting the card and using their PIN at an Omni agent. For each withdrawal, agents received the standard Omni cash-out fee of 1–1.5 percent. An NGO, Save the Children, provided extensive support to the beneficiaries, training them on how to use their card and PIN and even accompanying them to make their first withdrawal. This spared UBL staff from having to provide support to previously unbanked beneficiaries. Based on the UBL’s experience and subsequent feedback from the WFP and customers, all parties involved were extremely satisfied with and confident in the process. One enormous benefit was that the program mobilized the local economy and generated employment and business opportunities in the affected communities. The biggest benefit was that the total cost of distributing aid was the 5 percent commission that the WFP paid to UBL plus the minor administrative cost of its monitoring staff. If other development agencies adopt the process, the aid distribution structure could be made more efficient, because in the current system about 60 percent of aid is spent in the distribution chain and does not translate into any benefit for the intended recipients. Source: CGAP 2010. Box 12.7  Cardless ATM Transactions Paynet Kenya developed the world’s first soft- grown to more than 500 ATMs nationwide, ware that allows cardless transactions at enabling Kenyans to withdraw cash, pay bills, ATMs. In March 2005, PesaPoint was founded access their M-PESA accounts, inquire about to provide convenient ATM locations country- their bank balance, and more. wide. Through the integration of financial insti- PesaPoint is a “white label” ATM network. tutions, as of 2012 the PesaPoint network had One year after its launch, M-PESA partnered (continued next page) Payment Services and Delivery Channels 281 Box 12.7  (continued) with PesaPoint. Customers can now retrieve this transaction. By accessing the PesaPoint money from any PesaPoint ATM. To do so, ATM network, M-PESA customers can now they must select “ATM withdrawal” from their make withdrawals from their stored-value M-PESA menu. They then receive a one-time accounts at any time without having to go to authorization code, which they enter on the an M-PESA agent. ATM keyboard. No bank card is needed for Source: Mas and Radcliffe 2010. Box 12.8  Payment Terminals in the Russian Federation The payment terminal is a grassroots Russian than 1,300 companies through its terminals. invention. Terminals take in, but do not dis- Qiwi is expanding internationally and works in burse, cash—their main limitation and major 22 countries in Europe, Asia, Africa, and the distinguishing characteristic from ATMs. Americas. Payment terminals came about as a conve- There were approximately 250,000 ter- nient means to top up mobile phones. minals in Russia as of early 2011, and the Customers enter their phone number into the number is growing. In places where people machine and insert cash into the terminal. The have limited access to the Internet or paid amount net of commission is automati- agents, payment terminals remain the best cally added to their mobile account. way to pay for services without going to a Currently, payment terminals can also be bank (Boris 2011). used to pay for utilities, traffic tickets, and In 2010, the average payment size was movie tickets, to transfer money to bank Rub 132 (US$4.20), and the total volume of cards, as well as to pay a variety of other ser- transactions was Rub 772.2 billion (US$24.7 vices. In 2009, Qiwi, the leading operator in billion), implying approximately 5.8 billion Russia, offered payment services for more transactions (Qiwi Channel 2011). Source: Jenya Shandina. For information on Qiwi, see http://tv-technopark.ru/index.php?option=com_content& view=article&id=479&catid=11 and http://qiwi.ru/about/world/ (both in Russian). security, and the option of generating a printed portable and equipped with biometric scanners transaction receipt.8 Retailers, providers, or their and wireless connection capabilities, including agents can use this feature to issue ministate- Bluetooth,9 Wi-Fi,10 GPRS,11 and even a dial-up ments showing, for example, the last 10 transac- modem to allow data connections over analog tions on a client’s account. phone lines (similar to fax machines). Recharge­ Multiple models of POS devices cater specifi- able batteries typically allow several hundred cally to development finance markets by being transactions to be performed between charging. 282 The New Microfinance Handbook POS devices have their own proprietary operat- self-serve terminal, typically located in a retail ing systems that can be configured to operate outlet that is the primary source of liquidity for with essentially any core banking system or the device. To use the POS device, clients insert transaction-processing platform. their access card, enter their PIN, and then select The physical POS device operates software a transaction from the device display. For with- that allows it to establish a secure data connec- drawals, the device generates a bar-coded receipt tion with the back-end systems of a bank. An that the client then takes to a retailer cash point encrypted data connection is used to protect the where the receipt is validated and the retailer client’s private information, including account provides cash to the client. numbers, balances, and access code. Data com- munications protocols12 used by the POS device Mobile Branches to communicate with the core banking system Mobile branches operate either as mobile ATMs are robust and involve multiple exchanges of loaded onto a van or, within the van, as a mini- data between the device and the banking plat- branch staffed by a teller equipped with a small form to ensure that the transaction has been suc- laptop, mobile phone, or POS device linked to the cessfully completed. Should the communications provider’s core banking system and often by a link be severed during a transaction, the POS security guard. These models are designed to transmission protocol will ensure that the trans- enable transactions in sparsely populated rural action is voided in a way that protects the cli- areas where distances make travel inconvenient ent’s account balance. and costly and there are no alternative access Some manufacturers have experimented with points (box 12.9). Mobile branches generally have turning POS devices into “cashless ATMs.” In fixed schedules, arriving at remote villages on this operating mode the POS device is used as a market days when clients regularly gather. They Box 12.9  Urwego Opportunity Bank’s Mobile Bank and Open Sky System In an effort to reach rural populations in Rwanda, When the mobile bank was launched, it Urwego Opportunity Bank launched a mobile appeared to be one of the more attractive banking service in 2010. A vehicle was equipped methods for reaching rural clients, but after with networks, modems, and an application the pilot phase, it was determined to be too called Open Sky, which enabled a low-band- costly. The vehicle itself was expensive to pur- width real-time connection to the core banking chase and set up, as were the operational system operating at the head office. With this costs related to vehicle maintenance, fuel, technology, key banking services were avail- and secure cash transit. able in the communities visited, including teller At the same time, more options became transactions, new client registration, and loan available for using mobile money to extend applications. A schedule was determined and outreach. Although the initial vehicle remains advertised so that customers knew when to in use, the bank shifted its focus to mobile expect the mobile bank visits. phone technology. Source: Geraldine O’Keeffe, Software Group. Payment Services and Delivery Channels 283 provide cash-in, cash-out services and can be exception of debit cards, they have routinely used to update accounts instantly if the systems failed to open up enough space within the can connect to the Internet. crowded set of payment service options for cus- tomers and merchants. While there are various Mobile Phones ways to carry out electronic transfers, mobile Similar to POS devices, mobile phones can facili- payments using mobile phones may be the game tate basic transactions: withdrawals, deposits, changer. From 2010 to 2012, the number of peo- payments (through agents), and account inqui- ple with access to a mobile phone but not to tra- ries. The mobile phone does not have to be con- ditional financial services is expected to have nected to a bank account. If the customer has a grown from 1 billion to 1.7 billion (Baptista and bank account, then the mobile phone becomes Heitmann 2010). Although only a few of the the device for conducting transactions in and out mobile money deployments in the developing of the account. If the customer is unbanked, then world have reached scale, those that have demon- the mobile phone simply provides electronic strate the significant potential for mobile phones money services or “mobile payments.” The pro- to revolutionize access to financial services for vider of mobile payments may, depending on local poor people living in developing countries who law, be the MNO itself, a commercial bank, or a have few alternatives to cash (see chapter 1). third party (the distinction as to whether a In Kenya the MNO Safaricom developed deployment is bank-led, MNO-led, or provided by M-PESA, an e-money transfer and payment prod- a third party lies with which party “owns” the uct, becoming the first mobile money deployment customer and builds out the network of access to reach scale (see box 12.10). M-PESA is an MNO- points). In each case the mechanism is the same: led deployment, and customers are not required using a mobile phone to conduct the transfer. to have a bank account. Rather, customers can A mobile phone can also become a “mobile choose to retain electronic value on the mobile wallet” for storing monetary value or “e-money” device itself, sometimes referred to as stored (referred to as stored value), for depositing value. The rapid uptake of the payment and additional value by giving cash to a cash-in, stored-value services of M-PESA, and the fact that cash-out agent, or for transferring funds to the service is increasingly being used by poorer another individual or a business. The mobile clientele, shows its value to customers. wallet has the same value to the customer as a Mobile phones can potentially replace a bank low-balance bank account. Some clients deposit card and a POS device. GSM phones hold account funds onto their mobile account purely for secu- and transaction information on each customer’s rity without the intention of transferring them SIM card.13 Clients can apply for a SIM card to another person or bank account (Kumar, directly from an MNO retail outlet or from an issu- McKay, and Rotman 2010). For example, Savings ing bank working in partnership with an MNO, Groups may use a mobile e-wallet to store excess which ensures that some form of identification is group liquidity as well as to save for specific provided to satisfy the know your customer/anti- purposes such as bulk purchases of fertilizer. money-laundering regulations for bank accounts. Given the risks of theft, some members believe The customer’s PIN and bank account number that storing money in a secure mobile e-wallet is are recorded on the SIM card or in the phone’s better than using the traditional lockbox kept in memory, and in this way the phone acts as a vir- their homes. tual card (Mas and Kumar 2008). Once recorded, Many electronic money schemes have been the customer can move funds to and from the tried in developed countries, but with the account using a menu on the mobile phone as 284 The New Microfinance Handbook Box 12.10  M-PESA Reaching Scale with Mobile Money M-PESA, a Safaricom-led mobile money ser- convenient, and more secure than the infor- vice in Kenya, was launched in 2007 with the mal methods they had previously used to simple proposition to “send money home.” send and receive money (Rotman 2010). The M stands for mobile, and PESA means 2008 survey also found that among nonusers money in Swahili. By the end of 2009, more the lack of adoption was due to inadequate than 70 percent of households in Kenya and, access to network agents. more important, more than 50 percent of the Overall, M-PESA’s success has demon- poor, unbanked, and rural populations were strated that leveraging mobile technology to using the service (Jack and Suri 2010). By extend financial services to large segments of June 2010, 70 percent of all financial transac- unbanked poor people is possible, largely tions in Kenya were done using M-PESA, but because cell phone technology is becoming the total value of these transactions repre- ubiquitous in the developing world. In contrast sented only 2.3 percent of the total transac- to traditional banking models that rely on the tion value, demonstrating the demand for a debt capacity of borrowers to generate reve- great many very small transactions (Jack and nue from interest and fees charged on loans, Suri 2010). As of November 2011, M-PESA M-PESA’s revenue model is based on usage had more than 14 million subscribers and fees. This usage-fee model has proven to be well over 28,000 agents across Kenya. profitable despite targeting a client segment M-PESA’s perceived safety and conve- of hard-to-reach poor. In addition, M-PESA has nience are major reasons that early adopters demonstrated the importance of offering low- chose to use it. In the fall of 2008, researchers cost payment services. completed a survey of 3,000 randomly The early support of Kenya’s central bank selected Kenyan households to gain further for the pilot M-PESA and the fact that insight into M-PESA use. Within the sample, Safaricom held a dominant position in the 26 percent of M-PESA users reported that market at the time of the launch were key fac- safety was their main motivation for adopting tors that led to the rapid uptake. Even so, the the service, whereas 45 percent stated ease M-PESA results demonstrate that low-income of operation as their reason. About 12 percent clients sufficiently value the ability to make of users stated that they use M-PESA for payments for payment services to be consid- emergencies (see Jack and Suri 2010 for full ered a financial product (along with credit, sav- survey results). Additionally, the vast majority ings, and insurance) that helps poor people to of users viewed M-PESA to be faster, more manage their financial lives. Source: Jack and Suri 2010; Rotman 2010. defined by the MNO. Cash-in, cash-out services 1. Short messaging service (SMS). The client still need to be performed in a branch, at an ATM, sends a specially coded SMS message to the or with an agent. intended recipient. This is usually referred to MNOs offer three types of transaction messag- as texting or a text message. ing protocols to perform financial transactions 2. Unstructured supplementary service data over GSM mobile networks: (USSD). The client begins the session by Payment Services and Delivery Channels 285 typing in an MNO-defined code on the phone staff or agents working with the consumer are and pressing “send.” A transaction menu well trained and can assist the customers in how prompts the client to choose the desired to use the service. action. USSD messages create a real-time con- These technical decisions on message proto- nection, which makes them more responsive cols, encryption standards, and software platforms than SMS messages, and do not store the cus- can have a great effect on the customer experience tomer’s data, unlike the SMS protocol. (Mas and Kumar 2008; see box 12.11). Technology choices can also affect the relationship between 3. Custom-built application. The provider uses a the bank and the MNO. Applications using the purpose-built application software program on SIM card require the active support of the MNO to the SIM card or in the phone’s internal mem- install the menu and enable the encryption keys. ory to enable the user to launch the financial Likewise, applications based on USSD may require transaction menu directly from the handset. the MNO to allow access to its USSD server to Although each option has both positive and send and receive messages to and from the clients’ negative characteristics, the customer generally mobile phones. Other applications, including does not get to choose among them. When an those that are purpose built, do not require sup- MNO, a bank, or a third party launches an elec- port of the MNO or even the MNO’s knowledge tronic payment platform, the protocols have that mobile banking transactions are taking place. already been decided. Whatever the functionality, These variations in dependency can create a deli- the most important factor is to ensure that the cate balance of power between the bank and the Box 12.11  Banking with a Mobile Phone: The Customer Experience To open a bank account, the customer visits a account and be able to make payments—for bank branch or an agent accredited by the example, pay utility bills (P2B) or transfer bank where she is properly identified as money to others (P2P). required by law. She fills out a form, supplies If she wants to withdraw cash from her her name, address, and mobile phone num- account, she can do so through an agent who ber, and presents an acceptable form of iden- represents her bank. She simply selects the tification. If she already has a bank account, application from the phone’s menu, enters her she can use her phone to sign up for mobile PIN, and selects “withdraw” from the menu. banking by sending a text message to a partic- She will be prompted to select the account ular number. Once the account is opened, the from which she wants to withdraw, enter the bank transmits the mobile banking application amount, and then enter the phone number of wirelessly to the customer’s phone, where it the agent. The next screen prompts her to con- appears on the main menu. The customer reg- firm the transaction. Both the customer and isters her phone number and selects and the agent then receive a message confirming types in a PIN. She can now begin transact- that the customer’s account is debited, and the ing. She will be able to receive her salary, amount is transferred to the agent’s account. remittances, and other transfers into this At this point the agent gives her the cash. Source: Mas and Kumar 2008. 286 The New Microfinance Handbook MNO that can ultimately affect the pricing struc- Clients can also use phones to check their ture to the clients. account balances and recent account activity, Figure 12.1 shows the relationship between allowing them to detect fraud if they do not rec- the customer, the agent, and a bank in conducting ognize recent transactions or to increase their a mobile banking transaction. After the agent balance if necessary. opens a bank account and the account is opera- tional, the agent can assist the client in opening Internet Banking (e-Banking) an account so that the client does not have to go Financial service providers around the world to the bank at all. allow clients to transact on their account via the More and more financial service providers are Internet. To do so, the client must have some form using mobile phones to create greater efficien- of Internet-connected access device, such as a cies for themselves and for their clients. Some personal computer, tablet,14 or smartphone. Users use mobile phones to send transaction confirma- connect to the provider’s Internet platform via a tion messages as well as other information to cli- browser or an application installed on their device. ents via SMS or USSD. Some use basic SMS As always, cash-in, cash-out transactions must be messages to remind borrowers that a loan install- performed with an agent or at an outlet. However, ment is due. For example, rather than having a given the high costs of dedicated broadband infra- loan officer visit a client when a payment is over- structure and the cost of the connection devices as due, the provider can send an SMS the day before well, Internet banking does not yet have signifi- the payment due date as a reminder, lowering cant outreach in developing countries. costs for the provider, helping the client stay on Enabling clients to perform financial transac- track, and potentially reducing portfolio risk. tions via smartphones is a huge step forward Figure 12.1  Relationship between the Customer, the Agent, and a Bank in Conducting a Mobile Banking Transaction Bank Client opens Agent opens bank – Agent account debited bank account account (accessible 1 4 1 + Client account credited (accessible by by mobile phone) mobile phone) 2 Cash-in Agent Client Electronic 3 value sent Source: Adapted from CGAP. Payment Services and Delivery Channels 287 in terms of accessibility and convenience. services and related infrastructure before inter- Smartphones, like personal computers, have operating their systems with others. random access memory and local storage that The hesitancy of providers to “interoperate” can be used to install small purpose-built soft- has given rise to third-party payment platforms ware applications, typically just called “apps.” that allow clients from any mobile network (or Banks and other financial service providers any bank) to transact using the same interface. develop and distribute apps to give clients with With some notable exceptions such as United smartphones access to their accounts. Bank Limited (UBL) in Pakistan, which devel- Transacting on a smartphone provides a oped its own technology to create a payment plat- higher-quality experience than transacting on a form for providing the service known as Omni regular mobile phone, but smartphones are sig- and a national network of Omni agents, most nificantly more expensive. In addition, the data banks do not have their own platform and instead plans that enable Internet connectivity are a partner with third-party providers—independent “premium service” for which the client pays companies that provide the platform giving more. For poor women and men in rural areas, access to bank customers (see box 12.12). the benefits of a smartphone may be moot (at this Third-party platform providers may initially point) given that many mobile telephone data negotiate a nonexclusive contract with one networks do not operate reliably outside of met- MNO but then are free to market to other ropolitan areas. A smartphone also requires more MNOs and banks. This is particularly useful for frequent battery charging than a regular mobile smaller banks and MFIs, which can access a phone. This may not be a major consideration for platform without having to negotiate individual people living and working in an area with reli- relationships with MNOs or to develop their able electricity, but rural populations in many own platform. For example, bKash in developing countries frequently live off-grid and Bangladesh is an independent entity that devel- have to pay someone to charge their mobile oped the payment platform and has the brand phones. and the agent network, but a commercial bank As a practical matter, smartphones are per- holds the customer balances to comply with haps best suited for interacting with clients in the central bank regulations. The bKash service has field, that is, by the provider’s staff or agents to agreements with multiple MNOs that enable access information and services traditionally their customers to become customers of bKash available only from branches. (see box 12.13). Interoperability can be defined at the platform level, where a customer with an account with one Interoperability service provider can transact with the account of A major challenge facing mobile banking is the a customer with a different service provider; the need for interoperability so that providers within agent level, where agents can serve customers for the same sector can recognize each other.15 Banks more than one service provider (as long as the and MNOs have negotiated interoperability platforms are interconnected); and the customer agreements that allow their customers to transact level, where a customer can access his or her beyond the markets they directly serve (ATMs for account using any phone with a SIM card on the banks and “roaming” for MNOs, for example) but same network or access multiple accounts on one are hesitant to do so for mobile banking. In the SIM (Kumar 2011). case of mobile banking, providers often want to The incentive for providers to interconnect recoup the substantial investments in developing depends on the size of their relative market 288 The New Microfinance Handbook Box 12.12  Third-Party Providers: New Business Models In some countries, third-party technology world, with more than 45 million customers, companies are developing “technology-­ and is still growing. Eko’s customers can enabled business models” in partnership with transact via cell phones without going to an banks and non-banks. Examples of these agent, unless they want a cash transaction. include FINO, Eko, ALW, and SubK in India and Most of Eko’s transactions are person to per- Wizzit in South Africa. son (P2P) and not government to person FINO and ALW and several similar compa- (G2P). nies in India use card and card-reader sys- Wizzit has a platform company called tems, usually focusing on G2P payments. Wizzit International with contracts in several The accounts are held by banks, and all trans- countries and a business in South Africa also actions must be done with an agent. These called Wizzit. All Wizzit accounts are held in companies manage agents and their acquisi- the South Africa Bank of Athens, which is tion of and interaction with customers, but responsible for meeting central bank know banks “own” the customers and are fully lia- your customer and risk management ble for meeting all know your customer, doc- requirements. Wizzit is a P2P transaction umentation, and other requirements. FINO’s business in which customers get both a agents are not stationary; instead they set up debit card and a SIM card that are linked to temporary disbursement sites on payment the same bank account and use both for days. transactions (transactions on the two chan- FINO and ALW use smartcard technology nels were about half and half at the time of with biometrics, which is relatively expensive writing). For the most part, Wizzit has (both cards and the readers) and does not link recruited, trained, and managed its own into the national payments system. Eko uses agents, called Wiz Kids, an innovative sales cell phone technology that requires the cus- approach that other providers have copied. It tomer to be familiar with numbers. SubK (a has tried to work with retail networks, the subsidiary of BASIX Group) uses a voice bio- post office, and fast-moving consumer metric system that might work better for poor goods companies, but with little success so people; its system could be linked into the far. None of these start-up companies is national payments system. Some of these profitable yet, and some have struggled to companies have both their own platforms and find equity investors and to grow to scale. a separate not-for-profit business correspon- But they have demonstrated new business dent company that manages the customer models, and this has influenced regulators and agent relationship. FINO claims to be the to open up space and attracted other busi- largest branchless banking business in the nesses to invest. Source: Steve Rasmussen and Kabir Kumar, CGAP. shares and their strategy for maintaining a geo- fewer agents and (2) the necessity of competing graphic presence. To become comfortable shar- on the basis of superior products and service ing platforms or agent networks, providers need rather than trying to establish exclusive geo- to (1)  understand the power of broad client graphic zones with high barriers to entry (Mas reach versus exclusive operational control over 2008). Payment Services and Delivery Channels 289 Box 12.13  bKash Ltd. bKash was created in 2010 to develop a national payments platform accessible to a majority of the poor in urban and rural Bangladesh. bKash functions as a third-party network that aspires to work with multiple MNOs and multiple banks. The components include the following: • An interoperable mobile money software platform that allows customers to make deposits, withdrawals, transfer funds, pay bills, and store funds through a mobile wallet account • An extensive agent network that registers customers, assists them with transactions, and serves as cash-in, cash-out points • A mobile operator through which bKash uses a USSD channel to conduct secure transactions over the air (initially bKash partnered with Robi, but recently Grameen Phone, the MNO with the largest market share in the country, has signed on to permit its customers to use the bKash platform) • A bank that will hold customer accounts; the first bank partner was BRAC Bank, but bKash is looking to add additional banks in the future • Other platform participants, such as governments, merchants, bill-pay services, and credit and insurance providers. Since the official launch in July 2011, customers are able to receive electronic money into their bKash accounts through salaries, loans, domestic remittances, and other disbursements and eventually can cash out at any of the thousands of bKash agents, hold the money in the account for safe keeping, or make electronic payments. The bKash mobile wallet is a Visa technology platform, fully encrypted to ensure secure transactions. Money can be deposited into and withdrawn from this account or used for various services. Source: Author interview with b-Kash. In places where interoperability is limited, Agent Networks consumers respond by opening multiple mobile money accounts and swapping SIM cards in and Financial services can be delivered to a majority out of their phones. This arrangement, although of poor households only if the service provid- workable, is far from ideal because the client is ers—banks and MNOs—use retail distribution required to maintain a much larger aggregate channels to get closer to where the poor live at amount of on-deposit funds than if a single fully a fraction of the cost of traditional banking (see interoperable account were possible. Allowing box 12.14). These agents who convert cash to clients to access their accounts via other SIM electronic money (e-money) or convert cards increases not only the potential size of the e-money to cash are the human face of all agent market but also the likelihood that the clients will banking systems. Therefore, when building, choose another MNO as their primary service incentivizing, and managing a network of retail provider. MNOs may fear that a service accessible agents, providers must address the operational to their subscribers will cannibalize their own challenges in a way that fosters a positive and service (CGAP n.d.). consistent customer experience that will create 290 The New Microfinance Handbook Box 12.14  Branchless Banking in Brazil The market for payments, whether it is people treated as a regulated banking service, so util- paying utilities, taxes, or credit card bills (P2B) ity companies cannot sign up local shops as or the government making welfare payments agents for bill collection points, as is com- (G2P), has been tapped most successfully by monly done in other countries. the larger banks in Brazil. The country now has On the supply side, two factors helped to more than 130,000 outlets acting as agents of create a distributed network of agents. First, the bank (although only 39,000 of these out- state resources were used effectively. State- lets offer full banking services) and serving owned Banco do Brasil and Caixa Federal led about 13 million new bank customers who the charge in signing agents (the latter using a have been added since 2002. major lottery chain), and the extensive postal As a result, Brazil is the first developing network was auctioned off as an exclusive country with at least one banking outlet in banking agent (won by Banco Bradesco, every municipality. The success of the Brazilian which then created the Banco Postal as a joint model hinges on country-specific factors. On venture with the postal service). These the demand side, two factors created captive became three early and powerful agent net- markets for new banking agents setting up in works that prompted other banks (Banco areas previously unserved by banks. Real, HSBC, Unibanco) to join in. Second, a First, the government embraced the early special retail payment technology infrastruc- use of bank accounts to distribute welfare ture allows agents to deposit and withdraw benefits (under the Bolsa Familia program), from their account at the branch of any bank. and most of the new bank account holders This enables banks to provide service to are welfare recipients. Second, bill payment is agents who are far from their own branches. Source: Mas 2009. and maintain trust in the system (Lehman there are enough agents to serve customers and 2010). enough customers to keep the agents interested in providing the service (see box 12.15). Building an Agent Network Safaricom, the single most successful mobile An effective agent is well trained, trusted by cus- money deployment to date, invested heavily in tomers, strategically and conveniently located, developing the M-PESA agent network with a and properly incentivized to follow procedures, focus on a consistent customer experience. Each ­ ustomers. keep sufficient float on hand, and serve c one of its more than 20,000 agents provides the Banks typically select larger and more established same services (that is, signing up new customers retail stores, whereas mobile networks are more and facilitating cash-in, cash-out transactions), inclined to use smaller retail outlets such as road- follows the same procedures, and has the same side stands, “mom and pop” shops, or kiosks (Mas branding. Other providers have assigned different and Siedek 2008). Some providers choose to out- roles to different agents, which has resulted in source agent recruiting and training altogether. difficult trade-offs. For example, MTN Uganda Either way, the size and growth of the agent net- separated the “field-based” account-opening work has to be planned carefully to ensure that function from the “static” cash-in, cash-out Payment Services and Delivery Channels 291 Box 12.15  From Payment Terminals to Multiple Services Inspired by a network of payment terminals pay a commission to Express Pay for process- in Russia, Express Pay—an unregulated pay- ing transactions. For money transfers, cus- ment service provider—started in Tajikistan tomers pay a maximum 3 percent of the in 2007 and now offers a web of financial ser- transaction amount. vices for numerous providers. According to In addition to payment terminals, Express Express Pay’s co-founder, Dilshod Niyazov, Pay has extended its network to include 1,600 a forward-thinking representative of the agents, most of whom are local shopkeepers National Bank of Tajikistan discovered located throughout Tajikistan. Agents perform Express Pay’s first terminals within the busy the same functions as terminals but also markets of Dushanbe and insisted that offer “cash out” services to customers and Express Pay set up a licensed microdeposit soon will be able to register new accounts. organization in 2009 to carry on business. In (Currently, customers must register for a new response, FG Vavilon was established allow- account at a central office.) ing Express Pay to capture savings legally as Niyazov estimates that 25 percent of well as to make transfers and bill payments. Express Pay’s business comes through Today, Express Pay manages 800 termi- agents and 75 percent comes through termi- nals, small street-side machines that resem- nals. That will change as its presence expands ble a one-way ATM, providing cash-in but not geographically and the company deepens its cash-out. Through these terminals, users can offerings, particularly to utilities, where com- pay bills, make domestic money transfers to pany employees travel from home to home to other account holders, top up mobile airtime, invoice customers, collect payments, and and, in some cases, repay loans. Express Pay issue paper receipts. It is not difficult to imag- is convenient for clients. Bill pay services are ine a time when certified, roaming Express free. Utility providers (water, electricity, Pay service agents will perform this function Internet) and other financial service providers for a variety of companies. Source: Kim Wilson, Fletcher School, Tufts University. function to speed up the acquisition of new cli- Orange Money in West Africa, which has a regis- ents. However, this created a situation in which tration process that takes up to a week. As a result customers signed up even though they did not of this long wait time, only 6,000 of its first 120,000 need the service or could not find an agent with customers, or 5 percent, actively used the account. which to transact (Davidson and Leishman 2010). When an agent can both open accounts and Managing Liquidity facilitate transactions, not only does the agent An agent is essentially an aggregator for the cash have an incentive to provide services to custom- requirements of a community. It is a cash-storing ers, but customers are encouraged to use the ser- and transfer business that absorbs the risk inher- vice. If customers cannot transact immediately ent in handling cash. An agent must maintain ade- upon opening an account, they lose the instant quate cash and e-money float balances to meet gratification of being able to use the service. This customer cash-in, cash-out requests. If too much situation is well illustrated by the deployment of cash is taken in, the agent may run out of e-float 292 The New Microfinance Handbook and not be able to accept more deposits. If there both to recruit agents and to manage their floats, are too many withdrawals, the agent will accumu- transporting cash for the agent if necessary. The late e-float but run out of cash. In either case, cus- aggregator receives a flat fee for each new agent tomers will get discouraged if the agent cannot and a percentage of the agent commissions. This provide the services they need when they need provides the incentive to sign up high-quality them. In addition, a secure mechanism needs to agents who actively conduct transactions be in place to transport cash to and from an agent. (Davidson and Leishman 2010). When agents provide a range of services (for Banco de Crédito del Perú (BCP) found out- example, account opening, deposits, withdraw- sourcing management of its 2,300 agents to be als, or bill payments), they are able to generate less efficient, so it chose to use in-house agent volume and more easily maintain liquidity. executives to identify, prepare, and manage each Providers have developed a variety of mecha- retail outlet. In densely populated areas, BCP nisms to ensure agent liquidity and assist the agents have a sufficient mix of transactions to bal- agent in handling cash. The options available ance cash-in, cash-out, but in more remote areas, depend to a great extent on the banking infra- the agents themselves need to travel to the bank structure in the markets where the agents oper- branches more frequently. BCP is finding it hard ate and the willingness of banks to take charge of to train and manage rural agents, a challenge that secure cash transport. will require added incentives for the agents and Vodacom Tanzania, for example, tested multi- adjustments to the agent management model (see ple strategies and settled on using “aggregators” box 12.16). Box 12.16  Cost of Managing Agent Liquidity Managing agent liquidity is the critical piece The central factor influencing cash-handling in ensuring the viability of the agent system. costs is the ability to minimize the amount of Regardless of how providers and agents cash that needs to be moved between the share the burden of cash management, a bank and the retail agents—the ideal agent burden that is too heavy will compromise being one that is fully “cash neutral” at the the sustainability of the entire system or end of every day. Because cash-handling costs price the transactions beyond the poor’s are typically proportional to the volume of cash ability to pay. in transit (secure transport firms charge close Emerging data from the Bansefi-Diconsa to 1 percent of cash volume in Mexico, for correspondent banking pilot program in example), the notion that a large number of Mexico indicate that handling cash may transactions per agent ensures viability of the amount to anywhere from 35 to 60 percent of system comes into question. If the volume of total system costs. Most cash-handling costs transactions involves the transport of large are outlays for secure transport services and amounts of cash to the retail payout point, insurance premiums, and about 10 percent then the net effect on system viability is uncer- are the opportunity costs of holding cash and tain. Large social payments programs (G2P) reserves for theft. present a special challenge in this respect. Source: Lehman 2010. Payment Services and Delivery Channels 293 Managing the Channel Even if a proper incentive structure were Agents will not provide quality service to custom- developed, it is unclear whether a sales repre- ers without ongoing on-site supervision and in- sentative would have the skills to manage and store training to ensure they are liquid, consistently train agents. branded, and following the prescribed business processes. Providers need to decide how to divide • Build a new team of dedicated staff solely the various management functions and whether focused on monitoring and training agents. to keep those functions in-house or outsource MTN Uganda created a new in-house team them to an independent service provider. As the with the sole responsibility for training and networks grow, it is increasingly difficult for the monitoring agents. It works well but requires a provider to cover the “last mile” of the distribu- major increase in payroll. tion chain, so most use third parties for part or all • Outsource the monitoring function to a third of the channel management functions. party. Safaricom in Kenya uses a third party, Providers need a system of regular site visits Top Image, to keep direct and centralized con- to ensure that agents are in compliance with the trol over key elements of the customer experi- business processes and maintain proper brand- ence, including store selection and agent ing and merchandising. There is a choice of training and supervision. models: • Use existing airline sales and marketing staff in Agent Costs and Fees the field for MNO-led models. Zain in Tanzania Agent banking systems are much less expensive used this method for budgetary reasons but to operate than bank branches. As shown in figure found that its marketing teams were unwilling 12.2, the monthly costs associated with five sav- to focus on agent training and management. ings account transactions (two deposits, two Figure 12.2  Monthly Costs in Dollars Associated with an Illustrative Transaction Account Bank-provided account linked to e-wallet Mobile wallet Mobile-based bank agent POS-based bank agent Branch cashier 0 2.0 4.0 6.0 Acquisition cost per account per month Total variable costs Total fixed costs Source: Veniard 2010. 294 The New Microfinance Handbook withdrawals, one transfer in the agent channels) needs to be based more on the number of transac- ranged from less than US$1 for a mobile wallet to tions and less on the number of new clients. almost US$5 for a bank cashier.16 Common methods for calculating agent com- There are several reasons for this differential missions include (1) a fixed percentage of the in costs: transaction value (easy to understand), (2) a flat fee per transaction (easy to understand but dis- • Agent banking minimizes fixed costs by lever- courages small transactions), or (3) a flat fee per aging existing retail outlets and reduces the tiered transaction values (allows appropriate need for banks and other financial service pro- incentives for all transactions but is more compli- viders to invest in their own infrastructure. So cated to understand and calculate). although agent banking incurs higher variable By bringing the channel closer to clients, agents costs for commissions and communications, may benefit from additional revenue associated the fixed costs per transaction are significantly with transactions such as bill payments. Although higher in branches than through agents. customers can pay bills at a branch for no charge, • Acquisition costs are lower for mobile-enabled agent proximity may increase their willingness to agents. By using mobile phones instead of pay for these services in that customers are already ­ electronic payment cards and POS devices, willing to pay for remittance and other transfer mobile wallets and bank accounts linked to a services. A recent study found that households mobile phone are able to acquire customers at using M-PESA doubled the number of remittances less than 70 percent of the cost of a branch or they sent between 2008 and 2009 (Jack and Suri POS-enabled agent. 2010). This is especially relevant when serving • Agents receive a commission only if transac- poor customers with low-balance accounts, tions are realized, while the fixed costs of a because it is hard for the provider to cover the branch remain even though the branch may be operational costs of the account on financial mar- underused. gin alone and because the provider needs to move to a transaction-driven revenue model. It is a delicate balance to set both the agent commissions and the prices charged to customers at a level that incentivizes the behavior wanted by Notes providers. For example, M-PESA paid its agents  1. In some cases transfers can also occur the equivalent of about US$1 for every new between two communities. account (another factor for the rapid uptake of  2. When people migrate for work, they need to customers) in addition to paying a commission send money back home. This type of transfer is for every transaction, whether or not the cus- called a remittance because it involves a labor tomer was charged; M-PESA clients pay only for component and some sort of redistribution of “cash-out” transactions and transfers to other wealth between members of the same family accounts because those transactions carry the or community. greatest value for the customer.  3. These definitions were provided by CGAP, Commission structures are adjusted over time with some variation and additions made by the to match the state of the agent network. Initially authors. when there are few clients, agents need to be com-  4. Interview with UBL, March 2012. pensated for signing up new clients; as the num-  5. See the discussion under mobile phones for ber of clients grows, the commission structure definitions of GMS networks. Payment Services and Delivery Channels 295  6. This section was contributed by Kim Wilson, and phone book. This allows the user to retain The Fletcher School, Tufts University. his or her information after switching  7. Ultra-low-cost POS-like transaction terminals handsets. Mobile phones based on CDMA without card-reading capabilities do exist, but technology do not have removable SIM lack the security features associated with bank cards and are not prevalent in developing cards (see, for example, www.movilway.com). countries.  8. The printing technology on most POS devices 14. A tablet computer is a highly portable is thermal paper printing, which means that computer, larger than a mobile phone or the receipts become illegible if they are personal digital assistant, which is integrated exposed to direct sunlight or other forms of into a flat touch screen and operated primarily heat; however, many mobile devices use a by touching the screen rather than using a Bluetooth printer to ensure that receipts are physical keyboard. It often uses an onscreen available irrespective of the paper used. virtual keyboard, a stylus pen, or a digital  9. Bluetooth is a proprietary, open wireless pen (http://en.wikipedia.org/wiki/Tablet_ technology standard for exchanging data over computer). short distances (http://en.wikipedia.org/wiki/ 15. This section draws on CGAP (n.d.). Bluetooth). 16. This is based on a confidential analysis of the 10. Wi-Fi is a technology that allows electronic costs of six financial service providers by devices to exchange data wirelessly over a Veniard (2010). computer network. A device enabled with Wi-Fi, such as a personal computer, video console, smartphone, tablet, or digital audio References and Further Reading player, can connect to the Internet via a *Key works for further reading. wireless network access point (http://en AFI (Alliance for Financial Inclusion). 2010. .wikipedia.org/wiki/Wi-Fi). “Mobile Financial Services: Regulatory 11. General packet radio service (GPRS) is a Approaches to Enable Access.” AFI, packet-oriented mobile data service on the 2G November. and 3G cellular communication system’s GSM. Alexandre, Claire. 2010. “10 Things You Thought It provides moderate-speed data transfer, by You Knew about M-PESA.” CGAP Technology using unused time division multiple access Blog, CGAP, Washington, DC, November. channels in the GSM system (http://en .wikipedia.org/wiki/Gprs). *Alexandre, Claire, Ignacio Mas, and Dan Radcliffe. 2011. “Regulating New Banking Models That 12. Data communication protocols are hardware Can Bring Financial Services to All.” Challenge and software standards that govern data Magazine 54 (3, May-June): 116–34. transmission between computers. In the banking sector, this is usually XBRL (eXtensible Almazan, Mireya. 2010. “Beyond Enablement: Business Reporting Language). The term Harnessing Government Assets and Needs.” “protocol” is used for hundreds of communica- Brief written for the Global Savings Forum, Bill tions methods. A protocol may define the and Melinda Gates Foundation, Seattle, packet structure of the data transmitted or the November. control commands that manage the session, or Alvarez, Gabriela Zapata. 2010. “Turbocharging both. the Client Proposition through Proximity: 13. The two main mobile phone technical Agent Banking in Latin America.” Brief written standards are GSM or code division multiple for the Global Savings Forum, Bill and Melinda access (CDMA). One of the key features of Gates Foundation, Seattle, November. GSM is the SIM card, a detachable smartcard *Baptista, Piya, and Soren Heitmann. 2010. containing the user’s subscription information “Unleashing the Power of Convergence to 296 The New Microfinance Handbook Advance Mobile Money Ecosystems.” Report, *Frankiewicz, Cheryl, and Craig Churchill. 2011. IFC and Harvard Kennedy School, Washington, Making Microfinance Work: Managing Product DC, and Cambridge, MA. Diversification. Geneva: ILO. 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D. von Pischke, Supports Cash Transfer Payments.” CGAP, 147–72. Berlin: Springer. Washington, DC. Jack, W., and T. Suri. 2010. “The Economics of ———. 2011. “Global Standard-Setting Bodies and M-PESA: An Update.” Georgetown University, Financial Inclusion for the Poor: Toward Washington, DC. Proportionate Standards and Guidance.” White *Kendall, Jake, Phillip Machoka, Clara Maurer, Paper prepared by CGAP on behalf of the and Bill Veniard. 2011. “An Emerging G-20’s Global Partnership for Financial Platform: From Money Transfer System to Inclusion. CGAP, Washington, DC, September. Mobile Money Ecosystem.” School of Law ———. n.d. “Interoperability and Related Issues in Research Paper 2011-14, University of Branchless Banking: A Framework.” California, Irvine. PowerPoint presentation. CGAP, Washington, Kumar, Kabir. 2011. “Banks Have Some Good News DC. http://www.cgap.org/gm/ … Are They Listening?” CGAP Technology Blog, document-1.9.56025/CGAP_Interoperability_ CGAP, Washington, DC, September 21. Presentation.pdf. *Kumar, Kabir, Claudia McKay, and Sarah Rotman. Chatain, Pierre-Laruent, Andrew Zerzan, Wameek 2010. “Microfinance and Mobile Banking: The Noor, Najah Dannaoui, and Louis de Koker. 2011. Story So Far.” Focus Note 62, CGAP, “Protecting Mobile Money against Financial Washington, DC, July. Crimes.” World Bank, Washington, DC. Lahaye, Estelle. 2011. “Rural Finance: Let’s Crack the Davidson, Neil, and Paul Leishman. 2010. Nut!” CGAP Microfinance Blog, CGAP, “Building, Incentivizing and Managing a Washington, DC, August 16. Network of Mobile Money Agents.” Global Lehman, Joyce. 2010. “Operational Challenges of Savings Forum. Agent Banking Systems.” Brief written for the Dolan, Jonathan. 2009. “Accelerating the Global Savings Forum, Bill and Melinda Gates Development of Mobile Money Ecosystems.” Foundation, Seattle, November. IFC and Harvard Kennedy School, Washington, Mas, Ignacio. 2008. “Being Able to Make (Small) DC, and Cambridge, MA. Deposits and Payments, Anywhere.” Focus Note Eijkman, Frederik, Jake Kendall, and Ignacio Mas. 45, CGAP, Washington, DC. 2010. “Bridges to Cash: The Retail End of ———. 2009. “The Economics of Branchless M-PESA.” Savings and Development 34 (2). Banking.” Innovations 4 (2): 57–75. http://ssrn http://ssrn.com/abstract=1655248. .com/abstract=1552750. Payment Services and Delivery Channels 297 ———. 2010a. “Banking for the Poor: State-of-the- Developed Countries.” Focus Note 51, CGAP, Art Financial Offerings for the Developing Washington, DC, December. World.” The International Economy (Fall, *Mas, Ignacio, and Hannah Siedek. 2008. “Banking November 14). http://ssrn.com/ through Networks of Retail Agents.” Focus abstract=1709164. Note 47, CGAP, Washington, DC. ———. 2010b. “Savings for the Poor: Banking on Mylenko, N., et al. 2009. Financial Access 2009. Mobile Phones.” World Economics 11 (4). http:// Washington, DC: World Bank. ssrn.com/abstract=1663954 or http://dx.doi Pickens, Mark. 2010. “Where Will the Next Mobile .org/10.2139/ssrn.1663954. Money Innovation Come From?” CGAP ———. 2010c. “The Utility of Retail Payments in Technology Blog, CGAP, Washington, DC, Addressing the Financial Inclusion Gap in November 18. Developing Countries.” Lydian Payments ———. 2011. “Which Way? Mobile Money and Journal 1 (November). http://ssrn.com/ Branchless Banking in 2011.” CGAP Technology abstract=1694867. Blog, CGAP, Washington, DC, March 9. *Mas, Ignacio, and Mireya Almazan. 2010. 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Average Total Cost of Migrant Remittance Mas, Ignacio, and Sarah Rotman. 2008. “Going Services.” Remittance Prices Worldwide Cashless at the Point of Sale: Hits and Misses in 3 (November): 1–6. 298 The New Microfinance Handbook CHAPTER 13 Beyond Products: Building Integrated Customer Experiences on Mobile Phones Ignacio Mas The previous four chapters have discussed indi- services should be in relation to clients’ objectives, vidual financial products and ways in which insti- with the various financial options presented in a tutions might deliver them. In this chapter we consistent way so customers can select the option argue that, for customers to make sense of all that most suits them, or indeed mix and match these products, they must be embedded within a between them. In this fashion, the service tran- financial planning tool. The use of all financial scends the constituent financial service elements services should logically flow from a customer and becomes an integrated customer experience—­ desire to organize payments to meet present and one that allows users not only to choose but also to future needs. construct their own bouquet of services based on Financial services are a means to an end, and a their specific circumstances and needs. full financial service is one where customers are Such a customer experience should permit, presented with various options to achieve their and indeed require, a high level of interaction objectives. For instance, an objective might be between customers and their money. The per- buying a motorcycle, which a customer might get sonal, always-with-you, connected nature of the by setting some money aside and by borrowing the mobile phone presents a unique opportunity to remainder and repaying it over time. This sug- conceive financial services as a conversation gests that the most useful way of offering financial between the client and the provider. Beyond Products: Building Integrated Customer Experiences on Mobile Phones 299 The principal challenge in designing these client’s financial profiles, such a service ought to expanded, flexible customer experiences is in allow providers to extend advances to clients on developing an intuitive, easy-to-access mobile the fly. user interface. A good user interface lets custom- This chapter will be of interest to mobile ers discover and try out new services with rela- banking and mobile money players who are tively little prodding or guidance, it prompts eager to build a fuller value proposition to customers to reveal more about themselves to the address the low take-up and especially the low provider, it induces customer loyalty through usage that we are currently seeing with many sheer familiarity, and it offers a diversity of brand- such systems. Regulators might also note the ing and cross-selling opportunities. potentially crippling effects of pigeonholing With today’s mobile money platforms, the providers into narrow product sets: payment value proposition for keeping money digital and providers, storage of electronic money, credit driving up usage of digital payments is still thin. issuance, banking, and the like. Mobile money is built on speed (real-time clear- ing) and liquidity (thousands of merchants where Putting Personal Financial you can cash in and out). It is ready cash (an Management at the Heart of immediately accessible mobile wallet), cash to go Financial Service Propositions (person-to-person money transfers, bill pay). But mobile money is a flexible tool that can be Setting money aside for planned future expendi- expanded from making payments now to helping tures or for a rainy-day fund is tough if you are people earmark funds for and build up to the poor and you feel like you have a whole backlog of things they want to pay for tomorrow. Savings things you would like to buy today. Poor people and credit enable a shifting of expenditures in need to be quite deliberate in planning what they time. Therefore, savings and credit ­ services are a are saving for, what expenditures to forgo, and logical extension of a payments service. how they build up assets over time. In this section The chapter is in three parts. The first section we look at the psychology of savings, in terms of describes the need to put personal financial man- how poor people define and set spending and agement at the heart of financial service proposi- financial goals, and how they assign savings vehi- tions. It argues for embedding the kind of mental cles to these goals. models and psychological discipline tricks that people engage in informally within formal finan- The Psychology of Savings and Goal cial services. The second section describes the Setting basic elements of a mobile financial service deliv- People’s notions of spending goals are quite ery platform, emphasizing the role of the user diverse. Some goals are explicit, a typical one interface as the key link between clients’ mental being paying for school fees at the beginning of representation of money and the digital represen- each school term. There is a clear amount that tation embodied in formal financial services. The needs to be paid and a clear due date; let us call third part illustrates how an integrated mobile these objectives. But oftentimes the goals are financial service fulfilling a broad variety of needs aspirational and without a clear timeline— might be constructed, simply by recasting shorter-­ things such as buying a motorcycle, a “perma- term savings as a set of payments to oneself and nent” (for example, brick) house, or a plot of permitting a range of early liquidity options. By land. There is a clear desire, but no clear plan to giving providers a more meaningful window to get there; let us call these intentions. The key 300 The New Microfinance Handbook ­ ifference between objectives and intentions is d decide not to raid your savings for current the degree of earmarking of money to the spe- expenditures (discipline out). cific, stated goal. • Certainty versus surprise. People want to know A continuum is found between objectives and that the money they have set aside is accounted intentions, and in fact goals can transform for and safe. They like to be able to check at between these categories. Goals may be recali- any point in time how much they have saved brated based on circumstances. For instance, (hence the popularity of passbooks and check building an emergency fund for unplanned balance capabilities on mobile-enabled solu- health or funeral expenses may look more like an tions), and they want to know what return intention (no specific target amount, no clear they can expect. On the other hand, people timeline for its consumption), but it turns into a also like to surprise themselves about how very tangible objective the moment someone much they have saved, to feel the elation of falls ill or dies. Or I may be saving for a bicycle, breaking the (real or virtual) piggybank. They but if the roof starts leaking I will shift the goal to may also embrace surprises as savings rewards, fixing that. In other words, some goals must be either by investing in schemes with higher understood as a proxy for a category of potential although uncertain returns or by participating expenditures. The individual might be quite clear in a lottery mechanism. While certainty cre- about what kinds of expenditures he or she is sav- ates confidence, an element of surprise carries ing for, but for an observer these might appear as more of a prospect of a different future, and shifting goals. that can be more motivating. The next question then is how people assign savings vehicles to (classes of ) goals. People will • Privacy versus social display. People may have consider tensions along three key dimensions: a strong preference to keep larger amounts of savings private given social pressures to share • Liquidity versus discipline. Liquidity is about bounties. On the other hand, saving publicly having the flexibility to meet changing goals helps create the commitment of regular sav- and circumstances, for instance, by being able ings which members find so important, and it to dispose of saved balances quickly in the can also be used to signal success or claim event of an emergency or when a good invest- social status. ment opportunity arises. Yet people know that if money is too accessible, there is a constant The choice of savings vehicle will therefore temptation to spend it. Saving and keeping depend on the nature of the goal in question. money saved becomes an active decision that School fees, which I—and everyone else around must be revisited every time there is a spend- me—need to pay one way or another, might be ing opportunity. These little decisions that saved in a mechanism that involves more prevent depletion of savings can grow exhaust- discipline/less liquidity, more certainty, and ­ ing, and once decision fatigue sets in, self-con- more social contact. A village-level savings trol flies out the window. Discipline is therefore scheme might meet these criteria. The motorcy- about making it hard for people to revisit prior cle that I aspire to might be saved for in a mecha- savings decisions, in terms of how much and nism that involves more liquidity/less discipline how often to forego current expenditures and (I might want to change my goal, after all), more set money aside (we can call this discipline in) surprise (I will take a gamble on it), and less pri- as well as at any time subsequently when you vacy (announcing that I am working toward a Beyond Products: Building Integrated Customer Experiences on Mobile Phones 301 bicycle). Buying a couple of pigs might meet returns (and correspondingly accepting higher these criteria. risks). • Vesting savings with social meaning and con- Informal Discipline-Building Mechanisms straints. People often seek to add a social People have attached a remarkable range of infor- dimension to their savings in order to mal discipline-building mechanisms to their sav- increase the stakes of failing to save or actu- ings practices, among them the following: ally dis-saving. This can be done for instance • Fragmentation of savings across multiple pots, by embracing peer pressure as a way of mak- assigning a clear purpose to each. Creating a ing regular savings contributions through tight mental association between savings community-based savings groups, or by dis- objectives and instruments (for example, the playing savings publicly and linking that to goats are to pay for school fees and uniforms, social status. the rotating savings and credit association The end result is a compartmentalized, almost account is to buy a sewing machine) helps ritualized treatment of savings, where uncon- keep savings goals always in view (you are scious mental processes substitute for conscious reminded of your children’s future every time ones. you see the goats) and makes it more difficult to justify to oneself tapping into these savings The Trouble with Banks: Inflexible Products on a short-term whim. Banks typically structure their mass-market offerings into a few standard products. Their • Indivisibility of individual savings pots to communications strategy with their clients is prevent casual raiding. People often save in centered on explaining to customers when, why, gold jewelry rather than small pieces of gold; and how to use each product. That works well they convert a pile of small banknotes into with the formally employed who have larger, reg- fewer larger ones; and they trade up from ular, and stable income streams. Products involv- chickens to goats to cows. One might be ing a rigid structure of payments over time tempted to take out a one-dollar bill from (whether a loan schedule, regular pension plan under the mattress or sacrifice a chicken to contributions, or a term deposit) are easy to ana- fulfill some small desire, but everyone would lyze in the context of one’s income. hesitate to break a hundred-dollar bill or sell But the informally employed face a more a cow unless there is a strong reason. There bewildering range of risks because they do not is a higher guilt factor about tapping into a have regular, guaranteed income flows. Poor peo- high-ticket savings item. ple naturally find it harder to build steadily • Mental labeling of broad savings categories, for toward their goals; they need more help. But instance, drawing a sharp distinction between banks’ rigid products rarely work for them; they savings and investments, or calling certain are not seen as relevant. Banks could offer more forms of savings heirlooms. All these represent diversity of products or more flexible terms for not-consumed assets, but calling something an poor people in the informal sector, but that would investment or an heirloom removes it from make their service complex to market, sell, and contention for meeting day-to-day needs. manage. Instead, they fall back to the single prod- They seek to reinforce these distinctions by uct, the catch-all liquid account, which simply putting different expectations on them, for does not connect with people’s mental model instance, expecting investments to yield higher around money and discipline. 302 The New Microfinance Handbook Rather than confronting poor people with a in India (see box 13.1).  KGFS’s strategy entails barrage of separate financial products, each with high-touch individualized service and product its own set of conditions and rules, we need to recommendations based on thoughtful analysis of envelop them within a consistent customer experi- livelihood sources and asset portfolio analysis. It ence that blurs the boundaries between the various may seem counterintuitive to provide high-touch constituent products. Whether it is by providing services for the poorest persons, but the KGFS electronic payments, savings, or credit, the objec- premise is that private banking seems right for tive is to help customers buy the things they aspire the very affluent (who have complex wealth man- to. We also need to blur the boundary between for- agement choices to make) as much as for the very mal and informal financial services by bringing in poor (who have vital risk management choices to elements of self-discipline, peer pressure, and make). It is the people like you and me in between social capital that serve people well today. Even who feel adequately served by helping ourselves more fundamentally, presenting mobile financial from a menu of off-the-shelf banking products. services as means for planning expenditures Building a high-touch channel reaching mil- involves a blurring of the notions of savings and lions of poor people is an expensive proposition, consumption. Buy that bicycle you have long desired involving steady investment in staff training. Any can be as much a call for consumption as for staff-centric model is also likely to suffer from saving—you will manage to buy the bicycle by not inconsistent quality of service as it grows, because buying other (supposedly less important) things in quality will become harder to measure and finan- the meantime. That is why the ability to plan is at cial measures of success will tend to dominate. the heart of the savings problem. This chapter is an attempt to visualize what a vir- tual KGFS model might look like—one that An Interesting Experiment achieves the same level of customer support but The most ambitious project to date in this regard with a higher element of self-service and remote is the private banking for the poor model of KGFS interaction. Box 13.1  IFMR Trust in India Since 2008 a new microfinance model has and addressing the financial needs of the been tested in three remote rural regions of approximately 10,000 people and 2,000 India under the franchise name Kshetriya ­ households living in the area. Work begins Gramin Financial Services (KGFS). Sponsored with a financial well-being assessment that by IFMR Trust, the goal of KGFS is to provide collects household-level data in household vis- complete financial services to all individuals its; these data are entered into a series of pre- and enterprises in a predefined area. The oper- set formulas for easy analysis. Based on that ations of each franchise organization are lim- assessment, frontline staff (called wealth ited to between two and three contiguous managers) recommend a tailored combina- rural districts with total populations ranging tion of financial products for each household. from 4 to 5 million; within its catchment area, Each KGFS unit is “product agnostic,” advising each branch is responsible for understanding clients on the right combination of savings, (continued next page) Beyond Products: Building Integrated Customer Experiences on Mobile Phones 303 Box 13.1 (continued) credit, insurance, and pension services for ing up clients, and completing transactions. that particular household’s current needs. However, most services are contractually Financial well-being assessments and recom- between the clients and actual providers mendations are updated on a regular basis as (large partner financial institutions). This household needs change. arrangement is necessary to deliver a full Achieving this vision requires the capacity range of services that is being adjusted con- to deliver a full range of services. KGFS stantly, but KGFS also believes that a larger focuses primarily on establishing a “front-end” specialized financial institution is better placed presence with close client relationships. Staff to manage systematic and actuarial risks than members visit households to conduct assess- a relatively small microfinance organization. ments and provide financial advice, whereas The one exception to this model is credit. In services are provided only in branch offices, most cases, KGFS provides loans directly which are within walking distance of all house- from its own resources. This is to ensure that holds in the catchment area. Management and the incentives of KGFS to underwrite and staff incentives are geared toward understand- monitor loans are intact and that the relation- ing and catering to the needs of the popula- ship with the financial institution is not one of tion, not toward delivering products. a pure agent. KGFS partners with a range of commercial Three KGFS franchises have already been banks, pension funds, brokerages, and insur- launched in very different regions of India, all ance agencies. A central (shared) product significantly underserved rural areas, and more design unit sources and designs appropriate franchises are being incubated. Franchises products. KGFS does the heavy lifting of adapt to their local environment but are tied extending services to remote rural areas, sign- together through a common culture and brand. Source: Greg Chen and Steve Rasmussen, CGAP. Delivering Financial Services over usability barrier (friendly and intuitive customer Mobile Platforms experience). What makes these problems particularly diffi- What might a financial system that includes every- cult is that they cannot be thought of separately or one look like? We can guess at some of the constit- tackled sequentially. These three aspects must uent elements of the solutions by looking at what come together at the marketing level to answer has been successful in various related sectors. Box the three main questions customers will have: 13.2 ascribes two success factors or lessons to each (1) what is it, what does it do; (2) why should I use of microfinance, informal finance, mobile money, it, what are the benefits; and (3) how does it work, mobile telephony, and the Internet. where can I use it? The sheer magnitude of the financial inclu- sion gap—70 percent of households in develop- ing countries are unbanked—calls for pretty Elements of a Mobile Financial Service radical solutions. We need to overcome an access Proposition barrier (last mile infrastructure), a relevance bar- We can distinguish between three basic elements rier (right-sized products and services), and a of a mobile financial service proposition. First, 304 The New Microfinance Handbook Box 13.2  What Are the Attributes of Success in Adjacent Sectors? Microfinance success stories are many and by digitization of services. The first one is diverse, but two common factors stand out the packaging of individual offerings into a across all of them. The first is the value of fuller, friendlier, customizable customer proximity: They all found ways to get physi- experience. The second one is the customer cally close to the customers they wanted to information that can be gleaned from their serve. The second is simplicity: They focused transactions or interactions with the ser- on streamlining the product set and standard- vice, which can be used in turn to tailor izing features. products and further optimize the customer There are now high hopes for mobile experience. money as a new platform for financial inclu- The informal money management prac- sion, following M-PESA’s success in Kenya. tices that people use in their daily lives have One lesson is the importance of cultivating the two characteristics that set them apart from edge of the electronic payment network: Make what banks normally conceive. First, they blur conversion in and out of cash easy and reliable. the boundaries between savings, credit, and The other major lesson is that profitability in insurance (for instance, savings-led groups or financial services need not come from credit lending money among friends). Second, they alone: There is substantial willingness to pay use a range of discipline devices beyond for some types of payment services that are sheer time commitments (fragmentation by costly or inconvenient for people to do today. purpose, indivisibility of savings vehicle, creat- The rampant growth of mobile telephony ing habits, peer pressure, and assigning even in the poorest countries has shown us social/family value). the power of two additional drivers of demand. Let us now connect all the emphasized The first one is the immediacy of the service, keywords: To crack the financial inclusion prob- which is inherent in the technology: being able lem all we need to do is to design a customer to communicate here and now, on demand. experience that (1) combines features of sav- The second one, slashing price barriers, came ings, credit, and insurance and offers a variety with the shift to prepay: introducing tiny top-up of self-discipline tools, (2) is manageable by amounts (as low as US20 cents) and eliminat- the customer within a simple-to-use, logically ing fixed fees and usage commitments. consistent framework, (3) is delivered as and From the internet, we have learned when people need it in any amount they need, about two new key sources of value enabled and (4) has convenient local liquidity options. there needs to be an infrastructure to exchange network of cash in/out points that people can physical cash for electronic value (most com- incorporate into their daily routines. These monly, branches and ATMs). This is not banking points need to be near where people live and per se because it merely enables exchange work, located in retail environments that want to between two forms of money, just like one might serve poor people like them, and offering two- exchange notes for coins. But it allows people to way services (deposits and withdrawals) in small easily combine the forms in which they are paid amounts. their wages, store money, and spend it. There The most promising approach is to engage needs to be a much more dense and cost-effective everyday stores as cash in/out points, where they Beyond Products: Building Integrated Customer Experiences on Mobile Phones 305 offer to buy and sell electronic money to or from payment system—cash—to new interconnected their customers against cash (constituting a with- electronic payment platforms. drawal and deposit, respectively), much like they Finally, there needs to be a set of financial ser- would sell rice by exchanging their holdings of vices that map simply and directly into people´s rice for their customers’ holdings of cash. This mental models of their money. These services can be made secure as long as stores operate on a allow people to plan how to achieve their invest- fully prepaid basis (it holds balances in both cash ment and spending goals and how to manage cer- and electronic value), and the electronic transac- tain risks. Whereas the functions of exchange and tions between stores and their customers are transfer work best the more immediate they are, authorized securely in real time using a digital planning is by definition something that occurs communications network. over time. Second, there needs to be a digital payments ecosystem which makes electronic money Building a Platform That Balances directly useful for people, by allowing easy Specialization and Scale transfer of value within the electronic cloud. Successfully fulfilling these elements requires This is more immediately convenient than cash building a costly infrastructure and supporting a for larger payments (where cash presents a sig- complex service delivery chain. There is a need to nificant risk), remote payments (cash is costly to redesign the institutional structure and the value transport), business-related payments (cash chain within which financial services are offered leaves no evidence trail), and at unattended to the mass market of poor people in developing points of sale (cash fills and jams ticketing countries. Most financial institutions have nei- machines). Over time, electronic payments nat- ther the proper cost structure to scale nor the urally come to be seen as increasingly convenient marketing capabilities to cater to customers’ for smaller, face-to-face, everyday transactions diverse needs. Figure 13.1 shows a schematic of (for example, at retail shops) between people the journey that is required. who have (are long) electronic money and do not Today most microfinance institutions ser­ wish to incur the hassle of converting back to or ving the poor tend to offer a limited number of from cash. discrete products (often just one, for example, We need to find mechanisms to induce more group-based lending or ordinary savings accounts) payments in the informal economy to be made within a proprietary delivery structure (they electronically, such as for the sale of day labor, manage their own cash points, treasury and goods, or services, in order to get as many people investments, loan evaluations and recovery, and as possible long electronic money. This is a more the like). Many interventions in support of direct method of access than through cash-in net- financial inclusion entail creating new uncon- works. One priority should be on electronifying nected, vertically integrated institutions in the sources of money rather than making it un- or underserved areas. These institutions are convenient for people to use electronic money, often mission based and develop very good as the latter will follow naturally from the for- affinity and proximity with their target custom- mer. The second priority should be to connect ers. But because they combine all functions all the electronic accounts and wallets into one (some scalable, some not) into a single struc- interconnected network: No one should be rel- ture, they tend to operate at very high unit egated to an island. This is about catalyzing costs, and their systems and procedures cannot and speeding the transition from the legacy handle geographic expansion well. 306 The New Microfinance Handbook Figure 13.1  A Platform Perspective Single user experience Products Products Products Sort out the Sort out the economics marketing (delivery) (what/why/how) E-payment E-payment platform platform Standalone products Financial products on Mobile phone as in vertically integrated mobile money rails a financial tool institutions Balancing customer intimacy and scale is product development, through which they could ­ enerally achieved through institutional special- g develop deeper and richer relationships with ization. One approach, shown in the middle of their customers. figure 13.1, is to separate the operation of the basic payment platform from the development and Creating a Single-User Experience marketing of value-adding financial services that This separation of functions would go a long way ride on that platform. The e-payment platform to put financial service providers on a more sound box in figure 13.1 refers to the basic exchange and economic footing, but the proliferation of services transfer functions described above. This service running on these rails presents significant mar- could be supplied by larger banks through inter- keting challenges of their own. Communicating operable switches or by mobile network opera- what each product does (features and terms), why tors (MNOs) under mobile money schemes. or in what circumstances it might be relevant for Although it is possible that these players might people (benefits), and how it is used (procedures) operate such platforms as a closed loop, one requires a level of attention from poor customers would expect that over time they would open that providers may not be able to garner, and even them up to an ecosystem of specialized financial if they did, it may entail a cost which providers institutions that wish to offer a fuller set of ser- are not able to bear. vices to their customers. These specialized insti- There is a need to create a simple framework tutions riding on the scalable platforms could through which people can discover, learn about, operate as cashless banks, because they would col- and manage a diverse set of services. That is rep- lect and return value to their customers through resented by the single-user experience box on the third-party electronic payment platforms. Freed right-hand side of figure 13.1. Customers might from the operational challenges of handling cash avail themselves of many products and services, and electronic payment networks, they would be but all are presented and managed in a consistent, in a position to focus more fully on marketing and seamless way through common interfaces. Beyond Products: Building Integrated Customer Experiences on Mobile Phones 307 Note that here we are talking about a single-­ from increasingly remote locations, a key ingredi- user experience per customer, but different classes ent for building trust; and (2) they are cheap and of customers might be presented different user already out there, thus slashing deployment costs experiences based on their sociodemographics in comparison with other technology platforms. and level of familiarity with financial services. In Mobile phones not only represent the key to fact, one could imagine customers having their unlock access, they are also the key to increase user interfaces upgraded over time to deliver a usage. Promoting financial inclusion involves richer and expanded set of potential services, developing customer experiences that help peo- commensurate with their growing financial capa- ple plan for and achieve their goals, whether bilities and needs. these relate to concrete planned expenditures or The customer experience box would be made looser financial cushions. That requires two consistent by the following elements: things: (1) extracting information from clients as to what their goals are and in what timeframe • A user interface available on customers’ elec- they aim to achieve them, and (2) presenting the tronic access devices (mobile or web), which various available financial services (savings, allows them to find, contract, and interact with credit, payments, and insurance) in the context of their services on a self-serve basis. those goals. • A customer relationship management system, Both these things are hard to do when cus- which allows the provider to create a detailed tomer interactions are infrequent and not very picture of each of their customers based on the consistent. In one month, a bank client typically history of interactions they have had through listens to one bank advertisement on the radio or the user interface, as well as any other avail- TV and walks over to a branch once, which means able sociodemographic data that can be that communication is very limited and mostly cross-referenced from external sources. This one way. In this setting, the bank’s promotion has system would also have a customer analysis to be as simple as possible, and that means mak- and proposition engine, which evaluates the ing it product driven. suitability of customers for certain services But when banks (or alternative financial ser- (for example, credit scoring) and triggers rele- vice providers) and their clients are connected by vant outbound messages to customers (for mobile phones, the potential exists for the rela- example, to reinforce goals or propose a new tionship to be much more frequent and interac- service that the customer is likely to want). tive. With this in place, the bank can start thinking about having a conversation with their customers • An assisted sales and service channel, which based on their goals (whether based on aspira- customers can use when they want to interact tions or fears) rather than on the bank’s standard with people. This might be a chain of dedi- list of products. There is less pressure to propose cated stores, an outbound sales force, or a call the right products to customers from the outset, center. because customers will guide banks on an ongo- ing basis as to what they need. The mobile user Why Mobile? interface should draw customers into this conver- There is much promise of using mobile phones, in sation, so it must be structured around people’s combination with retail shops acting as cash in/ goals. It is up to the bank to fit their products to out points, in solving the access barrier. There are these goals. The interactions would also be bank two key advantages of using mobile phones: (1) initiated: to remind people of their stated goals, they enable secure real-time communications congratulate them when they work effectively 308 The New Microfinance Handbook toward their goals, and propose new ways in how to get people who are new to banking to which they can achieve their goals. understand and use such a variety of financial ser- Mobile phones can be used as a lower-cost vices on a simple mobile phone. alternative to rolling out cards and point-of-sale Overcoming these challenges probably terminals. But, beyond cost, the real opportunity requires integrating the rails and the products with mobile phones is for the bank to establish a more tightly, from early on. On the other hand, direct, on-demand connection with its custom- optimizing the mobile money environment by ers. Mobile phones make it possible to think of a adding higher-level financial services (savings future where banks and their customers have commitment features, credit, insurance) runs the daily interactions that are based less on the banks’ risk of making the concept of mobile money more products and more on the customers’ goals. In a complex to market and practically unwieldy to successful mobile banking relationship, clients manage on simple mobile phones. would be reaching for their phone every time To break out of this dilemma, what we need is they have money coming in. How do I assign this a single mobile-enabled customizable experience money across my goals? Banks’ offerings then go that puts customers’ goals and needs as the basis from being productized (offering choices within a for the interactions between the bank and its cus- set à la carte menu) to being mass customized tomers. The key driver for this experience will be (where customers interact uniquely although less the underlying financial products that fulfill using the same set of tools). the service and more the user interface and cus- The key challenge in visualizing the single-­ tomer information management systems that user experience box is in imagining how multiple, guide the interactions. apparently disparate services might be presented Telecommunication companies and banks will within a single logical framework and common certainly play a role in enabling such integrated user interfaces. service concepts, but perhaps what we really need is a third party playing an Amazon.com–like The Mobile Money Journey Thus Far role: managing customer insight, presenting rele- Mobile money today mostly offers a basic transac- vant offers, and organizing the service delivery tional account. In Kenya and elsewhere, we have chain behind them. seen customers taking up this service in large This is the area explored in the next section. numbers. But these accounts largely fulfill a The aim is to examine how one could offer a rich means of payment function: They are not gener- menu of money management services in a way ally used to store significant amounts of money that is appealing to the bulk of poor people in over long periods of time, and they are generally developing countries. not linked to other financial products such as credit or insurance. Turning the Mobile Phone into a As a result, financial inclusion enthusiasts Financial Management Tool have tended to look at mobile money as providing low-cost transactional rails; once those are in So far we have developed two core ideas. First, place, we can then devise the right products to from a usability point of view, mobile financial ride on those rails. But that leap is proving hard. services need to be conceived as a single customer Without the necessary range of products, we can- experience that integrates across a range of not ensure sufficient usage of the rails, which underlying financial services. This makes it possi- undermines the case for the necessary infrastruc- ble to design a simple mobile user interface logic ture and marketing investments. Yet it is not clear that guides customers to appropriate financial Beyond Products: Building Integrated Customer Experiences on Mobile Phones 309 services and usage patterns. Second, from a rele- Deferred Payments vance point of view, people interpret the use of Because spending goals represent future expen- various financial options within the context of ditures, one could use a system of deferred pay- deeply entrenched mental models of financial ments to apply current income to future goals management. This presents the opportunity of (Mas and Mayer 2011). One could therefore pres- designing the integrated mobile user interface ent savings services as an extension of payments: fundamentally as a financial management tool, In the same way that you can use mobile money to one that incorporates the psychological discipline send money immediately to someone else, you mechanisms that people engage in instinctively. ought to be able to send money to yourself to be This section illustrates how this might be done in received at a future date. Think of these as a simple fashion. self-payments (“Me2Me,” across time), instead of the garden-variety person-to-person payments Introducing the Time Dimension into (“P2P,” across space, in real time), as illustrated in Mobile Money figure 13.2. Mobile money, as it is currently conceived, All it takes to create these deferred payments works best when there is a coincidence of tim- is one additional optional field in the standard ing between sources and uses of funds, because money transfer menu: the date when the trans- then the transaction can be realized immedi- action is to take effect. (Immediate execution ately. But when there is separation in time could be the default, if no date is specified.) between when money is available and when it Users can then associate future dates with goals needs to be paid out, mobile money has so far and commit money to those goals as and when proved less useful. they earn it. The separation in time can occur for two main When customers check their mobile money reasons: (1) if the payment needs to be made on a balances, the provider would provide a fuller future date (for example, rent, school fees, elec- description of saved balances: total amount in the tricity bill, seeds for planting) or  (2)  if the pay- account, available or liquid balance, and value of ment is sizable relative to income flows, such that deferred payments (which could be split between there needs to be an accumulation of funds before deferred payments to others and to oneself, that the commitment of the expenditure (for exam- is, savings). ple, buying a motorcycle or new farming imple- With these services, users would be able to ment). These desired future expenditures thus allocate or deal their money across their various create goals. goals each time they come across some income. Bridging that gap in time between money The various dates would operate like earmarked inflows and expected outflows is the role of the savings receptacles. Consider two examples: stored-value account in a mobile money system, except that it appears that most people do not • Casual laborers would be enticed to reach for leave much value in there. That is to a significant their phone every time they have money com- extent because, for regulatory reasons, mobile ing in—which happens unpredictably but money is usually not marketed as a savings vehi- often daily. Thus, if I had a good day and made cle. But it could also be that people find mobile US$5 today, I will cash in the US$5, send US$2 money too liquid, too easily available: Like cash in to myself for February 28 because that is when the pocket, it is best gotten rid of in favor of some- school fees are due, and another US$2 to thing that will stick, lest it comes to be used for myself June 30 because that is when I aim to something superfluous. buy a bicycle; the remaining US$1 I will keep 310 The New Microfinance Handbook Figure 13.2  Transactions in Space and Time Here and now Distance 1 2 3 4 5 6 7 8 9 Send 10 11 12 13 14 money home Time 15 16 17 18 19 20 21 Mobile phone screens 22 23 24 25 26 Money transfer 27 28 My balance Buy Total saved:_________ Phone#:____________ bicycle Available:___________ Amount:____________ 29 30 31 Committed:_________ PIN________________ For a / b / c:_______ Buy books (Value date_________) For x / y / z:_______ in my liquid mobile money account for daily sometimes be interpreted to be not necessarily expenditures. exact dates when certain payments are planned but rather future financial decision points. Thus, I • Farmers have the opposite problem: All their might push money to April 1 simply so that I do money comes at once, at harvest time. Thus, I not have to think about how to use that money could deposit the entire value of the crop and until then; on April 1, I might decide to do some- send large parts of it to myself on those dates thing with it, or simply roll it over to, say, July 1. when I need to pay for the rent of the land for Me2Me payments to future dates are function- the next season, and pay for soil preparation ally equivalent to commitment savings subac- and seeds at planting time. With the remaining counts, each of which is associated with a value, I could even create monthly payments particular future date. Through this scheme, to myself emulating a salary until the next there is no need to predefine or open multiple harvest. accounts. In the customer’s mind, each date, and Remember the previous discussion on goals: hence each subaccount, would be associated with Some, like school fees, are clear objectives, a goal. whereas others, like buying a motorcycle, might Most people save because they want to buy represent a more fuzzy category of intentions. something. Applying a payments logic to savings Thus, future payment dates to oneself might behaviors makes it more tangible and relevant for Beyond Products: Building Integrated Customer Experiences on Mobile Phones 311 people. It is “parking” money for a purpose, it is regularly they meet their objectives constitutes pushing money forward. From a marketing point valuable information for credit scoring. of view, it reinforces the positives (the spending goals) rather than the sacrifices (savings). Liquidity versus Commitment Where there is a very common goal, such as We noted above that when people make finan- school fees, that could be a useful prototypical cial or investment choices they must strike a use case to drive marketing of deferred pay- delicate balance between liquidity (being able ments, for example, “pay yourself to pay for your to access funds if and when I wish) and commit- kid’s school,” much like “send money home” was ment (not accessing funds until I really need to). used to drive the notion of P2P payments in So far, the deferred payment scheme has shown Kenya. how people might commit by pushing money Enabling Me2Me payments could offer signifi- forward to certain dates. But what if they need cant added value for mobile money providers. But to access their funds earlier? How can a bank be more importantly, it can help soften the brutal expected to offer both flexibility and discipline, network effects that are inherent in the early at the same time? phase of development of P2P networks. With One approach is for banks to position a port- Me2Me, mobile money may be very useful even folio of products, some catering to the liquidity when few other people are on the network, objective (current and savings accounts) and because it helps people manage their own money. others to the commitment objective (deferred If people were comfortable keeping higher bal- payments or time deposits). Users can then seg- ances, it would likely increase the activity rate on ment their wealth and treat part of it as a mobile money transfers, as well as reduce the liquidity reserve and part of it as a commitment proportion of transfers that are converted back fund. But the choice seems unnecessarily artifi- into cash—a costly step. cial and removed from most people’s daily wor- ries. Remember that no one is guaranteeing Harnessing Customer Information them a periodic income; they are exposed to The interactions could also be bank initiated and deep crop price fluctuations and crop failures, evolve into an ongoing conversation. If the cus- and no one is underwriting their health risks. tomer is saving money for March 31, why not con- They may want to put away some savings for the tact her (by SMS/text message or a call from the future, but they will want to retain access to contact center) to find out what her goal is and their money if a new business opportunity how much she needs? If she does not seem to be arises, or if they get sick. following through on a pattern of set-asides for Instead of assigning each dollar I save to either her March 31 goal, why not reach out to her to a liquidity pool or a commitment pool, I would remind her of her goal or find out why she is hav- like to assign a measure of liquidity and a measure ing trouble? of commitment to each dollar I save. I want to Each of these interactions is an opportunity to strike a balance between flexibility and discipline capture information that can be useful in two with each dollar I resolve to set aside, based on ways. First, the bank can play back this informa- what I think I am setting it aside for and how tion to the customer and show that it listens and much uncertainty I have in my life. I may want cares about her. Receipts for deposits, for instance, more commitment if I am setting aside money for can now refer to how far the customer is from school fees (which I need to pay one way or ­ getting her motorcycle. Second, knowing how another) than for a bicycle (which I can defer if a people manage their money and observing how more urgent need arises). 312 The New Microfinance Handbook Early Liquidity Options raiding. Of course, if the full amount is not What we need is more of a continuum in liquidity-­ required for the emergency, the user can still commitment options. This would need to be sup- liquidate the deferred statement and set up a ported, functionally, by having the user assign a new one to the same forward date for the priori an early liquidity option to each savings unused balance. goal (which might be associated with a date or • Waiting period: Users must preannounce an subaccount). This option would logically be com- early (partial or full) withdrawal, and the posed of two key choices: (1) under what condi- funds will become available one or two days tions can the customer request early liquidity later, which gives the user an opportunity to (that is, what are the liquidity triggers) and (2) rethink whether the early withdrawal is justi- how is the early liquidity facility provided (such fied or not. This seeks to avoid impetuous as early withdrawal or as a loan). financial decisions. In terms of the liquidity triggers, six options are available. The two extreme options, at either • Peer pressure: The user must nominate one end, are the following: person they trust upfront who will act as their • Free disposal (full liquidity): The user is “savings buddy.” The buddy is informed of, or entirely free to withdraw any amount saved at even must agree to, any (partial or full) early any time even before the specified due date. withdrawal. The buddy would readily agree if The deferred payment still contains a mental she knows there has been an emergency and discipline element, insofar as one can mentally can talk to the saver if she feels the saver is associate a purpose and a timeframe to a par- being rash. The sheer notion that the savings ticular pot of money. This can be reinforced by buddy would be notified may by itself dis- the provider with every early withdrawal courage hard-to-justify early withdrawals. made (for example, on a small withdrawal: The consultation with the savings buddy “Are you sure you want to set back your motor- would occur automatically by SMS/text cycle fund by US$10, when it is not even message. March?”). But there is nothing stopping users • Financial penalty: There is a financial cost to from accessing their money. exercising early liquidity, which might be a • Time-locked (illiquidity): The account is illiq- flat fee (to disproportionately punish small uid until a defined point in time in the future, temptations) or a percentage of the amount the deferred payment date. This offers full withdrawn. commitment on amounts saved. These triggers are intended to be deterrents— In between, there might be the following four but not outright barriers—to dis-saving. If these early liquidity options. Their objective is to make selected trigger conditions are met, the early it a little hard for customers to dip into their sav- liquidity facility can be provided in two ways: ings prematurely, but falling well short of block- ing access: • Liquidating savings balances: This is the straightforward reduction of saved balances • All-or-nothing (indivisibility): Early withdraw- following an exercise of early liquidity. This als are allowed, but they must be for the entire is easiest to implement, but has the drawback balance. The intention is to raise the stakes of that the continuity of the savings goals is dis-saving, thereby providing liquidity for large compromised or may even be extinguished emergencies but preventing casual account when clients exercise early liquidity. Beyond Products: Building Integrated Customer Experiences on Mobile Phones 313 • Borrowing against one’s savings: Savers can credit in the system allowed it to be sold through request a loan up to the value of what they third-party, mass-market retail channels, with- have stored to a certain date. An amount equal out requiring any customer screening. But its to the unpaid balance of the loan is frozen usefulness will grow when it evolves into being from that deferred payment balance, so the also like a credit card. To do so scalably requires loan is riskless. There might be fixed or flexi- reliable credit scoring, which will come from ble repayment terms on the loan, which in either capturing more relevant financial infor- effect offers clients a path to rebuild their sav- mation from people or harnessing community-­ ings. There might be an interest cost to the level information. loan, which we can map to the financial pen- Credit is important because it expands cus- alty option above, but equally there might be tomer’s payment opportunities. The deferred no interest if other discipline mechanisms are payment scheme outlined above allows people used instead. Providing early liquidity in this to build their own prepaid installment plans— fashion gives savers an opportunity to meet accumulate money, then use it. Credit offers dif- unforeseen needs while preserving savings ferent means for the same purpose: It can be goals. It is often observed that poor people thought of as a postpaid installment plan. Credit save and borrow at the same time, and that is is also important because customer ­ willingness because they are simultaneously juggling goals to pay is higher for credit (payout now, disci- and needs. pline later) than for savings (discipline now, payout later) and hence is often a key driver of Thus, for a bank, helping discipline savers goes profitability for banks and microfinance institu- beyond extracting time commitments and can tions. The possibility of credit is also an impor- include a variety of other planning devices that tant hook for people to choose formal over customers might be free to choose from. It may informal savings in the first place (Johnson et not be necessary to offer all these options: With al. 2012). appropriate market research, this can be boiled We can incorporate credit into our framework down to the essential set of options that people in three ways: consider most useful. Regardless of how this is implemented, here is • Credit collateralized by user’s own savings. As the key: People yearn for ways to commit to them- mentioned earlier in the liquidity section, it selves and possibly to each other in the community, ought to be possible for users to request credit but not to outsiders and much less to banks. In against a deferred payment or savings balance. their informal savings mechanisms, they do not If the user’s savings are frozen until the credit commit to the savings medium itself: They make is repaid, this is fully collateralized credit and no promises of long life to the cow. Bank commit- hence should be riskless for the institution and ment mechanisms (recurring deposits, time depos- cheap for the user. This mechanism gives its) are all about committing, in the first instance, liquidity to users without breaking their men- to the bank. That does not feel right to poor people: tal model of how and why they save. No one is guaranteeing them anything; why should • Personal credit scoring based on user’s past they be guaranteeing money to the bank? financial behavior. The deferred payment scheme gives providers a good perspective on Adding Credit to the Mix how people manage their money. If the bank Mobile money so far has been a pure prepay knows how often I set goals (number of deferred product, acting like a debit card. The absence of dates I use), how regularly I contribute to them 314 The New Microfinance Handbook (number of deferred payments I make), how three ways, two of which have already been often I exercise early withdrawal options, and mentioned: the purpose and extent of achievement of my • Vouching for other users’ credit requests. Users goals (based on information obtained from the can develop a reputation with the bank for user through outbound calls from the provid- reliably vouching for the integrity of other bor- er’s contact center, as mentioned above), then rowers. Each time they do so they are putting the bank has a pretty good handle on my finan- their reputation (but not necessarily their cial habits. That ought to translate into auto- money) on the line. Building up this reputation matic credit based on a behind-the-scenes allows them to help their peers when they credit-scoring engine. The provider can now require credit, which helps them build social offer the customer to advance the rest of the capital within their community. money the customer needs to achieve a particu- lar goal. The promise of the advance itself can • Managing early liquidity. People who have set induce the customer to set aside some more money aside for a future date may opt to nom- money (“if you get to 50 percent of your goal inate someone they know as a savings buddy. within a month, we will advance the rest of the A savings buddy helps you keep your savings money you need for your motorcycle”). intact, either because she will not agree that you are ­justified in withdrawing your money • Social credit scoring based on the quality of users’ early, or be­cause you might be shy to ask her social network. A user soliciting credit might be in the first place unless you have a good rea- able to extend his personal credit score by ask- son. This brings the notion of peer pressure to ing peers to vouch for him. Peers need not work for savers. be guaranteeing the debt; they could simply be endorsing the borrower. People would be • Incentivizing community-level savings. Imagine assigned a social credit score based on the that when a bank is opening a new outlet in a repayment track record of people they have rural area and announcing that when the vouched for in the past. They could build up whole village saves a certain amount, it will do social capital with their social network by something to benefit the whole community: vouching for them, but their social credit score repaint the school, purchase medical supplies would reduce and eventually vanish if they for the local hospital, or build a new football vouched for people who end up not repaying field for the youngsters. their loans. The objective is to endow mobile financial services with as much richness of interpersonal Taking Advantage of Social Capital interactions as possible. But it will certainly be Microfinance has shown the power of leveraging impossible to capture electronically the subtlety social capital within communities and invoking of informal financial relationships. Johnson et peer pressure. This generally operates at two lev- al. (2012) note that there is an underlying logic els: to induce and screen new joiners into groups, of give and take and social connections in and to impose loan repayment discipline. But the people’s transactions. Giving money to others is use of peer pressure has generally been limited to a form of saving, of putting money beyond people living in proximity and to the management immediate reach: Although there is no explicit of credit. demand for payback, there is an implicit expec- The deferred payment scheme can take tation that it might be returned in some way, advantage of social capital and peer pressure in eventually. Beyond Products: Building Integrated Customer Experiences on Mobile Phones 315 Customer Service Channels model works for mobile money providers as long Figure 13.3 maps the four channels mentioned as there is a rough balance in the number of above along two key dimensions: How much of a cash-in versus cash-out transactions. heavy investment do they require from the pro- With the expanded service proposed here, it is moting financial institution, and how much ser- envisioned that Me2Me transactions would be vice support do they offer. The objective is to free, that is, customers would not be charged for place as many customer interactions as p ­ ossible reallocating their money across subaccounts. through the top-left quadrant—­ involving low However, new direct revenue sources would customer support through a direct channel. open up: • More savings mobilization. The fragmentation Business Model and commitment features would result in The business model would build on top of the higher average customer balances, which model already in place for mobile money, namely, should result in a funding-cost advantage for charging per transaction fees on P2P money the bank holding the funds. Raising deposits transfers and cash-out. Account registration and from poor people will never be an overly prof- cash-in tend to be free to customers, although itable business, but it could definitely make a the provider generally pays agents a commission nice business. for both. Cash-in commissions are generally recouped by the provider at the time of cash-out • Margin on loans. The system ought to result in (the cash-out fee payable by customers is roughly good quality credit being placed, which would equal to the commissions payable to agents for generate additional interest income (and pos- both cash-in and cash-out). Thus, the business sibly fees) for the provider. Figure 13.3  Channel Mix Low Customer support level High Basic service Aided service Financial operation operation advice Low Client’s mobile Direct to phone with basic customer user interface Channel investment required (UI) Retail cash Contracted merchant for retail agents cash in/out Own devices Tablet device at third-party with enhanced locations UI at kiosk Own staff, brick and Face-to-face full-service channel mortar High 316 The New Microfinance Handbook To benefit from these two additional revenue fundamentally, financial services are about streams, the mobile money provider would need trusting or being trusted, and that is a function to structure its offering in such a way that a bank of the information you have on the other party. is the customer account issuer of record and Viewing finance as an information service has negotiate some kind of revenue sharing with the five implications. First, money needs to be bank. digitized—­ turned into pure information—as A separate benefit of increasing customer much and as quickly as possible. I am not saying balances is to reduce the number of withdrawal going cashless, I am saying that we need to create transactions taking place. This would reduce a cheap and extensive infrastructure that allows the total cost of operating the mobile money poor people to convert cash into electronic value service, because agent commissions represent on demand, in small amounts that are relevant to a significant share of the cost of the service. On them, as close as possible to where they live and the other hand, the mobile money provider work. How many physical points do banks make might find itself funding agent commissions on available for poor people to cash in their meager cash-in without these being compensated by wages? (ATMs do not count; those are still mainly customer charges upon cash-out. Thus, the about de-digitizing money, that is, withdrawals.) provider would need to monitor carefully the Second, information about money has value in impact of this service on the ratio of cash-in to and of itself. Financial service providers must try cash-out transactions. to extract as much information value as possible On the cost side, the business case for this ser- from each interaction they have with their clients, vice would need to factor in the increased burden and indeed they must seek to maximize the num- on marketing and contact center resources, ber of interactions so that they can create a fuller because of the more sophisticated nature of the picture of each client. That can power service offering. propositioning and credit-scoring algorithms. Third, we need to get over the obsession with finding silver-bullet financial products and focus Some Final Thoughts: Financial much more on the platforms that create the basis Information Is Financial Access for proper service innovation and delivery of The notion that we cannot count on brick-and- whatever it is that customers need. Mobile money mortar investments to massively expand access to needs to be enhanced with a framework that puts finance in developing countries is now widely customers in control of how they think about accepted. We need to go branchless, and to do so their financial needs and aspirations, that collects safely we have an opportunity to leverage mobile relevant insights from customers, that presents phones that are increasingly ubiquitous. That is all the information that is pertinent to custom­ clear at an infrastructure level, but there is insuf- ers in a simple framework, and above all, that ficient understanding of what that means at the makes transactions commercially viable so that service level. they become the friend rather than the enemy of The starting point is recognizing that finan- the bank. cial services are primarily about information. Fourth, information commands a premium Mechanically, financial services are about if it is immediate—available here and now. recording numerous credits and debits: how Convenience is just a precondition: finding the much you would like to transfer to whom, how channels through which I can find service. much you have, how much you owe, how much Immediacy is about being able to take action the you will be owed if certain events occur. More moment I make a mental decision (pay the Beyond Products: Building Integrated Customer Experiences on Mobile Phones 317 electricity bill, set some money aside for that bicy- They reworked their distribution around prepay cle I want to buy). Exercising responsible finance arrangements to allow people maximum buying is about having discipline, and putting hassles and convenience. They know they are payment layer delays in front of the customer is an excellent enablers rather than packaged product excuse to avoid it. providers. Fifth, information wants to be accumulated, But MNOs’ role may remain limited. In their but mostly it wants to be shared. We need to look core voice and data services, MNOs deliver basic at poor people’s money in the same way. The connectivity but struggle to supply the value-­ microfinance worldview has been mostly about added platform layers on top (content manage- accumulation: helping microentrepreneurs build ment, unified communication, or business up the capital they need. But what poor people support services). In the same way, other finan- need most is to be connected. With connections cial service providers will need to ride on MNOs’ come opportunities. Financial inclusion is then mobile money systems to build the kind of rich, about connecting poor people to a digital pay- tailored customer experiences that people and ments grid that allows them to transact more entrepreneurs at the base of the pyramid want. cheaply and broadly with each other (support What we will need is precisely the opposite: networks across friends and families), larger nimble players that are specialized in horizontal service providers (utilities), their business rela- segments of the value chain. That is what being a tionships (clients and suppliers), government platform player means: You do only a small part entities (getting social welfare payments or pen- of the total job, but you feel secure doing that sions), and, yes, financial institutions. Primacy because you can do it better and more cheaply has to be given to the network; financial prod- than others, and you come up with frequent ucts will follow if that network allows for effi- innovation. These are players who will think cient distribution. more in terms of customer interfaces and tools Banks tend to do none of these three things rather than in terms of financial products and when it comes to the poor: They do not go near education. where poor people live and work, and when poor people go to them they tend to discourage trans- actionality through charges and long lines. References and Further Reading Indeed, in providing banking to the poor two key Johnson, Susan, Graham Brown, and Cyril service attributes are often neglected: conve- Fouillet. 2012. “The Search for Inclusion in nience and immediacy. Formal financial service Kenya’s Financial Landscape: The Rift providers lose out to a range of informal services Revealed.” Report. Financial Sector Deepening or practices mostly because they are not so easily Trust of Kenya, Nairobi, March. http://www and reliably available. .fsdkenya.org/pdf_documents/12-03-29_Full_ It is not surprising that MNOs have taken the FinLandcapes_report.pdf. lead in branchless banking in developing coun- Mas, Ignacio, and Colin Mayer. 2011. “Savings as tries. They have seen the power of letting people Deferred Payments.” http://papers.ssrn.com/ communicate and share pictures here and now. sol3/papers.cfm?abstract_id=2018807. 318 The New Microfinance Handbook PART IV INSTITUTIONAL MANAGEMENT FOR SCALE AND SUSTAINABILITY CHAPTER 14 Monitoring and Managing Financial and Social Performance Joanna Ledgerwood, Geraldine O’Keeffe, and Ines Arevalo This chapter addresses data and financial man- Different stakeholders require data and informa- agement for planning, reporting, and monitoring tion for different purposes: managers rely on finan- of social and financial performance and financial cial and social performance information at the risk. This is different than measuring financial institution and unit level to understand areas of inclusion at the national, regional, or global level operations that may require attention or focus; discussed in chapter 5. This chapter is about man- investors use financial information to measure value aging data and monitoring performance and risks and determine institutional performance relative to of individual institutions providing financial ser- business plan targets and other potential invest- vices—primarily credit and savings. It does not ments; other funders use information on financial address insurance providers or payment service and social performance to allocate funding for spe- providers. It focuses on institutional providers, as cific interventions or to monitor existing grants or community-based providers generally do not debt; regulators use financial information primarily require sophisticated levels of data collection or to measure compliance and support their oversight financial management of the type discussed here.1 of financial service providers within their area of It will be of interest to practitioners, funders, jurisdiction; policy makers use aggregated informa- ­ regulators, and others interested in understand- tion on institutional financial performance to struc- ing performance management metrics. ture and protect the financial sector and to ensure Contributions to this chapter were made by Julie Earne. Monitoring and Managing Financial and Social Performance 321 that policies and laws are appropriate and support interactions with each other and the higher-level increased financial inclusion. management information that the facilitating Financial management and reporting require- agency or external lender (if applicable) needs to ments reflect the level of sophistication of the assess group performance and the overall inter- product offering as well as the size and scope of vention. Typically, group-level data are handled operations. Nongovernmental organization (NGO)­ with manual records (passbooks, ledgers) main- providers tend to adopt standard measures of per- tained by the groups themselves, although with formance and reporting standards to both the emergence of low-cost smartphones, some self-regulate and enable external comparative initiatives are aiming to help groups replace their analysis. Formal structures such as deposit-taking manual recordkeeping with an automated sys- microfinance institutions (MFIs) or state banks tem. For example, mobile applications can allow generally have complex operating policies and groups to keep records, helping to develop the procedures set out by regulatory authorities, sector and to support linkages. including specific reporting requirements. For facilitating agencies or lenders, a more While performance indicators vary depending complex system is needed to enable periodic on the type of financial service provider, overall the assessment of the group and its obligations based industry has developed an increasingly standard- on agreed indicators. This information must be ized list of measurements. The standardization of easy to collect and ideally should allow the facili- indicators improves transparency by enabling tating agency to generate core ratios that reflect comparisons and benchmarking.2 Several frame- the state of the group and the program (see box works are used to organize social and financial 14.1). Microsoft Excel is typically used, although ­ ollect and man- indicators; first it is necessary to c more complex systems are evolving, including age data through information systems. those that allow the submission of data collected via mobile devices. For example, in 2010, the Savings Groups Information Exchange (SAVIX) Information Systems for Financial developed an online reporting website to aggre- Service Providers gate data from the MIS on a quarterly basis. The A system that manages information is often next generation of this tool aims to replace the referred to as a management information system Excel-based system and move users to an online (MIS) or a core banking system (CBS), depend- system that is integrated more closely with the ing on the nature and size of the provider. These SAVIX website but is still easy to use. systems fulfill various functions ranging from Small NGO MFIs require a basic system for transaction processing to basic portfolio reports credit-only operations, which is often either a to real-time financial statements required by manual Excel-based system or an off-the-shelf regulators and investors. As providers grow in software developed for microfinance. The sim- size and their operations become more formal, plest systems track client loan portfolios and gen- the systems they require generally become more erate reports for management. Some systems also complex and are typically at this stage referred integrate a general ledger function facilitating the to as CBS. Smaller, unregulated entities typically automation of financial statements. adopt the term MIS. Mid-size providers with more than 10,000 cli- Community-based providers such as Savings ents, multiple products, and multiple locations Groups (SGs) or Self-Help Groups (SHGs) need require a more robust system to ensure effective to consider two levels of information: the infor- management. The capacity to handle increasing mation that the groups need to manage their volumes of transactions and accounts becomes 322 The New Microfinance Handbook Box 14.1  Performance Monitoring of Savings Groups To support the periodic assessment of groups, VSL Associates and Software Group, have made available an open-source, Excel-based MIS that stores information collected from each SG and generates core ratios. The adoption of a common MIS has advanced the stan- dardization of reporting in the sector and enabled all practitioners and donors to adopt a stand-alone MIS that would otherwise be prohibitively costly and time-consuming to develop separately. No data are collected on individual members. Rather the focus is on (a) group profile and member satisfaction; (b) group financial performance and sustainability; (c) efficiency and productivity of facilitating agencies; (d) sustainability of service delivery, post-project; and (e) the cost per member, measured both during the life of a project and in the long term. The MIS is structured around three primary reports: • Performance ratios. A quick overview of the program based on 16 key indicators of perfor- mance (see table B14.1.1) • Overall project performance. A detailed summary of performance including 48 metrics cov- ering outreach and profile of members, financial performance of the group, and operational and financial efficiency of the facilitating agency • Portfolio performance comparison. A report providing consolidated portfolio performance data for each facilitator based on 13 key indicators of performance to identify differences across facilitators, to allocate resources and efforts more efficiently, and to resolve weaknesses. Table B14.1.1  Key Indicators of Performance for Savings Group Facilitation Ratio Formula Purpose Member satisfaction Attendance rate Number of members Indicates short-term attending meeting/number relevance and value of of active members services and appropriateness of methodology Retention rate Number of active members/ Indicates long-term relevance (number of active and value of services and members + number of appropriateness of dropouts) methodology Membership growth rate (Number of active members Indicates long-term relevance – number of members at and value of services and start of cycle)/number of appropriateness of members at start of cycle methodology Financial performance of groups Average savings per Value of savings/number Indicates level of member member of active members confidence in the system and demand for savings (continued next page) Monitoring and Managing Financial and Social Performance 323 Box 14.1  (continued) Table B14.1.1  (continued) Ratio Formula Purpose Return on assets Net profits/total assets Measures profits in relation to member investment Annualized return on (Net profits/total Measures profits in relation assets assets) x (52/average to member investment; age of groups in weeks) allows for comparisons across projects of different ages and maturity Return on savings Net profits/value of Measures profits in relation savings to member savings Average outstanding Value of loans outstanding/ Indicates the ability of the loan size number of loans system to meet the credit outstanding needs of members Portfolio at risk Unpaid balance of late loans/ Indicates quality of loan value of loans outstanding portfolio Average write-off per Value of write-offs/number Indicates quality of loan graduated group of graduated groups portfolio Operating efficiency of groups % of members with loans Number of loans Indicates degree to which outstanding outstanding/number of loan access is equitable active members Loans outstanding as Value of loans Indicates operating and a % of total assets outstanding/total assets financial efficiency of loan activities and member demand for credit Efficiency of facilitating organization Caseload: groups per Number of supervised Indicates outreach and trainer groups/number of trainers operational efficiency Caseload: members per Number of active members/ Indicates level of staffing trainer number of trainers efficiency Ratio of trainers to total Number of trainers/number Indicates level of staffing staff of project staff efficiency Cost per member assisted Total expenditures to Measures financial efficiency date/cumulative number of and the cost of service individuals assisted by the delivery project Source: Adapted by David Panetta based on the Community-Managed Microfinance Management Information System of VSL Associates; SEEP Network 2008; and program materials developed by the Aga Khan Foundation and Freedom from Hunger. Source: Panetta 2012; www.thesavix.org. 324 The New Microfinance Handbook critical at this point, and many providers find that and the Microfinance Information eXchange their original systems no longer cope efficiently, (MIX) both provide a listing of such providers on necessitating new ones. Real-time reporting and their websites.3 accessibility of reports also become more critical The following section focuses on the capabili- as institutions grow. ties required of a CBS and the process of selecting At this size and scale, some MFIs may become and installing a new system. regulated entities; those undergoing this transfor- mation generally must either upgrade or replace Functions of Core Banking Systems their systems to comply with regulations and The required functions of a CBS differ for each meet the demands associated with their new sta- financial service provider depending on the tus. For example, deposit mobilization requires a nature of its products and services and its organi- new level of regulatory reporting with a commen- zational structure. However, some common func- surately higher-integrity system. If the regulated tions are typically available in most systems: entity offers current accounts with checks or other negotiable instruments, it may require Customer Information Systems modules for administering checks and clearing Customer information systems create and man- (although many will either not offer current age customer records. This includes the capture accounts or will clear checks and other negotiable of data such as name and address as well as other instruments via a correspondent commercial information. Many systems also support the cap- bank already participating in a clearing system; ture of photos, signature scans, and possibly bio- see chapter 18). metrics, all of which help to verify the customer’s The information requirements of financial identity. Within this module, it is common to have cooperatives largely overlap with those of other the ability to capture “user-defined” fields that deposit-taking institutions; cooperatives may are specific to the individual provider’s needs, require specialized functions for calculating such as social performance tracking or other member dividends and payments. They often seg- unique data. regate their systems into front-office and back- office administration, although for many this is Group Management just a logical segregation of functions within the For providers offering products based on a group same system. lending methodology, the system needs to pro- Larger, more advanced institutions that are vide the functionality to create and manage group regulated and intermediate deposits use systems membership. Many systems offer this within the developed for banks capable of regulatory and customer information system by specifying a type real-time reporting. For example, commercial of customer as a solidarity group. Irrespective of banks require functionality including clearing, how the functionality is included, the system money markets, treasury, current accounts, and should allow validation of group size (minimum- the capacity to calculate floating interest rates. maximum), identify group leaders, have an option Many deposit-taking MFIs and specialized com- for identifying subgroups, track exits from the mercial microfinance banks use bank systems tai- group, and ideally track meeting attendance. lored to microfinance. Over the years, several tailored systems have Loan Portfolio Tracking been developed to cater to financial service pro- A loan portfolio tracking module is used to viders working in low-income markets. The define loan products and support the processing Consultative Group to Assist the Poor (CGAP) of loans from application through to repayment Monitoring and Managing Financial and Social Performance 325 and settlement. To support these requirements, the general ledger to manage all noncustomer- the system needs to offer a large amount of flex- related transactions. More complex systems can ibility with regard to product definition, with also offer submodules, such as bank reconcilia- multiple options for calculating interest, associ- tion and budgeting. Lastly, while large providers ated fees, and other parameters to ensure that require additional support for accounts payable the system can enforce loan policies. For pro- and receivable, payroll, and fixed assets, it is rare viders working with groups, the system should to find this as part of an integrated CBS; if it does support bulk or group-based loan processing. exist, the functionality may be quite limited. Information derived from this module is used by various stakeholders and supports a range of Audit Support decisions, from granting repeat loans to assess- All systems should provide some basic function- ing portfolios. ality for managing the provider’s audit functions, including interfaces or possibly reports for audit- Deposit Account Management ing user interactions, particularly those consid- For providers offering deposit products, the sys- ered high risk. Audit support should also consider tem needs to support the definition and manage- the general security of the system, which can ment of liability accounts. These may be in the range from user access rights to logical controls form of voluntary savings accounts, mandatory or preventing unauthorized access to the system guarantee funds linked directly to a loan, fixed or (see box 14.2). term deposits, or current accounts. For all liability products, the system needs to support the method Reporting of calculating interest as well as of handling fees The reporting module overlies all other modules and other charges. to provide end users with the reports necessary to conduct their business. Reports can range in Transaction Processing detail from a listing of accounts or transactions to Support is required to process transactions to summary management reports that show the and from customer accounts. These modules overall performance, both financial and social, of should enable efficient data capture, both for the provider. Users of these reports can be inter- individuals and for groups. Financial service nal or external, such as regulatory bodies or rat- providers offering full teller services require ing agencies. For larger providers with more cash management support to monitor teller complex reporting requirements, a dedicated and vault floats. Transaction processing should reporting system is often deemed necessary. also c­onsider ­ automation of receipts and These dedicated reporting systems can be in the ­ potentially authentication of user identity via form of either a reporting warehouse that simply biometrics. stores reports or more complex systems capable of extracting data from multiple sources and Accounting aggregating the information into a consolidated The extent and functionality offered by an inte- set of reports. Irrespective of what type of report- grated accounting module can vary considerably. ing system is used, whether bundled or separate, At a minimum, one should expect basic general reporting tends to require ongoing investment ledger support to ensure that all transactions are because the need for information is never static. summarized in the general ledger. Additionally, it The most successful systems have the capacity to should be possible to post basic journal entries to add and edit reports over time. 326 The New Microfinance Handbook Box 14.2  Software Application Controls Software application controls are preventive, detective, and corrective in nature. Automation enables and facilitates a range of such controls very effectively. All software applications contain some generic controls. Regardless of whether the software is purchased or developed, applica- tion-based controls should be in place to ensure that the following objectives are fulfilled: • Input controls. Check the integrity of data entered into a system, regardless of when, where, or how, to ensure the information is within specified parameters. Examples include the se- quential entering of receipts, prevention of entering duplicate transactions, controls around the entry date, and prevention of entering duplicate loan numbers. • Processing controls. Ensure that processing is complete, accurate, and authorized. An exam- ple is ensuring that the sum of all debits and credits posted by the system on any given day are always equal. Processing controls also include user access for various activities and levels of authority to carry out those activities. • Output controls. Address what is done with the data or the transactions. Output controls compare output results with the intended results and outputs with inputs. An example is verifying receipt batch entries and their allocation to principal, interest, and fees with the database report summary. • Integrity controls. Monitor data in process or in storage to ensure that data remain consistent and correct. • Management trail. Provide a historical traceable record of transactions and processes. The “audit trail” enables management to track transactions from the source to the ultimate results reported and to trace backward from results to the events and activities they record. Source: Richards, Oliphant, and Le Grand 2005. Identifying a System Provider processes and products. This phase should The process for identifying a new information produce a list of functional, technical, and system is critical. No one system will satisfy all other system requirements. This is one of the of an institution’s requirements. Experts gener­ most important steps. If a provider does not ally suggest that if a system can cover 75 percent have the in-house capacity to carry out this of requirements, the remaining needs can be step, it should consider hiring a technical “plugged” with supporting applications. Following consultant. are steps for identifying a core system: • Request for proposal. Translate the require- • Business case development. Identify and come ments into a request for proposal that will to agreement about the need for a system and prompt suppliers to describe how their sys- procurement requirements to source it. tems meet the requirements of the specific • Requirements analysis. Conduct mapping and provider. Each requirement should be rated in documentation of existing systems, products, terms of importance to the provider, as some and processes and identification of “future” will be “must have,” while others will be “nice Monitoring and Managing Financial and Social Performance 327 to have.” Requests should be sent to an agreed old and new systems. Undertaking multiple sam- shortlist of providers. ple data conversions before moving to the new system is strongly recommended to ensure that • Evaluation. Evaluate all proposals received both systems fully reconcile with each other. and list questions for clarification, followed Many providers will need to include a “data- by demonstrations and site visits. Supplier cleaning” stage at this point to rectify any incon- demonstrations should be used to confirm sistencies identified during the extraction and answers received in the request for proposal conversion process. and obtain an overall sense of the system; they also provide an opportunity to interact Customization with and assess supplier staff. Site visits and Customization involves tailoring the system to references are the best way to evaluate the the specific needs and products of a provider. quality of supplier support and implemen- Staff members need to understand the system tation. A standard list of questions should be before any changes are made to ensure that cus- developed for reference. At this stage, it may tomized elements reflect the institution’s opera- be useful to assess the gaps between the insti- tions. In many cases, the institution will find a tution’s stated requirements (output from standard feature perfectly adequate, albeit not the “requirements analysis” stage) and the identical to the functionality envisioned by the standard functionality of the systems being end users during the scoping of requirements. proposed. During these discussions, it is important to ask • Negotiation and selection. Review contracts, whether clients or other stakeholders will derive finalize negotiations, and make the final significant additional value from customization. selection. This process should yield clear Setting aside personal preferences, if no objective contracts with service-level agreements for measure of incremental benefit can be identified, support. the institution will save both money and imple- mentation time by accepting the standard feature Installing a Core Banking System already programmed into the system. These sav- The first step for installing a new system is to ings will compound with each new release of the create a team of representatives from all key software that does not have to be customized. departments. Change management and broad- Customization can create significant complica- based buy-in are crucial. Similarly, staff mem- tions and should be done only for high-priority, bers need to understand why the system is significant changes. All customization should be changing and how the institution will benefit fully documented, with clear agreement between from the change. the supplier and the provider on exactly how it will work. Where customization is required, Data Preparation and Extraction additional time will have to be allocated for If moving from one system to another, informa- testing. tion needs to be extracted from the old system and put into the new system. Data converted to a Training new system must be accurate and free of errors. The mantra of experts and those who have Suppliers will differ in the extent to which they installed a new system is “train, train, train, and assist with the extraction of data. Whoever per- then train some more.” All levels of staff need to forms the extraction and conversion must have an be trained on the new system, from end users to intimate knowledge of the structure of both the senior management. Training should occur at 328 The New Microfinance Handbook various stages, including the pilot stage before introducing new channels can add significant customization, before full rollout, and continu- risk. The first step is to ensure that transactions ously after rollout. Follow-up training is particu- can be processed reliably and that the data with larly important after staff have used the system to which to monitor new channels are available in allow them to ask specific questions. Training regular reports. typically is done using a “core team” and a train- A CBS has two primary user components. The the-trainer approach. This has the benefit of “front end” of the system facilitates client trans- building capacity in-house to support the system actions and is what is accessible to the end users and can also help to bridge cultural and institu- of the system, including tellers, loan officers, and tional differences that may exist between the sup- accountants. The “back end” refers to the data- plier and the end users. base that stores the data and is typically only When training is not conducted thoroughly, accessed by the information technology depart- field staff may continue to keep parallel manual ment. As providers deliver services through records or continue to use the old system. Reasons increasingly diverse delivery channels, an inter- for this usually stem from a lack of trust in the face is required to enable the system to receive (new) system or a lack of direct access to it. When transactions electronically from a source other two parallel systems are running, it is impossible than its own front end. Two primary options are to know which is the correct version and whether available for posting transactions to and from data entered into one system have been entered delivery channels: into the other. Engaging staff in data verification 1. Manual system. Some providers opt to interact exercises and ensuring that all field staff have with branchless delivery channels via the use access to the system as well as effective training of batch files that are manually uploaded or will increase buy-in and ownership. downloaded between the system and the delivery channel. For example, payments User Acceptance Testing made to an e-wallet service could be down- After the system has been installed, configured, loaded periodically in a format compatible for and (potentially) customized, financial service uploading to the system, such as Excel or CSV.4 providers need to confirm that it is functioning to This method is by far the cheapest, but it is their requirements. This is typically done during associated with several security issues because a user acceptance testing phase whereby a series data may be manipulated during the transfer of test cases or scenarios is run on the system to process. Further, it does not process transac- confirm that it operates as required. This critical tions in “real time,” so there will always be a phase should not be rushed, as it is much easier to delay before payments are reflected in the resolve issues arising at this point than when the accounts of the customer. For these reasons, system is live. Ideally, user acceptance should be manual systems are typically only used when tested by a team of primary users or the core team the volume of transactions is low or the pro- that was trained, as testing often consolidates vider does not have enough revenue to invest what was learned in theory-based training. in an automated system. Delivery Channel and Systems Upgrading 2. Automated system. To allow two or more sys- The development of new technologies and chan- tems such as a CBS and an e-wallet service to nels of delivery is becoming increasingly relevant communicate with each other in real time, for expanding outreach and access. However, if some type of middleware software is required the information systems are not stable or scalable, to sit between the two systems. The most Monitoring and Managing Financial and Social Performance 329 commonly used software of this type is expected to grow rapidly, particularly as custom- referred to as a “bridge” or “switch,” which ers realize that it offers them more control over could be provided either by the CBS supplier their interaction with providers (Rao 2009). or by a third party (see chapter 18). These Data from the CBS form the basis for analyzing applications enable the two systems to com- social and financial performance and for manag- municate with each other using an agreed lan- ing financial risk. Data captured via these systems guage, or protocol, to structure the transaction also support other operational processes, such as data into a machine-readable format (such as human resource management, product manage- ISO, NDC, JSON, XML). Messages are then ment, and operational risk management, which sent in the preferred protocol using an agreed are discussed in chapter 15. interface, which could be a published applica- tion program interface, a Web service, a sim- Financial Management ple object access protocol (SOAP), or a transmission control protocol (TCP) socket. Financial management involves a continual pro- Using this type of technology, multiple sys- cess of recording, measuring, monitoring, assess- tems can communicate seamlessly in real ing, and managing financial performance and time. This approach provides many clear ben- financial risks.6 Financial management extends efits for the financial service provider, includ- beyond simply reporting and managing accounts; ing automated handling of errors, a full audit rather it is a comprehensive process that includes trail, real-time processing, and lower risk of business planning, financial reporting and analy- transaction fraud because no manual inter- sis, performance management, and profitability vention is required. analysis. Financial management also includes the management of financial risks, including asset The increased use of branchless banking has quality, capital adequacy, asset-liability manage- also created new security requirements, and ment (ALM), and liquidity management. security technology has evolved accordingly. Responsibility for sound financial manage- Whereas a branch teller could ask to see a photo ment rests primarily with the board and senior identification, technology-enabled transactions management. The board determines the broad require alternative forms of verification and secu- strategy and financial objectives, including limits rity. Security usually is broken down into three on the level of acceptable financial risk. Senior types: (1) something you know (password), (2) management then determines how to operation- something you have (bankcard), or (3) something alize these goals and remain within acceptable you are (biometric).5 Biometric verification mea- risk parameters. If applicable, regulators often sures an individual’s unique physical characteris- stipulate the level of financial risk allowed for dif- tics to recognize and confirm identity. ferent types of providers and, as such, influence Mobile banking transactions use a combina- how and which financial risks should be moni- tion of traditional personal information number tored and assessed. codes, real-time alerts, and approval verification codes. Real-time alerts are notifications or mes- Business Planning sages that inform customers of a certain event, The business planning process incorporates three such as a deposit or a withdrawal. The alerts are primary stages: strategic or long-term planning, delivered across a wide variety of channels and annual operational planning, and budgeting. devices, including e-mail, text messages, personal Strategic planning is normally embodied in a digital assistants, and fax. Alerting technology is strategic plan (generally covering a three- to 330 The New Microfinance Handbook five-year period) approved by shareholders (if being achieved and to identify risks, opportuni- applicable), the board or management commit- ties, and challenges for discussion with manage- tee, and senior management. A strategic plan out- ment. External stakeholders, including donors, lines the provider’s medium- to long-term goals investors, and regulators, examine financial and highlights its plan with regard to markets statements closely to assess financial perfor- served, growth, product offerings, product deliv- mance and to determine future engagement. ery, channel development, marketing, staffing, Internally, financial reports inform management funding, risk management, and related systems. of the financial performance and financial condi- The strategic planning process should be under- tion for the period or at a point in time (SEEP taken at least once every three years and is used to Network 2005). guide providers through a comprehensive review An organization’s accounting system continu- of operations and to achieve widespread buy-in ously collects, summarizes, and updates data on from all stakeholders. assets, liabilities, equity, revenues, and expenses. Operating plans are created on an annual basis Although different accounting standards are used and provide detail on outreach, projected reve- around the world, the International Financial nues, expenses, and capital expenditures, while Reporting Standards are emerging as the primary the budgeting process provides more detail. accounting system in most countries. Budgets generally present financial information The chart of accounts is the core of the account- on a month-by-month basis, including line-by- ing system. The structure and design of the chart line details of revenues and expenses for the of accounts ultimately determines the type of entire organization. Budgets can usually be disag- financial information that can be accessed and gregated by location and by time period. Often analyzed by management or reported to external when developing a new product, a budget is pre- parties. In most regulatory frameworks, the cen- pared that details staff and training costs, required tral bank or other regulatory bodies provide funding (including market research, marketing, specific guidelines for an institution’s chart of ­ and capital costs), and related revenues based on accounts. For unregulated providers, accounting projected outreach. Budgets provide a bench- software packages provide charts of accounts that mark against which to assess performance. follow industry standards for microfinance. An accounting system (and the related chart of accounts) is normally linked to an organization’s Financial Reporting CBS. To minimize potential errors, the portfolio While budgeting and planning predict future quality information system should be integrated activity, financial reporting is concerned with directly with the accounting system. Accounting tracking and observing historical results. systems produce financial statements on a sys- Financial reporting refers to the timely produc- temwide basis, and most can also produce finan- tion of financial statements based on up-to-date cial statements for geographic or functional areas, and accurate financial records (SEEP Network depending on the provider’s organizational 2005). Financial reporting summarizes financial structure. transactions and aggregates them by category or at a certain point in time. Various stakeholders use financial reports to Financial Statements understand performance and identify risks. The Financial statements contain both stock data board assesses information to determine whether (information on data at a moment in time) and the overall financial and operational strategy is flow data (information on the flow or summary of Monitoring and Managing Financial and Social Performance 331 transactions over a defined period of time). They purchases, plus any subsequent equity invest- generally include the following: ments). The greater the proportionate amount of liabilities versus equity, the greater the leverage of • Income statement (profit and loss the provider. As leverage increases, so does risk, statement) as liabilities are borrowed funds and must be • Balance sheet (financial position) repaid. For regulated providers, the degree of • Cash flow statement (sources and uses of leverage is mandated by the regulator to ensure funds) that the institution is financially secure and, in The balance sheet represents the financial con- particular, that the funds on deposit are not at dition of a provider at a point in time (that is, undue risk.7 stock data) and is divided into three primary cat- The income statement is a flow statement and egories: assets, liabilities, and equity. Assets are on reflects the financial results of operations over a the left-hand side of the balance sheet, and for specified period of time by aggregating all reve- most financial service providers the loan portfolio nues and deducting all expenses. The result is net is the largest asset. It changes over time as loans income. Net income represents the primary link are repaid and new loans are made. The balance between the income statement and the balance sheet normally shows the gross loan portfolio—all sheet. The net income (or loss) is added to (or outstanding principal amounts including current, deducted from) equity through the retained earn- delinquent, and renegotiated loans—but not loans ings account on the balance sheet. Equity that have been written off. The gross loan portfo- increases (or decreases) as net income is recorded lio is reduced by the amount of loan loss reserve and transferred from the income statement. At (or impairment loss allowance), resulting in the the beginning of each income period, the income net loan portfolio. When loans are written off, the statement begins at zero. In contrast, the balance gross loan portfolio and the loan loss reserve are sheet is cumulative over time. reduced by the same amount, leaving the net loan For most financial service providers, the pri- portfolio unchanged. mary revenue-generating asset is the loan portfo- Other assets include cash, deposits with other lio. While cash is an asset, it generally does not financial institutions, amounts due to the finan- earn revenue. Revenue from interest, fees, and cial service provider but not yet received, and commissions on loans plus any other earnings are property and other capital assets. Capital assets recorded on the income statement. This includes decline in value over time through the deprecia- not only interest received, but also interest tion expense, which is recorded on the income accrued and not yet received. Expenses include statement. Assets are funded by liabilities and salaries and other staff costs, funding costs (that equity. is, interest and fees paid on debt), loan loss provi- Liabilities and equity together equal the total sions (or impairment loss expense), rent, depreci- amount of assets. Liabilities represent what is ation, other operating costs, and taxes (if owed by the provider and include client deposits applicable). (if applicable) and borrowed funds (debt) or pay- A cash flow statement provides information ments due but not yet paid. Assets minus liabili- about the cash receipts and cash payments dur- ties equals equity—or the net worth of a provider. ing a period of time. Some cash flow statements Equity includes retained earnings as well as any classify cash flows resulting from operating, ­ invested funds (that is, start-up capital either investing, and financing activities. Operating through donor grants or through shareholder activities are the activities carried out in the 332 The New Microfinance Handbook course of operations and include cash inflows, (In an effort to be conservative, many providers such as interest received on loans or repayment ­ provision 1 or 2 percent of current loans even of principal, and cash outflows from expenses though they are not past due.) The total amount incurred, such as staff costs or loan disburse- of the required loan loss reserve is determined ments. Investing activities refer to the invest- by multiplying the total portfolio outstanding in ment of money into return-generating each time bucket by the provision percentage instruments such as treasury bills or other and adding each amount together for a total. investments. Financing activities involve cash This is calculated on a periodic basis, generally inflows through either infusions of equity (from as balance sheets are updated. The amount of shareholders or grants, for example) or bor- the new loan loss reserve is compared to the rowed funds (short- or long-term debt) and cash amount of the existing loan loss reserve on the outflows when debts are repaid or dividends balance sheet to determine if additional reserve declared. is required. If so, this amount—the difference between the amount of new loan loss reserve Portfolio Reports and the amount of reserve currently on the bal- Portfolio reports provide detail on lending activ- ance sheet—becomes the amount of loan loss ities by disaggregating the loan portfolio into provision on the income statement (recorded as sectors, geography, and overdue amounts. They an expense). The loan loss provision, in turn, are used to analyze asset quality and composi- reduces the net income (because expenses tion as well as outreach. Sector breakdowns are increase) transferred to the balance sheet and used to evaluate concentration in a given subsec- thus keeps the balance sheet balanced—that is, tor and to evaluate the diversity of a loan portfo- both sides of the balance sheet are lower because lio. A geographic breakdown is helpful for assets are reduced by the increase in the loan analyzing the performance of the portfolio by loss reserve (a negative asset) and equity is branch or region and for pinpointing any issues reduced by the reduction in net income trans- associated with location, including staff or con- ferred to equity (retained earnings). textual factors. Similarly, the value of capital assets (for The most common disaggregation of portfo- example, vehicles) on the balance sheet is lio reports involves grouping the principal reduced over time by recording a depreciation amount of loans according to how many days a expense on the income statement. Most capital payment has been missed; such reports are used assets are depreciated over a period of years to analyze the quality of a portfolio. From the matched to the anticipated life of the asset, portfolio report, providers can then calculate the which is generally stated in accounting princi- loan loss reserve and loan loss provision. The loan ples or by the accounting regulatory body. The loss reserve represents the amount that institu- amount of the capital asset (on the balance tions set aside to cover projected bad debt. The sheet) is decreased by the amount of the peri- amount of the loan loss reserve is calculated by odic depreciation expense (on the income state- splitting the loan portfolio into time buckets, ment), which again keeps the balance sheet which refer to the number of days a loan is past balanced since net income is reduced by the due (that is, current, 0–30, 31–60, 61–90, and amount of the depreciation expense (that is, the over 90 days). Regulations, if applicable, and value of capital assets is reduced by an amount local or international standards often stipulate equal to the reduction of net income transferred how much an institution should provision. to equity). Monitoring and Managing Financial and Social Performance 333 Financial Performance Monitoring Financial Performance Monitoring and Risk Management Financial performance is a function of two pri- mary areas: revenue and cost. Revenue is received Several standardized frameworks help to moni- through interest and fees (and, if applicable, other tor and manage financial performance, includ- financial services provided by the institution).11 ing financial risk. Some have been developed by Expenses consist of funding costs (interest paid rating agencies and others by networks or other on debt and to depositors), operational costs stakeholders to standardize performance report- such as staff, insurance, transportation, and prem- ing of MFIs. Commonly used frameworks ises, among others, and loan loss provisioning include ACCION’s CAMEL, Planet Rating’s expenses. Often costs are measured as a percent- SMART GIRAFE rating system, and the SEEP age of the portfolio. Given that the loan portfolio Network’s Microfinance Financial Reporting is the primary earning asset, it is useful to Standards (MFRS). While these frameworks suit understand how much it costs to originate and most institutional providers of credit and sav- manage the portfolio. Financial performance is ings, the World Council of Credit Unions devel- measured by looking at efficiency and productiv- oped PEARLS specifically for credit unions and ity, and profitability. other financial cooperatives.8 Each has a core set of ratios used for analyzing financial and risk Efficiency and Productivity management, depending, to some extent, on the Ratios that measure efficiency and productivity type of provider. The indicators are similar, provide information regarding the rate at which however, and generally fall into six categories: providers generate revenue to cover expenses efficiency and productivity, profitability, asset (see table 14.1). Efficiency refers to the cost per quality, capital adequacy, and liquidity. CAMEL unit of output. Productivity refers to the volume also includes qualitative measures for manage- of business that is generated (output) for a given ment, while MFRS includes indicators for out- resource or asset (input). Both productivity and reach. Each framework can be used to assess the efficiency ratios can be used to compare perfor- performance of individual institutions or to mance over time and to measure improvements assess performance across institutions.9 in a provider’s operations. The MFRS is a framework developed by the SEEP Network for institutional financial service providers, including NGO MFIs, deposit-taking Profitability Indicators MFIs, various types of banks, and others providing Profitability indicators provide information on credit and savings, and in some cases, payment ser- returns generated on assets, particularly the loan vices (see SEEP Network 2010). Updated in 2010 portfolio, and on equity (see table 14.2). They also from the SEEP Network’s original “sweet 16,” the indicate profit margins. MFRS framework includes a core set of ratios. It also has a set of “noncore” ratios for the growing Financial Risk Management number of regulated financial service providers Financial analysis and risk management are struc- that intermediate deposits and have complex tured around four core areas: asset quality or credit financial structures.10 Because the MFRS risk, capital adequacy, liquidity management, and framework applies to a wide range of providers, asset-liability management. Capital adequacy, the MFRS ratios are used throughout the rest of liquidity, and ALM are often managed jointly this section on financial performance and risk within treasury management. The main rationale management. for a comprehensive approach stems from the fact 334 The New Microfinance Handbook Table 14.1  Efficiency and Productivity Ratios (MFRS) Ratio Formula Explanation Portfolio to assets Gross loan portfolio/assets Measures the provider’s allocation of assets to its lending activity; considered to be the core activity for a microfinance lender Operating efficiency Operating expense/revenues Highlights personnel and administrative ratio expenses relative to total revenues Operating expense of (Direct + indirect operating expenses Evaluates whether deposit mobilization deposits ratio (cost allocated to deposits)/average is cost-effective. Can guide the provider per unit of deposits savings balance (average deposits) on how to price its deposit products. mobilized) Requires a disaggregation of all direct and indirect deposit-related costs. Only relevant for deposit-taking providers Cost of funds ratio Financial expense on funding liabilities/ Calculates a blended interest rate for all average (deposits + borrowings) of the provider’s funding liabilities Financial expense (Interest + fees on funding liabilities)/ Measures the total interest expense a ratio average gross loan portfolio provider incurs to fund its portfolio Financial expense Total interest expense of deposits/ Allows providers to compare the cost of deposits ratio average savings balance (average of funds of deposit activities directly to (cost of deposits) deposits) borrowing opportunities in the market. Does not factor in the benefits of deposits as a product for clients. Only relevant for deposit-taking providers Cost per active Operating expense/average A simple but effective measure of the client number of active clients average cost of maintaining an active client. Costs per client may vary significantly depending on the type of product. “Client” should be interpreted as “unique client” for this ratio, since a client may access multiple products. Providers should clearly define “active client”—for example, a client who has used a financial product from the provider in the last 12 months Borrowers per loan Number of active borrowers/ Measures the average caseload of the officer number of loan officers average number of borrowers managed by each loan officer Active clients per Number of active clients/total Measures the overall productivity of staff member number of personnel staff who are managing clients, including borrowers, depositors, and other clients. Client should be defined as “unique client.” Varies both by productivity and by the nature of the product mix Source: SEEP Network 2010. Monitoring and Managing Financial and Social Performance 335 Table 14.2  Profitability Ratios (MFRS) Ratio Formula Explanation Portfolio yield Cash received from interest, fees, Indicates the provider’s ability to and commissions on loan portfolio/ generate cash from interest, fees, and average gross loan portfolio commissions on the gross loan portfolio. Excludes revenues accrued but not paid in cash Operating profit margin Net income before taxes and Measures a provider’s profitability in donations/operating and terms of its effectiveness in managing nonoperating revenue costs Return on assets (ROA) Net income after taxes and before Measures how well the provider uses donations/average assets its assets to generate returns. Is net of taxes and excludes donations Return on equity (ROE) Net income after taxes and before The definitive measure of commercial donations/average equity profitability. Calculates the rate of return on average equity for the period. The numerator does not include donations and is net of taxes Source: SEEP Network 2010. that most financial risks are ­ interrelated. For portfolio over time. Visits to clients—to authen- example, liquidity risk could easily lead to credit ticate their existence, verify loan balances, and risk if borrowers begin to lose confidence in the gather feedback on satisfaction—are also an provider’s ability to satisfy their demand for loans. essential part of understanding and managing Similarly, credit risk may aggravate liquidity risk both credit and fraud risk in the loan portfolio. and capital adequacy. Asset quality refers to the quality of the loan portfolio, the cost and impact of nonperforming Asset Quality loans, and the percentage of nonearning assets Credit risk is a well-known and well-understood (see table 14.3). Credit risk is the core risk affect- risk for financial service providers, particularly ing asset quality. In general, many providers offer since lending is the prime source of revenue in relatively few products, which for the most part most contexts. Credit risk is essentially the risk focus on credit for investment in productive faced by lending one’s resources to others. There activities. This often results in homogeneity of is an inherent risk that loans will not be repaid; borrowers, either geographically or by livelihood, for this reason, institutions design eligibility cri- resulting in covariance risk. Because the loan teria, loan policies, and procedures and guide- portfolio usually constitutes a proportionately lines to assess and analyze a client’s ability and large share of overall assets, difficulties affecting a willingness to repay and the appropriateness of large number of borrowers, such as a poor har- the size and term of the loan. Portfolio analysis— vest, can have a substantial effect on overall per- with reports segmented by branch, loan officer, formance. As providers expand their loan product, and aged delinquency—is one of the products or target sectors, covariance risk may best ways to understand and manage a loan decline. 336 The New Microfinance Handbook Table 14.3  Asset Quality (Portfolio Quality) Ratios (MFRS) Ratio Formula Explanation Nonperforming loans (Nonperforming loans > 30 days + 90 days overdue is the most common as of 30 days past value of renegotiated loans)/gross international measurement of a due (NPL30) loan portfolio nonperforming loan; for microfinance, 30 days is a more appropriate time horizon for this ratio Renegotiated loans Value of renegotiated loans/gross Includes all rescheduled, restructured, ratio loan portfolio refinanced, and renegotiated loans. Because renegotiated loans are sometimes not disclosed or cannot be identified separately within NPL30, this ratio discloses the risk level of the renegotiated loan portfolio Write-off ratio Value of loans written off/average The percentage of loans that have been gross loan portfolio removed from the balance of the gross loan portfolio because they are unlikely to be repaid; write-off policies vary; it is recommended that managers calculate this ratio on an adjusted basis Nonperforming loans (Average nonperforming loans Gives the most comprehensive measure as of 30 days > 30 days + value of renegotiated of asset quality. Includes all NPLs past-due + write-off loans + value of loans written off)/ > 30 days, all renegotiated loans, and ratio average gross loan portfolio write-offs. In the past, troubled loans could be shifted among these categories. Shows the combined impact of these three components of asset quality Loan loss rate (Write-offs – value of loans Provides a true picture of loan losses recovered)/average gross loan from write-offs by including the offsetting portfolio value of recovered loans. Tends to vary far more than the write-off ratio, since loan recovery tends to be sporadic and occurs irregularly in time and amounts Risk coverage ratio Loan loss reserve/(nonperforming Measures how much of the nonperforming loans > 30 days past due + value loans as of 30 days past due plus the value of renegotiated loans) of renegotiated loans is covered by the loan loss reserve Loan loss reserve Loan loss reserve/average gross Measures the loan loss reserve as a (impairment loss loan portfolio proportion of the gross portfolio. Can allowance) ratio also be measured as a proportion of NPL30, with NPL30 in the denominator Loan loss provision Loan loss provision/average gross Indicates the expense a provider incurs (impairment loss loan portfolio to ensure an adequate loan loss reserve, expense) ratio which will increase as the portfolio grows Source: SEEP Network 2010. Monitoring and Managing Financial and Social Performance 337 Capital Adequacy Capital structure policy involves a trade-off Capital adequacy management involves deter- between risk and return and reflects the organi- mining if the amount and type of capital a pro- zational mission, appetite for risk, and regulatory vider has is sufficient and working as efficiently as requirements. The appropriate degree of leverage possible (see table 14.4). Financial service provid- for a provider ultimately depends on its ability to ers have different sources of funding, primarily manage the risk (Ledgerwood and White 2006). equity, debt, and deposits (if regulated as a Higher leverage indicates a higher level of risk, as deposit-taking institution). Equity is the most an institution may have limited ability to absorb permanent source of funding. A financial institu- unexpected losses or may have borrowed more tion leverages its equity by taking on debt. Debt than it can repay based on cash flows. Leverage can be obtained in three primary ways: (a) bor- that is too low may indicate that an institution is rowing from institutions (bank debt) or govern- not using an adequate amount of debt to generate ment, (b) mobilizing deposits from the public or an increase in revenue. If an institution can gener- members, and (c) borrowing from the public ate greater returns on its operations (that is, through issuing a bond. Debt funding can be short return on assets or return on equity) than the cost term or long term. Long-term debt, which has a of debt, it may make sense to increase leverage, term greater than one year, is often borrowed albeit in a conservative manner. from other banks or accessed from the capital markets in the form of bonds. Short-term debt has Liquidity Management a term of less than one year. Deposits can be short Liquidity management involves effectively man- term or long term. aging liquidity to finance daily operations Table 14.4  Capital Ratios (MFRS) Ratio Formula Explanation Debt to equity Liabilities/equity Measures the overall financial leverage (or gearing) (leverage) of an institution and how much cushion the provider has to absorb losses after all liabilities are paid Equity to Total equity/total assets A measure of the solvency of a provider. The assets ratio information derived from this ratio helps a provider to assess its ability to meet its obligations and absorb unexpected losses. The denominator should exclude goodwill and intangible assets Capital Total capital/risk-weighted Measures the amount of capital in relation to risk- adequacy assets weighted assets (risk weights are generally provided by ratio the regulator). It is a more finely tuned indicator of a provider’s solvency and its ability to meet its obligations and absorb unexpected losses. The denominator should exclude goodwill and intangible assets Uncovered (Nonperforming loans Indicates how the provider is managing its level of capital ratio > 30 days + value of all loan portfolio risk relative to the amount of capital it renegotiated loans – impairment has. The lower the ratio, the better. Nongovernmental loss allowance)/total capital organizations and other nonregulated providers may substitute equity for total capital in the denominator Source: SEEP Network 2010. 338 The New Microfinance Handbook (including withdrawals, if applicable), while goals of ALM are to protect shareholders and minimizing the costs of holding idle cash (see depositors, maintain sufficient liquidity to cover table 14.5). Assets are considered liquid if they cash flow requirements and invest idle liquidity are easily accessible and convertible into cash. profitably, manage the interest rate gap to maxi- When evaluating a provider’s liquidity and its mize earnings with risk limits, generate attractive liquidity risk, it is important to look at the struc- foreign exchange earnings within risk limits, and ture of the balance sheet, the different types of price products to support asset and liability man- funding sources, and the assets they fund. agement and maximize earnings (Ledgerwood and White 2006). ALM does not rely on ratios; Asset-Liability Management instead, ALM tables are included in the MFRS ALM analyzes the structure of the balance sheet (see SEEP Network 2010). and the risks and returns inherent in this struc- An asset and liability committee (ALCO) is ture vis-à-vis the relationship between pricing often set up to manage exposure of the balance and the cost of funds, maturity of assets and liabil- sheet to market risks. It generally consists of ities, and the currency of funding versus the cur- members of the management team. Their respon- rency of lending.12 ALM seeks to manage the sibilities include (a) decisions with regard to the balance between risk and return by maintaining a provider’s exposure to market risks and supervi- positive spread between the interest rates earned sion of their implementation, (b) development (on loans and other interest-earning assets) and and adoption of medium- and long-term financial the interest rates paid (on borrowed funds). The and liquidity plans, (c) identification of funding Table 14.5  Liquidity Ratios (MFRS) Ratio Formula Explanation Liquid ratio (quick (Cash + trade investments)/ Indicates level of cash and cash equivalents ratio or acid-test (demand deposits + short-term time the provider has to cover short-term ratio) deposits + short-term borrowings + liabilities. Short-term liabilities refer to assets interest payable on funding or liabilities, or any portion thereof, that have liabilities + accounts payable + a due date or a maturity date or may be other short-term liabilities) readily converted to cash within 12 months One-month Current assets/(current liabilities + A forward-looking ratio that measures stressed liquidity one-month operating expenses + whether there is sufficient liquidity for one ratio one-month net portfolio growth) month of disbursements, including portfolio growth. Can be modified to measure three or six months Liquid assets to Cash/total assets Measures the percentage of total assets total assets supported by fully liquid assets Savings liquidity (Reserves against deposits as Provides information on the cash available to required by regulators + unrestricted meet withdrawals in demand deposit cash)/total demand deposits accounts. Regulators generally require a statutory reserve against demand deposits that may directly affect this ratio Loans to deposits Gross loan portfolio/deposits Measures the relative portion of the portfolio ratio funded by deposits. Provides information on the role of deposits as a funding source Source: SEEP Network 2010. Monitoring and Managing Financial and Social Performance 339 needs and strategies for meeting those needs, and term, detailing the maturation of assets and liabil- (d) continuous review of market conditions and ities for each currency and an institution’s expo- adaptation of business operations (Ledgerwood sure to foreign exchange risk in each time frame. and White 2006). Some boards have a board-level ALCO that sets higher-level strategies for manag- Social Performance Management ing financial risk. A provider suffers from maturity mismatch if For many institutional financial service providers the maturity of its assets differs substantially from as well as their funders, social performance and the maturity of its liabilities. For example, a bank development impact are as important as financial could have substantial long-term assets (in the performance. Social performance is the effective form of long-term loans or mortgages), funded by translation of an institution’s mission into prac- short-term liabilities (such as demand deposits tice in line with accepted social goals (Social that can be withdrawn on short notice) or short- Performance Task Force 2012). If social perfor- term commercial paper (a money market security mance refers to whether or not an institution issued by financial institutions to meet short-term achieves its mission, social performance manage- debt obligations). Issues of maturity mismatch are ment (SPM) refers to how an institution achieves often compounded in developing countries where it mission—the operational systems that allow the a broad range of financial securities (negotiable institution to create benefits for clients. financial instruments holding value) is often not Social performance management has increased available to match maturities. in importance in recent years, in large part as a Interest rate risk represents repricing risk, result of ongoing concerns of mission drift as defined by the difference in the time frame in many institutions begin to serve higher-income which interest rates on assets and liabilities reset clients in the move toward commercialization and and may reprice. For example, an institution profitability. Similarly, global debates about the could have all of its liabilities in floating interest effectiveness of microfinance as a poverty allevia- rate bonds (bonds whose interest rate can fluctu- tion tool (increasingly brought to light through ate with market conditions usually related to impact assessments) has reinforced the impor- lending risk), but all of its assets in fixed-rate tance of ensuring that financial service providers loans. If interest rates were to rise, the cost of its are assessing the social impact of their operations funding could rise above the fixed rate it earns on and making changes as needed to improve social its loans. performance. Concerns of over-indebtedness Given the large volume of cross-border, fixed- highlight further the importance of responsible income investments denominated in foreign cur- finance, which does not equate to but is a funda- rencies (currencies other than the currencies in mental part of social performance management which providers are operating), some providers (see chapter 3). Overall, social performance man- have significant foreign exchange exposure. agement helps to ensure that the industry’s mis- Foreign currency risk considers assets and liabili- sion of helping poor people to manage their ties held in foreign currencies relative to total financial lives remains intact in the face of evolv- equity and measures the risk of exchange rate ing market conditions (Social Performance Task fluctuations. If the institution holds a currency Force 2012). that depreciates, foreign exchange losses are Managing social performance is the process of incurred when repaying the source of foreign integrating the mission into the day-to-day busi- funding. Liquidity risk per foreign currency mea- ness of an institution. It involves setting clear sures the foreign exchange risk for each loan social goals and objectives, defining a strategy for 340 The New Microfinance Handbook achieving them, monitoring and assessing prog- • Improve the quality and appropriateness of ress toward achieving them, and using this infor- the financial services available to clients mation to improve performance and align through the systematic assessment of their organizational systems to the social mission specific needs (Campion, Linder, and Knotts 2008). The Universal Standards for Social Performance • Create benefits for clients, their families, and Management produced by the Social Performance communities related to strengthening social Task Force define the key practices that consti- capital and social links, empowering women tute a strong social performance management and other disadvantaged groups, increasing system (see box 14.3). assets and income, and reducing vulnerability Managing social performance requires that an • Improve the social responsibility of providers institution actively manages its progress toward toward employees, clients, and the communi- achieving its social goals. Financial service pro- ties served. viders generally have the following social objec- tives (Social Performance Task Force 2012): Balanced Performance Management • Serve increasing numbers of poor and excluded For institutions to manage and align operations people in an ongoing, sustainable way both by with their social goals, a system is needed for broadening and by deepening outreach ­ collecting and analyzing information on the Box 14.3  Universal Standards for Social Performance Management In June 2012, the Social Performance Task Force launched the Universal Standards for Social Performance Management, which is “a set of management standards that apply to all microfi- nance institutions pursing a double bottom line. Meeting the standards signifies that an institu- tion has ‘strong’ social performance management practices.” The standards are divided into six sections: 1. Define and monitor social goals 2. Ensure board, management, and employee commitment to social performance 3. Treat clients responsibly 4. Design products, services, delivery models, and channels that meet client needs and preferences 5. Treat employees responsibly 6. Balance financial and social performance. The standards were developed in consultation with industry players, including MFIs, inves- tors and donors, social rating agencies, networks, and associations. They build on previous initia- tives in the industry, including those of the ImpAct Consortium, MicroSave, and the Smart Campaign. The standards seek to guide institutions in the self-evaluation and implementation of their social performance management. It is also expected that MIX Market, social rating agen- cies, and funders will incorporate them into their reporting, rating tools, and due diligence processes. Source: http://www.sptf.info/sp-standards#1; Social Performance Task Force 2012. Monitoring and Managing Financial and Social Performance 341 ­ institution’s performance in relation to these profitability and the two exist in a mutually rein- goals. Financial data alone are not sufficient to forcing relationship” (Guarneri, Moauro, and allow managers to make operational and strategic Spaggiari 2011). decisions or to permit funders to assess the social value of investment choices. A balanced approach The Social Performance Process to performance management uses information on In order to satisfy the need to measure social both financial and social performance to inform objectives and be responsive to clients, a frame- and shape the strategy and operations of the insti- work was developed for managing social perfor- tution (see table 14.6). mance by the Social Performance Task Force, an Several recent studies show the existence of industry-wide working group composed of both synergies and trade-offs between social industry stakeholders, including practitioners, and financial performance (González 2010; donors, investors, national and regional net- Bédécarrats, Baur, and Lapenu 2011; Guarneri, works, technical assistance providers, rating Moauro, and Spaggiari 2011). Using regression agencies, academics, and researchers (see figure techniques to analyze and quantify potential 14.1). relationships (both positive and negative) In March 2005, the Social Performance Task between indicators of social and financial perfor- Force agreed to the following dimensions of mance, they seek to establish both causality and performance: correlation between the variables. Findings indi- • Intent and design. What is the mission of cate that, overall, social and financial perfor- the institution? Does it have clear social mance not only are compatible, but also reinforce objectives? each other: “The overall social rating score is closely associated with several dependent vari- • Internal systems and activities. What activities ables and above all, with the PAR 30 [portfolio at does the institution undertake to achieve its risk more than 30 days] and FSS [financial self- social mission? Are systems designed and sufficiency]. This means that social performance, in place to achieve and measure those in general terms, is strongly linked to financial objectives? Table 14.6  Balanced Performance Management Scope Financial performance management Social performance management Main goal Solvency and growth of the financial Benefits for clients, their families, and institution the wider community How is it assessed? Systematic bookkeeping and Routine monitoring of scope, outreach accounting of services, and changes in client conditions plus periodic more in-depth understanding of the reasons behind patterns and trends observed through monitoring How is it used? To influence decisions about prices, To influence decisions about prices, products, service delivery systems, products, service delivery systems, and and strategies strategies How is it validated? Internal and external audits; financial Internal cross-checks and external ratings reviews; social ratings Source: Social Performance Task Force 2012. 342 The New Microfinance Handbook Figure 14.1 The Social Performance Process, Indicators, and Assessment Tools Social performance process Internal systems Intent Outputs Outcomes Impact and activities Indicators • Mission and • Range of products • Outreach by • Change in social goals and services geography, poverty status • Governance for • Staff training on gender, poverty, • Employment social social performance lending generated performance • Staff incentives methodology • Clients’ children for social performance • Product in school • Assessing client performance • Other poverty, retention, and satisfaction • Market research • Social responsibility/ policies and practices toward: staff, clients, community, environment • Transparency in pricing Social performance assessment tools Client assessment tools (including poverty assessment tools, satisfaction/exit tools) Social ratings Social audits Source: Adapted from Social Performance Task Force 2012. Ċő /.*/.Ą Does the institution serve poor and improvements be attributed to institutional very poor people? Are the products designed activities? to meet their needs? Social Performance Indicators Ċő /.)'Ą Have clients experienced social SPM does not focus on proving impact; rather it and economic improvements? Can these focuses on gathering information that allows Monitoring and Managing Financial and Social Performance 343 ­ roviders to understand their clients’ needs and p step in the social performance process, MIX behaviors and to improve the appropriateness Market and the Social Performance Task Force and effectiveness of financial services (IFAD have jointly developed a set of core indicators of 2006). A range of qualitative and quantitative social performance (middle panel of figure 14.1). indicators is available for assessing each dimen- sion of social performance (as shown in figure The Social Performance Standard Report 14.1). Measuring aspects of a provider’s social per- Most of the social performance indicators formance provides information that can influence included in figure 14.1 have been brought together the institution’s products, policies, or even mis- in a report on social performance standards, sion (illustrated by the feedback loops in figure which allows institutions to report their social 14.1). For example, if clients are poorer than performance to the MIX Market (Pistelli 2010). expected, the provider may design products that The indicators included in the report were chosen are more suitable to that segment of the popula- according to the following criteria: (1) relevance tion. Low levels of educational attainment among for use in social performance management deci- clients’ children may make the case for develop- sions; (2) clear link to a specific desired result; ing an education loan or a contractual savings (3) testable; and (4) easily validated by a third product for clients who have school-age children party (see table 14.7). The reporting framework (Social Performance Task Force 2009). For each increases social performance transparency and Table 14.7  Indicators in the Social Performance Standard Report Indicator category What the indicators measure   1. Mission and social goals The MFI’s stated commitment to its social mission, its target market, and development objectives   2. Governance Whether members of the board of directors have been trained in social performance management and the presence of a formal board committee that monitors social performance   3. Range of products and services Both financial and nonfinancial products and services offered by the MFI   4. Social responsibility to clients The number of Smart Campaign Client Protection Principles applied by the MFI Transparency of cost of services   5.  How the MFI states its interest rates to clients Human resources and staff   6.  The MFI’s policy regarding social responsibility to staff, including incentives human resource policies, board and staff composition, staff turnover rate, and staff incentives linked to social performance goals Social responsibility to the   7.  Whether the MFI has policies and initiatives in place to mitigate the environment environmental impact of financed enterprises   8. Poverty outreach Poverty levels of clients at entry and their movement out of poverty over time Client outreach by lending   9.  The type (or types) of lending methodology employed by the MFI methodology 10. Enterprises financed and The number of enterprises financed by the MFI and employment employment created opportunities created by the enterprises financed 11.  Client retention rate The client retention rate of the MFI Source: http://www.themix.org. 344 The New Microfinance Handbook accountability and enables grand-scale social per- Formally assessing customer satisfaction and formance benchmarking (MIX 2011). investigating reasons for exit can shed light on who is using the institution’s products and ser- Social Performance Assessment Tools vices, who is not (that is, those who leave), and The industry has developed and continues to why. This involves investigating how clients and develop tools that financial service providers can former clients use products to meet various house- use to measure and assess their social perfor- hold needs (education, health, business); their mance. Different tools focus on different steps in opinion on product characteristics (cost, loan the social performance process (see bottom size) and institutional features (time required for panel of figure 14.1). Certain tools focus specifi- transactions, distance to branch); their percep- cally on institutional processes and internal sys- tions of whether the provider’s services meet their tems by assessing intent and activities. Others needs; and why they stop using the institution’s help to assess the institution’s outreach (outputs) products (for former clients only). These issues and whether clients are experiencing changes in can be investigated through focus group discus- their lives, in line with the social mission of sions, participatory tools, and surveys. The tool- the institution (outcomes). Social performance kits of MicroSave, the ImpAct Consortium, and assessment tools are used to assess clients and the SEEP Network include client satisfaction and institutional processes.13 exit tools that can be used to assess client satisfac- tion and client exits.16 Client Assessment Tools Client assessment involves looking at three main Social Ratings types of client data: (1) the socioeconomic pro- Social ratings measure the likelihood that a finan- file of clients, (2) their experience using finan- cial service provider will create the social value cial services and their needs and preferences for that it aims to create (social performance) and the products, and (3) whether their lives are chang- social risk of not achieving its social mission (SEEP ing in line with the objectives of the financial 2008, 112). Social ratings are undertaken by an provider. Collecting information of this sort can external party. They provide a score or rating, help institutions to design better products for which is based on a scale of performance. At the their clients (in terms of affordability and utility) time of writing, four rating agencies conduct social and to improve service and client retention. ratings: Micro Credit Rating International, Client assessment tools help institutions to MicroFinanza Rating, MicroRate, and Planet investigate clients’ needs, satisfaction, and rea- Rating (see chapter 16). While each rating agency sons for leaving. has its own methodology, they all use the process Poverty assessment tools, such as the Progress and indicators presented in figure 14.1 as the ana- out of Poverty Index (PPI)14 of the Grameen lytical framework of reference. Foundation or the poverty assessment tool (PAT) of the U.S. Agency for International Social Audits Development,15 assess the level of poverty of cli- A social audit is an internal assessment of an insti- ents (see chapter 5). This information helps pro- tution’s intent (mission) and internal systems and viders know who their clients are and whether activities conducted for the purpose of improving they fit the target profile. It can be analyzed its existing systems and procedures to enhance against operational aspects of interest to the pro- social performance. The result of a social audit is, vider, for example, by product, branch, or other unlike a social rating, a set of recommendations on aspect. how to enhance social performance; it does not Monitoring and Managing Financial and Social Performance 345 Box 14.4  Social Audit Tools The CERISE social audit tool uses a question- and weaknesses of the processes and man- naire and guide to examine (1) outreach to the agement systems vis-à-vis the institution’s poor and excluded populations, (2) adaptation social mission and goals through a four-step of products and services for target clients, (3) procedure: (1) a gap analysis with manage- improvement in social and political capital, ment, (2) interviews and group discussions and (4) corporate social responsibility. Given with key stakeholders of the financial provider its focus on organizational systems and pro- to get more in-depth information on the sys- cesses, CERISE determines outreach to the tems and processes, (3) a summary of find- poor through indirect means rather than ings that are summarized in a report, and through client assessments. It analyzes the (4) a discussion of the findings with an internal mission statement, board and staff commit- audit panel of key stakeholders. This last fea- ment, and targeting methods to approximate ture is thought to be useful in validating the whether poor clients are being served. Rather results of the assessment and building under- than analyzing client empowerment at the standing within the institution of the various household and community level, it assesses aspects of social performance. The final output the social and political capital of clients by of the assessment is an action plan for the looking at their involvement in MFI decision actions that could help the institution to making and at the transparency of financial improve its current social performance.a As transactions. such, it is a good entry point into social perfor- The quality audit tool was developed by the mance management for financial service pro- Microfinance Centre and Imp-Act. It can be viders that are new to social performance implemented either internally by staff or exter- management, but it is also good for institutions nally by a consultant. It identifies the strengths wanting to improve their current practices. Source: http://www.cerise-microfinance.org/publication/impact.htm; SEEP Network 2008. a. For more information on the tool, see SEEP Network (2008); http://www.mfc.org.pl/. For a user’s review, see http://api.ning.com/files/S6i7J1FpYVkkMGKF4TG901dP2qw2vr7x8FDcMyztLOMw7tHVp9mhE1a5lU6BFgsc/ UserReviewVol1No6QAT.pdf. seek to obtain a valuation of existing social perfor-  2. For example, the uniformity of measurement mance within the institution.17 Various organiza- across countries and markets allows for tions have developed social audit tools including benchmarking and comparison, helping to CERISE (Comité d’Echanges, de Réflexion et d’In- inform investment decisions. This information formation sur les Systemes d’Êpargne-crédit), is a vital part of the due diligence of any investor and sends important signals to the MFC (MicroFinance Centre), EDA, and MicroSave. market regarding the current value and The social audit tools of CERISE and MFC are anticipated performance of a given financial described briefly in box 14.4. service provider.  3. The lists can be found at http://www.cgap Notes .org/p/site/c/template.rc/1.11.160192/  1. The exception is organizations that facilitate 1.26.3104/ and http://www.mixmarket.org/ Savings Groups using a standardized service-providers. management information system and thus it is  4. Comma-separated value, like Excel, but in a discussed briefly in this chapter. more basic format. 346 The New Microfinance Handbook  5. Interview with Joakim Vincze, October 14, total assets is useful for understanding the 2011. amount of loan portfolio relative to total  6. Parts of this section were contributed by Julie assets. Common size analysis is also used to Earne. evaluate a provider’s capital structure.  7. If a provider were to collapse, its assets would Variance analysis is used primarily to compare be sold to pay off its liabilities and the remain- the budget to actual costs, but also to assess ing amount would be distributed to its owners the achievement of targets, such as growth (or, in the case of an NGO, to some other civil projections, outreach to a particular sector, or society body or, less likely, the donors). percentage of women reached. Budget to actual variances are used to highlight areas  8. The six categories of analysis in the PEARLS that may require closer evaluation. framework are similar to those in the MFRS framework, but are organized differently. 10. In addition to noncore ratios, a set of ALM Protection refers to a cooperative’s ability to tables is included focusing specifically on protect depositors and focuses on loan loss liquidity risk, repricing risk, foreign exchange reserves and the impact of write-offs on risk, and foreign exchange liquidity. These capital and deposits. Effective financial tables are useful for providers with complex structure focuses on a cooperative’s sources funding structures and those seeking to of funds (savings, shares, external credit, and undertake a broader analysis of how an institutional capital) and use of funds (loans, institution’s funding structure is sensitive to liquid investments, financial investments, and market risks. See http://www.seepnetwork.org/ non-interest-earning assets). Asset quality pocket-guide-to-the-microfinance-financial- focuses on portfolio at risk and overall reporting-standards-measuring-financial- delinquency. Rates of return and costs performance-of-microfinance-institutions- evaluate profitability. Liquidity measures a resources-180.php. cooperative’s ability to respond to member- 11. Nonfinancial services, if any, should be tracked client demands for withdrawals and dis- separately. bursements. Signs of growth measure member 12. This section was contributed by Julie Earne. satisfaction and appropriateness of product 13. For information on tools, see http://www.sptf offerings. .info/sp-task-force/online-trainings; SEEP  9. The primary tools for analysis include ratio Network (2008); IFAD (2006); http://www analysis, trend and common size analysis, and .sptf.info. For a review of some tools, see variance analysis. A ratio expresses a http://www.sptf.info/page/ relationship between one quantity and user-reviews-of-sp-tools. another. Some ratios are used to evaluate 14. PPI is a poverty scorecard that measures performance vis-à-vis a standard number, absolute poverty. It can be used to estimate the such as the capital adequacy ratio, for likelihood (probability) that a household has example, which has a specific target set by expenditure or income below a given poverty regulators. Others are used to compare the line, to estimate a group’s poverty rate at a performance of one institution to that of point in time, to track changes in a group’s another or one performance period to poverty rates over time, and to target clients. It another. Trend analysis is used to analyze derives the indicators from national income direction and growth and can be applied to a and expenditure surveys and the national single indicator such as a ratio or to a range of poverty line using the logit regression model. items in a financial statement. Common size The PPI is also calibrated to other poverty analysis is used to determine the proportion lines. The result is a 10-indicator scorecard of a single item in the total group or subgroup. that is country-specific, expenditure-based, For example, the proportion of the portfolio to objective, and with known accuracy. Field staff Monitoring and Managing Financial and Social Performance 347 can fill in the scorecard in the client’s home in *Campion, Anita, C. Linder, and K. E. Knotts. five to 10 minutes. Results can be computed 2008. Putting the “Social” into Performance using an Excel spreadsheet provided by the Management: A Practice-Based Guide for developer. Training and quality control are Microfinance. Brighton: Institute for fundamental to ensure the quality of the data Development Studies. collected. *CGAP (Consultative Group to Assist the Poor). 15. PATs, developed by the IRIS Centre, measure 2003. “Microfinance Consensus Guidelines: absolute poverty. They are country-specific Definitions of Selected Financial Terms, Ratios, scorecards comprising 16–30 indicators and Adjustments for Microfinance.” Report, derived from nationally representative CGAP, Washington, DC. household surveys. They use one or more ———. 2010. “Rewarding Innovation in Social poverty lines to calculate the incidence of Performance Reporting.” Report, CGAP, poverty and assess changes in poverty levels Washington, DC. for a group. Unlike the PPI, the PAT cannot be *Ekka, Rashmi, and EDA Rural Systems. 2011. used to assess the poverty level of an individ- “Risk Management: Integrating SPM into ual. The PAT scorecard is collected through a Microfinance Capacity Building.” Guidance 15- to 20-minute interview with clients Note, Imp-Act Consortium, Washington, DC. (individuals). Results are entered into a *González, Adrian. 2010. “Microfinance Synergies software program either by hand or with a and Trade-offs: Social vs. Financial handheld device. To ensure accurate results, Performance Outcomes in 2008.” Report, MIX, the individuals who collect and process the Washington, DC. data should be trained on the specific require- ments of the PAT scorecard and the software Guarneri, M., A. Moauro, and L. Spaggiari. 2011. used to analyze the data. “Motivating Your Board of Directors to Actively Promote and Deepen the Social Mission.” 16. MicroSave (http://www.microsave.org), the Workshop paper commissioned for the 2011 ImpAct Consortium (http://www.imp-act Global Microcredit Summit, Valladolid, Spain, .org), and the SEEP Network (http://www November 14–17. .seepnetwork.org). *Hashemi, Syed, and Laura Foose. 2007. “Beyond 17. For an excellent resource on social ratings and Good Intentions: Measuring the Social social audits and all social performance Performance of Microfinance Institutions.” information, see http://www.sptf.info/images/ Focus Note 41, CGAP, Washington, DC. spm%20essentials%20resource%20hand book.pdf. *IFAD (International Fund for Agricultural Development). 2006. “Assessing and Managing Social Performance in Microfinance.” IFAD, References and Further Reading Rome. * Key works for further reading. *Ledgerwood, Joanna, and Victoria White. 2006. Aga Khan Foundation. 2010. “Monitoring, Transforming Microfinance Institutions. Evaluation, and Learning Plan for Savings Washington, DC: World Bank. Initiatives.” Internal document, Aga Khan MIX (Microfinance Information eXchange). Foundation, Geneva. 2011. “MIX Brings Social Performance to the Bédécarrats, F., S. Baur, and C. Lapenu. 2011. Forefront of Microfinance.” Press release, MIX, “Combining Social and Financial Performance: Washington, DC. A Paradox?” Workshop paper commissioned *Panetta, David. 2012. “Performance Monitoring.” for the 2011 Global Microcredit Summit, In Savings Groups at the Frontier. ed. Candace Valladolid, Spain, November 14–17. Nelson. Washington, DC: SEEP Network. 348 The New Microfinance Handbook Pistelli, Micol. 2010. “Social Performance Institutions: A Framework for Reporting, Standards.” Report, MIX, Washington, DC. Analysis, and Monitoring.” Financial Rao, S. 2009. “Real-Time Alerts a Big Step Forward Services Working Group, SEEP Network; in Collaborative Banking.” Report, Infosys Alternative Credit Technologies, Technologies, Bangalore. Washington, DC. Richards, David A., Alan S. Oliphant, and Charles *———. 2008. “Social Performance Map.” Social H. Le Grand. 2005. “Information Technology Performance Working Group, SEEP Network, Controls.” Global Technology Audit Guide, Washington, DC. Institute of Internal Auditors, Altamonte *———. 2010. “Pocket Guide to the Microfinance Springs, FL. Financial Reporting Standards Measuring *Rosenberg, Richard. 2009. “Measuring Results of Financial Performance of Microfinance Microfinance Institutions: Minimum Institutions.” Report, Financial Services Indicators That Donors and Investors Should Working Group, SEEP Network, Track: A Technical Guide.” CGAP, Washington, DC. Washington, DC. Social Performance Taskforce. 2012. “What Is Saltzman, S., and D. Salinger. 1998. “The ACCION Social Performance?” http://www.sptf.info/ CAMEL: A Technical Note.” Microenterprise what-is-social-performance. Best Practice Report, ACCION International, *Yamini, Veena. 2010. “The Overlap Boston. between Customer Service and Social *SEEP (Small Enterprise Education Performance Management.” Briefing Note 91, and Promotion) Network. 2005. MicroSave. “Measuring Performance of Microfinance Monitoring and Managing Financial and Social Performance 349 CHAPTER 15 Governance and Managing Operations Peter McConaghy Chapter 14 discusses data management and finan- manages risks, and ensures accountability. Good cial and social performance monitoring for insti- governance provides management with the tutional providers. This chapter provides an proper incentives to pursue objectives that are in overview of governance and other issues related the interests of the organization. Governance to the management and operations of institu- structures also facilitate effective monitoring and tional providers, including human resource man- feedback of information, encouraging providers agement, product management, and operational to make good decisions and use resources risk management. It will be of interest to practi- effectively. tioners, funders, and board members wanting to The ownership and governance of a financial improve their understanding of the governance institution depend largely on its legal form, its and operations of financial service providers. primary stakeholders, and if and how it is regu- lated or supervised. The legal form could be a shareholding company licensed by the govern- Governance ment, such as a bank or insurance company, a Governance is the system of people and processes member-owned cooperative registered locally, that defines and upholds the organization’s goals or a nonprofit such as a company limited by guar- and mission, guides major strategic decisions, antee, or a nongovernmental organization (NGO) Contributions to this chapter were made by Ruth Dueck-Mbeba. Governance and Managing Operations 351 microfinance institution (MFI). Most institutional monitors the deployment of human and financial providers have a board of directors (or a similar resources to ensure that they are used effectively structure) who are either elected or appointed and efficiently. In addition, it identifies risks and and provide the primary governance mechanism: ensures that the provider operates prudently to mitigate them. To this end, the board also approves • NGOs and companies limited by guarantee do external audits and ensures proper internal con- not have owners and are normally overseen by trols; generally the internal auditor reports to the boards, which, unlike shareholder boards, do board or the board’s audit committee. not have a fiduciary responsibility, but rather a While the board should not be directly responsibility to protect the organization’s involved in managing the organization, it should assets and fulfill its mission. be confident in the senior management team and • Financial cooperatives and other member-based the policies and procedures in place for monitor- organizations are by definition owned by their ing performance. Management accountability members, usually with each member having should be monitored through both a robust one vote. They are generally governed by a reporting system to measure progress against board elected by the members with oversight benchmarks and third-party reviews. Benchmarks provided by a government body. should correspond to operational and business mandates of the provider and be measurable, • A shareholding company can be government transparent, and fair. Well-designed benchmarks owned (such as state or postal banks) or pri- highlight potential deficiencies in management vately owned (such as specialized microfi- performance and help to identify operational nance banks, commercial banks, and some issues that require attention from senior manage- NBFIs) and possibly publicly traded; it is nor- ment or the board. mally governed by a board of directors and External reviews conducted by third parties, often regulated by the central bank. including (a) bank supervisors, (b) internal audi- tors, (c) external auditors, (d) legal counsel Board of Directors (internal and external), and (e) rating agencies A board of directors oversees management and and consultants, can provide additional informa- is largely focused on (a) upholding the mission tion that helps boards to monitor and supervise and vision of the organization and providing management and to ensure compliance with strategic guidance, (b) ensuring the adequacy of board policies as well as applicable laws and reg- resources (financial, leadership, and reputation), ulations. Boards and management should ensure and (c) designing and implementing policies to that all relevant parties see the reports submitted achieve the institution’s strategy and ensure man- by external agencies. Furthermore, boards should agement accountability (Council of Microfinance have direct access to a provider’s internal legal Equity Funds 2005). counsel or other experts, if applicable. The board selects the head of the institution and approves his or her compensation. While the Building and Growing an Effective Board board supports management and monitors perfor- The number of board members normally ranges mance, it does not have a direct role in managing from five to 25, with most falling in the range of the day-to-day operations (other than in times of seven to nine members.1 The ideal size for a board extreme crisis). The board ensures effective orga- depends on its organizational responsibilities as nizational planning, including succession plan- well as the strategic direction and funding needs ning at both the board and executive levels, and of the organization. The board should be large 352 The New Microfinance Handbook enough to complete work effectively, secure settlements in civil or criminal proceedings, or funding as needed, provide continuity, and involved in a company or organization that has ensure that quorums are easily met for meetings. contravened any requirements or standards of Simultaneously, however, it should be small the regulatory system. See box 15.1 for the enough to allow for substantive decisions to be specific board requirements for an NGO MFI ­ made and for board members to establish a rela- transitioning into a regulated institution. tionship of trust and accountability with each Board members should be skilled profession- other. The board should have an odd number of als who can devote intellectual resources, practi- seats to avoid the possibility of a tied vote. cal experience, and commitment to improving the The composition of a board is perhaps more organization. Similarly, it is useful if board mem- important than its size. It is not unusual for bers have networks to help source funding and bank laws and specialized non-bank laws to ensure the organization’s good standing within authorize supervisors to review the qualifica- the financial services industry. Achieving diverse tions of each board member, typically known as gender, ethnic, and cultural backgrounds can the “fit and proper test.” As a general rule, this ensure that the board has a broad perspective. kind of supervisory assessment is focused on Board members should be free from political screening out individuals who are inappropriate exposure and other conflicts of interest that could to direct the activities of a regulated financial influence their decisions and prevent them from intermediary rather than to find ideal members. acting in the best interests of the organization. A fit and proper test assesses the integrity, hon- Ineffective boards are often composed of individ- esty, and reputation of a potential board mem- uals chosen based on political or social patronage, ber through an in-depth background check. The rather than skill and dedication to managing the purpose is to ensure that directors do not have a strategic direction of the organization. history of fraud or criminality and are not polit- When there is a vacancy, the board (or its nom- ically exposed, subject to adverse findings or inating committee, if applicable) is responsible Box 15.1  Board Consideration for NGO MFIs Transforming into Regulated Institutions Specific governance considerations exist for the very different challenges and risks faced NGO MFIs that are in the process of becom- by a deposit-taking institution, as well as meet ing regulated deposit-taking microfinance regulatory requirements. This includes under- institutions. One crucial challenge facing such standing the role and time commitments of institutions is how to incorporate old board board members of regulated MFIs. Some members into an updated governance struc- transforming MFIs secure training to help ture. Board members of the NGO MFI prior to board members to comprehend the roles they its transformation face an important and in may be asked to play in the new governance some ways unique challenge—they must pro- structure. In other cases, members leave the vide continuity to the institution, including a board (or do not join the new board) as the reminder of its history (and dedication to its MFI transforms. social mission), acknowledge and respond to Source: Ledgerwood and White 2006. Governance and Managing Operations 353 for identifying one or more candidates to fill the and hears reports of internal and external vacancy, investigating each candidate, and mak- auditors ing recommendations for election. Potential • Personnel and compensation committee. board members are evaluated based on their pre- Reviews strategic personnel issues and overall vious experience on boards, leadership ability, compensation policy and recommends com- diversity, knowledge of financial services for the pensation for senior management poor, and, perhaps most important, specific skills such as microfinance, financial management, • Risk management committee. Monitors the audit, legal, or project management experience. adequacy and implementation of risk policies Despite the fact that new board members may be recruited by fellow board members or other • Nominating committee. Develops board mem- stakeholders, once appointed or elected they ber responsibilities, identifies and evaluates serve the organization and not the body or person potential board members, and provides orien- that nominated them. tation to new members Directors may be held personally liable for • Ad hoc committees. Respond to specific issues, their actions as board members, and if their usually for a limited period of time. actions are found to fall short of the “standard of care” expected of them (which is often Strategic Governance Considerations defined in local law), they may be subject to civil Governance is complex because of the double (or and criminal penalties. Many financial service triple) bottom line implicit in financial inclusion. providers procure directors and officers insur- Governance structures have evolved to adapt to ance, which provides an indemnity to cover any industry developments, including the introduc- civil penalties that might be imposed on direc- tion of diversified products (for example, leasing tors or to pay legal costs should directors be and microinsurance), a significant increase in pri- sued for alleged misbehavior, although protec- vate investment, and, in many cases, exponential tion is not available when criminal liability is an growth in financial activities. This growth has issue. The extent to which such insurance or made the operational processes of most financial indemnity is available varies greatly with local service providers more complex, further rein- practice and laws. forcing the need for strong and relevant gover- Board committees are often formed according nance structures and practices. In particular, to the needs of the provider and, if applicable, the governing bodies need to pay special attention to requirements of the regulator, which may man- strategic risks. date the presence of certain types of committees. Strategic risks include internal risks, such as The following are the most typical board commit- adverse business decisions or improper imple- tees and their functions: mentation of decisions, poor leadership, or inef- fective governance, which can result in • Executive committee. Authorized by the board reputational risk—the risk of losing value as a to act on problems or make decisions between ­provider because of negative public opinion (Ekka board meetings, with such decisions to be rati- and EDA Rural Systems 2011). Commensurate fied later by the full board with managing reputational risk, a crucial chal- • Audit or finance committee. Oversees expendi- lenge for governing bodies is balancing the need tures and budgets, ensures internal control for both financial and social performance (see and financial analysis, recommends expendi- chapter 14). Regulated institutions are often ture power within a board-approved budget, required by law to maintain solvency and protect 354 The New Microfinance Handbook deposits of the public. Shareholders expect finan- The organizational structure determines cial institutions to produce a return on invest- human resource requirements and functions, ment. Given this financial mandate, an important clarifies reporting and accountability channels, aspect of governance is ensuring that providers and structures information flows, allowing for also focus on social goals. maximum efficiency while supporting social and The ability of boards to balance financial and financial goals. Large, regulated providers gener- social performance is facilitated by the develop- ally have more complex structures, while others ment of social performance metrics that help to purposely have flat and nimble structures. assess the social impact of providers. Some boards Organizational structures are also influenced by create a social performance management com- the provider’s intended target market, product mittee or at least have a social performance cham- offering (structured by type of client or by business pion on the board. line or product units), delivery channels, available Strategic risks also include external risks technology and infrastructure, and whether deci- such as changes in competition or in the politi- sion making is centralized or decentralized. The cal environment. The entrance of new players organizational structure is generally commensu- places competitive pressures on providers to rate with the size and level of sophistication of a match innovations and operational processes. provider’s product offering. For example, a pro- This can stimulate innovation, which can bene- vider with a broad geographic footprint may have fit clients, but also can create predatory prac- systems and procedures to support decentralized tices in the search for new clients and market decision making and ensure the integrity of data share. The imposition of interest rate ceilings across different outlets and channels. could potentially limit outreach. In some coun- An organizational structure should support tries, governments have forced providers to for- increased accessibility to clients and lower trans- give loans outstanding to certain groups of action costs and risks. Accessibility for clients clients or related to a particular occurrence, means that staff members are able to visit clients such as a natural disaster or a political event. and clients can easily use services or receive Politicians are increasingly questioning tax required support. Close proximity to the poor exemptions for NGO MFIs as commercially via- makes it easier for providers to understand client ble microfinance becomes more prominent. needs, develop trust with the communities in Boards need to be aware of competitive pres- which they operate, and develop and offer prod- sures and political developments and work with ucts and services in line with the financial needs management and other stakeholders to mitigate of intended target markets. Improving accessibil- external risks. ity often implies increasing the number of access points that serve the poor either by opening new branches or by entering into agent relationships Human Resource Management and using the associated technological platforms. Human resource management is the process Flat organizational structures—as opposed to through which an institution recruits, develops, hierarchical or matrix structures—generally allow and motivates people to accomplish its mission providers to interact more often with clients and (Frankiewicz and Churchill 2006).2 Human respond quickly to their demands and changing resource management supports efforts to give needs. However, flat organizational structures staff and management the appropriate skills, require the ability of frontline staff to make deci- incentives, and compensation (financial and non- sions without reverting to senior management. financial) to achieve institutional mandates. This requires sound training of frontline staff or Governance and Managing Operations 355 agents, trust between various levels of the organi- and motivate staff. Training and staff development zation, and appropriate supervision and informa- include training for a specific skill, development tion feedback that allows decentralization to of leadership abilities, coaching or mentoring, and occur without compromising service quality and on-the-job training. Human resource develop- outreach. ment focuses on the knowledge, skills, and atti- tudes necessary for long-term achievement of an Human Resource Policies individual’s career goals as well as the provider’s Most providers have human resource policies objectives. that provide coordination and procedures for While training is fundamentally about equip- managing staff and respecting local labor laws. ping staff with the knowledge and capacity to Human resource policies usually include general ensure the social and financial performance of a policies, such as recruitment, training, and com- financial service provider, these mandates will be pensation, as well as corporate policies regarding achieved more easily when training incorporates conflicts of interest, harassment, and security. a client-specific lens. Organizations may have to modify their training or turn to external trainers Recruitment and Screening to incorporate knowledge of client behavior into A critical component of any human resource their curriculum. strategy is hiring a sufficient number of individu- als at the appropriate time who have the adequate Salary and Incentives skills, attitudes, and motivation to complete An important objective of human resource their responsibilities on time and in an effective management is to retain well-performing and manner. To identify and recruit the best staff, a experienced employees and to provide incen- financial service provider may want to consider tives to achieve results. Financial compensation qualitative assessments such as written tests, includes a base salary and possibly additional diagnostic tools such as psychometric tests, and incentives, either financial or nonfinancial. role-playing exercises that test the character Financial and other incentives should align the and aptitude of applicants. Many providers hire goals of the institution with the employee’s per- staff with very basic skill sets and provide train- sonal goals, encouraging desired behavior. This ing to build their skills and capacity over time. is particularly important in a decentralized Institutions dedicated to providing poor women organizational structure where employees work with financial services often hire large numbers in remote and rural areas. Incentive schemes of women. This is particularly important in cul- should reward both quantity and quality. For tures where it is uncommon for men and women example, for loan officers, this involves balanc- to engage in professional or interpersonal activity ing rewards for the number of borrowers, the outside of the home. If a provider cannot hire a volume of portfolio, and the quality of portfolio sufficient number of women, it is important to (for example, percentage of on-time repay- screen male applicants for their attitudes toward ments). For agents, incentives should encourage women. Finally, staff members who believe in an adequate liquidity and the accessibility of ser- organization’s mission are more likely to be satis- vices as well as the number of transactions and, fied and productive long-term employees. above all, customer service. Financial incentives must be crafted carefully Training and Development to discourage staff from engaging in aggressive Training is used to update skills, reinforce the insti- sales techniques or behavior aimed at maximiz- tutional culture and values, promote teamwork, ing their earnings at the expense of the safety and 356 The New Microfinance Handbook respect for the client and the security and culture Performance Management of the institution (see box 15.2). A financial incen- Performance management is the process of set- tive scheme that does not balance safety of clients ting performance objectives to achieve opera- and the provider with maximization of individual tional and outreach mandates. It is the method profits can prevent an institution from achieving by which managers delegate, monitor, and evalu- its mandate. ate responsibility (Pityn and Helmuth 2007). Other incentives can include additional bene- An effective performance management strategy fits, such as increased vacation time, sabbaticals, requires managers to set performance objectives staff development grants or external training pro- and evaluation criteria with each employee for a grams, pensions, or employee loans. Cultivating a specified period of time; supervise employee positive working environment where people feel performance; support successful performance they are making an important contribution and and discipline employees whose performance or are respected also provides intangible rewards behavior is unacceptable; and evaluate the that foster commitment and loyalty. For example, degree to which employees achieve their goals impact studies and client success stories can so performance can be rewarded, adjustments remind staff why they do what they do. To keep can be made, and goals for the following period them interested and engaged, employees can be can be set (Frankiewicz and Churchill 2006). A invited to participate in committees or task forces well-designed performance management process working on innovations or improvements, engag- establishes sound communication principles, ing in market research, or assessing impact. including providing and receiving feedback, and Box 15.2  Principles of Well-Designed Incentive Schemes • Gradually introduce incentives. Especially when base salaries are high, the ratio of salaries to incentives can be decreased over time by gradually increasing incentives. Incremental intro- duction of incentives also allows for impacts to be monitored and adjusted as needed. • Adjust incentives to account for inequalities. Incentives should be adjusted for different envi- ronments. For example, urban loan officers may have different targets than rural staff, or expectations for staff may be different in established than in new branches. • Reward healthy growth. Incentives should encourage loan officers to grow at a steady and stable pace until they reach (but do not exceed) maximum productivity levels. • Encourage innovation. Monthly staff bonuses for innovative ideas tend to fuel creative thinking. • Keep it simple. To achieve its goals, a scheme should be simple; having too many variables will make it more difficult for staff to allocate their time and resources to maximize financial return. • Promote teamwork with group incentives. To promote teamwork, consider a combination of group and individual incentives based on the performance of the branch or the organization as a whole. Group incentives include profit sharing, whereby a percentage of any surplus is distributed to staff members, and employee stock ownership programs. Source: Frankiewicz and Churchill 2006. Governance and Managing Operations 357 provides the opportunity for staff to participate require specific technologies and access to infra- in planning and monitoring their own work structure (settlement systems, communication (Pityn and Helmuth 2007). technology). Providers must determine an appro- Team and individual performance objectives priate mix of products that will meet the needs of should be set to attain objectives that are SMART: their current and potential clients as well as specific, measurable, achievable, realistic, and achieve their stated objectives and mission. time-bound. Objectives should not only be quan- Providers can determine the most strategic titative in nature, but also incorporate objectives mix of products in various ways, including taking for quality, such as customer service, attitude, a market segment approach (offer a combination teamwork, and overall commitment to meeting of products to meet the needs of specific target the mandate of the provider. Performance objec- markets), a client life-cycle approach (offer prod- tives should be set for all staff within an organiza- ucts that meet client or business needs during tion, not only for frontline staff dealing in each stage of development), or a developmental revenue-­ generating activities or interacting with approach (offer products that help clients to tran- clients. sition out of poverty; Frankiewicz and Churchill 2011). Depending on the specific mix, some prod- ucts may be more profitable than others; less Product Management profitable products may still be important for Product management is not limited to the devel- retaining clients or having the ability to cross-sell opment of new products or refinement of existing more profitable products. Overall, a financial ser- products; rather it is the sum of institutional pro- vice provider must understand the margins of cesses that result in an understanding of client each product and monitor trends to understand needs and thus an appropriate mix of products profit (or loss) drivers. coupled with appropriate delivery and, which is In addition to ensuring an overall appropriate important, customer service. The ability of finan- product mix, managing products involves devel- cial service providers to offer quality products oping new products, product costing and pricing, rests on their ability to understand complex cli- and product marketing. ent needs. Although efforts have been made to offer products tailored to local economic and Product Development sociocultural contexts, many providers simply Product development begins with market replicate successful models, offering products research followed by product design and testing, based on assumptions rather than a good under- product launch, and then rollout.3 It considers a standing of client needs through market research. range of potential products and successively nar- Tailoring products to the specific needs and con- rows the choice of products as project feasibility sumption habits of clients can improve client sat- is researched and analyzed (Brand et al. 2009). isfaction and retention as well as profitability Increasingly, providers are placing client needs at (see box 15.3). the forefront of product design, developing prod- The ability of providers to offer various prod- ucts only after studying the complex set of activi- ucts depends on the needs of the target market ties used by the poor to manage their financial and the capacity of the provider itself. For exam- lives (see box 15.4). ple, some products (savings, insurance) require Understanding client needs, forecasting specific regulatory status, while others require demand, and segmenting the market can be done specific skills and access to information (housing through a variety of market research methods, loans, index-based insurance), while still others from surveys and client feedback forms to close 358 The New Microfinance Handbook Box 15.3  Client-Focused Product Design in Practice Grameen Bank began as a project to deliver credit to poor rural Bangladeshis in 1976. Led by its managing director, Mohammad Yunus, it steadily developed what it now calls classic micro- credit. Poor villagers (means-tested through land and asset ownership) formed groups and par- ticipated in weekly meetings where savings were collected, loans were disbursed, and joint lia- bility or support was provided should they fall into difficulty. Loans were repaid over one year in weekly installments. By 2000 almost 2 million members—the majority women—were served by Grameen’s credit program. That same year, work began on Grameen II, known formally as the Grameen Generalized System. Grameen II represents a series of important changes to the prod- uct offering, consolidating many of the lessons learned during years of providing services. Important changes include the following: • Public deposit services. The bank became a true intermediary by mobilizing deposits from the general public, not just from members, whose mandatory deposits were part of the bank’s credit methodology. • Extended member deposit services. It introduced a wider range of savings opportunities for members, including a commitment-savings account known as Grameen pension sav- ings. Personal savings accounts were made far more flexible, and group savings accounts largely disappeared. Passbook savings accounts and contractual savings products were added. • Improved loan products. It introduced a wider range of loan products with variable terms and repayment schedules. Larger loans for business use are available. Loans may be “topped up” mid-term or paid off early. There is no obligation to borrow. Borrowers in repayment difficulties have their loans rescheduled (into “flexi” loans). Joint financial lia- bility among group members is formally not allowed (although members still undertake to help each other). The introduction of a wider range of financial services and options help customers to manage their complex financial lives. Top-up loans allow members to maintain capital in their businesses or to manage unforeseen challenges or shortfalls and to extend repayment periods in a struc- tured manner where necessary. Grameen II also offers special terms for the very poor and makes education grants and loans. Grameen II has achieved significant results. After a difficult period of stagnation and compro- mised portfolio quality, the bank has grown significantly both in the number of customers and in profitability. Grameen took 27 years to reach 2.5 million members and then tripled that with Grameen II. Between 2002 and 2005, Grameen’s deposit base tripled and its loans outstanding doubled. As of October 2011, Grameen had 8.35 million borrowers, 96 percent of whom were women; 42 percent of the branches had borrower deposits equal to 75 percent or more of out- standing loans of the branch. According to senior managers, the improvement in the bank’s performance is related to the attractiveness of Grameen II’s wide range of consumer-focused loan products. Source: Rutherford 2004; Wright 2010. Statistics are from http://www.grameen-info.org/. Governance and Managing Operations 359 Box 15.4  Microfinance Opportunities’ Listening to Clients Series With a grant from the Ford Foundation, International Development and by MicroSave. Microfinance Opportunities and MicroSave The series includes modules on client satis- collaborated in 2002 to produce the Listening faction, analysis of financial sector trends, and to Clients series, a pioneering audiovisual surveys of the use of loans and savings. market research training program for microfi- Adding to its value, compact disks present nance practitioners. It contains 13 modules PowerPoint scripts explaining the tools and that present a collection of assessment tools video clips illustrating key applications. The originally developed by the Small Enterprise compact disks can be used in many settings, Education and Promotion (SEEP) Network enabling wide dissemination of the client under the AIMS Project of the U.S. Agency for assessment tools. Source: Cohen n.d. analysis of financial and social monitoring infor- in a particular area, market research often focuses mation.4 Depending on organizational resources, on improving client outreach, market positioning, market research can range from having a full staying ahead of the competition, and enhancing research department to lighter-touch techniques delivery channels of products and services. involving ongoing feedback such as rapid surveys Traditional product design builds off market administered by staff to monitor client experi- research findings to identify gaps in service deliv- ence, client-focused discussions at staff meetings, ery and unmet client demand. In the design pro- suggestion boxes in branches, or simple questions cess, product characteristics such as eligibility, on account forms. Further information can be terms, price, and accessibility need to be deter- gathered by reviewing industry trends and by dis- mined, operational procedures outlined, risks aggregating the existing client base by product, identified, and cost analysis and revenue projec- size, and term to begin to segment the market and tions estimated (Frankiewicz and Churchill 2011). potentially expand the product mix. More pur- This will help to determine if the product is poseful research can be carried out through peri- potentially viable or not based on assumed mar- odic focus group discussions or surveys with ket size. If the product seems viable, the next current, potential, and former clients, through stage is the pilot test. feasibility studies and pilot projects, or through Piloting involves the introduction of a proto- detailed competition analysis. type on a limited scale to determine acceptance For financial service providers interested in and refinement of needs. Pilot testing helps to operating in or expanding their services, key mar- predict how different clients will respond to ket research questions center on understanding the new product, to assess potential demand, the financial service needs of potential clients, and to get a sense of operational processes. It determining the level and quality of infrastruc- includes selecting test sites (size, location), ture (if moving to a new area), and understanding establishing test duration, and setting land- sociocultural and historical issues. For well-­ marks during the pilot phase for analysis and established providers with experience operating product refinement. 360 The New Microfinance Handbook The 10 steps of pilot testing include (Wright and institutional issues involved with revising the 2010): product design (Wright 2010). Success in the pilot test phase will be defined 1. Define the objectives differently for each provider based on context 2. Compose the pilot test team and stage of institutional growth; once it has 3. Develop the testing protocol been deemed successful, the next step is to 4. Prepare all systems launch the product officially and then roll it out 5. Model the financial projections broadly. Closely tied to a product launch is a 6. Document product definitions and procedures sound marketing plan. Providers must antici- 7. Train relevant staff pate needs in terms of staff training, incentives, 8. Develop product marketing plans and information systems, and infrastructure (see materials box 15.5). 9. Commence the pilot test 10. Monitor and evaluate. Product Costing This phase provides crucial information that is Product costing analysis allows a financial ser- used to determine product expansion by consid- vice provider to assess products that are profit- ering the financial, competitive, methodological, able on a consistent basis versus products that, Box 15.5  The Cost of Failure: Equity Bank’s Painful Lesson Equity Bank in Kenya is a strong proponent of and manage relationships daily had been a market-led approach that embraces pilot underestimated. Soon one Equity employee testing as a core step in developing success- was managing a portfolio of 5,000 clients. ful financial products. Its exponential growth Post transformation, it took more than in 2003–04 and its transformation from a three months for Equity to connect to the building society to a bank challenged manage- central payment system. This caused sev- ment to find ways of giving adequate atten- eral months of arrears to pile up quickly as tion to the changes taking place. With the customers’ loan payments fell due, but their potential of 100,000 customers per year, the salaries were yet to be credited. Portfolio at bank decided to roll out an apparently straight- risk greater than 30 days rose (from 7 to forward salary-based loan product without 18 percent in three months). Equity Bank testing it. In the words of the CEO James quickly reviewed and reengineered the Mwangi, “We thought it would be a quick win.” product, identified and mitigated risks, pur- There was enormous demand for the prod- chased and installed a robust core banking uct. It was easy to administer at low volume, system, and launched a major collections so the bank scaled up, reaching a portfolio of effort. By November 2005 recovery had risen US$3.75 million in only nine months. Then the to 90 percent. The key lesson is that pilot trouble started. The amount of staff time testing is absolutely essential to forecast required to complete an employer assessment demand and address risks. Source: Wright 2010. Governance and Managing Operations 361 while important to the product mix, are unprof- should complete the identical set of activities as itable. Cross-subsidizing products may allow much as possible, each time a costing exercise is providers to balance financial sustainability with undertaken. expanding access to hard-to-reach customer segments. Product Pricing There are two primary methods for allocating Product pricing is the process through which costs: traditional cost allocation and activity- financial institutions analyze costs, assess com- based costing.5 Traditional cost allocation meth- petitive trends, and forecast demand in order to ods use allocation bases to distribute costs among set prices for products. Correct pricing is cru- products, such as direct labor hours or total cial to ensure that adequate revenue is generated account balances of a specific financial product. to cover the full costs of operations. Providers Traditional cost allocation generally relies on set prices using a wide variety of metrics and volume-related metrics, such as portfolio volume strategies. Prices may be based on each transac- of staff time dedicated to a particular product. tion, such as opening a savings account or trans- This method may overestimate the costs of prod- ferring money, or may include higher up-front ucts with higher volumes and, in general, fails to fees and unlimited access to services. A product’s capture the full and complex picture of specific price should normally reflect the product’s com- product costs. plexity and relative value proposition. For exam- Activity-based costing (ABC) traces the costs ple, a savings account that can be accessed on an of activities before linking them to products. unlimited basis is more convenient for clients For each major process, a costing team identi- than one that can only be accessed three times a fies the main activities performed by staff at month. However, the cost of offering the unlim- both the branch and headquarters—for exam- ited savings account is higher than that of the ple, processing a loan application or opening a limited savings product. Thus the fees associated savings account. These particular activities are with the unlimited savings account will generally “used” or “consumed” by different products, need to be higher and the interest rates paid will depending on specific attributes that drive likely be lower. activity costs (for example, number of housing There are three primary methods for pricing loan applications received, number of passbook products. Under the cost-based method, prices are savings accounts opened). A given product based on the cost of the product plus a particular consumes many different activities; when these ­ margin or markup. This method can ensure that activities are added up, the total cost of deliver- all costs are covered, but it may be difficult to link ing the product is revealed (see figure 15.1). An direct and indirect costs to each specific product. important challenge with ABC is the level of Using the competition or market-based method, detail required, which may exceed the scope of prices are based on the prices charged by compet- available information of many financial service itors and industry comparables.6 This approach is providers. quite common in markets where service offerings To maximize accuracy and effectiveness, prod- are relatively standard or the number of competi- uct costing should be conducted at least once a tors is limited. Competition-based pricing can be year. While conducting more regular costing exer- inexpensive, quick, and easy to adjust as condi- cises may provide insight into seasonality issues, tions in the market change. Pricing based on com- tracking costs over time will provide insight into petitive trends, however, may not fully cover costs, whether efforts to increase the efficiency of inter- depending on the provider’s efficiency. Similarly, nal operations are effective. In general, providers given that the market for financial services for 362 The New Microfinance Handbook Figure 15.1  Traditional Cost Allocation versus Activity-Based Costing COST ALLOCATION Income and expense Allocation bases Product costs Loan product Staff costs No. 1 Staff timesheet Loan product Non-staff costs No. 2 Portfolio volume Savings product No. 3 ABC Income and expense Activities Drivers Product costs Core Loan product process (A) No. 1 Staff costs # Loan applications Core process (B) Loan product Non-staff costs No. 2 # Transactions Core process (C) Savings product No. 3 Sustaining activities Source: Grace and Helms 2004. low-income and remote populations often has Finally, with demand-based pricing, prices are significant information asymmetries and few pro- determined based on the customers’ willingness viders, it can be difficult to select appropriate and capacity to pay. This method sets prices based competitive benchmarks. In addition, certain on the value proposition of the product to the cus- providers may receive subsidies from donors and tomer. Value is a function of the benefits that come therefore may price their products at prices that from using a particular product, such as quality, are not sustainable. This can lead to substantial convenience, safety, or commitment features that distortions in pricing. create discipline to save or repay on time. Governance and Managing Operations 363 Most providers use a combination of all three conditions and preventing misleading or dishon- strategies to price products. For example, an insti- est claims about products. Ensuring that clients tution can set a price that covers the full cost of understand all the conditions and risks of the delivering a product or service. It can then com- financial products they are using can safeguard pare this price with that of competitors and ana- against misleading marketing practices. lyze what makes its specific product unique, helping it to understand what clients would be Risk Management willing to pay and thus to adjust the price based on demand. In light of the commercialization of microfinance, recent reputation challenges, and rapid diversifi- Product Marketing cation of service providers and delivery channels, Providers use marketing to inform consumers of good governance, risk management, and internal the products on offer and to communicate their control and audit are essential regardless of value and differentiate them from those of their whether the provider is a mobile money operator, competitors.7 They typically communicate value a participant in the agricultural value chain, a to potential customers through the five compo- commercial bank, a credit union, an MFI, or a nents known as the marketing communications bank.8 The degree of professionalization and mix: personal selling, advertising, sales promo- complexity will vary, ranging from very sophisti- tions, public relations, and direct marketing. cated, tightly supervised or controlled methods in Providers can draw from any or all of these strat- regulated entities to much less-structured egies to create a sales strategy that is appropriate approaches in more informal providers. for their products, target market, and available Risk is the possibility that current and future resources. events—expected or unanticipated—may have an Branding is an important tool for positioning adverse or harmful impact on an institution’s within the marketplace and communicating key objectives, capital, or earnings. Risk is measured value propositions to existing and potential clients. in terms of impact and likelihood. Financial ser- A brand represents a collection of information vice providers face many risks—both internal and about a product or an institution and typically con- external. Risk is an inherent part of business in sists of a name, identifying mark, logo, and distin- general and of the environment and operations, in guishing visual symbol and image (Brand 2006). particular. Financial service providers focus on developing Risk management is the systematic process of brands that are associated with the provision of identifying, assessing, managing, and controlling quality services that meet the needs of their target potential events to provide reasonable assurance clients. They use brands to generate knowledge of achieving objectives. Risk management and awareness of core products in order to expand includes balancing risk taking against a well- outreach, build loyalty with existing clients, target designed control environment. It effectively new clients, and inform clients of new services. reduces the likelihood that a loss will occur, min- As discussed in chapter 3, responsible finance imizes the scale of potential losses should they in the microfinance industry attempts to ensure occur, and adds value by helping the provider consumer protection by developing financial meet its objectives. Risk management must be capabilities and ensuring transparent and fair proactively led by a provider’s board and senior pricing. Institutional providers may also be sub- management through approval of policies, over- ject to regulatory review of their marketing prac- sight of the internal audit function, and monitor- tices, requiring full disclosure of all terms and ing of management and operations (see table 15.1). 364 The New Microfinance Handbook Table 15.1  Roles and Responsibilities for Risk Management Institutional role Responsibilities Board Approve policies and monitor adherence to them Senior management Identify risk and develop policies, procedures, systems, and guidelines to reduce risk Branch management Implement procedures and monitor adherence to policies and procedures Operational staff Comply with policies, procedures, and risk-mitigating controls. Offer suggestions for and provide feedback on proposed operational changes and new, emerging risks Internal control staff Monitor compliance and verify that policies and procedures are followed accordingly Internal audit Test and verify that policies and procedures are followed, assure management that risk-mitigating approaches are adequate, and determine the extent to which risks remain uncontrolled Source: Adapted from Campion 2000. Risk should also be evaluated in light of the Providers take a variety of approaches to imple- opportunities to create value—financial and menting risk management. Many institutions social—that risk taking represents. Successful risk establish a risk department (or officer) or a risk taking and a well-managed appetite for risk and compliance department (or officer). A risk should be evaluated periodically relative to the manager’s role is to support the effective and effi- rewards and results they bring. This approach cient governance of a provider and the implemen- implies that the response to risk—whether avoid- tation of an enterprise-wide risk management ing, accepting, transferring, or controlling risk—is strategy. This individual continually monitors and a careful process that evaluates the trade-offs in measures the institution’s evolving external and developing risk-mitigating strategies. Controlling internal risks, generally in conjunction with board risks affects costs, efficiencies, and the client member(s) or board appointees charged with risk experience and must be weighed against the management. Other institutions form a risk man- expected benefits. agement committee composed of senior managers A common framework presented to under- from all operating units and areas. A strong com- stand risk management is the risk management mittee will ensure that a risk management strategy “feedback loop,” which incorporates risk man- is well incorporated into all of the provider’s busi- agement activities throughout an organization. ness activities. As the provider grows in size, scale, The risk management feedback loop has six key and complexity, its board may choose to appoint a components: (1) identify, assess, and prioritize risk committee or a risk officer. Most small- to risk, (2) develop strategies and policies to mea- medium-size institutions do not have a risk man- sure risks, (3) design policies and procedures to ager and, until one is appointed, the entire role of mitigate risks, (4) implement and assign responsi- risk assessment and reporting often falls to the bilities, (5) test effectiveness and evaluate results internal audit department, a task that compro- and efficiently communicate the findings, and mises the objectivity and independence of its (6) revise policies and procedures as necessary internal audits. (Campion 2000). Risk management is an ongoing Neither risk management nor internal audit- process, as vulnerabilities change over time and ing should be confused with internal controls; improvements to risk mitigation strategies prove however, the three are interconnected in current effective. best practices and should be well understood and Governance and Managing Operations 365 coordinated to maximize their efficiency and strategic risk), natural disasters and other physi- effectiveness (see figure 15.2). cal risks, and political and macroeconomic risks, The role of an internal auditor is to test and such as high inflation or devaluation. assess independently and objectively the effective- Credit, liquidity, and market risks are dis- ness of risk management strategies and internal cussed in chapter 14; the risk and risk manage- controls. Therefore, the role of an internal audit in ment approaches discussed in this chapter focus the risk assessment process needs to be managed on operational risks. carefully in order to maintain audit independence. Internal auditors may perform an advisory role in Operational Risks and Risk the identification and management of risks, but Management they should not be involved in implementing a provider’s risk management policies. Operational risks are the vulnerabilities that a Risks faced by financial service providers gen- provider faces in its daily operations—fraud and erally include credit risk, liquidity risk, market theft, systems and human errors, portfolio integ- risk (including interest rate risk), operational risk rity, and security—all of which can undermine its (including fraud, systems, transaction, and error financial and reputational position. Through risks), compliance and legal risk, reputational oversight, effective processes, and risk-mitigat- risk, strategic risk, governance risk (including ing controls, management has some degree of commercial and social mission risks), human control and influence over operational risks. The resource risk, and insurance and counterparty core activities in financial service intermediation risk (if relevant). involve transactions of value through cash, docu- Although they have limited control over them, mentation (receipts, vouchers, and negotiable organizational managers and directors must also instruments such as checks), accounting entries, assess the external risks to which they are and electronic entries or messages that are exposed. An institution with relatively strong ­negotiated or exchanged between customers and management and staff and adequate systems and staff. Risk mitigation strategies for operations are controls may still experience major problems due designed to protect assets, protect information to the environment in which it operates. These and systems, assure the integrity of transactions, risks include regulation, competition (part of and assure the reliability of financial reporting. Several inherent risks are related to the entry Figure 15.2  Relationship between Risk and processing of transactions in financial ser- Management and Internal Control vices delivery. Transactions may be incomplete, inaccurate, or omitted from processes or records. For example, a loan that is not repaid results in a Risk mangement loss for the provider and potentially a negative credit rating for the borrower. This is a result of Internal control incomplete information, inaccurate information, interruption in transaction handling or process- Internal audit ing, or the lack of capacity of the client or the pro- vider to complete the transaction. Another inherent risk in all of these areas is that humans—staff, management, and clients— are ultimately conducting business transactions. Source: Campion 2000. 366 The New Microfinance Handbook The risk of fraud refers to the potential loss of Figure 15.3  Components of Internal Control cash or revenue as a result of intentional decep- Internal control components tion by an employee or client. Cash theft by loan officers or other staff members is one of the most Management’s objectives common incidences of fraud. Others include cre- ating false financial statements or other docu- ments, engaging in bribery, bypassing computer software or application controls, manipulating Monitoring systems’ data input, and recording borrowers or Information & loans that do not exist. Control activities communication Having an honest, well-qualified, competent, and motivated staff is the best way to manage and Risk assessment control operational risks, as staff members imple- ment control procedures, policies, and processes. Controls are designed to limit the opportunities Control environment for staff to make deviant or fraudulent choices in order to take advantage of situations for personal, Source: http://bibiconsulting.homestead.com/coso_s_internal_ rather than organizational, gain. control.ppt#260. An Internal Control Framework that support the achievement of a provider’s mis- Internal controls are the integrated set of com- sion, strategies, and related business objectives. ponents and activities to address the risks, chal- lenges, and issues faced by providers in the Control Environment pursuit of both financial and social objectives. The control environment is the overall attitude, The integrated internal control framework awareness, and actions of the board of directors developed by the Committee of Sponsoring and managers regarding the internal control sys- Organizations of the Treadway Commission tem and its importance. If top management (COSO) is a commonly accepted model of inter- appears to give just lip service to internal control nal control, although other reliable models also or to apply double standards and policies for exist. The COSO framework defines internal themselves, it is almost certain that the control control as follows: environment will not be effective for organiza- Internal control is broadly defined as a pro- tional staff. cess, affected by an entity’s board of directors, A strong control environment is generally management, and other personnel, designed characterized by the following: to provide reasonable assurance regarding • Involvement of the board of directors and its the achievement of objectives in the follow- committees, particularly the audit committee ing categories: effectiveness and efficiency of operations; reliability of financial reporting; • Philosophy and operating style of senior man- and compliance with applicable laws and agement as well as its commitment to regulations.9 competence Figure 15.3 illustrates an internal control sys- • Commitment of senior management and staff tem consisting of five interrelated components to integrity and ethical values Governance and Managing Operations 367 • Organizational structure and the methods Risks are usually prioritized through a ranking used to assign authority and responsibility exercise that categorizes risks as increasing, sta- within this structure ble, or decreasing. Increasing risks that have both the potential and likelihood of significant impact • Design of the control system and control are generally considered a priority that should be methods, including the internal audit func- addressed through risk-mitigating strategies and tion, by senior management controls. This process helps to determine the • Human resource policies and procedures, most appropriate and cost-effective approach to including segregation of key duties determining control activities, since financial ser- vice providers must continually focus on opera- • Senior management’s awareness of and atten- tional efficiencies. tion to external influences. Control Activities Risk Assessment Based on the risk assessment, providers can Periodic risk assessments help to identify, mea- choose to avoid risks (change business processes sure, and prioritize risks. A risk assessment exer- that have inherent risks), transfer risks (purchase cise generally recommends acceptable risk insurance if available), accept risks (and thereby parameters, risk reporting, and means of moni- do nothing to manage, mitigate, or eliminate risks), toring specified risks on a periodic basis. It begins or seek to control risks. A risk-based approach to with the first two components of the risk manage- internal control links specific controls to the pro- ment feedback loop: (1) identify, assess, and prior- vider’s objectives. This section describes the most itize risk and (2) develop strategies and policies to common approaches to control activities and pro- measure risks. Some providers appoint an inde- cedures in a financial service provider. pendent consultant or evaluator to conduct an Control procedures are the policies and pro- objective, independent assessment; such an eval- cedures that guide staff to process transactions, uator reports directly to the board. In other pro- manage assets, and conduct their work. They viders, the risk management committee or a risk also enhance and strengthen the consistency officer is responsible for conducting regular risk and reliability of data and information in the assessments. accounting system. Accounting and transaction Prioritizing and measuring risks are perhaps controls are designed to meet management’s the most challenging parts of the process, in that objectives of profitability or sustainability, com- the assessment considers risk tolerance and risk pliance with policies, safeguarding of assets, rewards. It is usually a subjective, evaluative prevention and detection of fraud and error, activity that articulates and shapes the institu- accuracy and completeness of accounting tion’s response to risk. Numerous tools are used records, timely preparation of reliable financial to provide a systematic approach to assessing all information, discharge of statutory responsibil- aspects of risk, including both quantitative and ities, and protection of staff members against dis- qualitative measurements. However, most insti- information. The integrity of the entire financial tutions find that risk assessment is an iterative and accounting system, including the financial learning process that is strengthened over time if reports, depends on the internal control proce- undertaken thoughtfully and objectively. Another dures that assure the integrity and consistent common approach to identifying, analyzing, and treatment of individual transactions—including prioritizing operational risks is through “process their validity, accuracy, timeliness, classification, mapping.”10 and authorization. 368 The New Microfinance Handbook Control procedures are preventive or prescrip- • Design and use of adequate documents and tive, detective (the internal audit), and corrective records. Prenumbered documents, document in nature. They may include, but are not limited registers, multiple copies, sequential and to, any of the following elements: numerical documents, and a chart of accounts that organizes the accounting transactions in • Segregation of duties. Segregation of duties the general ledger. among different departments and individuals to reduce the risk of inappropriate action and • Physical control of assets. Safes and lockboxes to ensure that no specific individual or entity where three people are required to access cash has a concentrated amount of responsibility to ensure that assets are safeguarded and used that can threaten transparency. Segregation of appropriately. In addition, having more than duties pertains to responsibilities for authoriz- one employee transport assets, particularly ing and recording transactions and handling cash, between branches or from a provider related assets including cash. branch or outlet to the client can help to mini- mize the risk of fraud and theft. • Dual controls. Dual or triple controls for access or oversight, such as access to cash vaults, sys- • Accounting controls. Daily postings and monthly tem changes, reconciliations, and independent reconciliations, including full and timely bank review and verification. reconciliations to inform management and the • Human resource controls. Rotation of duties, board of the financial position. Sequential num- mandatory vacation policy, and authorization bering of items such as cash receipt vouchers of overtime. and checks reduce staff fraud or exposure. All transactions should leave an audit trail to • Signature requirements and approval autho- ensure transparency. Portfolio accounts (loans, rizations. Requirements for transaction savings, and other subsidiary accounts) should approvals, transaction limits, report reviews, be reconciled regularly to ensure that discrep- and approvals by a third party, adding a level ancies are found quickly. of transparency to critical activities and functions. • Information technology (IT) general controls. • Accounting, administrative, reporting, and Commonly understood as “standards” in IT financial policies and procedures. Clear, acces- management control. These controls are sible, and current policies and procedures that intended to ensure the appropriate develop- support the correct and consistent treatment ment and implementation of applications as of transactions and operational activities. well as the integrity of programs, data files, and computer operations generally. The • Budgets and comparative reports. A means of most common IT general controls are logical exercising fiscal control. When actual expenses access controls over infrastructure, applica- are reported regularly against budgets, they tions, and data, system development life- become an effective management control tool. cycle controls, program change management • Limits on cash or expenditures. Policies designed controls, physical security controls over the to safeguard and prevent abuse when using data center (including climate controls and cash, such as authorizing designated personnel electricity supply and control), system and to handle cash, including cash limits, and a data backup and recovery controls, com- series of documentation procedures to trace puter operation controls, password security the flow of cash in and out of the provider. controls for varying levels of access, use, and Governance and Managing Operations 369 application, and system protection, such as and informal providers have self-governed inter- antivirus, registration, and updates of nal control and monitoring functions. licenses, firewall, and version-configuration Part of the management function involves compatibility (see box 15.6).11 supervision and monitoring on a day-to-day basis. Through segregation of duties and independent Monitoring checks and verification, an element of ongoing Internal control is a continuous process whereby monitoring takes place in everyday operations of the board or management committee and senior a financial service provider. Budgets and compar- management monitor the (a) efficiency and ative reporting are also a regular means of moni- effectiveness of activities; (b) reliability, com- toring operations. Perhaps the strongest and most pleteness, and timeliness of financial and man- effective monitoring in the internal control pro- agement information; and (c) compliance with cess takes place through the internal audit func- applicable laws and regulations. Internal control tion (discussed below). structures facilitate the constant flow of infor- mation critical to the monitoring and mitigation Information and Communications of all business risks and vary depending on the The information and communications compo- type and size of the provider and regulatory nent of an internal control system is not a stand- requirements (if applicable).12 Formal financial alone component. It intersects, interacts with, institutions, such as commercial banks, often and is part of each of the other four elements just structure the internal control function accord- discussed. Staff and management must be fully ing to central bank guidelines and must have informed and aware of the policies and proce- their internal control structure approved and dures of the provider. Policies that are not avail- monitored by the regulatory body. Nonregulated able to staff cannot be implemented. Business Box 15.6  IT Disaster Recovery and Business Continuity Management The more an institution relies on information technology, the more important are the develop- ment, testing, and comprehensiveness of an IT disaster recovery and business continuity plan. However, all institutions should develop a plan, regardless of their size or dependence on technology. A very basic, simplistic approach includes the following: • Regular documented system of backups—whether twice a day, daily, or weekly (not recommended) • A revolving backup system, where several days’ data are maintained • Off-site storage of backup data • Occasional testing of backup restoration and an efficient time period for recovery (ideally within one to two days) • Plans for alternate or remote work locations and equipment. Source: Ruth Dueck-Mbeba. 370 The New Microfinance Handbook strategies and objectives must be communicated • Staff turnover. Staff who have worked in an area throughout all channels in the provider as well. for some time are normally more efficient Without information and communication, pro- than new staff; rapid turnover or growth of viders cannot prioritize risks, detect fraud, com- staff may diminish the effectiveness of controls. ply with legal and statutory requirements, monitor • Workload volume. Compliance with policies performance with regard to budget, or make data- and procedures may become weak when driven, informed decisions about performance workloads are large, given competing priori- and operations. ties for attention and effort. Communication channels between staff, man- agement, and internal audit must also be a contin- • Collusion. If a control depends on the segrega- uous, efficient means of ensuring the effective tion of duties, internal controls can easily be implementation of internal controls. The reports circumvented when two or more of those and results of internal audits, monitoring activi- responsible decide to defraud the institution. ties, external evaluations, and assessments should be shared in a timely manner to address risks and • Staff irresponsibility. Persons responsible for a concerns early. Regular meetings between super- control may also neglect or abuse that respon- visors and individuals or work teams, meetings of sibility; this limitation normally arises when the management team, and an “open door policy” employees are not satisfied or are bored with should help to foster a culture of open and honest their jobs. communication. Internal Audit The Institute of Internal Auditors defines inter- Limitations of Internal Controls nal auditing as “independent, objective assur- Internal controls are developed and used by man- ance and consulting activity designed to add agement to support them in achieving objectives. value and improve an organization’s opera- However, controls can only be implemented as far tions. It helps an organization accomplish its as is practical. The following limitations to inter- objectives by bringing a systematic, disciplined nal controls must be considered in the design approach to evaluate and improve the effective- process: ness of risk management control and gover- • Cost versus benefit. The cost of implementing a nance processes.”13 control must be evaluated relative to the prob- The internal auditor is independent of other ability of the risk of loss and the size of loss. business processes, reports to the board of direc- Most benefits are difficult to determine since tors (usually the audit committee), and focuses on institutions are dealing in loss probabilities. detective controls—testing for compliance with policies, procedures, and controls, the reliability • Abnormalities. Controls are typically directed of financial reports, the effectiveness of risk man- toward normal, everyday transactions; abnor- agement strategies, and the presence of previ- mal and unusual transactions are generally not ously unidentified risks. covered primarily because of cost-benefit Ideally, the board will appoint an audit com- issues. mittee that operates as a subcommittee of the • Human error. This factor is always present to board with a specific mandate to oversee the some degree, as humans are prone to error and internal and external audit functions. The audit impaired judgment. committee is preferably composed of a qualified Governance and Managing Operations 371 accountant or auditor, a treasurer (if the board has reviewed and approved by the board or its audit such a position), and perhaps another individual committee. A typical audit plan entails audits of all well versed in accounting and auditing matters. headquarter departments, including IT systems, The audit committee reports to the board. A human resources, and of branches at regular inter- direct reporting line to the audit committee estab- vals (usually ranging from once a quarter to once a lishes the internal auditor’s independence and year). Its scope may also expand to risk and gover- objectivity, although he or she retains an indirect nance functions. An audit manual, outlining poli- line to senior management for coordination of cies and procedures, guides the audit function. work and communication. While most departmental audits can be carried Large, formal financial intermediaries nor- out by the internal auditor, specialized skills are mally have an audit department, staffed by a sometimes required for audits of more advanced senior, experienced professional (see box 15.7). systems, and an external specialist may be hired. Small or informal providers may not have a dedi- Branch audits often form the core task of cated audit function, in which case the task can be the audit function, regardless of the size of the outsourced to an external consultant or audit firm provider. Key areas of branch audits include that does not have responsibility for the external cash, loans, provisions, write-offs, savings, audit. In larger, more formal institutions, the audit transfers, IT systems, fixed assets, and finan- function is based on an annual audit plan that is cial and operational reporting. Audit officers Box 15.7  Audits Performed by the Internal Audit Department The internal audit department or function performs various types of audits: • Financial audits assess the reliability of the accounting system, data, and financial reports. • Compliance audits assess the quality and appropriateness of the system established to ensure compliance with relevant laws, regulations, policies, and procedures. • Operational audits assess the quality and appropriateness of operational systems and proce- dures, analyze the institution’s organizational structures with a critical mind, and evaluate the adequacy of operational methods and resources. • Management audits assess the quality of the approach of managers to risk and control within the framework of organizational objectives. • Reviews evaluate the means of safeguarding assets and, as appropriate, verify the existence of assets. • Evaluations of internal control systems assess the deterrence and detection of fraud and alertness to indications of fraud. • Periodic audits of computer systems and post-installation evaluations determine whether major data-processing systems meet their intended purposes and are capable of fulfilling their objectives. • Special reviews are conducted at the request of the CEO or the board (for example, fraud investigations, efficiency reviews, risks related to new branch openings, new products, or delivery channels). Source: http://www.seepnetwork.org/filebin/pdf/resources/Board_Audit_Guide_2010_final.pdf. 372 The New Microfinance Handbook typically also visit randomly selected clients to of the provider’s balance sheet (or statement of verify credit files. The results of audit findings financial position), income (profit and loss) and analysis are documented in audit reports statement, cash flow statement (or statement of and include management response to the rec- changes in financial position or cash flow), and ommendations submitted to the board of direc- statement of changes in equity. Financial service tors or audit committee. providers generally undergo an external audit While primarily relevant for institutional pro- because managers, donors, investors (if applica- viders, internal audits do exist in the informal ble), and the board want assurance that the sector. For example, Savings Groups employ a statements fairly reflect the state of operations. regular audit function called an “action audit.” Normally, regulators require an audit of finan- Action audits require the group to distribute all of cial statements; licensed financial intermediar- the group’s savings and earnings from interest ies may also be required to publish audited and fees periodically to the members. The audit is financial statements. Most countries require usually timed to occur during an important time providers licensed as NGOs to produce audited of year when members require larger lump sums, financial statements. such as the start of the agricultural planting sea- External financial audits assess whether infor- son or the school year. At the end of the action mation in the financial records is congruent with audit (or “share-out”), groups normally reconsti- the accounting standards adhered to—generally tute and begin the savings and loan process again, accepted principles or International Accounting but with “clean books.” Standards and International Financial Reporting An increasing number of financial service pro- Standards. The accounting principles of financial viders are now integrating checks on social per- service providers are tested to ensure that finan- formance metrics into their internal audit function cial statements are free of material misstatement— to ensure compliance with the social mission.14 claims or misrepresentations of the financial information that are substantive enough to External Audit affect  decision making. Audits are governed by An external audit is a formal, independent review auditing standards developed under the of a provider’s financial records, transactions, and International Accounting Standards. Based on operations, performed by professional accoun- the results of the audit, external auditors provide tants. The objective of an external audit is to an audit opinion on the financial statements. The express an opinion on the fairness and reliability audit opinion can be unqualified (clean), qualified, of the financial statements of the provider’s posi- or adverse. tion and results. External audits also establish the External audits are an important component of credibility of financial statements and other man- the control environment and risk management. agement reports. Through an objective review and External auditors make assessments and observa- analysis of an institution’s operations and perfor- tions about internal control and the procedures and mance, external audits assure that the provider is policies that are designed to mitigate risks through reporting reliable information internally (to staff the management letter. However, the role of the and the board) as well as externally (to donors, external audit is not to identify fraud or risks. That investors, or regulators). External audits usually responsibility lies squarely with management. occur annually, following the fiscal year end. The work of the external audit—from the For many financial service providers, the development of terms of reference, request for financial statement audit is the most common proposals, selection of auditors, agreement of the type of external audit. It includes an assessment scope of work and terms of contract, supervision Governance and Managing Operations 373 of the work, and receipt of the auditor’s manage-  6. Using this method, pricing is not necessarily ment letter—is the responsibility of the board or its set directly by mimicking the competition. designated members, such as the audit committee. Rather, prices are set after conducting a Financial service providers draw on a range of detailed investigation of the pricing structures other audit services as necessary, including and charges of major competitors (Frankiewicz, Wright, and Cracknell 2004). special-purpose audits, operational audits, agreed- upon procedures, and reviews and compilations.15  7. This section draws on Frankiewicz and Churchill (2011). As financial services and providers diversify, particularly with technological innovations and the  8. This section was contributed by Ruth Dueck-Mbeba. possibilities they bring, the nature of operational risks will no doubt evolve as well. Practitioners and  9. http://www.cpa2biz.com/AST/Main/ support professionals in the fields of risk, control, CPA2BIZ_Primary/InternalControls/COSO/ PRDOVR~PC-990009/PC-990009.jsp. audit, IT, and management disciplines in gover- nance, change management, human resources, and 10. See www.MicroSave.org for tools to support process mapping to document work flows, organizational development will need to maintain identify risks in those work processes, and relevance and deepen capacity to meet the changes suggest ways in which to manage those risks and the challenges that those changes will bring to while retaining efficiencies. financial services for the poor. 11. Adapted from Bellino et al. (2007, 2). 12. This definition is based on guidelines outlined Notes by the Basel Committee on Banking Supervision, which is a group of supervisory  1. This section draws on Ledgerwood and White authorities established by the central bank (2006); http://microfinance.cgap.org/2010/10/ governors of the G-10 that developed a 14/getting-back-to-governance/. framework for evaluating financial institutions’  2. This section draws on Churchill, Hirschland, internal control systems. http://www.bis.org/ and Painter (2002). publ/bcbs40.pdf; BCBS (1998).  3. This section draws on Wright (2010) and 13. The definition is from https://na.theiia.org/ Frankiewicz and Churchill (2011). standards-guidance/mandatory-guidance/  4. Chapter 5 provides an overview of research Pages/Definition-of-Internal-Auditing.aspx. methods with a focus on understanding 14. http://spmresourcecentre.net/iprc/assets/File/ consumer needs and behavior and the financial internal_control_guidance_note.pdf; Ekka (2012). sector as a whole. Here the term “market 15. For more information on external audits in the research” is used to describe research microfinance industry, see CGAP (1998). conducted by financial service providers directly to develop new or modify existing products, to understand clients, to understand References and Further Reading their financial service needs and their perceptions of the provider and its services or *Key works for further reading. products, to analyze problems such as an *BCBS (Basel Committee on Banking Supervision). increase in loan defaults or a decrease in market 1998. “Framework for Internal Control Systems share, to develop and monitor customer service in Banking Organisations.” BCBS, Basel. http:// strategies, or to analyze the depth of outreach. www.bis.org/publ/bcbs40.pdf.  5. This section draws on Grace and Helms *Bellino, Christine, Jefferson Wells, Steve Hunt, (2004). and Crowe Horwath. 2007. “Auditing 374 The New Microfinance Handbook Application Controls.” Global Technology Audit Ekka, Rashmi. 2012. “Internal Control and Audit: Guide. IIA, Altamonte Springs, FL. Integrating SPM into Microfinance Capacity *Brand, Monica. 2006. “Marketing and Building.” Guidance Note, Imp-Act Competitive Positioning.” In Transforming Consortium, Washington, DC. Microfinance Institutions: Providing Full Ekka, Rashmi, and EDA Rural Systems. 2011. “Risk Financial Services to the Poor, ed. Joanna Management: Integrating SPM into Ledgerwood and Victoria White, 95–129. Microfinance Capacity Building.” Guidance Washington, DC: World Bank. Note, Imp-Act Consortium, Washington, DC. Brand, Monica, et al. 2009. Product Development http://spmresourcecentre.net/iprc/assets/File/ for Microfinance Institutions. Course manual. internal_control_guidance_note.pdf. Washington, DC: CGAP. *Frankiewicz, Cheryl, and Craig Churchill. 2006. *Burge, Jennifer F. 2008. “Embedding Enterprise Making Microfinance Work: Managing for Risk Management into the Internal Audit Improved Performance. Geneva: ILO. Process.” IIA, Altamonte Springs, FL. *———. 2011. Making Microfinance Work: Managing *Campion, Anita. 2000. “Improving Internal Product Diversification. Geneva: ILO. Control: A Practical Guide for Microfinance *Frankiewicz, Cheryl, Graham Wright, and David Institutions.” MicroFinance Network and GTZ, Cracknell. 2004. Product Marketing Toolkit. Washington, DC, and Frankfurt. Nairobi: MicroSave. http://www.microsave.org/ *CGAP (Consultative Group to Assist the Poor). toolkit/product-marketing-toolkit. 1998. External Audits of Microfinance Grace, Lorna, and Brigit Helms. 2004. Institutions: A Handbook. Technical Tool Series “Microfinance Product Costing Tool.” Technical 3. Washington: CGAP. Tools Series 6, CGAP, Washington, DC. Churchill, Craig, Madeline Hirschland, and Judith Grameen Bank. 2012. “Grameen Bank: Painter. 2002. New Directions in Poverty Introduction.” Grameen Bank, Dhaka. http:// Finance: Village Banking Revisited. Washington, www.grameen-info.org/index.php?option= DC: SEEP Network. com_content&task=view&id=26&Itemid=0. Cohen. n.d. “Listening to Clients: How to Better IIA (Institute of Internal Auditors). Various years. Serve Your Customers.” MicroSave and “Tone at the Top,” no. 18 (June 2003); no. 28 Microfinance Opportunities, Washington, DC. (November 2005); no. 30 (March 2006). IIA, http://microfinanceopportunities.org/docs/ Altamonte Springs, FL. Listening_to_Clients_How_to_Better_Serve_ ———. 2008. “GAIT for Business and IT Risk.” IIA, Your_Customers.pdf. Altamonte Springs, FL. COSO (Committee of Sponsoring Organizations of ———. 2009a. “Adding Value to the Organization: the Treadway Commission). 1992. “The Questions and Answer Recommendations.” IIA, Internal Control: Integrated Framework.” Altamonte Springs, FL. COSO, Chicago. ———. 2009b. “Audit Committees and Boards of ———. 2004. “FAQs for COSO’s Enterprise Directors.” IIA, Altamonte Springs, FL. Risk Management: Integrated Framework.” ———. 2009c. “Fraud Prevention and Detection in COSO, Chicago. http://www.coso.org/ an Automated World.” Global Technology erm-faqs.htm. Audit Guide, IIA, Altamonte Springs, FL. *Council of Microfinance Equity Funds. 2005. ———. 2010. “International Standards for the “The Practice of Corporate Governance in Professional Practice of Internal Auditing.” IIA, Shareholder-Owned MFIs.” Consensus Altamonte Springs, FL. statement, Council of Microfinance Equity *Ledgerwood, Joanna, and Victoria White. 2006. Funds, Boston. Transforming Microfinance Institutions: Governance and Managing Operations 375 Providing Full Financial Services to the Poor. *SEEP (Small Enterprise Education and Washington, DC: World Bank. Promotion) Network, and Jeane Wehlau. 2010. *Pityn, Kim, and Jennifer Helmuth. 2007. “Human “Microfinance Internal Audit Toolkit and Resource Management: Toolkit.” MicroSave. Resources.” Financial Services Working Group, *Rutherford, Stuart. 2004. “What Is Grameen II? SEEP Network, Washington, DC. Is It Up and Running in the Field Yet?” *Wright, Graham A. N. 2010. “Designing Savings Grameen II Briefing Note 1, MicroSave. http:// and Loan Products.” Report, MicroSave, www.microsave.org/briefing_notes/ Nairobi. http://www.microsave.org/research_ grameen-ii-1-what-is-grameen-ii-is-it-up-and- paper/designing-savings-and-loan- running-in-the-field-yet. products-0. 376 The New Microfinance Handbook PART V SUPPORTING FINANCIAL INCLUSION CHAPTER 16 Funding Julie Earne and Lisa Sherk This chapter examines the role of funding, the var- increasing and varied investors and has also ious types of funders, and the funding tools avail- allowed various providers to serve more clients in able for providers within the core market system. diverse areas with a variety of products. The pro- This content will be most useful to microfinance liferation of microfinance investment intermedi- providers and investors. Chapter 4 addresses the aries demonstrates the view that financial service role of funding for support functions in the market providers (FSPs) can be good and profitable invest- system in greater detail. ments while still satisfying double-bottom-line Funders are largely differentiated by their roles agendas. More recently the emergence of “impact and purpose, which reflect in part their own investing” has brought funders actively seeking source of funding as well as the tools they use. In investments that explicitly include a social devel- the early days of microfinance, funding generally opment goal. came from philanthropic or development-focused While there is a range of funder types, there is donors such as foundations, bi-lateral and multi- also a range of funding tools, including grants, var- lateral agencies, and development finance institu- ious types of debt, guarantees, and equity. Member tions. As the industry has developed and grown, deposits and fees have, historically, funded the the types of funders have expanded significantly operations of savings-based cooperatives small to include private sector institutional investors, and large. Nongovernmental organization microf- commercial banks (both local and international), inance institutions (NGO MFIs) for the most part private equity funds, and individuals. have relied on grants for operations and loan fund The commercialization and professionaliza- capital until achieving financial sustainability, at tion of the microfinance industry has attracted which point many access loans from international Funding 379 and/or local lenders to expand their operations. sector have expanded funding sources to include Deposits and other forms of debt, equity, and capital markets. retained earnings are the main sources of funding Given the increasing complexity of funding in for more formal regulated providers. Public list- microfinance and the entrance of many new ings of financial service providers and keen actors and terms, a glossary of funding terms is involvement from profit-oriented investors in the provided in box 16.1. Box 16.1  Glossary of Funding Terms Bond: A bond is tradable debt security, in ­ ompany or cash of equal value, at an agreed- c which the “issuer” (borrower) owes the “hold- upon price. It is a hybrid security with debt- ers” (creditors) a debt and, depending on the and equity-like features. Although it typically terms of the bond, is obliged to pay periodic has a coupon rate lower than that of similar, interest (a coupon) for the life of the bond and nonconvertible debt, the instrument carries repay the principal on the maturity date. additional value through the option to convert A bond is a formal contract to repay borrowed the bond to stock, and thereby participate in money and differs from a loan principally in further growth in the company’s equity value. that it can be easily traded or transferred from Correlation: Correlation is the degree to one holder to another whereas a loan is a con- which two or more measurable items show a tract between two specific parties: the bor- tendency to differ at the same time. In finan- rower and the lender. cial markets, it is usually used to describe how Capital: In general, capital represents all the returns of two or more different invest- the accumulated assets—including cash, ments move together (or not). A correlation accounts receivable, and fixed assets—of a between two investments means that the company. Sometimes, however, the term two investments always move in the same capital is used synonymously with equity, rep- ­ direction, and a correlation of −1 means that resenting the accumulated wealth of a busi- they always move in the opposite direction. ness, represented by its assets less its Covenants: Covenants are contractual liabilities (as in tier 1 capital or tier 2 capital). It agreements in debt (loan or bond) agree- is important to know the context in which the ments requiring or forbidding certain actions term is being used to determine which sense of the debtor. Positive covenants require is being used. actions, whereas negative covenants forbid Capital markets: A capital market is a mar- them. In microfinance loan agreements, there ket for securities (debt or equity), where com- are often covenants related, for example, to panies and governments can raise long-term the level of a provider’s portfolio quality, profit- funds. It is defined as a market in which ability, or capital adequacy that must be main- money is provided for periods longer than a tained by the borrower over the life of the year. The capital market includes the stock loan. The exact terms of a covenant must be market (equity securities) and the bond written in the loan agreement/bond indenture. ­market (debt). If the terms of a covenant are not met, then Convertible debt: Convertible debt is a the debt holder may declare the borrower/ type of bond that the holder can convert into issuer in default and require repayment of the shares of common stock in the issuing loan/bond. (continued next page) 380 The New Microfinance Handbook Box 16.1 (continued) Currency swap: A currency swap is an may be incurred by an associated investment. agreement between two parties to exchange For example, if a European investor makes a cash flows in two different currencies over a loan in Mexican pesos to a Mexican FSP, it predefined period of time, in order not to may hedge movements on the euro versus take on the risk of fluctuations in the other the Mexican peso in order not to incur currency. exchange rate losses if the peso devalues Diversification: In finance, diversification against the euro. means reducing risk by investing in a variety Institutional investor: An institutional inves- of assets. If the asset values do not move up tor is an investor, such as a bank, insurance and down at the same time, a diversified port- company, or retirement fund, that is finan- folio will have less risk than the weighted aver- cially sophisticated and makes large invest- age risk of its constituent assets, and often ments, often held in very large portfolios of less risk than the least risky of its constitu- investments. ents. Therefore, any risk-averse investor will Liquidity: The degree to which an asset or diversify to at least some extent, with more security can be bought or sold in the market risk-averse investors diversifying more com- without affecting the asset’s price. Liquidity is pletely than less risk-averse investors. characterized by a high level of trading activity. Equity: Equity is equal to a company’s Assets that can be easily bought or sold are assets after all outstanding liabilities have been known as liquid assets. paid (or assumed to be paid). In a for-profit Mezzanine: Mezzanine refers to a subordi- company, it also represents the ownership of nated debt investment that is senior only to the company: Shareholders’ equity (or stock- that of the common shares. holders’ equity, shareholders’ funds, share- Private placement: Private placement means holders’ capital, or similar terms) represents direct sale of securities to a small number of the remaining interest in assets of a company, investors that meet certain eligibility criteria. spread among individual shareholders of com- Retail investors: Retail investors are indi- mon or preferred stock. Shareholders are the vidual investors, members of the general most junior class of investors in assets and can public, who buy and sell assets for their per- be paid only after liabilities are satisfied. sonal account, and not for another company First-loss tranche: A first-loss tranche is a or organization. high-risk investment that accepts first loss of Secondary market: Secondary market principal in a portfolio of assets, represented refers to the market for any existing financial as a percentage of the total portfolio. For asset to be bought and sold. A secondary mar- example, an investor that has a first-loss ket can be a formal exchange, such as a stock tranche equal to 5 percent of a portfolio of exchange, or an informal one (often called US$100 million in assets will lose all principal “over the counter”) where buyers and sellers if there are loan defaults, or other losses (due, negotiate directly on the terms of any transac- for instance to currency depreciation) in tion. If an active secondary market exists, then excess of US$5 million. investors may buy or sell their assets easily. Hedging: A hedge is an investment posi- Securitization: Securitization is the finan- tion intended to offset potential losses that cial practice of combining various types of (continued next page) Funding 381 Box 16.1 (continued) debt investments and selling bonds to inves- portfolio of assets that are funded by notes tors that are repaid by the proceeds from of various risk tranches, usually to different these debt investments. types of investors with different risk/return Senior debt: Senior debt is debt that appetites. takes priority over other debt owed by a bor- Subordinated debt: Subordinated debt is rower. Senior debt has greater seniority in debt that ranks after other debts should a the borrower’s capital structure than subor- company become bankrupt. Such debt is dinated debt. In the event the borrower goes referred to as subordinate, because the debt bankrupt, senior debt theoretically must be providers (the lenders) have lower status in repaid before other creditors receive any relationship to the normal, senior debt. payment. Because subordinated debt is repayable after Structured products: Structured products other debts have been paid, they are more are investment structures that combine a risky for the lender of the money. The Role of Funding and will be more interested to fund more mature, developed institutions. Funding is required by all financial service pro- Different types of funding support different viders to finance expanded outreach, to develop objectives. Debt financing is typically extended to new products and channels, or to move into new fund portfolio growth or refinance maturing debt. regions and market segments. The majority of Equity is often used as a foundation to support direct funding to microfinance is to support port- regulatory requirements and to secure other types folio growth,1 although this may vary depending of financing by acting as a financial cushion that on the stage of development of the provider being provides greater comfort for lenders to provide financed. For a greenfield or early stage institu- debt. Increasingly the type and structure of fund- tion, a greater proportion of funding—typically ing available is designed with the needs of the equity and grants—will be required for start-up actual microfinance client in mind. Innovations in costs, infrastructure, and capacity building, ver- structured finance allow investors with different sus portfolio funding for a more mature institu- risk and return appetites to participate in the tion already able to generate sufficient income to same funding vehicle with some investors taking cover its costs. “first loss” while others have a more secured posi- The type of provider a specific funder will sup- tion. This helps to increase the term and amount port depends particularly on their return expec- of funding available, which in turn facilitates dif- tations, mandate, and the importance of social ferent products such as longer term leasing and vis-à-vis financial return. Patient capital from housing credit. Local currency debt allows a pro- double-bottom-line investors with longer invest- vider to borrow in the same currency it uses to ment horizons provides investees the time they serve its clients. need to grow through a start-up phase or trans- Investments that require a return generally formation and become profitable. Other funders instill greater discipline and accountability for may have liquidity and/or return requirements 382 The New Microfinance Handbook the investee. Here, in a very tangible form, debates Cross-border funders are foreign funders on subsidy and sustainability come to a head. that allocate or invest funds in other countries, Although subsidies aligned with investment can whereas local funders allocate or invest funds support frontier projects and organizations ini- within their own country. The primary sources tially unattractive to the private sector, such sub- of funding in local markets are deposits, local sidies should also result in a public good beyond banks, and capital markets. Cross-border the specific company, such as new institutions or financing is increasing and reached US$24 products coming to market facilitating greater ­ billion in commitments as of December 2010, access. with about 70 percent from public funders and 30 percent from private funders (CGAP 2011). The 20 largest microfinance funders provided Types of Funders approximately US$15 billion in funding in 2010 A wide variety of funders support financial ser- and include 10 DFIs, 5 multilateral agencies, vice providers. Important distinctions to note 3  bilateral agencies, 1 institutional investor, and when discussing the types of funders include the 1 foundation. The top five largest funders include difference between funders and intermediaries, KfW with 18 percent of overall funds invested, public and private funders, and cross-border and followed by the World Bank with 11 percent, the local funders. Asian Development Bank with 11 percent, IFC at Funders allocate or provide funds directly to 9 percent, and EBRD 7 percent (CGAP 2011). financial service providers, and intermediaries Although the amount a funder commits to receive funds from various sources and then microfinance is one indication of its role in the invest them in individual providers. The distinc- sector, a funder’s effectiveness depends on its tion between these two groups is not always staff capacity, local presence, and relationship to completely clear: Banks, for example, intermedi- its partners, including governments, cofinanciers, ate (on-lend) funds they receive as deposits and and clients. Many of the largest cross-border are therefore usually considered “intermediar- funders have a presence in many countries and ies.” For the purposes of this chapter, however, increasingly a decentralized operating model. banks are included as “funders,” because it is the Despite this, in many markets, particularly bank’s board or management that has made the those in Sub-Saharan Africa, deposits are the decision to allocate funds to microfinance largest source of funding for most providers (in whole or in part). (CGAP 2012). Figure 16.1 provides the funding Intermediaries include microfinance invest- proportions by funder type and whether fund- ment vehicles, microfinance holding companies, ing was direct or through intermediaries. Note local apex organizations, and peer-to-peer aggre- that financing from local sources—deposits, gators. Intermediaries are themselves funded by local banks, and capital markets—is not included both public and private investors. in this graphic. Public funders include (1) bilateral agencies, Motives and return expectations vary consid- (2) multilateral agencies, (3) development finance erably by funder type, from public good to pure institutions (DFIs), and (4) local governmental profit and many combinations in between. agencies. Private funders include (1) foundations, Although private investors make up a smaller (2) NGOs, (3) private institutional investors, and percentage of microfinance funding than public (4) private individual investors, both retail funders, the amount of private funding is growing (the general public) and high-net worth individu- more quickly. This growth is predominantly als (see table 16.1). driven by large foundations and institutional Funding 383 Table 16.1  Public and Private Funders Public Bilateral agencies Multilateral agencies DFIs funders Examples Canadian International African Development Agencia Española de Cooperación Development Agency Bank (AfDB), Asian Internacional para el Desarrollo (CIDA), Gesellschaft für Development Bank (AECID), Belgian Investment Internationale (ADB), European Company for Developing Countries Zusammenarbeit (GTZ), Commission (EC), (BIO), Corporación Andina de Swedish International International Bank for Fomento (CAF), Dutch Development Development Cooperation Reconstruction and Agency (FMO), European Bank for Agency (SIDA), Swiss Development (IBRD of Reconstruction and Development Development Corporation the World Bank), (EBRD), European Investment Bank (SDC), U.K. Department International Fund for (EIB), Inter-American Investment for International Agricultural Development Corporation (IIC), International Development (DFID), U.S. (IFAD), United Nations Finance Corporation (IFC), KfW Agency for International Capital Development Entwicklungsbank (KfW), Multilateral Development (USAID) Fund (UNCDF) Investment Fund (MIF IADB) Tools used Grants, guarantees Grants, guarantees, Debt, equity, guarantees, grants debt, equity Private Institutional Foundations NGOs Individuals funders investors Examples Bill & Melinda Gates ACCION, ACP, Pension funds, High-net-worth Foundation, Ford Foundation, FINCA, insurance individuals, retail Grameen Foundation, Grameen Opportunity companies, private investors, individual Jameel, MasterCard International, equity firms, donors Foundation, Michael & Susan SEPAR commercial banks Dell Foundation Tools used Grants, debt, equity Grants, debt, Debt, equity Debt, equity, equity donations, deposits Note: DFI = development finance institution; NGO = nongovernmental organization. investors, two groups with often different motiva- more split, with foundations focusing more on tions. Where foundations often provide funding, market development and investors targeting a primarily grants, to achieve development goals, double bottom line where financial returns are individuals and institutional investors invest for balanced with objectives to improve financial both social and financial reasons and usually look access and impact. for a financial return. Some funders specify what funding may be The motivations of funders are increasingly used for. This is often detailed explicitly in the focused on scale, commercialization, and broad- case of grant funding. For debt financing, the use based financial inclusion. As discussed in chap- of proceeds is often not stipulated, although in ter 4, public funders tend to focus on the some cases lenders may require that funds be facilitation of market development, providing an used only to fund a specific product (for exam- example to private investors with the aim of ple, agricultural loans or loans below a certain “crowding in” or attracting private investors to size) or target market (for example, women or underinvested markets. Private funders are clients in rural areas). 384 The New Microfinance Handbook Figure 16.1  Sources of Microfinance Funding Public donors and Private donors and investors investors (multilaterals, bilaterals, DFIs) (foundations, institutional, and individual investors) $14.6 billion $6.7 billion $2.4 billion $5.7 billion Microfinance investment intermediaries (MIIs) $1.2 billion $1.2 billion $11 billion $0.9 billion Apexes and $8.1 billion other intermediaries No data Microfinance Source: Adapted from El-Zoghbi et al. 2011. Note: DFI = development finance institution. In line with CGAP’s definition, apex institutions are intentionally separated from micro- finance investment intermediaries because they tend to be funded publically and are generally local intermediaries only. Public Funders ­ ombination of initial country shareholder con- c Public funders provide funding to achieve devel- tributions and retained earnings, and they also opment goals and have clear social objectives often issue bonds on capital markets. Ultimately underlying their activities. They are funded these institutions are accountable to the public from national budgets in the case of bilateral at large and seek a double-bottom-line return. agencies such as USAID or SIDA, and from Public funders are therefore active through a country contributions in the case of multilateral variety of different tools, including grants, guar- agencies, including the World Bank or United antees, debt, and equity. Public funders gener- Nations. Development finance institutions (such ally provide support where the private sector as the German development bank KfW, FMO cannot or will not participate, to help create con- in the Netherlands, or IFC, the private sector ditions that will ultimately encourage private arm of the World Bank Group) are funded by a sector involvement. Funding 385 Bilateral and Multilateral Agencies (IFAD), the European Commission (EC), and the Bilateral development agencies are country- African Development Bank (AfDB) (CGAP 2011). specific government agencies that work directly with governments in developing countries and Development Finance Institutions other organizations. Bilateral strategies are often Development finance institutions (DFIs) differ linked to foreign policy initiatives of the donor from MDBs in that they largely focus on the pri- country. Funding from bilateral agencies is fre- vate sector. DFIs invest funds both directly in quently directed to developing markets through financial service providers and increasingly either supporting individual financial service through intermediaries such as investment providers or funding the development of support- funds or holding companies (discussed below). ing service markets. If not provided directly to the Some of the primary DFIs investing in microfi- government, bilateral funding is given to local or nance include KfW, the European Bank for international NGOs to support capacity develop- Reconstruction and Development (EBRD), the ment. Because of their strong credit standing, International Finance Corporation (IFC, the pri- bilateral agencies are also well placed to provide vate sector arm of the World Bank Group), and guarantees for providers to issue debt purchased FMO (the Dutch development bank). by private sector participants. As quasi-government, DFIs are double- Multilateral and UN agencies provide finan- bottom-­line investors and, as such, have dual obj­ cial support (grants, guarantees, and debt)2 and ectives of profitability and development impact. professional advice for economic and social DFIs generally allocate resources to p ­ rojects and development activities in developing countries. companies that may not initially be appealing to The term multilateral development bank (MDB) the private sector. Many DFIs attempt to crowd in typically refers to the International Bank for the private sector by investing in frontier projects, Reconstruction and Development (IBRD, com- demonstrating that these providers are inves- monly referred to as the World Bank, the public table, and exiting once greater confidence in a sector arm of the World Bank Group) and other given market is built. However, in economies regional development banks such as the African where there is a vibrant or emerging private and Asian Development Banks. These banks are investment sector, DFIs must be careful not to characterized by broad ownership, including crowd out the private sector by providing more both governments of developing countries and lenient terms or unnecessarily subsidizing governments of developed countries. Most multi- well-performing institutions. In particular, the lateral funding organizations are organized to choice of countries and funding tools as well as interact with a target country’s government,3 and the timing of a DFI’s exit from its investments is funds are largely provided as loans to govern- key to ensure effective development of financial ments. Governments then use the funds to on-lend markets. to various provider types and to support capacity- building initiatives of providers or to support Private Funders market infrastructure and policy development Most private funders in the financial service mar- (El-Zoghbi et al. 2011). Given MDBs’ extensive ket are driven by both social and profit motives. relationships with governments, they are well Impact investment, double-bottom-line invest- placed to influence policy makers. In 2011 the top ment, triple-bottom-line investment, or sustain- five multilateral funders of microfinance were the able investment is defined as investment in IBRD, the Asian Development Bank (ADB), the businesses or funds that intentionally set out to International Fund for Agricultural Development generate social or environmental good alongside 386 The New Microfinance Handbook financial returns. It has been driven by various efforts. Many are also active in areas other than factors including the recognition that govern- financial inclusion, such as health, women’s ment and charities alone do not have sufficient empowerment, children’s issues, or humanitar- capital to solve the world’s social and environ- ian relief. NGOs typically provide grants to assist mental problems, the corporate social responsi- product development, the provision of non- bility (CSR) considerations of private companies, financial services, or seed capital for operations and in some cases interest in a risk profile that is to serve specific, underserved groups that fall seen to provide greater social and financial under their general mission/target clientele. rewards (Reille et al. 2011). These return expecta- NGOs that have helped to start up local MFIs tions are becoming increasingly interwoven in (and often remain on as shareholders after trans- terms of both the investment tools used and the formation) include such entities as ACP (Acción metrics used for defining success. Comunitaria del Perú, founder of MiBanco); FIE NGO, founder of Banco FIE in Bolivia; Separ, Foundations founder of Confianza in Peru; Urwego, founder Foundations are endowed with capital from of UOB in Rwanda; and Acleda, founder of (generally) private sources, often from very suc- Acleda in Cambodia. cessful multinational corporations such as Microsoft (the Bill & Melinda Gates Foundation) Institutional Investors or the Ford Motor Company (the Ford Pension funds and insurance companies are Foundation). Foundations contribute to develop- increasingly investing in financial service mar- ment by supporting global philanthropic initia- kets for both social value and diversification in tives, recognizing that private money can returns with other investments that they typi- significantly help to address global poverty. cally make. “Impact investing” has emerged in Funding provided by foundations to microfi- the past few years as an overall investment nance can take a wide variety of forms, although it theme within the socially responsible investing is primarily in the form of, for example, grants for (SRI) sector and involves making investments training, capacity building, or product develop- that are specifically intended to have a positive ment, or as seed capital for start-up institutions. social impact. This differentiates them from Foundations often also act as “catalytic” investors, other types of SRI investments, which screen agreeing to take the first loss in an investment out investments in companies or products that portfolio to create a cushion for other, more risk- may have a negative impact, such as those that averse investors (that is, certain investments can pollute the environment or produce cigarettes be set up in such a way that if there is a default in and firearms. As of 2011, financial services was a portfolio, the foundation would absorb this loss, the sector that received the largest allocation and other investors would be protected). Some of investments within impact investing (Saltuk foundations also invest in microfinance invest- et al. 2011). ment vehicles (discussed below). Most investments in microfinance from pen- sion funds and insurance companies have been NGOs made through intermediaries. Although institu- Many NGOs, both local and international, are tional investors may have both social and finan- involved in funding microfinance. They obtain cial motivations, they do require a financial funding from multiple sources in the public and return. As a result, the majority of their funding private sectors and also raise funding directly goes to established, profitable providers. from individuals through targeted fundraising Institutional investors also generally have Funding 387 various requirements on reporting standards Banks that have influenced the way providers and Local commercial bank funding to microfinance intermediaries gather and provide information providers varies significantly by country; in on their operational, financial, and social results. some countries they are not active at all, whereas The entry of institutional investors into the field in others they are key funders in financial ser- of financial inclusion has been an important vices for the poor. They are typically present development in the evolution of the industry, only when both the local banking industry and resulting in microfinance being more in the the microfinance industry are well developed mainstream of investment alternatives with and/or if government mandates exist. In India, more standardized reporting, ratings by main- for example, local banks are actively encouraged stream rating agencies, and other more formal by a regulation that requires banks to lend to sector characteristics. Box 16.2 provides an over- “priority sectors” to help achieve national devel- view of the size of the institutional investor mar- opment goals. ket in microfinance and examples of noteworthy Commercial banks invest in microfinance to transactions. achieve both commercial and socially responsible Box 16.2  Institutional Investors in Microfinance The market for institutional investors in micro- combined assets under management, finance is relatively new. Institutional inves- launched a US$100 million Global Microfinance tors are the fastest growing investment group Investment Program. The program has since in microfinance, having increased their out- invested in ProCredit, a German holding com- standing investment in microfinance from pany with microfinance banks in 21 develop- US$1.2 billion in 2006 to US$3.5 billion in 2010 ing countries. Similarly, in April 2010, Dutch (CGAP 2011). A December 2011 survey con- pension fund ABP invested US$30 million in ducted by J. P. Morgan and the Global Impact global private equity fund Grassroots Capital. Investing Network on “impact investing” as a The investment brought ABP’s total debt whole (with microfinance constituting approx- and equity holdings in microfinance to imately 40 percent of current investment in US$215 million. The Swiss Post Pension impact investing) reported that institutional Fund dedicated CHF 130 million to microfi- investors who responded to the survey nance in 2011 and stated “our analysis of expected to allocate approximately 5 percent microfinance assets has shown that this of their total investments to impact investing asset class fulfills our set selection criteria: it over the next 10 years. offers an attractive risk/return ratio and can be A diverse set of institutional players are expected to enhance our portfolio diversifica- dedicating investment resources to microfi- tion.” Likewise, insurance companies with nance. Institutional investors include interna- long-term funding have begun to invest in tional banks, pension funds, and insurance microfinance. The Sonam insurance company companies. For example, in 2006 TIAA-CREF, in Senegal has invested in MicroCred Senegal a leading pension fund with US$453 billion in directly. Source: Reille et al. 2011; Saltuk et al. 2011; Responsible Investor 2012. 388 The New Microfinance Handbook goals. Although most banks initially engaged in NGOs, peer-to-peer aggregators (discussed microfinance by providing donations to achieve below), or increasingly, through microfinance CSR goals, many have now incorporated microfi- investment vehicles. nance activities to achieve both financial and social business goals. Local commercial banks some- Intermediaries times sell cash management services to smaller Although many public and some private funders microfinance providers, and after building a rela- directly fund individual providers, a large por- tionship begin to extend credit and other invest- tion of funding to microfinance is channeled ment services such as credit lines or term loans. through intermediaries. Microfinance invest- However, conditions tend to be more conservative ment intermediaries (MIIs) are attractive to than other lenders, for example, by requiring col- investors because they can provide economies of lateral or offering shorter term financing. Local scale, diversified portfolios, and dedicated commercial banks also sometimes provide equity regional and industry expertise that direct inves- to local providers or establish cobranded, special- tors may not have the budget or scope to build in ized subsidiaries with the aim of expanding the house. MIIs come in many forms and include financial sector locally or to reach a new market microfinance investment vehicles, networks and segment. Box 16.3 provides examples of commer- holding companies, apex institutions, and peer- cial banks’ investment in microfinance. to-peer aggregators. Individual Investors Microfinance Investment Vehicles (MIVs) Individual investors are driven by the dual Approximately half of all microfinance investment trends of retail investing and high-net-worth from DFIs, individuals, and institutional investors investing. Where some high-net-worth individ- is channeled through MIVs (El-Zoghbi et al. 2011). uals have made direct investments in financial MIVs are private investment funds managed by service providers (typically as equity), the vast specialized investment managers. They play an majority invest via microfinance investment increasingly important financial intermediation vehicles, whereas smaller retail investors chan- role between investors (usually foreign) and finan- nel funds through donations to foundations or cial service providers. Increasingly, MIVs target Box 16.3  Commercial Bank Investment in Microfinance Commercial banks invest both debt and equity their development finance group as part of in microfinance providers. Bank of Africa and the bank’s overall corporate social respon- BFV-SG (Société Générale) are minority equity sibility commitment, Deutsche Bank pro- investors in greenfield microfinance institu- vides debt, equity, and limited philanthropic tions. As minority investors, the banks have grants to the microfinance sector. Between board seats, help in the licensing process, and 2002 and 2012, Deutsche Bank microfi- provide complementary services to some nance had invested $215.5 million in capital SME clients as they grow larger. in over 50 countries benefiting an esti- Deutsche Bank was one of the first global mated 2.8 million poor entrepreneurs banks to establish a socially motivated (https://www.db.com/us/content/en/ microfinance fund in the late 1990s. Led by 1077.html). Funding 389 underserved markets and rural areas that other basis. Because of this liquidity feature, and funders may not have the capacity to engage with because loans made by MIVs to financial service directly. Symbiotics, a fund manager based in providers cannot easily be sold, loans provided Geneva, estimates there were more than 102 MIVs by these funds are usually short to medium term as of 2011, managing US$6.8 billion. The majority (usually averaging about two years, with maxi- of MIVs are focused on debt investments. A mums in the three- to five-year range). Typically smaller, but growing, proportion focus on equity such funds target established, well-performing investments, and some provide both (so-called institutions, although to varying degrees they mixed or hybrid funds) (Symbiotics 2011). Box 16.4 also invest in smaller institutions, and some may provides aggregated data on the MIV segment. also offer equity in addition to debt. Most MIVs are global in nature to maximize Debt and Hybrid MIVs diversification and geographical outreach. Although MIVs are largely funded by institu- Although the investment funds themselves are tional investors, some debt and hybrid MIVs are denominated in hard currency (usually dollars or open to retail investors, such as the Dexia euros, with some also in Swiss francs), most also Micro-Credit Fund, responsAbility Global make loans in local currency to providers. The Microfinance Fund, Dual Return Fund, and majority use currency-hedging instruments so Triodos SICAV. These are set up as mutual funds that their investors are not exposed to foreign and allow investors to buy or sell their shares in exchange risk and receive a more predictable the funds usually on a monthly or quarterly return. The funds typically target a stable return, Box 16.4  Aggregating Data on MIVs Since 2008, CGAP, and then Symbiotics, has conducted annual surveys of the MIV market, ana- lyzing data and industry trends. For the 2011 survey, 70 MIVs, representing 87 percent of the total estimated MIV market, responded to the survey. Some of the key findings were as follows: • Fixed-income funds are the main type of MIVs, accounting for 64 percent of the total partic- ipating MIVs and 83 percent of the total assets under management. Assets under Microfinance investment Number of management vehicles (MIVs) MIVs ($ million) % of total Fixed-income funds 45 4,881 83 Mixed funds 13 667 11 Equity funds 12 358 6 Total 70 5,906 100 • Private institutional investors represent the largest share of investors in each MIV peer group (figure B16.4.1). (continued next page) 390 The New Microfinance Handbook Box 16.4  (continued) Figure B16.4.1  Source of MIV Funding 100 9% 13% 26% 31% 75 60% percent 61% 50 45% 40% 25 30% 30% 31% 27% 0 All MIVs Fixed-income Mixed funds Equity funds funds Public sector funders Private institutional investors Retail investors and high-net-worth individuals • Geographical focus is concentrated in Eastern Europe and Latin America, although trends are for MIVs to expand their investments in underserved areas, such as Africa and the Middle East. % of portfolio invested in Microfinance East Asia and investment Eastern Europe Latin America Pacific, South Africa and vehicles (MIV) and Central Asia and Caribbean Asia Middle East Fixed-income funds 45 34 14 8 Mixed funds 27 39 27 8 Equity funds 6 47 45 2 Total 40 35 17 7 2010 growth across all funds 5 12 26 32 Source: Adapted from Symbiotics 2011 MIV Survey. usually somewhat higher than investors would Enhancement Facility (MEF), and the Rural receive on three- to six-month bank deposits. Impulse Microfinance Fund, with the main differ- Other, similar MIVs are private placement debt ence being that only “qualified” investors who and hybrid funds, such as the European Fund for meet certain regulatory requirements are able Southeast Europe (EFSE), the Microfinance to invest in these vehicles through private Funding 391 placements, and they may also be closed to new private institutional investors. Next in line for investors. They are also more likely to have repayment are so-called mezzanine “B” notes, regional or sectoral focuses than funds that are which are higher risk but also provide higher open to retail investors and usually also do not pro- return. These are often bought by DFIs willing to vide regular liquidity. These vehicles are funded support greater developmental return or private principally by institutional investors and DFIs. investors willing to take greater risk for a higher Other MIVs are cooperative/NGO structures, return. The third class—the first-loss “equity” such as Oikocredit or Alterfin funds. The differ- tranche—is paid back last and are generally ences with these funds are that these structures bought by foundations and bilateral and multi- are owned by their members and tend to target lateral development agencies that may not smaller institutions, with a more explicit focus on expect a return on their investment but are will- social performance than other funds. As a cooper- ing to provide the catalytic investment to allow ative MIV, Oikocredit in the Netherlands has a the structure itself to go forward. Given the different structure than other MIVs in that its development of different types of structured members provide the capital and vote on the size funds, box 16.5 provides examples of the evolu- of the annual dividends they receive annually, tion of structured funds in the market. which has historically been 2 percent or less. Members are principally churches, church-re- Equity Fund MIVs lated organizations, and support associations Equity fund MIVs are also usually of a fixed dura- (www.oikocredit.org). tion and, because of the long-term nature of the Other debt funds are set up as structured investment, do not generally allow investors to sell finance vehicles, often called collateralized loan their interest in the fund until the end of the fund’s obligations (CLOs) or collateralized debt obliga- term. Typically they have a “ramp-up” investment tions (CDOs). Structured finance vehicles are period of several years, followed by another multi- established for a fixed period of time and, in their year “exit” or divestment period. They are a het- simplest form, fund a portfolio of loans to provid- erogeneous group with varying return targets ers. They are funded by issuing “notes” to inves- typically offering a blend of equity and convertible tors whose repayment comes from the repayment debt to high-growth providers in emerging mar- of loans in the portfolio. They can also act as a kets. The first generation of equity MIVs were set means to “securitize” loans within the providers’ up largely by DFIs or international NGO networks. portfolio itself, combining a large number of loans Private investors—first high-net-worth and then made to provider clients into an overall structure institutional investors—have been increasingly and then selling notes to investors that are repaid involved, with regionally focused funds such as by repayment proceeds on these loans. Bellwether in India, global funds such as the Structured finance vehicles issue various BlueOrchard Private Equity Fund, and traditional classes of notes that appeal to different types of venture capital funds such as Sequoia Capital. The investors. In a typical structure, there are three Symbiotics 2011 MIV survey showed equity funds or more different classes of notes, which are paid to be the fastest growing segment of MIVs. sequentially (in a so-called payment waterfall) as One of the first equity funds dedicated to the loans that the structured vehicle has made to microfinance was ProFund, incorporated in 1995 providers are repaid. For example, the most as a for-profit investment fund, with funding senior “A” notes would be paid first and are principally from NGOs, DFIs, and multilaterals. therefore the lowest risk tranche in the struc- The fund was created both to provide returns to ture. Typical investors in these “senior” notes are investors and to act as an example for future 392 The New Microfinance Handbook Box 16.5  The Changing Character of Structured Funds The nature of structured funds has changed along with developments within the wider market of collateralized debt obligations (CDOs), a US$1.3 trillion global industry in 2007, which all but dried up in the 2008/9 global financial crisis. (In 2009 only US$4 billion in CDOs were issued globally, compared with US$455 billion at the market’s peak in 2007, according to the Securities Industry and Financial Markets Association.) In microfinance, the first large CDOs came to market in 2004–7 (for example, BlueOrchard Microfinance Securities, BlueOrchard Loans for Development, and Microfinance Securities XXEB) and were focused mostly on lending to top-tier financial service providers, with high coun- try diversification. These funds were viewed as a way to bring mainstream institutional investors into microfinance and were structured in the same way as mainstream financial market CDOs, with the highest target return going to the highest risk equity tranche. For example, BlueOrchard Loans for Development 2007 had its two senior tranches rated by Standard & Poor’s. Changes in the market conditions in 2008, however, meant that such products were difficult to sell to institutional investors after the crisis. More recent CDOs have been smaller focusing on tier II and tier III FSPs, with public donor funds taking the first-loss equity pieces, often with no expectation of return, and also tend to be regionally focused. The Regional MSME Investment Fund for Sub-Saharan Africa (REGMIFA) is one of this latter group. REGMIFA is meant to build, over time, a public-private partnership for Africa that leverages donor funds with private capital and supports the economic growth and job creation in the region. The fund is a partnership between various European member states, DFIs, and, through its tiered risk-sharing structure, aimed to attract private institutional investors. Figure B16.5.1 illustrates REGMIFA’s structure and flow of funds. The objectives of REGMIFA are (1) to offer and encourage additional but market-based financing—with an emphasis on local currency—to financial entities serving micro- and small ­ businesses (“microfinance institutions”), (2) to help establish microfinance as an asset class with mainstream investors and leverage donor funds with private capital, and (3) to support medium-term capacity building among financial entities serving micro- and small businesses. REGMIFA provides local currency debt financing to smaller banks, nonbank institutions, and commercially oriented NGOs that serve small and microbusinesses. A parallel technical assis- tance facility provides capacity-building support to investees. Figure B16.5.1  REGMIFA’s Structure and Flow of Funds Asset portfolio The facility Investors Issue proceeds Notes/ SICAV-SIF A shares Luxembourg Dividends/redempt. (private Portfolio of investors) loans and Investment guarantees manager • Board Issue proceeds to eligible • Investment B shares MFIs committee Dividends/redempt. (DFIs) • ALM committee Issue proceeds C shares (govts.) Dividends/redempt. Source: Adapted from International Finance Corporation. Funding 393 private, commercial investors. ProFund invested network model is shrinking in favor of more for- in 10 MFIs in Latin America and was liquidated, mal institutional models. as planned, in 2005, providing an overall 5.1 The holding company model was pioneered by percent annual return to investors. ProCredit Holding and has been replicated suc- cessfully by AccessHolding, MicroCred, and the Microfinance Holding Companies Advans networks, among others. The holding Many international microfinance “networks” company is usually the majority founding share- are set up as NGOs or holding companies. These holder and sponsor of network banks. It effec- networks, with their own donors or investors, tively acts as the investment vehicle for DFIs to channel funds to affiliate operations globally, set up and manage new providers in underserved providing grants, equity, debt, and parent guar- markets. Given that most holding companies have antees depending on the requirements of the DFI shareholders, they effectively create public– affiliate (table 16.2). Notable NGO actors in this private partnerships that demonstrate scalable realm include ACCION International and and replicable commercial microfinance models Opportunity International, although the NGO in nascent markets. Table 16.2  Holding Company Investment Examples Holding Number of Area of Assets Investors company investments investments Access €479.8 million (as 7 Primarily in Sub- CDC Group plc, European Holdings of December 2011) Saharan Africa and Investment Bank (EIB), founded 2006 Central Asia International Finance in Germany Corporation (IFC), KfW Entwicklungsbank (KfW), LFS Financial Systems GmbH, MicroAssets GbR (MA), Omidyar-Tufts Microfinance Fund (OTMF), the Netherlands Development Bank (FMO) Advans SA €133.5 million (as 6 Sub-Saharan Africa CDC, EIB, FISEA (Proparco), founded 2005 of December 2011) and Cambodia FMO, Horus Development in Finance, IFC, KfW Luxembourg MicroCred SA €108.7 million (as 6 Primarily in AXA Belgium, Developing World founded 2005 of December 2011) Sub-Saharan Africa Markets (DWM), EIB, French in France and China Development Agency (AFD), IFC, PlaNet Finance, Société Générale ProCredit €5.4 billion (as of 21 Eastern Europe, BIO, DOEN, FMO, Fundasal, Holding December 2011) Latin America, and IFC, IPC GmbH, IPC Invest founded 1998 Africa GmbH & Co., KfW, Omidyar- in Germany Tufts, PROPARCO, responsAbility, TIAA-CREF Source: Holding company websites: www.accessholding.com; www.advansgroup.com; www.microcredgroup.com; and www.procredit-holding.com. 394 The New Microfinance Handbook For example, FINCA, one of the world’s largest Peer-to-Peer Aggregators microfinance networks, announced the launch of Peer-to-peer lenders such as Kiva, MicroPlace, a subsidiary called FINCA Microfinance Holdings Globe Funder, Babylon, and Good Return provide (FMH) in July 2011. The holding company was an opportunity for individuals to “invest” money created to enable a US$74 million capital invest- directly in microfinance institutions. They act as ment from socially responsible investment insti- retail aggregators, by creating Internet-based tutions to strike the right balance between platforms that leverage technology to facilitate attracting capital needed for expansion and pro- direct investment from individuals on a small tecting the integrity of FINCA’s charitable mis- scale. Disadvantages for providers include the fact sion. The goal of FMH is to increase outreach as that most peer-to-peer aggregators do not nor- well as introduce new products such as savings mally provide local currency funding and report- and insurance products to existing clients (FINCA ing requirements are significant and costly. press release, Washington, DC, June 17, 2011). Financial service providers that use these funds Some holding companies have a number of are generally second- and third-tier providers that shareholders at the holding level, with the hold- do not have access to more commercial sources of ing company owning 100 percent of the subsid- funding. Proponents of the model claim there is a iaries, as is the case of FMH and most ProCredit facilitation role these aggregators play by provid- subsidiaries. Other holding companies have a ing funding deeper in the sector. Given the often number of investors at the holding level and at the limited recourse between the aggregator and the subsidiary level to facilitate local shareholders provider receiving the funds, providers may use and other strategic investors. these funds to finance risky clients and/or to fund pilots for new products. Although acting as a first- Local Apex Organizations loss facility is not necessarily the proclaimed strat- An apex is a pool of funds constituted domesti- egy of peer-to-peer lenders, it is a potentially cally to lend to providers that, in turn, disburse useful, if unintended, use of their funds. loans to low-income people. Apexes distribute Box 16.6 addresses the consequence of funding funds to providers mostly in the form of subsi- concentration in the microfinance sector. dized loans and occasionally as grants. Apexes are funded with public money but take various Funding Tools institutional forms, such as development banks, nongovernmental organizations, donor pro- Funding is provided through various tools. The grams, private commercial banks, and special mission and scope of the funder, the investee’s government or donor programs. CGAP mapped (financial service provider) performance, its 76 apexes in 2009 and found the largest 15 ability (or inability) to mobilize deposits, the apexes had a total gross loan portfolio of more regulatory framework, and the openness and level than US$3 billion as of 2009. Although apexes of development of the financial system all impact exist in all regions, they are most prevalent in the choice of funding tools used. In general, Latin America and South Asia (Duflos and however, as financial service providers mature, an El-Zoghbi 2010). The 15 largest apexes lent to increasing number of funding options are available 1,650 retail microfinance providers in 2009, to them. Whereas NGOs traditionally rely on across a wide variety of institutional types, subsidized grants to fund portfolio growth, including NGOs, cooperatives, microfinance sustainable and profitable institutions are able to banks, and other commercial finance compa- attract equity investors, issue longer term and nies (Forster et al. 2012). unsecured debt, and raise funds on capital Funding 395 Box 16.6  Funding Concentration Funding is crucial to improving financial access Microfinance investment is concentrated because it ensures that providers have the both geographically and increasingly through resources needed to expand, through either intermediaries. From a geographic perspec- increasing the volume of clients served, mov- tive, funding is concentrated mainly in Latin ing into new geographic areas, or introducing America and Europe and Central Asia. Ten new products into the market. countries with a combined population of 100 With debt and equity investments from million receive more than 60 percent of all public and private investors alike, providers ­foreign lending. have moved from donor-dependent projects There is similarly a great deal of concen- to sustainable financial service providers. tration among investee institutions. As of Between 2007 and 2010, foreign investment December 2010, DFIs committed US$9.1 in microfinance (including both debt and billion with half of this funding going to equity) quadrupled to reach US$24 billion 30 recipients: 12 MFIs with an average (CGAP 2011). Additionally, top-tier providers investment of US$120 million per institution are increasingly accessing financing through and 18 MIVs, holding companies, local banks, capital markets, as development oriented and funds with an average investment of investors are looking at tier 2 and tier 3 pro- US$160 million. viders as possible investments.a Investment concentration is a challenge to Although the benefits of increased funding truly expanding financial access and reflects are well established, there are those who the lack of viable MFIs in many markets. argue that a large surge of microfinance Diversification in recipient institutions and investment is now struggling to find appropri- countries is important to ensuring markets are ate institutions to invest in, with most money not flooded with capital, which may prompt still flowing to the same top-tier providers. irresponsible lending behaviors by providers. Source: Peter McConaghy drawing from El-Zoghbi et al. 2011. a. Tier 2 providers are often defined as successful, but smaller, younger, or simply less well-known providers. They ­ nderstandable are typically at or near profitability. Tier 3 providers are those approaching profitability that have u shortcomings due to, for example, being a young organization, lacking capital, or having weak information systems. markets, and deposit-taking institutions are able markets enables providers to diversify funding to intermediate savings from the general public. sources, reduce foreign exchange risks (via Funding is transferred either through a direct sources of local, rather than foreign, capital), and investment between a funder or intermediary and support growth and loan product diversification a provider or through public capital markets (for example, housing loans) through longer-term where institutions and governments raise funds in funding (Women’s World Banking 2006). the form of financial securities such as bonds and Capital markets provide investment access to stocks. Both bond (debt) and stock (equity) mar- the public at large and are regulated given the kets are part of the capital markets. Microfinance presumed lack of sophistication of retail public is increasingly tapping into capital markets, both investors. The securities laws of many countries as a fundraising tool for providers and as an exit require the issuer to register the offer of securities mechanism for investors. Accessing capital with a national securities regulatory authority 396 The New Microfinance Handbook before making public offers and sales. These reg- targets. Performance-based grants help ensure istration requirements impose a high standard of the subsidy is no greater than necessary to induce disclosure on the issuer. Through engaging with the required performance and do not simply capital markets, providers also develop capacity increase the profits for the provider. as they satisfy the demands of investors and the process of becoming “investment ready.” Thus, a Debt secondary benefit of drawing on capital markets Debt represents funds lent over a fixed period of is professionalization and skill building of the time and must be repaid, normally with interest. financial service provider. Debt is often defined by its level of seniority, or, in other words, which lender is paid first in the Grants event that the issuer runs into financial problems Grants are primarily used to encourage financial and cannot repay all of its obligations. At the top service providers to deepen their outreach, to are public depositors, who bear the least risk and develop new products and channels, or to support consequently generally earn the lowest return. At the development of the market. Grants are gener- the bottom are subordinated lenders, who bear ally nonreimbursable, meaning the donor does the most risk and typically therefore earn the not expect the funds to be returned. highest return. Grants can be used to fund technical assistance Debt can be secured or unsecured. Secured or as a tool to enable investment in riskier frontier debt is collateralized by the borrower pledging an markets and projects.4 When used to support asset. In the event that the borrower fails to repay frontier investments, grants can be used to according to the original terms, the lender can provide an equity-type first-loss cushion, which ­ take legal action to claim and, if necessary, sell the allows a provider to take more risk initially, collateral. Conversely, unsecured debt is backed enabling deeper outreach and innovation. A first only by the creditworthiness and willingness of loss can take the form of a cash reserve where the the borrower to pay and is not supported by first losses from a pilot or experiment are covered collateral. by a grant, or it can be part of a more structured facility or vehicle, taking the form of an equity Senior Term Loans tranche in a structured finance vehicle or Senior term loans are loans that have a fixed risk-sharing facility as described above. Likewise, maturity and are repaid first after depositors. first-loss funds can be used to facilitate financial Loan characteristics include the currency of the service providers to invest in underserved sectors funds borrowed, the term or length of the loan, such as health and education. pricing, which can be fixed or variable, and prin- When used as a tool to fund technical assis- cipal repayment terms, which can include a tance, grants are increasingly performance based. grace period in which no principal payments are Performance-based grants are structured to due, staggered amortizations of principal, or a incentivize desired behavior by the grantee and bullet repayment at maturity. Sometimes loans are paid conditionally based on results. They often are credit enhanced, whereby the borrower (the have a cost-sharing component and time-bound financial service provider) provides collateral, targets. Payment of performance grants can be usually in the form of portfolio or fixed assets, or structured where financial service providers pay a third party provides some form of guarantee for technical services up front and are reimbursed that could be called upon in case of default. Term once targets are met. They may also receive per- loans often also include “covenants,” which are formance bonuses for over achievement of conditions that the borrower must comply with Funding 397 to remain in good standing. These often include, term loans and all other debt) has been paid off. for example, limits on delinquency, related party Because of its higher risk, such debt typically car- lending, and capital adequacy ratios. If these ries a higher interest rate. Raising subordinated covenants are breached, then the lender has the debt is advantageous for institutions to help them right to demand early repayment of the loan. meet capital adequacy requirements, because in The majority of international debt funding to some cases it can count as equity for regulatory financial service providers comes in the form of calculations. Box 16.7 outlines the Basel regula- term loans from MIVs, DFIs, or banks. tions associated with subordinated debt. Subordinated debt instruments are also often Syndicated Loans convertible into equity. Convertible debt is debt A syndicated loan is a senior term loan for which with an option to convert part or all of the loan to there is a primary or lead lender of record and common shares of the borrowing organization. other commercial banks/lenders acquire partici- Although convertible debt usually carries a lower pation, that is, lend part of the value of the overall interest rate than nonconvertible debt, convert- syndicated amount. Participants share risks with ible debt offers investors a chance to participate the lead lender on a pari-passu basis (meaning all in the profitability of the borrower in exchange lenders have equal rights). Syndicated loans are for the lower rate. In some environments, how- used when the amount of debt required by an ever, having an option to convert debt into equity institution is larger than the exposure any single limits the debt’s qualification as tier 2 capital lender can manage. Through syndication, a group (Ledgerwood and White 2006). of investors agree to the same structure and terms, reducing the amount of bilateral negotia- Bonds tion necessary to raise a large amount of debt. In Bonds are essentially transferable or “securi- this way a provider is able to negotiate with the tized” versions of loans: that is, debt obligations lead syndication firm once, rather than individu- that can be easily transferred from one lender, or ally with all lenders. “bondholder,” to another. Similar to loan agree- Citigroup and a consortium of local banks in ments, the borrower, or “issuer” agrees to make Pakistan provided the first local currency syndi- payments of interest and principal on specific cated transaction for the microfinance sector in dates to the holders of the bond. 2007. The syndication enabled the Kashf Private bond placements offer providers an Foundation, a leading commercial provider in opportunity to tap a broader range of investors Pakistan, to access wider commercial financing. than straight loans from commercial banks but The landmark US$22 million term financing are more limited than issuing a bond on a public package provided funding to support Kashf market (Ledgerwood and White 2006). Private Foundation’s significant growth plans. (Citi placements are investments that are offered to Microfinance Business Unit, http://222.citigroup specific investors, rather than through the capital .com/citi/citizen/data/cr07_ch08.pdf ) market, and can be either debt or equity. Private placements are sold directly to institutional Subordinated Debt investors, such as banks, mutual funds, insurance Subordinated translates as to “below” or “inferior companies, and pension funds. to,” and subordinated debt is therefore below all Public bond issuances are available through other claims of debt. In the event of bankruptcy, the capital markets and thus evaluated by the liquidation, or reorganization, subordinated debt ­ ersus financial markets in terms of yield (return) v can claim assets only after senior debt (senior risk. Public bonds can be issued on local capital 398 The New Microfinance Handbook Box 16.7  Subordinated Debt and Regulatory Capital Because of the nature of subordinated debt, central banks often permit its inclusion in calculat- ing an institution’s supplementary (tier 2) capital (but not in the core capital, or tier 1, calculation). International standards on this are set out in the so-called Basel Accords, under which finan- cial institutions can include subordinated debt as supplementary, tier 2, capital under the follow- ing conditions and limits: • It must have a minimum original maturity of more than five years • In aggregate, only subordinated debt equal up to 50 percent of tier 1 capital may count as tier 2 capital • During the last five years of the subordinated debt’s maturity, the value of that debt that can be used as tier 2 capital will be discounted by 20 percent each year. Local regulations may differ from this depending on the jurisdiction. Source: Basel Committee on Banking Supervision 2006. markets or international capital markets. A local reduces exposure to foreign exchange risk. This is bond issuance will provide funding in the local a critical issue in financial services for the poor currency of the country it is issued in. International because the vast majority of funders (except for bond issuances can be denominated in different depositors) are based in developed countries and hard currencies, usually ­ associated with the access funds in U.S. dollars and euros, but provid- country in which they are issued, but not always. ­ ers located in developing countries require local Box 16.8 provides examples of private place­ ments currency. The consequence of foreign currency and public bond ­ issuances in microfinance. mismatch is discussed in box 16.9. Although some Significant administrative, regulatory, and MIVs and direct lenders will take on some amount reporting requirements are related to issuing of local currency risk (sometimes diversifying bonds, including ratings, and bonds are therefore across different currencies to lower their risk), typically only a feasible option if the amount of most local currency financing from international money being borrowed is significant, or if the pro- lenders is hedged in some manner, by either the vider is looking to establish its name in the market funder or the borrower. for future, larger issuance. Only a handful of Numerous tools have been developed to facili- providers use this funding option because few ­ tate local currency funding, including hedging have reached the scale that would make this an using back-to-back lending, swaps, forwards, par- economically attractive alternative and/or are tial credit guarantees, and specialized foreign present in markets that allow for bond sales. currency funds. The simplest form of a hedge is for a provider Local Currency Funding to take the hard currency it has borrowed, Local currency funding is important to the health deposit it into a local commercial bank, and use it of a financial service provider because it allows an as cash collateral to borrow local currency. This institution to borrow in the same currency it lends. is known as “back-to-back” lending. Although Matching the currency of assets and liabilities conceptually straightforward, a cash hedge like Funding 399 Box 16.8  Bond Issuance in Financial Services for the Poor Private Placements Developing World Markets (DWM), a U.S.– The first private placement of bonds in the based socially responsible financial group. microfinance world was made by BancoSol in DWM assists micro- and small businesses 1996 and 1997 for a total of US$5 million. Both throughout emerging markets to enter the issues were backed by a 50 percent guarantee international capital markets. from USAID and were relatively short-term two-year maturities. Since then BancoSol’s Public Issuance funding structure has evolved as the funding Because of the expense and administrative products available have increased relative to requirements of issuing bonds, this type of the institutions growth and formalization. funding is usually sought only by the largest Shortly after issuing partially guaranteed pri- financial service providers. MiBanco in Peru vate placements, BancoSol moved on to issu- had its inaugural bond issue in 2002, raising ing certificate of deposits. Although also short S/. 20 million (US$5.8 million) as part of a term in nature, these were less expensive multiyear program. Financiera Compartamos than private placements. in Mexico raised US$19 million in 2005 as Bonds can also be issued in international part of a US$50 million public issue pro- markets outside of the country a provider is gram and after three private bond place- domiciled. AccessBank Azerbaijan issued a ments. After its conversion to a bank, US$25 million Eurobond during 2007 and Banco Compartamos had one of the largest 2008. The bond was rated BB+ by Fitch, in public issues in microfinance, raising line with the bank’s (issuer) rating. Unlike a Mex$1 billion (US$81 million) in 2010 in local bond, a Eurobond is an international local markets. bond denominated in a currency other than It is not a requirement that a bond issuer the currency of the country or market in which be a for-profit, regulated institution, however. it is issued. The bonds were issued in Indeed, one of the largest bond issues in Luxembourg by MFBA Bond I, a special-­ microfinance came from the NGO WWB Cali purpose legal vehicle. The proceeds of the (although it has since transformed into a bond were defined to provide a senior loan to bank), a member of the Women’s World MFBA for financing its portfolio growth. The Banking network, which raised Col$120 million bond issue was sponsored and arranged by (US$52 million) in 2005. Source: Ledgerwood and White 2006; Microcapital.org and Women’s World Banking (www.swwb.org). this can be very expensive because the provider with microfinance providers and understand has to pay interest on both the dollar loan and microfinance better, hard currency cash deposits the local currency loan. The deposit of hard cur- can be leveraged, and a provider can borrow rency earns some interest, and the local currency multiple amounts in local currency vis-à-vis the loan should theoretically be priced lower to amount of hard currency it has deposited. reflect the limited risk the local currency lender A swap is a transaction in which two parties is taking with a 100 percent collateralized loan, agree to exchange one set of future cash flows for but often the price is not adjusted well enough. another. A currency swap facilitates the exchange As commercial banks become more comfortable of cash flows denominated in one currency for 400 The New Microfinance Handbook Box 16.9  Quantifying Foreign Exchange Risk for Currency Mismatch In June 2008 a financial service provider in the provider received som 35.92 million. On Kyrgyzstan borrowed US$1 million for two June 30, 2010, the dollar/som exchange rate years with repayment due in June 2010. Upon was 46.71, and the provider needed som receipt of the dollars, the provider converted it 46.71 million to repay the US$1 million. It into Kyrgyz soms and used the proceeds to therefore cost the provider an extra som 10.8 on-lend to its clients in soms. On June 30, million (equivalent at the time to US$233,000), 2008, the dollar/som exchange rate was reflecting a currency depreciation of more 35.92. Upon conversion of the US$1 million, than 20 percent over two years. Source: All historical exchange rate sources from www.oanda.com. cash flows denominated in another currency. For ­ ertain institution in a certain country, then the c every swap there is a counterparty who wants the price of a 50 percent guarantee fee would be 2.5 opposite currency. The lender usually initiates percent of the amount borrowed. The more com- the swap on behalf of the provider and then lends fortable the lending institution is with the risk of the local currency directly to the provider. Some the financial service provider, the lower the guar- currencies have well-developed swap markets antee required. When a provider has a good track with many potential parties interested in swap- record of on-time repayments and reporting dur- ping a certain currency. Other currencies have ing a first loan, the level of guarantee typically less liquid swap markets, where there are fewer declines as the local currency lender becomes interested swap partners. Many currencies in more comfortable with the risk. developing countries are too thinly traded to Specialized foreign currency funds have been develop a functioning swap market. created to address the lack of hedging instru- In countries where swaps are not available or ments for many local currency markets. They are the swap market is not liquid enough, partial typically based on a diversification principle credit guarantees (discussed in more detail in the whereby the lender tries to diversify its lending Structured Finance section) can provide good across a basket of currencies. Sometimes these local currency solutions. For a partial credit guar- funds are set up as structured finance vehicles antee (PCG) set up to manage local currency risk, (discussed in more detail in the next section), a well-rated institution such as an AAA-rated where risk is managed through a tiered invest- DFI or bilateral donor guarantees a loan between ment structure and “first-loss” investors bear the a commercial bank and a financial service pro- brunt of currency losses, cushioning more senior vider. A PCG can also be used to guarantee a bond investors. These funds act as counterparties to issued by a financial service provider on a capital borrowers who do not want to take on foreign market. The amount of the guarantee can be any currency risk, or to lenders who lend directly in percentage of the underlying loan; however, the local currency but wish to offload the currency usual range is anywhere from 80 percent down to exposure. DFIs and multilaterals have played a 10 percent. The guarantor is paid a fee commen- crucial role in the development of these funds and surate with the level of guarantee. For example, if in this capacity have kept very much with their a guarantor prices the risk at 5 percent for a mission to catalyze rather than replace private Funding 401 sector capital. Box 16.10 provides examples of at any time, and term deposits tend to be only a foreign currency funds. ­ few months in maturity—in practice they are usu- ally quite stable as a source of funding, with long Deposits holding periods and frequent rollover of term Deposits play a dual role for an institution. On the deposits. An exception to this is if depositors sud- one hand, they are an important service to clients. denly feel that their money is no longer safe, On the other hand, deposits are also a source of because of either institution-specific problems or local funding for financial service providers that economic instability, and a “run on deposits” are licensed to accept them. A portion of deposits occurs whereby large numbers of depositors are held aside as liquid assets to ensure clients can demand their savings at the same time, poten- withdraw their funds when desired, and a larger tially jeopardizing the health of the institution. portion are used by the institution to fund its loan Licensed providers that take deposits are less portfolio (intermediate). dependent on external sources of funding and Because of the importance of protecting pub- generally have more liquidity. A deposit-taking lic depositors’ funds, strict regulations are in institution is able to raise deposits in local cur- place to ensure the soundness of institutions rency and loan out or intermediate those funds allowed to mobilize deposits. These regulations in the same currency, thereby matching its vary significantly from country to country, but sources and uses of funds and reducing foreign usually include minimal capital ratios, minimal currency risk. standards on information systems and reporting, and other requirements (see chapter 17). Structured Finance Although deposits typically have very short Structured finance facilitates access to funding maturities—demand deposits can be withdrawn for providers that would not otherwise be credit Box 16.10  Specialized Currency Funds The Currency Exchange Fund N.V. (TCX), 60 ­currencies. As of October 2011, it had out- based in the Netherlands, has a mandate to standing exposure to 43 different currencies provide local currency and interest rate hedg- for an aggregate amount of US$835 million. ing products in emerging markets to its inves- Importantly, only shareholders or specified tors and their clients. TCX was launched in clients of shareholders can access the hedging 2007 by FMO, KfW, other DFIs, and commer- services of TCX. To expand accessibility to the cial banks, and the capital structure includes a services of TCX, “Microfinance Currency Risk first-loss component provided by the Dutch Solutions” or “MFX,” was created in January and German governments. The initial share- 2008 by a group of lenders, investors, net- holders were later joined by development works, and foundations. With a US$20 million banks, multilaterals, and MIVs, and as of credit guarantee from OPIC, MFX became a September 30, 2011, TCX had US$650 million shareholder of TCX, allowing it to offer the in capital and was rated A− by S&P. TCX hedging services from TCX to its clients, who enters into medium- to long-term swap agree- would have been unable on their own to com- ments and can transact in more than mit the capital required for direct access. Source: https://www.tcxfund.com/partners/investors/mfx-solutions. 402 The New Microfinance Handbook worthy on their own and facilitates investment Typically the sum the guarantor pays out under from funders who would not otherwise be will- the guarantee reimburses creditors for the loss ing to take exposure to an institution without irrespective of the cause of default. The guarantee added credit protection. Structured finance amount, as a percentage of the loan being guaran- includes guarantee structures for debt instru- teed, may vary over the life of the transaction ments (bonds and loans) through partial credit based on the borrower’s expected cash flows and guarantees, risk-sharing facilities, and participa- creditors’ concerns regarding the stability of tion in securitizations. these cash flows. Guarantors for PCGs are typi- cally highly rated international DFIs or bilateral Guarantees agencies backed by highly rated countries. For If a provider is unable to attract financing on its example, IFC and KfW have AAA ratings that can own, either because it is a start-up with a limited be levered for guarantees. PCGs benefit clients by track record, is located in a country that is deemed allowing a guarantor to absorb part of the credit too risky, or for some other reason is not seen as risk of a lesser known entity. Overall PCGs facili- “investable” on a standalone basis, guarantees are tate improved market access, longer-term fund- sometimes provided by creditworthy institutions: ing, and a broader investor base. multilaterals, DFIs, or, often, the network to Partial guarantees can be in either local cur- which the provider belongs. In this way, debt can rency (for domestic transactions) or foreign cur- be extended directly to the provider under the rency (for cross-border transactions). Local condition that if it is unable to pay, its guarantor currency partial guarantees are most applicable will be called upon to repay the debt. Although it for a provider that has local currency revenues is unusual to have a full guarantee covering 100 but lacks access to local currency financing of the percent of principal and interest, this is some- desired term. Cross-border partial guarantees are times offered in the case of networks guarantee- best for a provider that cannot access interna- ing debt issued to affiliate providers. Depending tional markets on its own because of the high-risk on the relationship between the guarantor and premium associated with the country in which it the financial service provider, the provider bene- is domiciled. With a cross-border partial guaran- fiting from the guarantee usually pays a guarantee tee a provider may gain access to international fee to the guarantor. markets by mitigating the sovereign risk associ- Guarantees are tailored to meet the needs of ated with the borrowing. both borrowers and creditors. In general, the Although a PCG is a guarantee between a objective of the guarantor is to offer the mini- guarantor and a financial service provider, mum amount of guarantee necessary to facilitate risk-sharing facilities allow a financial service a successful transaction. Guarantees have several provider to share the risk of a specific portfolio of advantages, allowing (1) the borrower in most loans (for example, loans made to the agriculture cases to achieve a lower overall cost of funds, sector, or to borrowers located in a specific high- (2) investors to maximize their return given their risk region). In this case, the assets typically risk tolerance, and (3) the guarantor to mobilize remain on the provider’s balance sheet, and the the maximum amount of financing for the bor- risk transfer comes from a partial guarantee pro- rower for a given level of credit exposure. vided by a highly rated institution. In general, the More common are PCGs, discussed briefly guarantee is available for new assets originated above, which represent a promise of timely debt by the provider using an agreed upon underwrit- service payment up to a set amount that is lower ing criteria, but in certain situations may also be than the full amount of the debt in question. used for assets that have been already originated. Funding 403 Typically a provider’s purpose in entering into a to new investors, lower the cost of funds, and risk-sharing facility is to increase its capacity to remove assets from balance sheets, thereby make more loans within a specific “high-risk” reducing the FSP’s debt/equity ratio. A lower area without increasing the risk it incurs. debt/equity ratio can be beneficial to an FSP to meet minimum regulatory capital adequacy Securitization requirements, and generally to improve its over- Securitization is a form of financing that involves all creditworthiness. Securitization structures the pooling and transfer of financial assets to a are most appropriate for a provider that seeks special purpose vehicle (SPV). This SPV then financing but is unable to tap funding sources issues securities that are repaid from the cash for the desired length of time (term) and fund- flows generated by the pooled assets. In general, ing cost because of its perceived credit risk. It is any asset class with relatively predictable cash important to note, however, that only providers flows can be securitized. The most common that have sound credit risk management tech- assets include mortgages, credit card debt, auto niques and a well-performing portfolio and have and consumer loans, corporate debt, and future demonstrated capable lending practices should revenues. This type of transaction allows financ- consider securitization. Box 16.11 highlights key ing to be based primarily on the risks of the asset microcredit securitization transactions. pool rather than solely on the risk of the institu- tion that originated the assets. Equity Securitization can be a valuable tool to Equity is an ownership interest in a financial ser- increase liquidity, spread credit risk, gain access vice provider through the form of shares that Box 16.11  Microcredit Securitization One of the first microloan securitizations was euro-denominated microfinance loans. Enhanced with BRAC in 2006. BRAC received US$12.6 by guarantees provided by the European billion Bangladesh taka (US$180 million) in ­ Investment Fund and KfW, these securities financing over six years from a microcredit secu- received a BBB credit rating, considered “invest- ritization structured by RSA Capital, Citigroup, ment grade” from the global credit rating agency FMO, and KfW. One billion Bangladesh taka Fitch. (US$15 million) was disbursed to BRAC every six In June 2009 Banco Solidario in Ecuador months, with a maturity of one year. During the securitized US$60 million of its loans by creat- transaction, a special purpose trust was created ing a special purpose trust that took title to to purchase BRAC’s receivables from its micro- these loans and issued five classes of notes credit portfolio and issue certificates to investors. to investors with maturities of up to The issuance received the highest quality credit 85 months. The notes were purchased by rating (AAA) from a local rating agency, Credit local banks, the apex organization Corporación Rating Agency of Bangladesh, and succeeded in Financiera Nacional, national pension funds, attracting two local banks as key investors. and MIVs. After the success of this program, Similarly, in May 2006, ProCredit Bank the bank issued another US$30 million securi- Bulgaria securitized US$47.8 million of its tization in 2011/2012. Source: Adapted from www.microcapital.org. 404 The New Microfinance Handbook represent a claim on the providers’ assets in pro- provider are either retained, increasing the equity portion to the percentage of the class of shares on the balance sheet, or they are distributed in the owned. Initial equity is often provided by local form of dividends to owners. NGOs or investors, international networks— Like debt, equity investments are made either NGOs or holding companies—and/or through private placements or public issuances multilateral agencies and DFIs. Equity for coop- (figure 16.2). A public offering is an issue of eratives comes from the members (depositors, securities that is offered to institutional and who to open an account at the cooperative also individual investors through a securities house contribute equity through purchasing shares). such as a stock exchange. When an institution DFIs play an active role in providing equity to raises funds for the first time on a capital mar- many providers, while private equity funds have ket, it is called an initial public offering (IPO). become increasingly active participants. It is An IPO is a key opportunity for investors who important to note that although NGOs also have have invested in an institution in the early stages equity (the difference between their assets and of its development to exit or liquidate some of liabilities), it does not represent “ownership” their investment. It is also an opportunity for per se, because the NGO cannot be owned. Here financial service providers to raise additional equity is provided as a donation from private funds from the public, resulting in a far more and/or public funders that may or may not ulti- diverse set of potential investors. It allows pro- mately be converted to actual transferrable viders to raise capital, gain increased market equity, depending on whether the NGO trans- visibility, and potentially achieve or attain forms into a for-profit institution. liquidity of the issuing securities depending on On rare occasions, some providers have given the level of secondary market activity in their clients an opportunity to become owners a given market (Women’s World Banking through the purchase of shares. 2006). Relatively new to microfinance, IPOs A closed private placement can be an innova- have received keen interest of various stake- tive tool to promote client ownership. Family holders (see box 16.12) Bank in Kenya, a financial institution committed There are two primary classes of shares: to serving the lower end of the Kenyan banking common shares and preferred shares. Common market through microfinance and mobile-bank- shares are units of ownership that entitle the ing products, in 2008 issued a private placement shareholders to voting rights. In the event that a in which microfinance clients participated in a provider is liquidated, the claims of depositors, closed private placement and now own shares in secured and unsecured creditors, and preferred “their” bank. The bank added more than 7,000 shareholders take precedence over the claims of new shareholders and raised more than K Sh 500 those who own common shares, in that order. million (US$5.6 million) through this process Preferred shares are units of ownership with (http://www.familybank.co.ke). preferential rights over common shares with As owners, equity shareholders take on the respect to dividends and in liquidation. Preferred highest level of risk and are the last to be paid out shares can be voting or nonvoting and typically in the case of institutional failure. Along with this pay dividends at a specified rate. higher level of risk comes a higher level of A provider’s shareholding structure can be made expected reward. Unlike debt, where most up of majority and minority shareholders. The returns are fixed, equity owners can earn unlim- largest shareholder is usually the sponsor or ited returns through dividends or gains made primary operator. The sponsor is responsible for from selling their shares. Earnings made by the the operational and financial success of the Funding 405 Figure 16.2  Three Main Stages in the Processing of Large Public Issues • Origination is the first stage in the process for distributing securities on the primary market • Origination occurs when a borrower authorizes an investment bank Origination to structure and manage a new issue on its behalf • The bank purchases the bonds from the borrower and distributes them to investors—a process known as “underwriting” • In this way, the issuer avoids the risk of being left with unsold securities • The lead manager rarely has the resources to underwrite the entire issue • For this reason, the lead manager may decide to form a syndicate to share the risk with other investment banks or security houses Syndication • This process is called “syndication” • On the day the issuer announces the issue, the lead manager invites other banks and security houses to join the syndicate • After closing day, the issue is distributed to syndicate members • A tombstone advertisement is often published in major financial Distribution newspapers after the closing date to advertise the issue for the syndicate • After the issue has been distributed to the syndicate members, the members begin selling the securities to their clients Source: Women’s World Banking 2006. institution. Minority shareholders own less than option provides the unilateral right to sell shares 50 percent of an institution’s equity and often less in a provider to a preagreed buyer under prear- than 20 percent. Typically, larger shareholders also ranged terms. Conversely a call option is the play an active governance role and often require right to buy shares in a provider at a preagreed one or more seats on the board of directors (relative price or formula. Sometimes debt funders are usually to their share of ownership), rights to vote interested in becoming equity holders. In these on board decisions, and other privileges. cases, sometimes a lower coupon (interest) rate One of the largest risks for equity investors is is negotiated in exchange for warrants. Warrants exit risk. Once an investor holds shares in a pro- are essentially options to buy, usually issued in vider, the only way to liquidate the investment is conjunction with another financial instrument, to find a willing buyer. Although the microfinance conferring the right, but not the obligation, to buy market is increasingly diverse and global, the vast stock at a stated price within a specific period. majority of investments are in private, unlisted companies, and as such, equity investments are Responsible Investing Practices not very liquid. Equity exit mechanisms include private trade sales to another investor or provider, With the strong growth in funding for financial ser- selling shares through the capital market, or a vice providers in the past decade and the expansion preagreed option arrangement. in the types of funders to the sector, many partici- A preagreed option arrangement involves pants in the industry have worked to codify princi- negotiation at the time of the initial investment ples and establish best practices to maintain a of an option to exit called a put option. A put healthy, sustainable, and inclusive financial system. 406 The New Microfinance Handbook Box 16.12  Access to Capital Markets Although numerous financial service provid- a very small number of people very rich and, ers have issued bonds, as of December 2011 overall, promote institutional incentives that only three microfinance stocks have been go against microfinance’s larger mission of listed on equity capital markets: Compartamos addressing vulnerabilities and extending finan- in Mexico, Equity Bank in Kenya, and SKS in cial access among the poor. India. The IPOs of SKS and Compartamos, One particular component of the IPO both of which were approximately 13 times debate is whether IPO prices are based on oversubscribed, drew keen interest from not intrinsic value or whether the lack of capacity only public and private actors in the microfi- in the market is bidding up the asking price. nance industry but also the mainstream Critics point out that the high valuation of public. both SKS and Compartamos were not in line Supporters argue that IPOs offer a crucial with market peers at the time of their IPOs. funding source that can help a microfinance In emerging markets, banks are valued at organization fully commercialize and scale three times book value on average, although operations, thereby enhancing the volume finance institutions serving low-income cus- and reach of the unbanked. Many supporters tomers are trading at 2.6 times book value. also suggest that an IPO is an ultimate SKS, on the other hand, was valued at 6.7 demonstration of the commercial potential times the company’s post-issue book value, of the microfinance model. The prospect of and about 40 times the company’s fiscal year an IPO has drawn keen interest from coun- 2010 earnings. At listing, Compartamos was tries with major microfinance industries such valued at 13 times book value and 27 times as Bangladesh, Mexico, Kenya, and India, as the company’s historical earnings.  well as private equity firms that have recently Another critical concern is that investors moved into the sector. buying at such a high level may pressure Critics, however, made up of a diverse set management to increase profitability, at the of stakeholders, including NGO FSPs, civil expense of clients’ interests and long-term society, and consumer protection advocates, company sustainability. The short-term and see IPOs as a tool that promotes mission drift profit-focused interests may in fact clash as they attract stakeholders with varied objec- with longer-term interest of the clients, tives and afford investors the opportunity to noticeably to access affordable and acces- cash in on profits. They argue that IPOs make sible financial products. Source: Reille 2010; Women’s World Banking 2006. This is related to concerns of over-concentration clients. Linked to this are concerns related to issues and over-indebtedness: If funders are all drawn to of transparency of pricing on loans and other issues providing their funds to the same small number of of client protection. profitable providers, or to certain specific regions Many initiatives have occurred on this front in that are easier to access, there is a risk that these the past several years, including the United Nations providers or regions will have more funding than Principles for Responsible Investment5 and the they can on-lend in a sustainable manner, and in Principles for Investors in Inclusive Finance.6 turn can lead to over-indebtedness of their own Guiding principles have also been established by Funding 407 the International Association of Microfinance assessment of risks, performance, market ­position, Institutions to help creditors and other stakehold- governance, and responsible finance practices. ers in cases where a provider is either in default or They measure the probability that a provider will in a distressed situation that may lead to default. continue to operate and remain a “going concern,” Underlying these principles and guidelines is the even in the case of an external shock. They have a basic idea that funding within the sector should strong focus on governance, on the quality of the be done in a responsible manner that takes into microfinance operations and systems, and on account the interests of the end client and the alignment of decisions with stated social goals health of the overall system. Box 16.13 provides an and client protection, which are considered core overview of responsible investor principles. assets for long-run sustainability. A credit rating is the product of conventional rating agencies (Standard & Poor’s, Fitch, and Ratings Moody’s are the best known rating agencies) and The prevalence and importance of ratings in has a narrower focus than general performance microfinance have grown exponentially since ratings. Credit ratings focus specifically on they were first introduced in the mid-1990s. whether a provider is able to meet its credit obliga- Used primarily by funders, including both tions, assessing the default risk during a given donors and investors, ratings are evaluations of period of time. The methodology applied to a institutions’ operational, financial, and more microfinance credit rating is the same as that recently, social performance based on standard- applied to any financial institution—its purpose is ized methodologies. primarily to make an opinion regarding the insti- Microfinance institutional ratings7 provide an tution’s default risk at a given time. Although opinion on long-term institutional sustainability many market players take interest in credit ratings and creditworthiness through a comprehensive as objective third-party assessments of provider’s Box 16.13  Responsible Investor Principles Institutional investors that adhere to the Responsible Investor Principles acknowledge they have a duty to act in the best long-term interests of investment beneficiaries. In this fiduciary role they believe that environmental, social, and corporate governance (ESG) issues can affect the perfor- mance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes, and through time). They also recognize that applying these principles may better align investors with broader objectives of society. By adhering to the principles, investors have agreed to the following: 1. Incorporate ESG issues into investment analysis and decision-making processes 2. Be active owners and incorporate ESG issues into ownership policies and practices 3. Seek appropriate disclosure on ESG issues from investees 4. Promote acceptance and implementation of the principles within the investment industry 5. Work together to enhance effectiveness in implementing the principles 6. Report on activities and progress toward implementing the principles. Source: www.unpri.org. 408 The New Microfinance Handbook creditworthiness, they are also used by investors provided. A social rating cannot in itself deter- and supervisory authorities as part of the compul- mine whether a provider has achieved a particu- sory requirements to comply with regulations. lar social impact. What a social rating contributes A social rating is an independent assessment of to, however, is whether the processes undertaken an organization’s social performance using a stan- by a provider have moved the institution closer to dardized rating scale (SEEP 2006; see chapter 14). achieving its particular social mandate. A social rating typically assesses both social risk Mainstream rating agencies tend to rate debt (the risk of not achieving social mission) as well as and the probability of default on a continuous social performance (the likelihood of contributing basis, upgrading and downgrading ratings social value). The social rating evaluates practices, accordingly. In contrast, the timing of updates for measures a set of indicators and scores them microfinance ratings is more fragmented, because against benchmark levels and generally accepted ratings tend to be valid for an extended period of standards. A social rating assesses how the pro- time (see box 16.14). Repeat ratings demonstrate cesses and performance of a provider have maturity in the market, as financial service contributed toward specific desired goals, with an providers have the resources and expertise at ­ analysis of overall outreach and quality of services their disposal to commission another rating.8 The Box 16.14  Microfinance Institutional Rating versus Mainstream Credit Ratings Since 1997, of providers that have been rated, ­ ilestone, because it is the mainstream m the vast majority had microfinance institu- product when seeking external investments tional ratings conducted, rather than traditional in capital markets. credit ratings, provided by such agencies as In addition to ratings for institutions, bond Standard and Poor’s, Moody’s, and Fitch. issuances and securitizations are also rated. A microfinance institutional rating is often Ratings for issuances are usually prepared by more adapted to MFIs given that mainstream mainstream rating agencies. Ratings of issu- credit ratings usually automatically see nega- ances are important because they enable reg- tively unregulated financial institutions with a ulated investors such as pension funds and relatively small asset size (small when bench- insurance companies to purchase investment marked to mainstream financial institutions or products meeting certain regulatory invest- banks) and uncollateralized loan portfolios. ment grade criteria. This has started to change as more MFIs Issuances generally have a long- or short- transform into banks, and the rating agencies term rating, reflecting the tenor of the paper themselves have developed more in-house issued. A bond will have a long-term rating, expertise on the sector. MFIs that are operat- and commercial paper will have a short-term ing as regulated financial institutions and/or rating. Long- and short-term ratings usually are sourcing their funding on local or interna- relate closely to the rating of the issuer. tional financial markets are more likely to use Ratings for securitizations may differ from standard credit ratings, rather than microfi- the issuers rating because they are based on nance institutional ratings. For many MFIs, a the quality of the portfolio securitized, not the credit rating represents an important issuer itself. Funding 409 Box 16.15  Ratings for MIVs and Funds Just as providers are rated, so too are MIVs CGAP and the United Nations Principles and funds. The Luxembourg Fund Labeling for Responsible Investment, a network of Agency is an independent, nonprofit organiza- international investors, in 2010 established tion created in 2006 to support microfinance criteria for measuring the nonfinancial perfor- and environmental related investments. The mance of microfinance investment vehicles. LuxFLAG Microfinance Label is a mark of qual- These criteria include environmental (carbon ity signifying to investors that a fund invests emission compensation, environmental the majority of its assets in the microfinance exclusions, and exposure to natural disas- sector and does so with transparency, respon- ters); social (average loan size, client protec- sibility, sustainability, and independence. tion principles, breadth of services, percent- In partnership with MicroRate, LuxFlag age of consumptions loans, percentage of also offers Luminis, an online analytical plat- female and rural borrowers, and percentage form on microfinance funds. Luminis offers of activity relating to health, education, and analysis based on performance, risk, social, women’s empowerment); and ­ governance and management data. The Internet-based (reporting, staff training, investee corporate platform enables investors to compare basic social responsibility policies, investee anti- data and analysis on 80 microfinance funds at corruption policies, whistle-blowing protec- no charge, with full fund profiles and reports tions, and seats on investee board of available on a smaller subset for a fee. directors). Source: www.LuxFLAG.org, www.microcpaital.org June 2012 issue, and www.CGAP.org. frequency of repeat ratings also demonstrates on-lending, versus 12% for capacity building that ratings are seen as a tool to improve gover- (8% at the retail level, 2% at the market nance or motivate change within the organiza- infrastructure level, and 2% at the policy level) tion to continue to reach organizational mandates, (El-Zoghbi et al. 2011). both financial and social. Typically the rated 2. The United Nations Capital Development Fund provider itself pays for the rating, as is standard (UNCDF) provides a small amount of equity to practice in mainstream ratings. Funding has been some MFIs, but it is generally an exception for multilaterals. ­ roviders to obtain their first ratings on a given to p cost-sharing basis by multilateral agencies and 3. In order to engage with the private sector, some MDBs have separate departments that focus on DFIs; however, this funding is being phased out.9 private sector clients; however, this is generally Ratings for MIVs and microfinance funds are also not their primary focus. available (see box 16.15). 4. The term “frontier” denotes less developed and postconflict countries as well as rural and underserved regions of countries with Notes ­ otherwise robust microfinance sectors. 1. A study by CGAP showed that in 2009, 88% of 5. See www.unpri.org/piif. funding to microfinance was destined for 6. See www.iamfi.org. 410 The New Microfinance Handbook 7. The term “Microfinance Institutional Rating” ———. 2009c. “MIV Performance and Prospects: was first introduced and defined in “Global Highlights from the CGAP 2009 MIV Microfinance Ratings Comparability” by Benchmark Survey.” CGAP, Washington, DC. Abrams (2012). M-CRIL, MicroFinanza Rating, ———. 2011. “2010 MIV Survey Report.” CGAP, MicroRate, and Planet Rating all agreed to Washington, DC, December. adopt it as a common rating product name. ———. 2012. “2011 Sub-Saharan Africa Regional 8. In 2010, 34 percent of the 396 MFIs having Snapshot.” CGAP, Washington, DC, February. performed at least one rating was a repeat Dieckmann, R. 2007. “Microfinance: An Emerging rating (ADA and PwC Luxembourg 2011, 29). Investment Opportunity: Uniting Social 9. In May 2001, the Inter-American Development Investment and Financial Returns.” Deutsche Bank (IDB) and the Consultative Group to Assist Bank Research, New York, December 19. the Poor (CGAP) launched a joint initiative DiLeo, P., and D. Fitzherbert. 2007. “The called the Microfinance Rating and Assessment Investment Opportunity in Microfinance: An Fund. The European Union subsequently joined Overview of Current Trends and Issues.” the Rating Fund in January 2005. In February Grassroots Capital Management, New York. 2009, the MIF of the Inter-American Duflos, E., and M. El-Zoghbi. 2010. “Apexes: An Development Bank and the Development Bank Important Source of Local Funding.” CGAP, of Latin America (CAF) launched the Rating Washington, DC, March. Fund II. www.ratingfund2.org *El-Zoghbi, M., B. Gahwiler, and K. Lauer. 2011. “Cross-border Funding of Microfinance.” Focus References and Further Reading Note 70, CGAP, Washington, DC, April. Forster, S., E. Duflos, and R. Rosenberg. 2012. “A *Key works for further reading. New Look at Microfinance Apexes.” Focus Note *Abrams, Julie. 2012. “Global Microfinance Ratings 80, CGAP, Washington, DC, June. Comparability.” Multilateral Investment Fund Freireich, J., and K. Fulton. 2009. “Investing (MIF), Member of IDB Group, Washington, DC. for Social and Environmental Impact: ADA and PwC Luxembourg. 2011. “Microfinance Executive Summary.” Monitor Institute, Rating Market Review 2011.” ADA and PwC Cambridge, MA. Luxembourg, Luxembourg, September. Gahwiler, B., and A. Negre. 2011. “Trends in Basel Committee on Banking Supervision. 2006. Cross-Border Funding.” CGAP Brief, CGAP, “International Convergence of Capital Washington, DC, December. Measurement and Capital Standards: A Revised *Goodman, P. 2007. “Microfinance Investment Framework Comprehensive Version.” Basel Funds: Objectives, Players, Potential.” In Committee on Banking Supervision, Basel, June. Microfinance Investment Funds: Leveraging Burand, D. 2009. “Microfinance Managers Private Capital for Economic Growth Consider Online Funding: Is It Finance, and Poverty Reduction, ed. Ingrid Marketing, or Something Else Entirely.” Matthäus-Maier and J. D. von Pischke, CGAP, Washington, DC. 11–46. Berlin: Springer. CGAP (Consultative Group to Assist the Poor). Harford, T. 2008. “The Battle for the Soul of 2009a. “Focus on Deposits and Consumer Microfinance.” Financial Times, December 6. Protection: A Silver Lining to the Crisis?” Ivory, G., and J. Abrams. 2007. “The Market for Article based on podcast interview with Microfinance Foreign Investment: Elizabeth Littlefield, May 28. Opportunities and Challenges.” In Microfinance ———. 2009b. “Microfinance Funds Continue to Investment Funds: Leveraging Private Capital Grow Despite the Crisis.” CGAP, Washington, DC. for Economic Growth and Poverty Reduction, ed. Funding 411 I. Matthäus-Maier and J. D. von Pischke, 47–65. and J. D. von Pischke, 147–74. Berlin: Berlin: Springer. Springer. Ledgerwood, J., and V. White. 2006. Transforming Reille, X. 2010. “SKS IPO Success and Excess.” Microfinance Institutions: Providing Full CGAP blog, August 11. http://microfinance Financial Services to the Poor. Washington, DC: .cgap.org/2010/08/11/ World Bank. sks-ipo-success-and-excess/. Mahmood, A. 2009. “Social Investment Matters.” Reille, X., and S. Forster. 2008. “Foreign Capital Deutsche Bank, New York. Investment in Microfinance: Balancing Social Market Data and Peer Group Analysis. 2010. “2010 and Financial Returns.” Report 44, CGAP, MIV Benchmark Survey.” CGAP, Washington, Washington, DC. DC, August. *Reille, X., S. Forster, and D. Rozas. 2011. “Foreign Matthäus-Maier, I., and P. J. von Pischke, eds. Capital Investment in Microfinance: 2006. Microfinance Investment Funds: Reassessing Financial and Social Returns.” Leveraging Private Capital for Economic Focus Note 71, CGAP, Washington, DC, May. Growth and Poverty Reduction. Berlin: Responsible Investor. 2012. “How One of Springer. Switzerland’s Largest Pension Schemes Invested McKay, C., and M. Martinez. 2011. “Emerging CHF130m into Microfinance.” March 14. Lessons of Public Funders in Branchless Saltuk, Y., A. Bouri, and G. Leung. 2011. “Insight Banking.” CGAP, Washington, DC. into the Impact Investment Market.” MicroRate. 2011. “The State of Microfinance J. P. Morgan Social Finance and the Global Investment 2011: MicroRate’s 6th Annual Survey Impact Investing Network. J. P. Morgan, New and Analysis of MIVs.” MicroRate, Arlington, VA. York, December 14. *———. 2012. “Microfinance Investment: A Primer.” Sapundzhieva, R. 2011. “Funding MicroRate, Arlington, VA. Microfinance—A Focus on Debt Financing.” Miller-Sanabria, T., and T. Narita. 2008. “MIF Microfinance Information eXchange, Retrospectives Investing in Microfinance: Washington, DC, November. Making Money, Making a Difference.” SEEP Network. 2006. “SEEP Network Social Multilateral Investment Fund, Washington, DC. Performance Glossary.” Social Performance Platteau, S., and H. Siewertsen. 2009. “Trends in Working Group. SEEP Network, Washington, Microfinance: 2010–2015.” Triodos Facet, DC, October. Bunnik, the Netherlands. Stauffenberg, D., and D. Rozas. 2011. “Role Portocarrero Maisch, F., A. Tarazona Soria, and G. Reversal Revisited: Are Public Development Westley. 2006. “How Should Microfinance Institutions Still Crowding Out Private Institutions Best Fund Themselves?” Investment in Microfinance?” MicroRate, Sustainable Development Department Best Washington, DC. Practices Series. Inter-American Development Symbiotics. 2011. “2011 MIV Survey Report: Bank, Washington, DC. Market Data & Peer Group Analysis.” Puillot, R. 2007. “Governance, Transparency, and Symbiotics, Geneva, August. Accountability in the FSP Industry.” In *Women’s World Banking. 2006. “Women’s World Microfinance Investment Funds: Leveraging Banking Capital Markets Guide for Microfinance Private Capital for Economic Growth and Institutions (MFIs).” Women’s World Banking, Poverty Reduction, ed. Ingrid Matthäus-Maier New York, New York, November. 412 The New Microfinance Handbook CHAPTER 17 Regulation Kate Lauer and Stefan Staschen Chapter 3, “The Role of Government and Industry of which are published or otherwise made in Financial Inclusion,” discusses at a high level public. This includes primary legislation (that is, ­ the role of policy makers in financial inclusion laws adopted by the legislature), secondary legis- and the role of governments as “rule makers.” lation (that is, circulars, regulations, or guidelines This chapter is more technical in nature and issued or adopted by the regulator), executive focuses on the how and what of regulation—the orders, declarations, decrees, and other similar rules that govern the financial system and the enactments and issuances. Typically primary leg- various actors within. It will be of interest to pol- islation designates and authorizes a government icy makers new to microfinance, practitioners authority to issue secondary legislation. For wanting to better understand how regulation example, the banking law may designate the works, and other stakeholders interested in central bank as the regulatory authority for understanding how formal rules affect the finan- banks. A microfinance law may designate a spe- cial ecosystem and how they can support markets cialized financial authority as the body respon- that work better for the poor. sible for regulating microfinance institutions (MFIs). Primary legislation typically can be changed only by the legislature, whereas sec- Definitions and General ondary legislation (such as regulations) can be Discussion changed by the regulatory authority. Some reg- Regulation: The term regulation is used in this ulation may be enforceable in court by private book to refer to different types of formal legal parties; some may be enforceable only by a edicts and pronouncements by government, all government agency. Regulation 413 Many areas of law and regulation impact Licensing may be required to operate as a spe- financial services, financial service providers, and cific type of institution. (Some jurisdictions use clients: Banking law (that is, primary and second- the term “permit” instead of license.) Banks and ary legislation) applies to banks and sometimes to other deposit-taking institutions, e-money issu- other depository institutions (in which case ers, and payment service providers are required other possible names may be used, such as to be licensed. In some countries, lending-only “financial institutions law”); nonprofit law is institutions are also required to be licensed or often relevant to nongovernmental organization “permitted.” (NGO) MFIs; financial cooperatives are often To be licensed, an application must be submit- subject to a specific law on cooperatives, although ted to the regulator that oversees or supervises in some countries they may also be subject to a the specific institutions that are licensed. The specific finance law (for example, non-bank application usually involves submission of vari- financial institutions law); insurance law governs ous documents, including a three- or five-year insurance companies; leasing law covers leasing business plan, operational policies and proce- companies; the commercial code or companies dures, evidence that proposed senior manage- law will typically apply to for-profit financial ment, board members, and significant owners entities as well as nonprofit companies (where (that is, those with an ownership interest exceed- they exist); and payment systems law generally ing a specified percentage) meet fit and proper governs the payment infrastructure (and may also criteria, and demonstrated ability to meet the reg- cover payment service providers and e-money ulatory minimum capital requirement. In some issuers, either directly or as elaborated in regu- cases a deposit of funds must be made at the time lations adopted under such law). Financial the application is submitted. An applicant for a consumer protection regulation should apply ­ banking or similar license may also be required to ideally to all financial service providers. Other demonstrate that it meets the following require- areas of law that may be relevant to financial ser- ments: well-designed and implemented risk man- vice providers include competition law, secured agement policies and procedures, an effective transactions/collateral registries, anti-money audit function, secure branches, contingency laundering and combating the financing of ter- plans, diverse ownership, and evidence that the rorism (AML/CFT), insolvency, capital markets, core banking system and other technology property rights, and foreign direct investment. requirements are adequate. A licensed institution The regulatory environment can have signifi- in some countries may be required to seek addi- cant impact on the particular models of financial tional licenses to engage in certain activities service delivery and the possibility of develop- (for example, foreign currency trading). ing innovative approaches. Supervision: The term “supervision” with Registration and licensing: Registration typi- respect to financial institutions is most often used cally involves filing basic information with a gov- to refer to prudential supervision of banks and ernment body designated as the registrar (for other deposit-taking institutions, although it can example, nonprofit registrar, MFI registrar, or also include supervision of nondepository institu- cooperative agency). Basic information includes tions, such as non-bank e-money issuers and pay- the provider’s name, address, and constituent ment service providers. The main objective of documents (for example, articles of association or banking (or prudential) supervision is to promote foundation, by-laws) and sometimes the names of the safety and soundness of banks and the bank- the founder(s) or owners, senior management, ing system.1 This does not mean preventing all and members of the board of directors. bank failure but rather reducing the “probability 414 The New Microfinance Handbook and impact of a bank failure.”2 Effective supervi- (theoretically, at least) more intensive and focused sion is critical to ensuring a well-functioning but can suffer from lack of coordination and com- financial sector. When a provider is subject to munication between the two regulators (although prudential supervision, the implication is that a there can also be a similar problem between two governmental body is ensuring that the risks departments of the same regulator). being taken by the institution (and, for banks and Self-regulation and delegated supervision: Self- other depository institutions, the risks being regulation and delegated supervision both place a taken with the public’s deposits) are not subject nongovernmental body in charge of monitoring. to undue risk of loss. In the case of self-regulation, this body may be an Supervision of financial institutions typically association of financial service providers; the includes licensing, ongoing review of the institu- “rules” that are being enforced may be a charter tions’ reports and operations (which constitutes a drafted by members or an industry code of con- part of off-site supervision and can inform deci- duct (see chapter 3). Although self-regulation sions about on-site supervision, such as whether may on the surface be preferable to no regulation the supervisor should conduct on-site supervision or supervision, it is often difficult to establish a of a particular institution), issuing compulsory system that is free from influence and enforce- instructions and corrective actions, temporary able; that is, the regulator can enforce standards administration, and mandated closure. against one of the members, especially if such The supervisor may document in detail the member is influential. tasks to be performed and the specific approach In the case of delegated supervision, the del- to be taken by individual supervisors. These egated authority could be a governmental agency documents may or may not be available to the or nongovernmental entity (for example, an apex public. Some supervisors use the “relationship institution), existing or established specifically management technique” that involves an in-depth for the purpose of supervising a category of understanding of the particular industry and the financial service providers. In comparison to individual firms, their business, and their risks. self-regulation, a delegated authority may have the Other supervisors rely on reports and computer advantage of enforcement power, especially if the analysis. Some supervisors apply relationship delegator retains ultimate responsibility for effec- management only to those providers that present tive supervision. Although the problem with systemic risk. improper influence is less in the case of delegated The two most common approaches to organiz- authority, problems remain of both capacity (both ing the supervision of financial institutions are (1) of the delegator and the delegatee) and funding. unified or integrated approach, with one supervi- This is an area in which time-bound donor sup- sor handling both prudential regulation and port to develop capacity can be critical. supervision and conduct of business regulation, and (2) twin peaks, which has one government Rationale and Objectives of agency responsible for prudential regulation and Regulation supervision and another agency responsible for conduct of business regulation. In general, uni- Imposing regulation on market participants fied supervision benefits from having the knowl- requires a clear justification, which can best be edge and understanding under one roof but is found in the theory of market failures. Although subject to criticism for lack of rigor on prudential substantial experience exists to date regulating regulation. The twin-peaks structure benefits microfinance, there is certainly no “one size fits from enabling the prudential supervision to be all” approach. In most countries the financial Regulation 415 services industry is the most heavily regulated more effective and efficient payment mecha- industry. Why is this the case, even though most nisms. Regulation is also necessary to address countries subscribe to the principles of a free the risk that would result from one payment market system? In other words, what is the eco- system participant’s failure to perform (that is, nomic justification or rationale for regulation? In failure to settle its obligations by paying the economic theory, it is assumed that the financial other participants what is due), whether as a sector is subject to market failures and that this result of an operational failure or a contractual provides a rationale for government interven- breach. tions in the form of regulation—the public inter- • Negative externalities cause the risk of “bank est view of regulation.3 runs” (many depositors withdrawing their The most important market failures that funds at the same time), which can cause provide a rationale for imposing regulation are otherwise healthy institutions to deteriorate, the result of information asymmetries and and contagion leading to a system-wide panic externalities: (the systemic risk). • Information asymmetries in deposit mobiliza- The objectives of regulation are either directly tion result in depositors lacking incentives and targeted at removing these market failures the means to sufficiently monitor the utiliza- (for example, by disclosure requirements that tion of their funds by the deposit-taking insti- mitigate information problems) or at alleviat- tution. In such a case, a regulator operates as a ing negative consequences of market failures “delegated monitor” on behalf of depositors (for example, by protecting clients). In financial and can monitor the provider more cheaply regulation the burden of proof should always be and more effectively. on the rule maker; only if there is a clear economic • In lending, borrowers hold superior informa- rationale for imposing regulation is regulatory tion about their capacity and willingness to intervention justified. repay and use borrowed funds, which makes it Table 17.1 summarizes the main regulatory difficult for the provider to choose the most objectives for financial services for the poor. Each creditworthy clients. One potential outcome of of the objectives is based on an economic reason this is credit rationing. for regulation and can be addressed by a specific type of regulation. The most widely discussed • With insurance, again information asymme- types of regulation in microfinance are prudential tries exist because of the complexity of the regulation, which is about the safety and sound- business and the inability of clients to assess ness of financial institutions, and conduct of busi- the viability of the insurer. Regulating to ness regulation, which focuses on how providers reduce risk of failure of the insurer is of partic- conduct business with their clients (see, for exam- ular importance given the specific vulnerabil- ple, Christen et al. 2012). The term “enabling reg- ity of the client: If the insurer fails to perform ulation,” which is often used in relation to access under the contract, the client will suffer the to finance, refers to the objective that microfi- loss at the moment when he or she or the ben- nance regulation should not unduly restrict eficiaries most need the proceeds. access to finance, but rather remove current bot- • Payment systems will—without regulation— tlenecks and enable its provision in a safe and generally favor first movers and can result in sound manner. The five regulatory objectives are the exclusion of competitors that can poten- subject to trade-offs (for example, strict safety tially serve broader populations and offer and soundness rules curtailing access), but also to 416 The New Microfinance Handbook Table 17.1  Regulatory Objectives for Microfinance Main reasons for Type and scope of Examples for regulatory Objective including objective regulation measures Promote safe Information problems in Prudential regulation Capital, liquidity, and and sound deposit and lending required only for deposit- provisioning requirements; financial business and negative taking institutions management and governance service externalities affect safety standards providers and soundness of providers Guard against Risk of contagion exists Systemic regulation Lender of last resort; deposit systemic risk among providers caused mostly for deposit-taking insurance; payment system by negative externalities institutions oversight both among deposit-taking institutions and—to a lesser extent—among credit-only institutions Establish a Regulation can establish Competition regulation Mergers and acquisition, competitive barriers to entry, and considering market power interoperability, anticartel, and market providers might benefit in certain locations and anticollusion rules from market power when newly created entry operating in unsaturated barriers markets Protect Negative consequences of Conduct of business Disclosure and fair treatment consumers market failures may hurt regulation for all types rules; recourse mechanisms loan and savings clients of financial institutions Improve Transaction costs, Enabling regulation for Removal of existing barriers; access information problems, and all types of financial adjusting norms to suit externalities as well as institutions microfinance regulation itself are all reasons for lack of access Source: Adapted from Staschen 2010, table 2.2. supportive relationships (for example, safety and between providers and clients (as opposed to a soundness rules improving the safety of clients’ market-creation role). Rules will be most effective deposits and thereby contributing to the con- if they follow the market.4 sumer protection objective). Regulation can play a role in pushing the “access frontier” outward over time and thereby Principles of Regulation and bring new clients into the formal financial sector Supervision (Porteous 2006). However, in a country with In designing an appropriate regulatory and super- very little capacity of providers to push the visory framework for an inclusive financial sector, access frontier, changes in regulation are likely various guiding principles can be identified: to have only a limited impact. Regulation (and supervision) primarily supports the development • Proportionality: The principle of proportional- and expansion of the core, that is, transactions ity advocates an approach to regulation and Regulation 417 supervision that (1) is tailored to the specific the same rules, regardless of which type of risks of a provider type, an activity, or a prod- institution is being regulated. This is also uct and (2) aims to keep the costs imposed on referred to as activity-based regulation rather providers, regulators, and consumers propor- than institutional regulation. This has impor- tionate to the benefits. This approach can have tant implications because many countries have significant implications on various regulatory chosen to establish a separate legal framework and supervisory initiatives targeted at provid- for microfinance, but at the same time allow ing the poor with financial services, especially mainstream banks to provide the same or simi- given that most existing regulations and super- lar products. Following the principle of com- visory structures may not have taken the spe- petitive neutrality, various types of institutions’ cific needs of the poor sufficiently into account. microloan portfolios should be subject to the However, assessing the costs and benefits is same asset quality and provisioning rules. The not an easy task, and different views often will same is true for conduct of business rules, be found among stakeholders (regulators, pro- which should equally apply to all types of lend- viders, consumers) on the risks as well as the ing institutions no matter whether they are quantification of costs and benefits. Regulatory prudentially regulated or not. However, pru- impact assessment can be a practical tool for dential regulation and supervision is mostly implementation of this principle (see box 17.1). targeted at the solvency of institutions, and thus an institutional approach is more appropriate. • Competitive neutrality: To establish a level play- For example, minimum capital requirements ing field, the same activity should be subject to Box 17.1  Regulatory Impact Assessment Regulatory impact assessment (RIA) is a change could be either broad (for example, the methodology to measure the success of spe- creation of a new institutional type such as a cific regulatory reforms. This can either be deposit-taking MFI or a non-bank e-money done ex ante, that is, as an estimation of the issuer) or narrow (for example, the change of a expected impact of a regulatory change, or ex specific prudential standard). An RIA can com- post, that is, after regulation has been changed. pare different options of regulatory change or RIAs have gained in popularity in developed assess one particular reform proposal in com- countries but are also slowly picking up in parison to a situation without any regulatory developing countries (Kirkpatrick and Parker change. Both qualitative and quantitative indi- 2007). As an instrument, they can play an cators can be used to measure the impact. important role in creating a proportional regula- One of the advantages of an RIA is that it tory framework. requires policy makers to clearly articulate the An RIA measures the impact a particular objectives of a regulatory change and the regulatory change has on the achievement expected impact it will have. It thus increases of regulatory objectives (effectiveness) and the accountability of regulators and explicitly the cost of implementing the new regulation acknowledges the costs imposed on the (efficiency) (Staschen 2010). The regulatory sector. 418 The New Microfinance Handbook are targeted at the institution as a whole and financial services to the poor in the world are should be tailored to the risk profile of its entire regulated as commercial banks. Depending on business (which could include microfinance as the flexibility of the banking law, it might be one of its activities). possible to also integrate deposit-taking MFIs under the same law, perhaps with some amend- • Flexibility: The history of microfinance is pri- ments. This is easiest if the specific prudential marily about financial innovation and “think- standards for microfinance are prescribed in ing outside the box.” Without a certain amount the secondary legislation (as opposed to the of flexibility in revising existing rules to make primary legislation). them more appropriate for financial services for the poor or to remove existing bottlenecks, • Create a special law: Various countries have much of the growth of microfinance might not promulgated a separate law for microfinance. have happened. Principles-based regulation (A few have instead adopted regulations, that rather than rules-based regulation has been is, secondary legislation, for microfinance.) advocated as an approach that provides more Although this permits the law to be tailored to flexibility for financial service providers, but it the specific risk profile of microfinance, har- is more challenging for less experienced regu- monization with the existing framework for lators and has also been criticized for being lax banks is more challenging. Such a law typically (Black 2008). The degree of flexibility also either covers only deposit-taking institutions depends on to what degree rules are stipulated or microlending institutions as well. The per- in primary legislation (requiring legislative mitted activities for institutions regulated change) or in secondary legislation such as under this law must be clearly defined to pre- regulations (can be changed by the regulatory vent “regulatory arbitrage,” that is, providers authority). being issued with a license that were not sup- posed to come under this law (for example, consumer lenders or other financial service Regulatory Structures for providers taking advantage of lower barriers Microfinance Institutions to entry). Most regulatory frameworks are not designed • Issue an exemption under the existing law: With with a view to allowing for innovative approaches this approach, MFIs are exempted from the of financial services provision to the poor: For banking law as long as they comply with example, only commercial banks might be certain conditions. These conditions define ­ allowed to mobilize savings, only branches the specific regulatory measures applicable licensed by the regulator might be permitted to be to MFIs. used as customer service points, and non-banks A tiered approach allows different financial such as mobile network operators might be pro- service providers to be under different institu- hibited to offer financial services. tional forms, each with different permitted activ- With regard to microfinance regulation, one of ities and subject to different regulatory standards. the challenges is how to integrate MFIs into the The different tiers could be defined in a single existing regulatory framework for banks. Three piece of legislation or in separate legislative acts. broad approaches can be distinguished: The advantage of such an approach is that the • Accommodate microfinance under existing intensity of oversight varies with the risks posed banking law: Some of the largest providers of by different providers, and as well, providers can Regulation 419 graduate from one tier to the next in line with and other depository institutions are subject to their stage of development.5 For example, the top prudential regulation. In contrast, nondeposi- tier may be commercial banks with the power to tory institutions may be subject to certain lim- engage in all types of activities from intermediat- ited nonprudential requirements, such as basic ing deposits to entering into international and reporting. foreign currency transactions. A second tier may In all cases, taking a proportionate approach to limit the scope of activities by allowing deposit regulation helps to focus attention on the relevant intermediation but not international transactions, risks and involves an assessment (ideally by both while a third tier may allow only credit activities providers and the regulator) of what activities, (see box 17.2). products, and services involve what risks and why. A primary objective of regulating for finan- cial inclusion—regulating so that markets work Regulation of Financial Service better for the poor—is ensuring that regulation is Providers appropriately crafted and not unduly burden- Financial service providers are subject to dif- some, and that it gives a clear signal to the market ferent regulations based on their activities and that financial services for the poor are a basic their specific legal form. For example, banks component and priority of the regulatory scheme. Box 17.2  Examples of Tiered Approaches In 2002 the Economic and Monetary service from institutions that accept deposits. Community of Central Africa (including In 2002 Kyrgyzstan passed its law regulating Cameroon, the Republic of Congo, the Central microfinance organizations. Kyrgyzstan sepa- African Republic, Equatorial Guinea, Gabon, rates all microfinance activity into three tiers/ and Chad) adopted a microfinance law that types: (1) microfinance companies, (2) micro- divides MFIs into three tiers: credit-only insti- credit companies, and (3) microcredit agen- tutions, institutions that take savings from cies that offer microfinance on a nonprofitable members only, and institutions that take basis. deposits from the general public. Mozambique Uganda was one of the first countries in divides institutions into two categories: those Africa to adopt a separate law for deposit-taking that are licensed and are prudentially regu- MFIs. In addition to commercial banks (tier 1) lated (“microbanks” and credit cooperatives) and credit institutions that cannot take depos- and those that are registered and are moni- its (tier 2), a new tier (tier 3) was created pur- tored by the central bank (credit programs and suant to the Microfinance Deposit-Taking savings and loan associations). Institutions (MDIs) Act in 2003. In the first Within Europe and Central Asia, countries five years after the law was passed, four including Bosnia and Herzegovina, Kyrgyzstan, NGO MFIs received a license under the new and Tajikistan have adopted specialized tiered law. However, since then, a commercial bank microfinance laws. These laws typically differ- bought one of the four MDIs, leaving only entiate institutions that provide only credit three MDIs after nine years. 420 The New Microfinance Handbook Banks Prudential regulation includes requirements Banks engage in the risky business of financial to comply with specified ratios (for example, intermediation: They take deposits from the liquidity ratios and capital adequacy ratios) and public (both legal entities and individuals) and other limits, including minimum capital require- lend these deposits (with and without collat- ment and capital reserves, credit exposure lim- eral) and other funds, including capital and bor- its and unsecured lending limits, restrictions on rowed funds to borrowers (who are likely not to insider lending, and open positions on foreign be net depositors). Basic banking activities typi- exchange (see box 17.3). Banks are often also cally include but are not limited to opening and permitted to hold only a specified percentage servicing clients’ accounts as well as correspon- interest in other legal entities. These rules and dent accounts; payment and money transfer requirements are intended to provide parame- operations, including the issuance of credit and ters for managing the risks of banking business. debit cards and other payment cards; safekeep- Savings banks differ from commercial (or ing; trust operations; issuing guarantees and universal) banks by more limited activities and stand-by letters of credit; and discounting bills their smaller size. Savings banks, and often rural of exchange and other promissory notes.6 Given banks, are generally regulated differently from these various activities and the two basic con- commercial banks and typically by a different cerns presented by banks—the stability of the regulator. Regulation for savings banks should financial system and the potential loss of the be differentiated from regulation of large inter- public’s funds—they are subject to prudential national financial institutions;7 however, with regulation (and supervision). respect to microlending activities these should Box 17.3  Certain Prudential Requirements Minimum capital is the regulatory require- weighted; that is, the riskier the asset, the ment for the minimum capital that a finan- more capital is required to be held. cial institution must have. By requiring Ownership, board, and senior manage- investors to put their own money at risk, ment requirements typically include certain capital should ensure that shareholders fit and proper criteria (owners may be sub- oversee the activities of the institution, ject to a financial capability standard; senior which in turn should promote good man- management and at least some board agement. To facilitate entry of institutions members will likely have to meet certain and promote access, prudential regulation requirements regarding experience and can serve as a balance against a lower expertise). Some countries may have cer- minimum capital requirement. tain additional requirements for significant Capital adequacy sets a framework for owners. how banks and deposit-taking institutions Maximum shareholding limits (which are capitalized or funded. Regulated institu- may be set at 20 percent, 25 percent, 50 tions are required to hold a certain amount percent, or higher) are intended to address of capital relative to assets. Assets are risk diversification interests. Source: Ledgerwood and White 2006. Regulation 421 be regulated similarly to other institutions their application to deposit-taking MFIs is pro- engaged in microfinance (Christen et al. 2012). portionate. Certain prudential requirements Agent banking (that is, a bank’s use of agents to applicable to banks and other deposit-taking provide various services to clients and potential institutions—minimum capital, capital adequacy, ­ clients) has been advancing in several countries ownership requirements and maximum share- as a means for reaching and serving rural popula- holding limits, loan-loss provisioning, and tions and others living in low-populated or hard- liquidity requirements—should be adjusted to to-reach areas where bank branches do not accommodate the specific risks and benefits of operate. Agents may engage in various services, microfinance activities11 (see box 17.4). including cash-in/cash-out, account opening or facilitation of account opening, collection of other Financial Cooperatives information (for example, loan application form) The term “financial cooperatives” refers to mem- on behalf of the provider, effecting payments and ber-based institutions with each member having transfers, and providing account balances. In gen- one vote. Financial cooperatives include a wide eral, agent banking is a type of outsourcing and variety of institutions of different size, member- should be regulated as such. However, in many ship criteria/composition, and operations, includ- countries, the lack of specific regulatory permis- ing credit unions, savings and credit cooperatives, sion regarding banks’ use of agents has been a cajas, caisses, and cooperative banks. In some barrier. It is critical to consider that rules are in countries financial cooperatives are found with place to ensure optimal and effective use of more than 100,000 members and total assets agents. These include (1) permitting the use of exceeding the equivalent of US$20 million. In agent network managers and a tiered retail struc- other countries, the financial cooperatives are ture (for example, agents and subagents) to enable local and small (fewer than 100 members) and cost-effective rollout of agent networks, (2) per- geographically dispersed. mitting a wide range of institutions (including Much less uniformity in approach to regulat- retail outlets and small shops) to serve as agents,8 ing (and supervising) financial cooperatives is and (3) permitting agents to effect or facilitate found than there is for banks, non-bank finan- account opening and perform other actions cial institutions, and insurance companies. In required to ensure the bank’s compliance with some countries financial cooperatives are sub- AML/CFT rules.9 In addition, it is important to ject to prudential regulation; in other countries, ensure consumer protection rules also address they are not. In many countries the regulatory the risks introduced by the use of agents.10 body in charge of all cooperatives is also the reg- ulator of financial cooperatives (and in some Non-Bank Deposit-Taking Institutions cases, although perhaps very few, the nonfinan- Typically, non-bank deposit-taking institutions are cial regulator is asked to supervise compliance permitted to engage in a subset of banks’ permit- with prudential regulations). In other countries ted activities. Lending activities may be limited one may find either an apex (or federation of (entirely or in part) to microloans, and activities cooperatives) or a separate financial regulator for other than lending and deposit-taking may be financial cooperatives. restricted. Other complex or risky activities such For small financial cooperatives, the com- as foreign currency exchange or derivatives may mon bond among members allows for a much not be permitted. Prudential requirements should less intrusive regulatory approach, especially if be evaluated by the regulator—which may be the they take deposits only from members (although banking regulator or a separate body—to ensure for many financial cooperatives, the distinction 422 The New Microfinance Handbook Box 17.4  Adjustments to Prudential Requirements to Accommodate Microfinance Activities • Minimum capital requirements are typically lower for microfinance providers given their more limited scope of activities and the nature of their business. The minimum capital— which is often used as a rationing tool (to avoid overburdening the supervisor)—should be sufficient to cover start-up costs as well as start-up losses. • There has been much debate about whether specialized MFIs should have a higher capital adequacy requirement (CAR) than diversified commercial banks. Although a higher CAR low- ers profits (and hence may deter potential investors from investing), it may not hamper growth of a new MFI in its initial years, because a typical MFI will require more time to build its microloan portfolio than a commercial bank will require to build a conventional loan portfolio. • Ownership, board, and senior management requirements (that is, fit and proper require- ments with respect to experience and ability to respond to capital calls) should be tailored to the specific business and risks of a deposit-taking MFI. • Maximum shareholding interests have been adjusted in some countries and in certain instances to permit the founding nonprofit MFI to be a sole shareholder or to hold in excess of the specified limit. If not adjusted, the limit can be problematic for a transforming NGO MFI that must find investors—and, specifically, investors who share the NGO’s commitment to the mission. • Provisioning requirements imposed on microfinance providers are often higher than those for banks to reflect the lack of or different collateral requirements, the shorter loan terms, and the more frequent repayment schedules of microloans. However, a strong argument can be made for having similar provisioning requirements until a microloan becomes delinquent; after a certain period of time, a short-term unsecured microloan should then be subject to a more aggressive provisioning than a secured bank loan. • Providers may need higher liquidity requirements because of the risk of contagion in bor- rower payment defaults, the ineffectiveness (for the typical MFI) of imposing stop-lending orders (that is, because microborrowers’ incentive to repay is largely dependent on an expectation of a follow-on loan), as well as the lack of access to a lender of last resort ­ facility. Source: Christen et al. 2012. between deposits of members and nonmembers regulator’s capabilities. Furthermore, these small is not significant given the ease of becoming a cooperatives generally do not have the capability member by paying a small fee). Supporting this (in terms of staff and information systems) or the approach is the underlying reality that it is dif- funding to comply with prudential requirements. ficult to create a sustainable system for the The alternative—to close down all financial coop- prudential regulation and supervision of small eratives that are not prudentially regulated and (for example, 100-member) cooperatives; a large supervised—would deprive many people of finan- number of small institutions can overwhelm a cial services that they need. However, there are Regulation 423 clear situations in which financial cooperatives reasons: (1) MFIs often depend heavily on the need to be prudentially regulated and supervised, availability of such funds for their business and specifically, when they are big (as measured by (2) the risk of loss of customer funds is limited to number of members and asset size) and/or take the amount by which (for any customer) the cash deposits from nonmembers. These institutions collateral exceeds outstanding loans owed by are often engaged in activities similar to those of such customer. microfinance banks and should be regulated Although credit-only institutions do not raise similarly. issues requiring prudential regulation, some countries have placed the bank regulator in charge Microlending Institutions of these institutions (typically using a newly cre- Microlending institutions may be nonprofit or ated department). Other options include estab- for-profit and may take different legal forms, lishing a delegated body, a separate regulator, or including associations, foundations, companies, self-regulation by an association or apex. Some or corporations. A microlending institution’s countries may have only a registrar that holds activities are typically limited to lending—which the basic registration information of credit-only it does using capital provided by donors, private providers. investors, and other lenders including commer- Many credit-only MFIs wish to transform cial banks—and other ancillary services, such as into a deposit-taking MFI in order to offer cli- providing business development services.12 ents savings services and also to access addi- Given the basic nature of credit-only opera- tional capital.15 Taking deposits is a complicated tions (which by definition do not introduce risk of business, and the new (or transformed) entity losing deposits), there is no reason to impose the should be subject to the applicable licensing cri- burdensome and difficult prudential regulation teria and the relevant regulatory requirements that is applied to banks and other depository applicable to such type of deposit-accepting institutions.13 Instead, a credit-only institution institution. There should also be clear rules should be subject to certain fundamental require- regarding how such a transformation is affected. ments (in addition to registration): conduct of Those rules should at a minimum permit the business (that is, consumer protection) rules, transfer by the credit-only MFI (including non- basic reporting, and perhaps fit and proper crite- profits) of its microloan portfolio to the new ria for senior management, board members, and, institution in exchange for assets of equivalent in the case of a company, owners. The reporting fair market value.16 Some of the other issues to requirement (if any) should be shaped by the consider and address include (1) whether to per- legitimate objectives of the regulator. It is always mit inclusion of the loan portfolio to satisfy a important not to impose burdensome or unneces- part of the initial capital requirement,17 (2) per- sary requirements.14 mitting an NGO to have an ownership interest in Some credit-only MFIs take cash collateral a for-profit company, and (3) permitting an NGO (also referred to as “compulsory” or “forced” sav- to hold a significant interest in a deposit-taking ings) from clients and intermediate or on-lend institution.18 such funds. Nondepository institutions should In some countries the transformation of an arguably be required to hold such funds in a bank NGO MFI into a deposit-accepting institution account or other safe and liquid investment and (or a for-profit microlending company) is prohib- should not be permitted to intermediate (that is, ited because of a concern regarding the transfer to on-lend) them. However, many would argue private actors of assets intended for public bene- forcefully against such a requirement, citing two fit. This is a complicated topic, but the concern 424 The New Microfinance Handbook can be addressed by ensuring that (1) the NGO long a PSP may hold a customer’s funds before MFI receives fair value for the assets transferred effecting a payment.20 (as determined by an expert valuation) and Unlike payments or transfers, which typically (2) the NGO continues to operate under applica- have to be cleared and settled within a specified ble nonprofit law or dissolves pursuant to such period, e-money (in most jurisdictions) can be law. Whether the transformed institution contin- held indefinitely.21 Its “redeemability” (with- ues to serve the same population as the NGO MFI drawing against cash) and thus its similarity to a will depend on the specifics of the transaction deposit has made regulators at times uncomfort- and the governing documents of the transformed able with allowing non-banks to issue e-money.22 institution. Yet an increasing number of countries as diverse as the EU member countries, Malaysia, the Payment Service Providers and Philippines, Indonesia, the BCEAO West African E-Money Issuers countries, and Afghanistan have created specific Non-banks such as payment service providers rules for non-bank e-money issuers. In other (PSPs) and mobile network operators (MNOs) words, they have permitted a non-bank-based providing e-money play an increasingly impor- model of branchless banking (Lyman et al. 2008). tant role in delivering financial services to the The two most important regulatory measures to poor. Typically these institutions are not subject mitigate the risks of such models are the follow- to prudential regulation for deposit-taking insti- ing (Tarazi and Breloff 2010): tutions, nor do they have to be as long as they comply with certain risk mitigation measures. • Fund safeguarding: The “e-money float,” which They normally offer a much more limited range of are the funds received in exchange for e-money services (that is, only payments and/or e-money), issued by the provider, has to be kept in safe and risks are therefore also more limited. assets so that it is available at all times. This Following the principle of proportionality, it is could either be in accounts with commercial best to bring PSPs and MNOs under a specific banks (in some cases subject to diversification regulatory framework for non-bank financial requirements to minimize residual risks) or in service providers.19 safe assets such as government securities.23 A growing number of countries have a dedi- The float also cannot be used for any purpose cated law for payments systems. Often the central other than paying it out to the clients. bank has regulatory authority; sometimes such • Fund isolation: The e-money float has to be iso- power is vested with another regulator. In many lated from claims against the issuer. This can countries, this power is implied as a part of the be a problem if the funds are held in the name regulator’s responsibility for ensuring the safety of the non-bank and the non-bank goes bank- and soundness of the financial system. rupt. Some countries have used trust or escrow Providers that engage only in payment ser- accounts to shield the money against creditor vices would generally be covered under this law claims.24 or secondary legislation (for example, regulations or guidelines) adopted thereunder. In some coun- Non-banks might be subject to other risk miti- tries, e-money issuers are subject to the same reg- gation measures such as a prohibition to engage ulatory requirements as PSPs; in other countries, in other activities (in particular lending), transac- one finds distinctions, including in particular the tion limits for e-money accounts, and minimum specified minimum capital requirement (if any), capital requirements. Furthermore, if non-bank where customer funds must be held, and how agents are used, the same rules for bank agents Regulation 425 should generally apply to non-bank agents to Insurance Supervisors, the primary purpose of ensure a level playing field between both models. supervision of insurance providers is to promote Questions about payment system interoper- a “fair, safe and stable” sector for the benefit and ability (the ability of clients of competing finan- protection of policyholders (IAIS 2011, p. 15, cial service providers to transact with each other) sec. 1.3). This implies that providers of microin- and agent exclusivity (the ability of a customer to surance are licensed and supervised by the use the agents of different providers for cash-in/ insurance supervisor.26 cash-out services) challenge policy makers to As with many other aspects of microinsurance develop rules that will facilitate fuller financial such as innovative product development or deliv- inclusion (Ehrbeck et al. 2012) (see box 17.5). ery, good practice in the regulation of microinsur- ance is emerging in terms of regulatory and Microinsurance supervisory options. First, there is recognition of Insurance companies are typically subject to a the leading role of the insurance supervisor in distinct supervisory regime because the risks of supporting microinsurance and the relevance of a insurance are different from those presented by clear development mandate for the supervisor: lending or deposit-taking institutions.25 Normally Access to insurance should be included in finan- insurance underwriters are prohibited from cial inclusion strategies. Furthermore, regulation engaging in other financial services; similarly, should be risk based and proportionate to the banks and other depository institutions are gen- nature, scale, and complexity of the risks inherent erally prohibited from underwriting insurance. in the individual business. Last but not least, As stated by the International Association of supervisors should build their capacities in terms Box 17.5  Financially Inclusive Ecosystems “Interoperability and nonexclusive agents can could ‘piggyback’ off of a large start-up invest- expand financial access by opening more ment. A few governments have imposed access points to a greater a number of cus- mandatory interoperability ex ante, some- tomers. They could also increase competition times even requiring connection to a state that could drive costs down, though this ulti- developed and/or -owned central switch for mately depends on pricing—freely negotiated funds transfer processing. Such efforts have or government imposed—for cross-network often achieved lackluster results. Other coun- transactions. But what is the best path to tries are considering mandating interoperabil- interoperation? ity ex post—often upon evidence that the “Permitting exclusive platforms and agent dominance of large players is suppressing networks can ultimately allow first movers or competition. And other governments have large actors to dominate the market, with the taken a less direct approach—encouraging possible result of limited competition and arti- the private sector to interoperate voluntarily, ficially high prices. However, mandating inter- with the tacit understanding that the govern- operability too early in the growth of the ment can impose interoperability on perhaps ­ market may discourage actors from entering less favorable terms if the voluntary approach the market due to concerns that competitors does not produce the desired results.” Source: Ehrbeck et al. 2012, pp. 7–8. 426 The New Microfinance Handbook of the different client segment, business model, risk. Creating a second tier of insurance license and internal challenges they face in their author- with entry and other regulatory requirements tai- ity to accommodate microinsurance. lored to microinsurance supports the entry of Existing insurance regulatory frameworks new providers. It can facilitate the formalization often show numerous barriers to inclusion, of member-based organizations, which are highly including the following: prevalent in microinsurance and often not for- malized under the insurance law. This regulatory • Product regulation approach can be necessary in the case of a signifi- • Demarcation between life and non-life lines of cant number of informal providers. business An increasing number of insurance supervi- sors allow innovative distribution channels to • Market conduct regulation to ensure that reach low-income populations through known the interests of the insured are adequately and trusted providers (for example, public utili- safeguarded ties, MFIs, pawnshops, religious groups, trade • Rules for claim payment or redress unions, or retail shops). There are more options for how the insurance • Capital adequacy, solvency, and technical supervisor can help to spur microinsurance, provisions among them, lowering the regulatory burden that • Prescribed standards on investment activities insurers and distribution channels incur, for example, by allowing the bundling of life and • Prescribed risk management systems non-life insurance in one insurance policy, or by • Prescribed underwriting systems and processes. simplifying requirements of product registration and agent training. Box 17.6 provides more infor- Regulatory areas beyond insurance also often mation on the policy, supervisory, and regulatory impact microinsurance provision, including bank- options supervisors can pursue to stimulate ing laws (which may impede bancassurance), sound microinsurance provision and broad-based ­ telecommunication laws (which can impede industry engagement by a variety of insurers and mobile-phone based delivery), and cooperative intermediaries. laws (which may provide different standards for this type of entity). Supervision of Banks and Other Insurance supervisors should develop a regu- Non-Bank Institutions latory solution that considers both insurance and other legal areas, encourages industry innova- Institutions subject to prudential supervision tions, and clearly defines insurance providers and generally include banks and other deposit-taking those that can act only as intermediaries. institutions, although not all deposit-taking insti- Insurance supervisors have been pursuing a tutions are subject to supervision. Other nonde- variety of actions to advance inclusion in their pository financial service providers engaged in jurisdiction. Some countries (for example, the activities that are similar to accepting deposits Philippines and South Africa) have established a (such as non-bank e-money issuers) may be sub- tiered regulatory structure for microinsurance to ject to supervision by the financial regulator, facilitate entry as well as growth and formaliza- although typically more limited than that of banks tion. This approach strives to make capital given the key distinction (that is, no deposits). requirements proportionate requirements rela- Credit-only institutions are typically not super- tive to the nature, scale, and complexity of the vised. There may be a regulator that oversees Regulation 427 Box 17.6  Making Insurance Markets Work for the Poor—Emerging Guidelines for Microinsurance Policy, Regulation, and Supervision • Take active steps to develop a microinsurance market—Confer a market development man- date on regulators over and above their normal supervisory mandate; understand the existing as well as potential market; consider both formal and informal providers; place information including market surveys about unserved market segments within the public domain; make a public commitment to the growth of microinsurance; allow space for market experimenta- tion while monitoring risk to the market and consumers. • Adopt a policy on microinsurance as part of the broader goal of financial inclusion—Formulate a policy appropriate to the circumstances of the country; consult formal and informal market players and relevant government departments; locate the policy within government’s approach to financial inclusion; base the policy on sound information about the market and its evolution. • Define a microinsurance product category—Determine the extent to which the current reg- ulatory burden inhibits the underwriting and/or distribution of microinsurance; if the regula- tory burden inhibits the growth of microinsurance, define a microinsurance product category with systematically lower risk that will justify reduced prudential and market conduct regula- tion; define microinsurance as wide as possible in terms of risk events covered and maxi- mum benefit levels; restrict the contract term of microinsurance polices; ensure simplicity of terms and easy communication. • Tailor regulation to the risk character of microinsurance—Consider the specific regulator pro- visions that restrict the growth of microinsurance; decide whether appropriate exemptions to key provision will be sufficient or if a new tier of regulation is required; design microinsurance regulatory tier to be attractive to existing insurers and potential new entrants; develop risk-proportionate rules for microinsurance providers; consider the need to maintain the strict demarcation between life and non-life insurers and if possible allow a microinsurance license holder to underwrite both. • Allow microinsurance underwriting by multiple entities—Allow multiple legal forms to under- write microinsurance, including cooperatives and other mutual types of member-based legal forms; ensure institutions that underwrite the same products are subject to the same regu- latory requirements; ensure all institutions are subject to corporate governance and account- ing and public disclosure standards adequate to ensure compliance; enable all microinsurance providers to access reinsurance. • Provide a path for formalization—Allow new institutional forms to underwrite insurance; pro- vide a tiered minimum capital and solvency structure; make underwriting mandatory of all or certain lines of business by larger insurers or reinsurers coupled with capacity-building requirements; coordinate formalization with other government agencies. • Create a flexible regime for the distribution of microinsurance—Allow multiple categories of intermediaries; avoid prescriptive regulation that restricts potential intermediaries; provide ease of consumer recourse. • Facilitate the active selling of microinsurance—Apply the lowest possible levels of market conduct regulation without comprising consumer protection; develop standard simplified (continued next page) 428 The New Microfinance Handbook Box 17.6 (continued) terms and conditions for microinsurance; ensure minimum disclosure of product and sup- plier information to the client; avoid price controls on intermediation. • Monitor market developments and respond—Prioritize supervisory capacity according to assessment of risk; carefully monitor. • Use market capacity to support supervision in low-risk areas—Where feasible, delegate aspects of supervision to other market players; clearly delineate roles and responsibili- ties; monitor and ensure effective consumer recourse mechanisms to ensure delegated supervision does not put consumer at risk. Source: Bester et al. 2008. compliance with regulatory requirements, includ- responsible for monetary issues, a separate regu- ing basic reporting, fit, and proper requirements lator responsible for systemic risk and pruden- (applicable to senior management, board mem- tial issues, a deposit insurance supervisor, and bers, and significant owners), as well as consumer different regulators of state banks, private banks, protection rules. smaller banks, and other banks (for example, In many countries one finds institutions that savings banks or rural banks). collect savings and intermediate them but are The focus of supervision for banks is risk man- subject to no prudential supervision at all. agement and should ideally be shaped by the Technically these institutions may not be taking application of a proportionate approach. This “deposits” (as defined under the law), but their should serve to increase financial inclusion activities involve risks similar to those of other because it advocates regulating according to risk deposit-taking institutions. These institutions (of both the institution and the particular activi- should probably be prudentially regulated and ties) and accordingly can serve to encourage and supervised if they exceed a certain size, measured enable innovations with confined scope (focused by assets (or in the case of financial cooperatives, on specific clients and products) and risk. number of members).27 However, supervisors may Prudential supervision of banks involves not have the staffing or capacity to take on such (1) monitoring (both off-site through reports responsibility, and the institutions themselves and on-site) to ensure banks are complying with may not have the staffing or funding to comply prudential regulations, (2) issuing compulsory with prudential requirements. Policy makers need instructions, (3) taking other measures to influ- to assess the situation and determine which is ence banks’ activities and actions, and (4) impos- preferable: institutions engaged in unsupervised ing sanctions. Supervision of banks’ agent deposit-taking (or depository-like) activities or the activities should be approached similarly to cessation of such institutions or such activities. supervising other outsourcing by a bank.28 Banks Non-Bank Depository Institutions The supervisor of banks is usually the central The supervisor of non-bank depository institu- bank, although there may be more than one tions may be the same as the bank supervisor supervisor; that is, the central bank may be (although typically there will be a separate Regulation 429 department for non-bank depository institutions) credit information, payment and clearing sys- or it may be a separate financial regulator. In some tems, deposit insurance, and collateral/secured situations, supervision is conducted by a nongov- transactions. ernmental agency, acting either pursuant to dele- The regulation of the credit information mar- gation by a regulatory (governmental) authority ket is usually tied to data privacy and bank secrecy or as part of a self-regulatory scheme. Certain laws.29 To transmit information about clients to supervisory practices may not work well with an outside party (such as a credit bureau), with- respect to institutions with loan portfolios pre- out a separate regulatory provision permitting dominantly comprising microloans. First, the off- such activity, a provider would typically need to site and onsite supervision techniques need have customers’ permission. (In some countries, adjustment because microloan portfolios are rela- regulation specifically requires providers to have tively light on documentation and cannot be customer’s consent to such activity.) In countries assessed by reviewing a sample of large loans. where there is low participation by non-banks in Rather, supervision should focus on compliance credit reporting, the regulator may decide either with the lending and collection policies as well as to require participation or to create incentives to performance of the portfolio. Second, certain participate (for example, by applying lower provi- supervisory actions—specifically, stop-lending sioning requirements for loans that were orders and forced assets sales and mergers—may extended based on review of the customer’s credit not work for such institutions. Given clients’ reli- report). To ensure customers are not subject to ance on follow-on loans, a stop-lending order can mistreatment as a result of inaccurate informa- result in widespread defaults (Christen et al. tion in credit reports, there is typically a require- 2012), and with the often close relationship ment to keep information up-to-date and remove between loan officers and clients, an asset sale or stale information, to provide customers’ access to merger that cuts such a relationship may also the information on file, and to correct informa- cause clients (who may also conclude that there is tion upon notification of error. less likelihood of a follow-on loan) to default. Although regulators have traditionally focused As stated above, less uniformity in approach on payment and clearing systems between finan- is found in supervising financial cooperatives cial institutions (for example, SWIFT), increasing than other non-bank financial institutions. Often attention and time is devoted to retail payments the financial regulator with responsibility over and transfers because of their increasing impor- the banking system has neither the required staff tance. Oversight includes promoting efficient, nor familiarity with financial cooperatives to secure and reliable systems, addressing opera- take on supervisory responsibility. This is a diffi- tional and other risks, and promoting fair and cult challenge, and policy makers must decide open access. Access to a particular payment sys- whether to impose the responsibility on such tem is usually determined by agreement among regulator, create a delegated structure, bring participants who decide which institutions may them under a separate supervisory body, or seek have access and at what cost. Ideally the partici- to impose self-regulation. pants of a payment system will set requirements (for example, proof that internal controls are suf- ficiently robust to address and cope with various Regulation of Financial risks) designed to ensure the system‘s integrity Infrastructure and stability. The reality is that formal payment Well-functioning and inclusive financial infra- systems are typically dominated by large com- structure is key to financial inclusion, including mercial banks that have little interest or incentive 430 The New Microfinance Handbook to serve the poor. In some countries, because of AML/CFT Requirements concerns about dominant players or out of an interest in promoting interoperability, regulators Although a number of countries do not have ded- have mandated access (or intervened in the case icated AML/CFT laws, many countries have of anticompetitive pricing) and regulated fees established requirements that follow the recom- (although these steps can be counterproductive mendations and guidance of the Financial Action for financial inclusion purposes if they serve to Task Force (FATF).30 The basic AML/CFT mea- inhibit innovation). An important factor in deter- sures include customer due diligence (CDD) mining whether to regulate ex ante or take ex post (often synonymous with “know your customer” regulatory enforcement or intervention  (which [KYC]), monitoring and maintaining records of may involve the competition regulator) is the customer transactions, and notifying the appro- state of maturity of the particular payment sys- priate authorities in case of suspicious transac- tem: in general, ex ante regulation is difficult to tions. (The AML/CFT CDD requirements may craft when the implications are little known or overlap with the KYC measures identified by understood, as may be the case with a new pay- the Basel Committee on Banking Supervision ment system. as an essential part of a bank’s risk management In the majority of countries, prudentially reg- practices. However, there may also be differ- ulated commercial banks have to participate in ences because the two sets of requirements the deposit insurance scheme. A few countries serve different purposes.) require or permit non-bank deposit-taking insti- As articulated in the new 2012 FATF recom- tutions to participate (either in the same scheme mendations, CDD measures should comprise the or a similar scheme), although usually this following, subject to a risk-based approach that applies only to those institutions that are pru- permits simplified measures for lower-risk prod- dentially regulated and supervised. Supervision ucts and services and exemption from certain of the deposit insurance scheme and its partici- requirements for proven low-risk products and pants may in some cases be undertaken by a sep- services: arate regulator, in which case coordination with • Identifying and verifying a customer’s identity the bank regulator is critical. In all events it is using reliable documents, data, or other essential to ensure that such a scheme can be information funded and that the covered institutions are effectively supervised. • Identifying the beneficial owner and taking Although collateral is typically not a feature reasonable steps to verify such identity of most microloans, effective use of collateral • Understanding the purpose and intended (that is, secured transactions) requires clear nature of the business relationship regulation on what can be used as collateral, how such collateral is registered, and how a • Conducting ongoing due diligence on the security interest in collateral is “perfected.” In ­business relationship. addition to having accessible collateral regis- tries (either physically accessible or accessible Because of the difficulty that poor customers electronically), it is critical to have a function- may have providing proof of identification and ing enforcement mechanism. However, estab- proof of address in the absence of a national lishment of registries and capacity in the courts identification (ID) program, a country’s AML/ ­ to enforce creditors’ rights is time consuming CFT requirements can negatively impact finan- and costly. cial inclusion efforts.31 The risk-based approach Regulation 431 supported by FATF is critical to addressing this  8. Many countries permit individuals to be potentially significant and negative impact of agents. Appropriate criteria should be AML/CFT rules. Low-value savings accounts and designed in light of the activities that the mobile money wallets particularly benefit from agents will engage in. See further discussion of this flexibility (Bester et al. 2008; Isern and de this and other regulatory issues relevant to bank agents in Tarazi and Breloff (2011). Koker 2009).  9. For a discussion of these issues and others, see Lyman et al. (2008). Notes 10. See further discussion on the consumer  1. Basel Committee on Banking Supervision protection issues raised by the use of agents in (2011), para. 16, p. 4. Dias and McKee (2010).  2. This in turn means working with resolution 11. See Christen et al. (2012) for a detailed authorities so the handling of the failure is discussion of the special prudential regulatory done in an orderly manner. Ibid., para. 16, p. 4. standards and the particular supervisory  3. The public (as opposed to private) interest actions that should be applied to depository view of regulation assumes that regulation microfinance institutions. See also Basel benefits the society as a whole (and not only Committee on Banking Supervision (2010). particular interest groups). See, for example, 12. Some microlending institutions also Barth et al. (2006). On market failures in engage in financial education activities as microfinance, see Staschen (2010). well as nonfinancial activities, such as  4. In rare cases, regulation might also spur the providing services related to education market, but only if it is closely tailored to what and health. the market needs. A case for this are the 13. Generally credit-only institutions do not Branchless Banking Regulations in Pakistan, introduce systemic risk, although in a few which were issued before any of the providers countries, the microlending institutions have had launched a product, but have since grown so large and have such significant facilitated a vibrant market. borrowings that their failure can cause  5. This approach was first described in van systemic instability. These risks, however, Greuning et al. (1998). should ideally be addressed through  6. Additional activities that may be permitted but prudential regulation of the banks that lend in some cases require an additional license to the microlending institutions. include investment banking operations, 14. Reporting may include updating basic foreign exchange operations, custody and sale elemental information on ownership, board of precious metals, leasing, factoring and membership, address, and names of senior similar activities (that is, buying and collecting management. Requiring some financial claims), and conducting operations outside reporting can be justified if it is made available country borders. Each country will have its to the public or if the regulator will use such own list of permitted activities that may information to better understand and monitor include some or all of the activities listed as the financial system as a whole. However, well as others. requiring reporting for the purpose of  7. WSBI-ESBG message to the G20 Leaders’ “training” the MFIs is more appropriately set meeting at the Cannes Summit in November forth in private arrangements, for example, 2011, http://www.wsbi.org/uploadedFiles/ with a donor or a lender. Position_papers/WSBI%20and%20 15. The terms “transform” and “transformation” in ESBG%20message%20to%20the%20G20%20 this case do not usually involve the conversion Leaders.pdf. of an institution from one type into another but 432 The New Microfinance Handbook rather involve the transfer of a microlending Technical Team of the Access to Insurance business to another institution. Initiative, on behalf of BMZ/GIZ. 16. Ideally such a transfer should be subject to an 26. Only one legal body should be responsible for expert evaluation, especially if the loans are supervision of insurance regardless of the permitted to be counted as capital for provider and its size. ­ purposes of satisfying the initial capital 27. In its Model Regulations for Credit Unions, requirement of the deposit-taking institution. the World Council of Credit Unions takes the 17. There are alternative mechanisms for using the position that all credit unions (that is, financial loan portfolio to satisfy the minimum capital cooperatives) should be prudentially regulated requirement, including giving the transformed and supervised, and it suggests a minimum institution time to satisfy the requirement requirement of 300 founding members provided that it does not engage in taking (WOCCU 2008). deposits during the period before the date on 28. For a more detailed discussion of such which the capital has been contributed in full. supervision, see Lauer et al. (2011). 18. See Lauer (2008) for a further discussion of 29. This discussion addresses the regulation of issues to be considered. private credit bureaus as opposed to credit 19. To ensure competitive neutrality, payment registries, which are typically housed in the services and e-money issuance by banks and financial regulator and are permitted by other depository institutions can be brought applicable financial regulation (that is, the under similar rules. banking law or the microfinance bank law) to 20. The second and third requirements are collect information from its regulated institu- related. If the funds may be held for only a tions as a part of the regulator’s activities. short period, the requirement applying to 30. Depending on the country approach, the e-money issuers regarding “fund safeguard- regulator responsible for enforcing AML/CFT ing” may not apply or may be less restrictive. rules (referred to as the financial intelligence 21. E-money can be defined as electronically unit [FIU]) may be housed in the financial stored value issued on receipt of funds for the regulator. If the FIU is an independent purpose of making payment transactions. It government agency or housed in another can be redeemed against cash or used for government agency (such as the police), payments and transfers. coordination with the financial regulator(s) 22. In fact, it has been argued that the money held will be important. in e-money accounts should also pay interest 31. A national ID program can also enable and be covered by deposit insurance. This, non-face-to-face account opening and the use however, is not the current practice. See of agents for KYC purposes. Ehrbeck and Tarazi (2011). 23. Even if these deposit accounts are subject to References and Further Reading deposit insurance, the value of funds in the account is typically much higher than the *Key works for further reading. coverage limit. The EU E-Money Directive Access to Insurance Initiative. http://www.access- also permits as an alternative to cover the full to-insurance.org. amount of the e-money float by an insurance Barth, J. R., G. Caprio Jr., and R. Levine. 2006. policy. 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Africa: Findings and Guidelines.” Journal of 2008. “Implementing FATF Standards in Money Laundering Control 12(4). Developing Countries and Financial Inclusion: Dias, D., and K. McKee. 2010. “Protecting Findings and Guidelines,” FIRST Initiative, Branchless Banking Consumers: Policy World Bank, Washington, DC. Objectives and Regulatory Options.” Focus Bester, H., D. Chamberlain, and C. Hougaard. Note 64, CGAP, Washington, DC. 2008. “Making Insurance Markets Work for the Ehrbeck, T., M. Pickens, and M. Tarazi. 2012. Poor—Executive Summary and Emerging “Financially Inclusive Ecosystems: The Roles Guidelines.” Focus Note 2, Microinsurance of Government Today.” Focus Note 76, CGAP, Network, Luxembourg. Washington, DC. Black, J. 2008. “Forms and Paradoxes of Principles *Ehrbeck, T., and M. Tarazi. 2011. “Putting the Based Regulation.” LSE Legal Studies Working Banking in Branchless Banking: Regulation and Paper 13. http://papers.ssrn.com/sol3/papers the Case for Interest-Bearing and Insured .cfm?abstract_id=1267722. E-Money Savings Accounts.” World Economic Chatain, P.-L., R. Hernandéz-Coss, K. Borowik, and Forum, Geneva. A. Zerzan. 2008. “Integrity in Mobile Phone Financial Action Task Force. 2012. “International Financial Services: Measures for Mitigating Standards on Combating Money Laundering Risks from Money Laundering and Terrorist and the Financing of Terrorism and Financing.” World Bank, Washington, DC. Proliferation – The FATF Recommendations.” Chatterjee, A. 2012. “Access to Insurance and Paris: FATF. Financial Sector Regulation.” In Protecting the IAIS (International Association of Insurance Poor: A Microinsurance Compendium, Vol. II, Supervisors). 2011. “Insurance Core Principles, ed. C. Churchill and M. Matul, 548–72. Geneva Standards, Guidance and Assessment and Munich: International Labour Methodology.” International Association of Organization and Munich Re Foundation. Insurance Supervisors, Basel. *Christen, R., K. Lauer, T. Lyman, and R. Rosenberg. Isern, Jennifer, and Louis de Koker. 2009. “AML/ 2012. Microfinance Consensus Guidelines: A CFT: Strengthening Financial Inclusion and Guide to Regulation and Supervision of Integrity.” Focus Note 56, CGAP, Washington, Microfinance. Washington, DC: CGAP. DC. http://www.cgap.org/gm/document- CGAP. 2011. Global Standard-Setting Bodies and 1.9.37862/FN56.pdf. Financial Inclusion for the Poor – Toward Kirkpatrick, C., and D. Parker. 2007. Regulatory Proportionate Standards and Guidance. A White Impact Assessment: Towards Better Regulation? Paper prepared on behalf of the G20’s Global Cheltenham: Edward Elgar. Partnership for Financial Inclusion. Lauer, Kate. 2008. “Transforming NGO MFIs: Washington, DC: CGAP, October. Critical Ownership Issues to Consider.” Committee on Payment and Settlement Systems. Occasional Paper 13, CGAP, Washington, 2005. “Central Bank Oversight of Payment and DC, May. Settlement Systems.” Basel: BIS. http://www *Lauer, Kate, Denise Dias, and Michael Tarazi. .bis.org/publ/cpss68.pdf . 2011. “Bank Agents: Risk Management, 434 The New Microfinance Handbook Mitigation, and Supervision.” Focus Note 75, of Legal Frameworks in 11 Countries CGAP, Washington, DC, December. Worldwide.” GTZ, Eschborn. Ledgerwood, Joanna, and Victoria White. 2006. ———. 2010. Regulatory Impact Assessment in Transforming Microfinance Institutions: Microfinance: A Theoretical Framework and Its Providing Full Financial Services to the Poor. Application to Uganda. Berlin: Washington, DC: International Bank for Wissenschaftlicher Verlag. Reconstruction and Development and the Tarazi, M., and P. Breloff. 2010. “Nonbank World Bank. E-Money Issuers: Regulatory Approaches to *Lyman, T. R., M. Pickens, and D. Porteous. 2008. Protecting Customer Funds.” Focus Note 63, “Regulating Transformational Branchless CGAP, Washington, DC. Banking: Mobile Phones and Other *———. 2011. “Regulating Bank Agents.” Focus Note Technology to Increase Access to Finance.” 68, CGAP, Washington, DC. Focus Note 43, CGAP and DFID, Washington, Trigo Loubière, Jacques, Patricia Lee Devaney, and DC, and London. Elisabeth Rhyne. 2004. Supervising & Regulating *Porteous, David. 2006. “The Regulator‘s Microfinance in the Context of Financial Sector Dilemma.” FinMark Trust, Johannesburg. Liberalization: Lessons from Bolivia, Colombia www.finmarktrust.org.za. and Mexico. Somerville: ACCION. *Porteous, David, Daryl Collins, and Jeff Abrams. van Greuning, H., J. Gallardo, and B. Randhawa. 2010. “Prudential Regulation in Microfinance.” 1998. A Framework for Regulating Microfinance Policy Framing Note 3, Financial Access Institutions. Washington, DC: World Bank. Initiative, Cambridge, MA, January. WOCCU (World Council of Credit Unions). 2008. *Staschen, Stefan. 2003. “Regulatory Model Regulations for Credit Unions. Madison, Requirements for Microfinance: A Comparison WI: WOCCU. Regulation 435 CHAPTER 18 Infrastructure and Outsourced Support Services Geraldine O’Keeffe, Julie Earne, Joakim Vincze, and Peter McConaghy In many developing countries, infrastructure is Outsourcing support services to third-party lacking or degraded, limiting efficient scale and providers can improve the efficiency of operations broad-based access to financial services. Physical by allowing financial service providers to special- infrastructure such as accessible roads, reliable ize in their core expertise while paying outside power, and efficient data and voice communica- specialists to fill gaps. It can also streamline the tion systems are all required to provide financial services offered by minimizing unforeseen costs services. Financial infrastructure, such as clear- and maximizing operational performance thus ing and settlement systems, deposit insurance, allowing for greater focus on providing services. and credit bureaus, facilitates transactions As the industry expands, more and more service between individuals and institutions and sup- markets are developing for outsourced services ports the efficient functioning of financial mar- including, for example, call centers, cash-in-tran- kets, enabling financial service providers and sit, audit services, or software as a service. others (including regulators) to exchange infor- This chapter briefly addresses some of the mation and settle payments. Reliable and efficient more crucial infrastructure required for the pro- infrastructure fosters financial stability and is vision of financial services and various outsourced imperative for the successful operation of mod- support services becoming available in the finan- ern, integrated financial markets. cial market system. It will be of interest primarily Contributions to this chapter were made by Candace Nelson. Infrastructure and Outsourced Support Services 437 to providers and policy makers as well as donors their liquidity, and for mobile branches to reach interested to support the development of strong remote villages. Clients who need to make deposits supporting functions. and withdrawals, apply for and receive loans, or attend group meetings all use roads. In rural or mountainous areas, road infrastructure is often Physical Infrastructure limited, and in high-density urban areas heavy traf- Roads are among the most basic infrastructure and fic can mean that a disproportionate amount of are used by all financial service providers, their time is needed to travel even short distances. This agents, and clients. While most relevant for branch has implications for both clients and providers: “In networks, even branchless banking requires acces- rural Africa women often walk ten miles or more sible roads for providers to service automated every day to fetch water. In the dry season it is teller machines (ATMs), for agents to replenish not uncommon for women to walk twice this Box 18.1  Lighting Africa When the sun sets in rural Kenya, about drugs to motorbikes and water tanks, were 96 percent of households light up their able to supply portable solar lighting technol- homes with candles and kerosene lamps. ogies at affordable prices by purchasing These sources of lighting are expensive, inef- lights in bulk. The solar lamps also double as ficient, and unhealthy. On average, a rural phone chargers. household spends approximately US$18, or While making this product available for pur- 20 percent of their total monthly income, on chase was a great start, smart financing solu- kerosene per month. To overcome this obsta- tions were necessary to ensure that rural cle, Lighting Africa, a program of the communities could take advantage of this International Finance Corporation and the new efficiency. The cost of each solar lamp is World Bank, has been helping to develop anywhere from US$22 to US$97 and is guar- commercial off-the-grid lighting markets. anteed to last without replacement costs for TechnoServe, a nongovernmental organiza- five years. While the up-front costs are signifi- tion (NGO) dedicated to building businesses cant, the dairy cooperatives agreed to intro- that create income and economic growth, duce a loan product through the village bank, has capitalized on this work and established something that was made possible by the a sustainable method whereby rural farmers security of the dairy business. participating in its dairy program can access Households realize the monetary benefits affordable lighting resources. of having a solar light after just four months. To supply lighting products at an afford- Assuming that a light lasts only five years (the able price, TechnoServe linked rural stores to minimum life span), the household will save leading global solar lighting companies such US$144 over the course of the first year and as d.light, Barefoot, and Green Planet. These more than US$800 for the remaining four rural businesses, known as agrovet stores, years, a total of nearly US$1,000 in savings for which sell everything from livestock feed and rural Kenyan farmers. Source: Keepper 2011. 438 The New Microfinance Handbook ­ istance.”1 Although the need for water is more d fund transfers (EFTs), direct debits, mobile pay- critical than the need for financial services, many ments, and e-commerce payment systems. These people, especially women, spend a large amount of electronic payment systems allow participating time in transit in order to obtain the basic necessi- institutions to facilitate client transactions in ties of life; at the same time, there is significant multiple locations, perform electronic fund trans- potential for branchless delivery of financial ser- fers, clear checks, and process card payments. vices, for example, via mobile phones, with clients Although this offers many potential benefits, par- being able to transact right in their village. ticipation is generally restricted to large, regu- Electrical power is critical to the operations, lated financial institutions and their clients data integrity, and security of providers. In areas (Glisovic, El-Zoghbi, and Foster 2010). where electricity sources are irregular and unre- Transactions between institutions or between liable, providers create their own electricity using clients using different providers require technol- a generator or an alternative source of energy ogy to allow one system to communicate with the such as solar panels. Clients also benefit from other. This is generally referred to as interoper- access to solar lighting (see box 18.1). Even in ability. Interoperability can also refer to the link- areas with electricity, unplanned power outages ing of networks to allow users of one network to occur. If available, uninterruptible power supply access the services of another (see chapter 12). devices or short-term back-up equipment, such Interoperability expands the number of ways and as an inverter, can supply power long enough to places in which money can be used and therefore support the proper shutdown of equipment and is of value to consumers. An electronic payment avoid the loss of data and incomplete posting of system promotes interoperability between insti- transactions. tutions, which, in turn, facilitates transactions between clients. Payment, Clearing, and Settlement National and International Payment Systems Systems Payment systems are the set of laws and regula- Banks and other depository institutions participate tions, procedures, and network infrastructure for in electronic payment systems via message- transferring money between two or more finan- routing systems that facilitate wholesale transac- cial institutions and their customers. They play a tions. These systems exist both as global systems key role in the functioning of financial markets by that facilitate international payments as well as facilitating communication between participants. national systems for in-country movements of These communications revolve around the clear- funds (see box 18.2). At the international level, ing and settlement of transactions. Clearing refers the Society for Worldwide Interbank Financial to the transmission and reconciliation of payment Telecommunication (SWIFT) network, a Belgium- orders and establishment of the final positions to based cooperative society, provides a global stan- be settled. Settlement is the event that actually dard for fund transfers and processes payment carries out the obligations—that is, the debiting orders on behalf of 9,000 financial institutions in and crediting of the accounts of the parties within more than 200 countries. SWIFT uses a unique the transaction. number to identify the institution initiating and Payment systems can be either physical or the institution receiving the transfer. In 2009 electronic, with electronic systems growing the SWIFT introduced Alliance lite, a simplified fastest with the emergence and wide-scale adop- product designed to facilitate the participation tion of systems such as debit cards, electronic of smaller banks. Alliance lite affords low-cost Infrastructure and Outsourced Support Services 439 Box 18.2  IRnet for Credit Unions Many credit unions that offer remittances do so account, account-to-cash, or cash-to-cash through an electronic platform developed by remittances for IRnet credit unions. A credit the World Council of Credit Unions (WOCCU) union that joins IRnet can choose which ser- called the International Remittances Network vices it would like to offer to its members. (IRnet). IRnet provides credit unions with the Consumers using an IRnet credit union can ability to offer money transfer services. On the send and receive money from the United sending side, WOCCU has contracted with States, Latin America, Asia, Africa, Europe, and MoneyGram, Travelex, and Vigo Remittance Australia. Since its establishment in 1999, Corporation, three well-established money more than US$1.3 billion has been transferred transfer organizations, to transmit account-to- through the network. Source: www.woccu.org. access to the SWIFT network for institutions a line of credit with a limit. Likewise, when it with a low volume of transactions.2 issues a debit card, it reviews the client’s account At the national level, several systems exist, to ensure that it holds sufficient funds for pay- including real-time gross settlement (RTGS), ment capacity. Clients can then purchase goods which is typically operated by the central bank to and services using the credit or debit card at facilitate high-value, low-volume transactions. In retailers that accept the payment processor’s an RTGS system, transactions are settled immedi- brand. The payment processor facilitates the pay- ately using accounts held at a central bank, which ment directly from the cardholder’s bank to the eliminates credit risk associated with settlement retailer’s bank. This process effectively transfers time lag. At the national level, EFT switches also the repayment risk from the seller to the financial facilitate electronic payments via networks of institution that issued the card, which should be ATM and point-of-sale (POS) devices. Switches more capable of analyzing credit risk than the can be either hosted by individual financial insti- retailer. tutions or shared among a group of institutions, as In addition to retail settlement systems, there is the case with national switching systems. is an increasing need for clearing payments origi- Through these national switches, clients of all par- nated by individuals or businesses outside of ticipating institutions can use shared ATMs and financial institutions. These person-to-person POS devices via debit or credit cards (see box 18.3). (P2P) payments, which are primarily facilitated by the Internet and mobile phones, require a sys- Retail Payment Processors tem for settling accounts between a triangle of Retail payment processors, such as Visa, clients, mobile network operators (MNOs) or MasterCard, Maestro, and CIRRUS, have their Internet merchants, and financial service provid- own settlement systems. Participating financial ers. Some facilitate electronic payments over the institutions issue branded cards to clients. When Internet alone, some provide a combination of an institution issues a credit card, it evaluates the mobile and Internet access points, while others creditworthiness of the cardholder and provides clear mobile payments only. 440 The New Microfinance Handbook Box 18.3  Regional or National Switches Shared regional or national switches have Another example of a national switch in been developed to extend financial access in Africa is Ghana’s e-switch, a national switch unbanked regions where access to interna- and smartcard payments system initiated by tional payment systems is limited or nonexis- the Bank of Ghana. The system, which was tent. Examples of regional switches include launched in part through financing from inter- Ferlo, the first electronic payment platform of national financial institutions such as the West African Economic and Monetary Kreditanstalt für Wiederaufbau (KfW), can be Union. Ferlo was founded as a partnership used for savings, payments, and transfers, as between Byte-Tech, a provider of electronic well as for managing various business trans- payment solutions, and AfricapFund, an actions. The technology is being deployed in investment fund owned by a pool of interna- rural areas through agent networks and mer- tional investors. Ferlo has positioned itself as chants in order to extend financial access in a provider of services and electronic payment rural areas. The technology permits offline solutions for microfinance institutions (MFIs), transactions and fingerprint recognition, mak- including integrated electronic payments at ing it as accessible and as convenient as pos- the community level. sible for the rural poor. Source: CGAP 2011b; http://www.ghipss.net/. Payment Integrators Internet banking platform, to the core banking system of the financial institution where the cli- To participate in an electronic payment system, a ent holds an account. The technology used to financial institution needs to consider how to connect the two systems is often referred to as a integrate its core banking system with the pay- “bridge” or EFT switch, which is a piece of soft- ment system so that payments are processed in ware that connects multiple financial systems. real time. This work is typically contracted to a Switches use industry standard communication payment integrator who supplies the technology protocols. The exact protocol used will depend on that connects the systems in the financial institu- an agreement between the payment system pro- tion with that of the payment system provider. vider and the financial institutions (see box 18.4). Payment integrators can play a large role in pro- In some cases, where the two systems generate or moting interoperability because having more require different formats, the EFT switch or financial providers connected to electronic pay- bridge will translate from one format to another. ment systems means a greater ability for clients to transact with each other and access their funds Voice and Data Communications from multiple locations. Infrastructure The integration of systems involves the trans- lation of banking instructions, or financial mes- Telecommunications technology comes in two sages, from the technology that originated the primary forms: fixed line and wireless. transaction, which could be either a mobile Traditionally provided by public entities, fixed (mobile banking, mobile money), POS, ATM, or telephone lines are sparse in many parts of the Infrastructure and Outsourced Support Services 441 Box 18.4  Payment Integrators Two broad categories of companies provide services to financial institutions and, either as payment integration services: core banking part of these other products or as a standalone system providers and independent providers. offering, also provides integration services. Within this first category, core banking sys- Included in this category are specialized soft- tem providers bundle payment gateways with ware providers that enable financial institutions their own core banking system. These gate- to connect to various payment systems or ways are typically sold as optional modules delivery channels via an EFT switch. This switch and can be implemented either at the point of is sold either together with one of their front- installing the core banking system or at a later end solutions (mobile, Internet) or on its own. point when the financial institution wants to Payment integrators may also offer integration connect to a payment system. as part of their mobile banking or commercial The second type of payment integrator is a services. Both can offer integration services to company that provides other products and a range of core banking systems. Source: Geraldine O’Keeffe, Software Group. developing world, as many governments have transmission.4 Faster transmission speeds allow instead favored partnerships with private clients to receive confirmations more quickly MNOs. and more reliably. Wireless connectivity requires the end user SMS messages are often used either directly to have a radio-equipped device, such as a by a financial institution or as part of an elec- mobile phone handset or a modem for connect- tronic payment system. Examples of direct com- ing a computer to the Internet. The vast major- munications include “push” SMSs, which the ity of the world’s mobile phones and modems provider sends to remind a client that a loan operate on a radio system called the Global repayment is due, for example, and “pull” mes- System for Mobile (GSM) communications.3 sages, which the customer initiates to request Users can access an MNO’s network of radio their balance or a mini statement via a text mes- towers by inserting an MNO-provided sub- sage. The second category includes SMSs used scriber identity module (SIM) card in their within a payment system, such as when a mobile device. A SIM card is a chip that stores client money provider sends an SMS confirmation information. Coverage exists when a radio sig- after each transaction or after a transaction is nal is picked up from a cell tower, allowing the done at an ATM. client to make and receive calls and send text Voice-based technology such as interactive messages, also known as short messaging ser- voice response (IVR) is a phone technology that vice (SMS) messages. GPRS, EDGE, 3G, and 4G allows a caller to select options from a voice are all wireless communications protocols that menu and interact with the phone system are advancements of the GSM technology, with (Krugel 2007). While IVR was used prior to the the primary difference being speed of data emergence of mobile money, it is now being 442 The New Microfinance Handbook adapted for transaction services targeting illiter- business tools. The ability to run customized ate populations. applications makes smartphones a viable channel Unstructured supplementary services data for delivering financial services. (USSD), a protocol used by GSM operators, is To take full advantage of smartphone applica- increasingly being used for mobile money ser- tions as a delivery channel, the financial service vices. Similar to SMS, it allows the phone user provider needs to consider the availability and and the server to exchange a series of messages capacity of the data transmission network in their using a real-time connection. It is generally clients’ locale. In many areas of developing coun- thought to be more user friendly than SMS tries, the only available Internet connection is via because customers receive a series of prompts the GSM networks of MNOs (see table 18.1). for information as they interact with the Further, for cost reasons, many MNOs have only service. installed mobile data services on cell towers located in metropolitan areas. This means that Smartphones mobile data services may not be available in rural Smartphones are the next step in mobile connec- areas where many financially excluded people tivity, adding computing, e-mail, and Internet live and work. functionality to a mobile phone. With the cost of smartphones becoming increasingly affordable Internet Connectivity for both clients and financial service providers Internet connectivity facilitates many functions (and their agents), they are becoming important in financial service provision. POS devices, tablets, Table 18.1  Implications of Telecommunications Connectivity for the Provision of Branchless Financial Services Packet-switched broadband SMS/USSD via 3G Internet via Internet (Wi-Fi) via Internet Connectivity level mobile network mobile network service provider Incremental business Basic bank account Full bank account Better performance of high- benefit obtained control through a control (via mobile bandwidth applications (for through mobile data low-resolution menu browser or app), example, customer support connectivity system on a standard e-mail access via live video link) mobile phone display Client considerations Low cost for access 3G-capable phones Smartphones relatively high cost device, limited relatively high cost compared to basic mobile transaction compared to basic handsets; Internet access functionality, lack of mobile handsets; mainly available via residences, permanent transaction cost of 3G data schools, or offices; public Wi-Fi records access (often quite hotspots not common in rural expensive) areas Availability (outreach) High: urban, periurban, Medium: urban, Low: urban, periurban, rural rural (most of the time) periurban, rural (less common) (less common) Source: Joakim Vincze, greenIP.co.uk. Infrastructure and Outsourced Support Services 443 and personal computers used in locations beyond details with the central database when condi- the head office require access to the core banking tions permit. platform of a financial institution. An excellent document developed by David Bridge and Ignacio Deposit Insurance Mas for CGAP (“Rural Connectivity Options for Micro-Finance Institutions”) summarizes the Deposit insurance is normally established by the Internet access options available for financial ser- government to protect depositors and to support vice providers, compares them with the types of the stability of the overall banking system in a uses, and comments on the viability of each option country. Deposit insurance protects depositors in (see Bridge and Mas 2008). full or in part from losses caused by the insolvency Providers can use the Internet to establish a of a deposit-taking institution. Deposit insurance is secure connection in the form of an encrypted needed because depositors cannot be expected to VPN (virtual private network) connection of a know the quality of a financial institution’s loan branch outlet with its head office and then portfolio and thus to evaluate the safety of their access the information system remotely. This funds on deposit. allows for the secure exchange of operational When developing deposit insurance schemes, data between branches, field offices, and the there are three primary dimensions to consider: head office. Clients can also use an Internet the extent to which the system relies on private browser to log onto their financial service pro- management or private funding, the breadth of vider’s platform if the provider offers some form formal and informal coverage, and the suscepti- of Internet banking. From the browser, they can bility to the shifting of hidden risk by insolvent look up account information, conduct transac- banks.5 Deposit insurance can be financed by the tions, and pay bills. While many microfinance central government through tax revenue, by par- clients do not have direct access to the Internet, ticipating financial institutions, or by a combina- this is rapidly changing with the increasing tion of both. The most common is to combine availability of smartphones and declining cost of private and government sources. A typical pre- data communications. mium paid by banks is in the range of 0.1 to 0.5 By necessity, financial service providers percent of insured deposits. Deposit insurance is almost always use a combination of communica- most commonly administered through the gov- tion technologies, depending on the location of ernment. In almost all countries, membership in their operations and the available infrastructure. a deposit insurance scheme is compulsory for Data transfer and connectivity solutions can use regulated banks (Demirgüç-Kunt and Kane telecom or Internet infrastructure to connect 2001). headquarters or a central database with other The level and scope of coverage provided by operating points such as branches. A wide area deposit insurance should be commensurate with network can be set up, allowing various operat- the level of risk clients are exposed to in the ing locations to use the same central database. banking system. A key feature of deposit insur- These point-to-point connections use a VPN ance is coverage limits, or the maximum amount that allows information and access only to pri- for which each individual deposit account or vate secured sites. When the Internet or telecom depositor is guaranteed. The amount of cover- lines fail, some banking systems allow systems to age is important because it affects both the continue processing transactions offline and behavior of clients and the market discipline of then to upload and consolidate the transaction depositors (Demirgüç-Kunt, Karacaovali, and 444 The New Microfinance Handbook Laeven 2005). Some countries offer 100 percent Most credit bureaus collect both negative and deposit coverage regardless of size—that is, no positive information. The former, often referred coverage limits; other countries offer deposit to as “black lists,” focuses only on a client’s cur- insurance set at a level higher than the average rent and past delinquency and defaults. Positive deposit account, while others offer coverage at a information, including details on all outstanding relatively low level that protects only the most and previous loans as well as repayment behavior, vulnerable depositors. can be more helpful in gaining a broader under- standing of the client. Some bureaus include other data on clients such as tax information, his- Credit Bureaus tory of guarantors and cosigners, business delin- Credit bureaus and credit registries collect indi- quency, bounced checks, and legal suits. In some vidual credit histories from various sources such countries, credit bureaus produce credit scores.7 as banks, non-bank lenders, mobile companies, A credit score is a numerical expression—a rank and public court records.6 They cross-check and order number or “score”—based on a statistical merge this information to produce a compre- analysis of a person’s credit history that indicates hensive credit report that is usually available to customers’ relative creditworthiness (or alterna- the market for a fee. The availability of this tively, risk). Components of a credit score typi- information benefits both lenders and borrow- cally include payment history, outstanding debt, ers; it contributes to lenders’ ability to assess the length of time managing credit, and types of creditworthiness of borrowers and motivates credit. clients to adopt good payment habits that trans- late into better access and service by establish- Operation and Oversight ing a “credit record.” Credit bureaus support the Credit bureaus are established and owned by expansion of credit, reduce information both public and private entities.8 The role of gov- asymmetries in the market, and increase trans- ernment includes (a) licensing and monitoring parency among all participants. credit bureaus, (b) providing regulatory incen- Credit bureaus collect various types of infor- tives for credit reporting, (c) mandating the shar- mation, including ing of data between credit bureaus and providers, and (d) requiring the sharing of credit data among • Applicant demographics (age, marital status, all licensed credit bureaus, which is typically sex, profession, residential status, education, accomplished by having the public credit registry status, employment, microenterprise history) share its data with the private credit bureaus on a • Client credit behavior and loan history (num- low- or no-cost basis (Christen et al. 2011). ber and types of previous loans, historical Sharing client credit information has occurred arrears) primarily among mainstream banks and consumer lenders (see box 18.5). Informal sector providers and if applicable, and the low-income consumers they serve remain largely outside of this information infrastructure • Enterprise profile (business type, size, history, (CGAP 2011a). As a result, in some countries, MFIs projected profits, business property) and their networks have set up their own special- • Enterprise financial statements (profit margin, ized bureaus. Some argue against specialized net profit, assets, liabilities, expenses, equity, microfinance bureaus because clients often bor- inventory turnover). row from several types of institutions; instead, Infrastructure and Outsourced Support Services 445 Box 18.5  The Evolution of Credit Reporting in Ecuador The Ecuadoran Rural Finance Network (RFR) In 2011, after years of intense competition looked at alternative approaches to credit and bare-bones pricing—reports cost less reporting and settled on a partnership with than US$0.10 each—only Credit Report is Credit Report, a privately operated credit left. Its unique access to data on borrowers bureau. It selected the firm because of the at the base of the pyramid through RFR’s strength of its technology platform, financial members is one of the key factors contribut- soundness, ownership by the international ing to its success. For RFR and the lenders it credit reporting firm Equifax (representing serves, working with a privately owned credit experience), and the price per report that the bureau provided access to data from other bureau guaranteed for RFR members. When parts of the credit market, to related tools, the deal was struck, six privately owned such as credit scoring, and to quality data— credit bureaus were operating in Ecuador. all at a very attractive price. Source: CGAP 2011a. they advocate incorporating microfinance into a more complete picture of a client’s obligations, mainstream credit bureaus as being more benefi- credit bureaus can facilitate the measurement cial to both the client and the institution. and mitigation of over-indebtedness. Knowledge Credit bureaus must be credible enough both of negative or positive payment behaviors, cou- to enforce participation and to ensure that sensi- pled with the ability to assess the probability of tive data are protected. An effective credit bureau default, helps providers to calculate how much requires consistent, reliable, and trustworthy data money to lend for how long. They can use the collected from and for both regulated and non- information to set appropriate interest rates and regulated providers. All relevant lenders in a other loan terms according to risk-based pricing. given market need to participate. Information In short, sharing credit histories reduces risk, security and appropriate disclosure to authorized increases efficiency and profit, and supports parties is critical to ensure equitable delivery of credit growth, leading to expanded access to information (Helms 2006). financial services (Simbaqueba 2006). Having a system in place for collecting consis- The Benefits of Credit Bureaus tent and reliable data will motivate clients to Although credit bureaus primarily minimize develop good payment habits, especially as they lenders’ risk, leading to a healthier portfolio, they experience the power of their credit report. A pos- are linked to a range of benefits for both providers itive credit history is an asset for clients as they try and clients. Credit reports facilitate better, faster to access more and different types of financial credit decisions. By making it easier to identify products. It may help them to secure more flexible loan applicants with poor repayment histories, terms or lower rates, and it may enable them to credit bureau data reduce lenders’ transaction seek other sources of finance rather than being tied costs and increase efficiency. By identifying those to one provider. Timely credit histories can also with loans in multiple institutions and providing reduce client over-indebtedness, as the system can 446 The New Microfinance Handbook identify those applying for multiple loans before range of bank and nonbank lenders serving the they result in delinquency or default. poor (see box 18.6).9 The coverage of private credit bureaus is broader than that of public Challenges to Credit Bureau Growth credit registries; however, there is great variation Today, only a handful of countries have function- in the coverage of private credit bureaus globally. ing credit-reporting systems that include the In Organisation for Economic Co-operation and Box 18.6  Modern Credit Databases: Transforming Low-Income Financial Services in South Africa South Africa has one of the most sophisticated Credit databases not only play a role in and inclusive credit bureau infrastructures in the initial credit decisions, but are also a platform world. Mass-market credit reporting started for collections. Databases provide address through parallel initiatives by the Consumer histories and current contact data; in addi- Credit Association (representing the major retail tion, they track debt-related and other public merchants), the consumer microlending indus- filings, such as real estate transactions, try, and private credit bureau operators. The death, marriage, and divorce. Thus credit Microfinance Regulatory Council (since trans- bureaus offer lenders the functionality to put formed into the National Credit Regulator) then long-term trace orders on delinquent borrow- took the initiative to regulate credit reporting and ers. A client whose loan has been written off mandate full consolidation of the various data and who is currently without revenues or streams into a National Loans Register. The assets, will automatically “pop up” for action operation of the register is outsourced to two if the name appears in a new credit transac- private credit bureaus—TransUnion and tion (indicating current revenues) or in a pub- Experian. Other leading credit bureau operators lic record filing (possibly indicating economic in South Africa are CompuScan and Expert activity or acquired assets). Although such Decision Systems. uses of credit databases are entirely legal Building a positive credit history is becom- and legitimate, potential for abuse does ing critical even for poor households, as the exist, especially when powerful credit- use of automated decision tools and credit reporting tools are introduced in the context scoring becomes ever more pervasive. Today, of a fiercely competitive consumer credit credit record checks not only are used in lend- gold rush. It is said that occasionally South ing decisions, but also are built into many other African micro-consumer lenders will deliber- routine processes, such as insurance under- ately report well-paying clients as delinquent, writing, employment screening, rental back- so that they effectively “own” their borrow- ground checks, and opening of utility accounts. ers and no competitor may legally lend to At the same time, maybe unfairly, the belief them or settle their high-rate debt. that “no credit history is a bad credit history” Despite its many advantages, the adoption has become entrenched in decision models. of sophisticated credit reporting calls for keep- Hence, credit databases will increasingly play a ing an eye on the potential for exclusion and gatekeeper role in the transition from poverty unfair discrimination that standardization of and into the economic mainstream. credit decision processes can bring. Source: Contributed by Joachim Bald, consultant with Frankfurt School of Finance and Management. Infrastructure and Outsourced Support Services 447 Development countries, private bureaus cover 61 of low-income clients into the formal fi ­ nancial percent of the adult population, while in Latin system. In countries with national identifica- America and the Caribbean they cover 31.5 per- tion systems, the government normally issues cent and in Sub-Saharan Africa only 4.9 percent and manages the identification cards, providing (CGAP 2011a). Credit bureaus face four principal a unique number assigned to each individual. challenges: Identification cards are used to synthesize and track information about the public. They • Market coverage. It is difficult to establish generally contain details such as the name, credit-reporting systems that cover all types of sex, address, and marital status of the individual lenders to the poor. In certain markets only and provide a unique identification number. regulated entities can access credit bureaus. The card can also include biometric informa- MFIs may fall under specific MFI legislation tion and smartchips. These cards are linked to that is separate from the laws governing other electronic databases that can be accessed by banks and financial institutions and, as such, authorized institutions such as regulated finan- are unable to access information from credit cial service providers or government entities. bureaus. Additionally, data on informal lend- An individual’s identity can be authorized ers are rarely captured at all. by referencing the unique identification num- • Business model. The small size of individual ber back to the database, thus facilitating iden- credit amounts poses a challenge as credit tity checks. With a nationwide unique identity bureaus rely on high-volume sales of credit system, individuals can establish their identity reports and economies of scale to cover their easily and effectively (Tiwari, Giri, and large up-front investment. Small loan vol- Mishra 2011). umes can be cumbersome and costly for tra- In certain markets, a unique identification ditional bureaus to handle. Providers may not card can be used to open a bank account and have the information systems or data quality is a valid document for satisfying know-your- they need to meet bureau requirements and customer standards. Furthermore, it can be may find the costs of obtaining credit reports used to verify customers and authenticate very high in relation to the size of the loans transactions. The ability to identify customers (Christen et al. 2011). is a significant challenge for mobile banking; • Identification. Sometimes the lack of a national universal identification cards can help to con- identification card, the absence of physical firm the identity of a mobile banking client. For addresses, or variations in names among example, the success of M-PESA, an e-money low-income clients can be hurdles to their transfer and payment system in Kenya, can be inclusion in a credit-reporting database. attributed, in part, to the fact that Kenya has a national identification card (Tiwari, Giri, and • Consumer protection. Protecting the privacy Mishra 2011). Where the client is obliged to and accuracy of data at a reasonable cost is dif- show a passport or proof of residency, mobile ficult given the high volume of transactions banking transactions can proceed more effi- and small size of loans. ciently. Similarly, someone with a unique iden- tification card may be more inclined to use Unique Identification financial services (mobile or otherwise) because Unique identification contributes to verifying establishing proof of identity is easier, signifi- identity and in doing so supports the integration cantly facilitating transactions (see box 18.7). 448 The New Microfinance Handbook Box 18.7  India’s New Unique Identification System The Unique Identification Authority of India the aadhaar and a fingerprint to the central (UIDAI) was created in 2009 to issue a 12-digit database. The UIDAI verifies the individual’s unique number (called aadhaar) to all 1.2 billion identity within eight seconds. Although pos- residents. Aadhaar is linked to each individual’s sessing an aadhaar is not mandatory, obtaining basic demographic and biometric information—­ a one does require proof of identity, an address, photograph, 10 fingerprints, and an iris scan— and a date of birth. Individuals without identifi- and stored in a central database. Individual iden- cation documents may obtain an aadhaar if tities can be verified using hand-held devices they are introduced to the issuing agency by a linked to the mobile phone network by sending current participant in the scheme. Source: Bhatnager 2011. Collateral Registries risks to lenders and reduces the costs of transac- tions by increasing transparency. Allowing a gen- While somewhat less relevant for microfinance eral (as opposed to a specific) description of clients because loan methodology may be based collateral can make security agreements more on peer groups or other unsecured mechanisms, flexible and does not require an update or new the ability to provide security for larger loans registration when, for example, movable collat- remains a tool for reducing risk.10 eral such as new inventory is ordered. Secured lending refers to credit transactions in Clear secured lending laws that allow the use which a lender holds an interest in a borrower’s of movable collateral can significantly increase land or movable property, such as inventory, the level of credit because they enable borrowers account receivables, livestock, equipment, or who otherwise might not qualify for loans to machinery, as collateral to secure a loan. The leverage their movable assets to obtain credit. In interest in land or property is referred to as a developed economies, borrowers with collateral security interest, pledge, or charge. In the devel- get nine times as much credit as those without it oping world, 78 percent of the capital stock of and also benefit from longer repayment periods businesses is typically in movable assets, and only and lower interest rates (Alvarez de la Campa 22 percent is in immovable property (Alvarez de et al. 2010). Secured lending laws improve com- la Campa et al. 2010). petition in the financial sector by enabling both Registries are publicly available databases banks and non-bank financial institutions to offer where interest in or ownership of assets is regis- secured loans. Using movable collateral also cre- tered. Different registries focus on different types ates more space for the securitization of loan of assets, including business registries, collateral portfolios in secondary markets and enhances the registries, vehicle registries, leasing registries, ability of regulators to analyze portfolio risks. ship or airplane registries, and land registries. For secured lending to operate efficiently, Registries allow lenders to assess their ranking effective dispute resolution is required. Allowing priority in potential claims against particular col- out-of-court enforcement through, for example, lateral. The use of reliable registries lowers the arbitration, is a key mechanism for making Infrastructure and Outsourced Support Services 449 enforcement more efficient. Court proceedings Auditors and accounting firms need to under- are often long and costly and therefore discourage stand the specific challenges and risks associated lenders from engaging in secured transactions. with auditing financial institutions serving the Quick enforcement is particularly important for poor. These can include the ability to account movable assets that depreciate over time.11 properly for donor funds or partially subsidized investor funds as well as the need to work across multiple reporting standards if international Outsourced Support Services investors or donors are involved (see chapter 14). With the growth of financial services to the poor and particularly the growing complexity of prod- Training and Advisory Services ucts and providers, many services are outsourced Specialized training organizations and manage- to third-party providers. Supporting functions ment consulting firms provide training, strategic commonly outsourced include accounting ser- advisory, and management services. For example, vices, training and technical assistance, manage- NGO MFIs may seek external technical assis- ment consulting, software as a service (SaaS), call tance to improve their financial management and centers, and security and cash-in-transit services. other operational skills, while downscaling banks Mobile banking also outsources most customer may bring in technical assistance to help them to transactions to agents or other third-party pro- adjust their systems, procedures, and staff skills viders. Agent banking is discussed in chapter 12. to provide products for lower-income clients. Training and advisory services encompass a wide Auditing and Accounting Services range of topics, including business optimization, Adequate auditing and accounting services financial management, strategic business plan- ensure accountability of financial records, com- ning, field staff training, product development, parability across institutions, and enhance overall branding or marketing, and human resource transparency of financial institutions. Many pro- training. viders engage external accountants to compile Training and advisory services can be pro- annual financial statements and to support their vided on a commercial fee-for-service basis or accounts and reporting activities. Most also may be subsidized by donors and investors. engage auditors to conduct external audits (this Particularly in parts of the world where the is a requirement for most, if not all, regulated microfinance industry has grown rapidly, there is institutions), which provides an independent a shortage of technical service providers offering review of a provider’s financial records, transac- up-to-date services in line with the needs of mar- tions, and operations (see chapter 15). External ket players. These services are often provided by audits give credibility to financial statements and international specialists. Numerous training pro- other management reports and can ensure grams have been developed to increase the capac- accountability of donor or investor funds and ity of providers, policy makers, and regulators identify weaknesses in internal controls and sys- (see box 18.8). tems (Isern, Abrams, and Brown 2008). They act In addition, some organizations such as the as a check on internal accounting and finance International Labour Organisation (ILO) offer departments that are responsible for entering accreditation programs for trainers (see box 18.9). transactions, following accounting and control Specialized consulting services are offered in procedures, conducting appropriate reconcilia- a wide variety of areas within the financial ser- tions, and producing financial statements that vices industry such as advising on the expansion can be used by senior managers. of operations into new markets or supporting 450 The New Microfinance Handbook Box 18.8  Training Courses for Capacity Building Several ongoing training programs are offered plus additional programs in Latin America and annually, providing excellent opportunities for elsewhere. Offering training in English and middle to senior management of financial ser- French (and Spanish in Latin America), the pro- vice providers, policy makers, and regulators gram is one of the most popular and well-­ to develop their capacity and knowledge of attended microfinance training programs. The financial inclusion. The following are some of extensive course selection is complemented the best-known programs. by a daily symposium, where numerous The Sustainable Microenterprise and industry leaders share their views on frontier Development Program is held at the Carsey issues. Institute at the University of New Hampshire The School of African Microfinance offers a in the United States. This two-week program two-week training program in Mombasa, emphasizes a livelihoods approach to microfi- Kenya, aimed at mid- and senior-level profes- nance, enterprise, and community economic sionals working in microfinance. The program development. The curriculum is built on a foun- consists of plenary sessions covering key top- dation of the five capitals of sustainable liveli- ics, electives (participants choose four out of hoods—natural, physical, human, social, and 14 options), and moderated discussions. The financial. It emphasizes tools and strategies of courses aim to provide participants with the transparency and good management practices tools to develop market-focused strategies, that honor the triple bottom line (financial, deliver appropriate products and services, and social, environmental) of sustainability. lead high-performing institutions. The Frankfurt School Micro and SME The European Microfinance Programme is [Small and Medium Enterprise] Banking a one-year master’s degree program focused Summer Academy is held in Frankfurt, on microfinance. The program is jointly orga- Germany. This one-week program is aimed at nized by four European universities and five managers of microfinance institutions, com- NGOs. Classes are taught in English at the mercial banks active in microfinance, and University Libre de Bruxelles in Brussels, microfinance investors. Several electives are Belgium. In addition to coursework, all stu- available. The program emphasizes the techni- dents complete a two- to four-month intern- cal aspects of microfinance and leadership. ship at a microfinance institution in a develop- The Boulder Institute of Microfinance ing country. To be eligible for the program, holds the annual Boulder Microfinance Training applicants must already have a master’s Program for three weeks from July to August degree. Source:http://www.microfinancegateway.org/p/site/m/template.rc/1.26.19317?cid=PSD_MFGatewayBulletinEN_W_EXT. the development of a strategic plan. Technical A growing number of consulting-based ser- assistance may also be provided for the develop- vices (both for-profit and not-for-profit) are ded- ment of new products and channels, transforma- icated to helping providers to access capital tion to a deposit-taking institution, human markets. On the investor side, consulting ser- resources and risk management, as well as regu- vices provide asset management services to latory compliance. institutional and commercial investors looking Infrastructure and Outsourced Support Services 451 Box 18.9  Making Microfinance Work: The ILO’s MFI Management Training and Trainer Accreditation Program As part of its Making Microfinance Work packages such as Making Microfinance Program, the ILO offers a three-phase Work: Managing for Improved Performance accreditation process for microfinance man- and Making Microfinance Work: Managing agement trainers and a comprehensive set Product Diversification (Frankiewicz and of training materials. Churchill 2006, 2011). Materials are available As of 2012, the ILO has accredited more in a wide range of languages, including than 100 trainers in Asia, Africa, the Middle Arabic, English, French, Portuguese, Russian, East, the Americas, and Europe to deliver Spanish, and Vietnamese. training to MFI managers using ILO training Source: Peter Tomlinson, International Labour Organisation; http://mmw.itcilo.org/en/home/home-page. to diversify their portfolios with socially respon- take the form of a core banking system based on sible microfinance investments. Consulting an SaaS model, whereby the system is hosted on firms that specialize in providing access to fund- servers sitting at a remote location managed ing are generally centered in high-growth micro- directly by the supplier or in the “cloud.” Such finance markets such as India or East Africa. arrangements relieve providers of the need to Some providers, particularly commercial banks invest in hardware and skills to maintain and sup- entering the microfinance market, use a manage- port the system in-house, reducing costs and the ment service contract, whereby management is need for skilled technical personnel, who can outsourced to a consulting firm specializing in often be difficult to find and expensive to hire. microfinance. This is usually a time-bound rela- SaaS options are increasingly available from tionship in which the consulting firm provides suppliers and are often cost-effective. The sup- technical assistance to the subsidiary or greenfield plier hosts the core banking system on its servers, institution on a fee-for-service basis. Technical which have been fully configured for the provider. assistance is greatest in the early stages, as the sub- Typically, costing of this type of service is either sidiary or greenfield institution builds its internal per client or per account and often does not capacity. Most greenfield institutions have ongoing require an up-front investment in a license. While management service contracts with their holding many providers may find this attractive, the pro- company (if applicable) to ensure standardization vider must have strong communication links to across a network of providers (see chapter 7). access the servers and must be fully assured of the quality of the day-to-day support of the supplier. Software as a Service Other models of IT outsourcing also exist Many providers find it difficult to obtain the nec- whereby the core banking system is hosted essary skills in-house to manage their informa- in-house, but third-party companies provide sup- tion technology (IT) environments. In these port in specific areas. In such cases, providers still cases, they may choose to outsource some or all need to have some IT resources available, but the elements of their IT management. This could number and skills of these employees could be 452 The New Microfinance Handbook lower than if the IT function were fully supported Call Centers in-house. The following types of services are typ- Financial service providers often rely on call cen- ically suited to this type of outsourcing: ters to respond to client requests and communi- cate with clients about products and services. • Strategic IT inputs. Help the institution to This is particularly true of mature MFIs and large design and manage a high-level IT strategy institutional providers such as postal banks or • Hardware and networking. Provide resources savings banks. A call center is a centralized office to manage the day-to-day work associated that receives and transmits a large volume of with running a network requests by telephone. It generally is used to man- age incoming inquiries from consumers for prod- • Core banking system support. Resolve issues uct and service support. Similarly, outgoing calls and facilitate communication through a help are also made to provide sales information or con- desk with a dedicated staff duct telemarketing. Some may also support loan • Core banking system audit. Execute audit checks collection by calling clients with arrears and facil- and report back to the provider’s audit depart- itating payment based on established procedures. ment. Technical checks focus primarily on the Call centers are not limited to telephone technol- integrity of the database, security, and function- ogy; they may also handle letters, faxes, live chats, ality of the backup system. Database audits help and e-mails. Call centers provide important phys- to ensure that the core banking system is work- ical and technological infrastructure because ing, provides accurate reports, and accounts for they provide the technology necessary to reach all transactions appropriately large numbers of clients. Call and contact centers have increased in • Disaster recovery and backup. Double as a importance in recent years as more poor women backup data recovery site with a replica of the and men have begun to use mobile technology machines required to run the information sys- (see box 18.10). The ability to attain support tem should there be a failure or loss of service through a telephone call or text message greatly • Custom developments. Develop reports and reduces the transportation and opportunity costs implement supporting systems. of visiting a physical location such as a branch. Similarly, call centers often process calls long Outsourcing of IT is quite common among after bank branches close for the day. Thus clients microfinance networks. For these organizations, can communicate with providers in a more con- a head office typically includes some elements of venient manner at more flexible times. IT support, which helps not only to support coun- try operations, but also to standardize the systems Debt Collection across all providers working within the same net- Many financial service providers outsource their work. In these cases, the country operations typi- collection practices to specialized agencies. cally still have in-house IT departments, but these Collection activities demand a significant tend to focus on the day-to-day operations, while amount of time and resources and require spe- the head office concentrates on special projects cialized skills if they are to be conducted well. and more strategic inputs related to technology. Collection agencies have trained staff with expe- Such support mechanisms work well provided rience in approaching clients and collecting past- that the head office maintains a good understand- due loans. Unlike frontline staff, they can ing of the challenges facing personnel operating dedicate the appropriate time to collection activ- in the field. ities. Collection agencies often employ a variety Infrastructure and Outsourced Support Services 453 Box 18.10  Call Center at the First Microfinance Institution Syria The First MicroFinance Institution Syria 32 percent of those called having a conversa- (FMFI-S) was interested in developing chan- tion with an FMFI-S staff member. Of this 32 nels beyond its branch network for marketing percent, about 10 percent visited a branch and its services. To improve services and expand received a loan. The overall number of loans outreach, FMFI-S established a call center to being disbursed increased 3 percent and was handle customer complaints and queries expected to increase further as the campaigns regarding products and services and also to continued. All of FMFI-S’s branches say that disseminate information on promotional cam- the call center has played a role in attracting paigns. By the end of 2010, seven promotional new clients. campaigns had been launched, resulting in Source: Aga Khan Agency for Microfinance 2011. of strategies for receiving payment, including Outsourcing collection services can also dis- calling, collecting on-site, setting up payment rupt the lines of communication between the pro- plans, and offering various payment collection vider and client. Procedures for contacting clients points. Collection agencies may be able to prompt should be simple, consistent, and take into payback in a more straightforward manner than account the local context. Providers using collec- loan officers because they do not have an ongoing tion agencies might find it useful to educate their relationship with the client. Thus a specialized clients on the role and authority of the collection agency may be able to secure payback while min- agency. If the client fails to acknowledge the col- imizing long-term damage to the relationship lection agency’s authority, the agency may have a between the client and the financial institution. difficult time recovering loans and may damage However, there are risks and costs to relying on the long-term relationship between the client and specialized collection agencies, and these must be provider (ACCION 2008; see box 18.11). assessed prior to deciding to outsource. Many collection agencies lack experience with the ­ Security and Cash in Transit low-income sector. As a result, providers need to Specialized firms provide security and cash-in- conduct a thorough due diligence of the collection transit services to minimize theft and fraud and agency and ensure that it understands the unique ensure that clients can draw on deposit, credit, needs and behaviors of low-income customers. It and mobile banking services safely. Outsourced also must ensure that outsourcing ­ collections security services generally involve the physical makes financial sense. Normally collection agen- safeguarding of branches and ATMs to certified cies take a percentage of the recovered debt, pro- (and sometimes bonded) staff. Security staff is viding the incentive for increased recoveries. A responsible for minimizing and preventing the full feasibility analysis including a multiyear possibility of robberies and for ensuring that cost-benefit analysis should be completed prior to security procedures for clients, staff, and other outsourcing debt collection activities. stakeholders are respected. 454 The New Microfinance Handbook Box 18.11  In Practice: Paraguay Financiera El Comercio The shareholders and board members of the some years of operations, El Comercio has Financiera El Comercio in Paraguay created reinstated its collections activities within the their own external collection agency, called institution. The main reasons behind this deci- Gestión, which managed El Comercio’s loans sion were high operating costs to maintain more than 180 days past due using special- two separate administrative structures (two ized collections officers and lawyers. The com- accounts, two boards), and the absence of pany also provided call center services for feedback channels between Gestión and the loans up to 30 days past due to support loan risk management unit of El Comercio for officers in their collection activities. After reviewing policies and procedures. Source: ACCION 2008. Cash-in-transit refers to the physical transfer M-PESA in Kenya reported that 10 percent of of bank notes, coins, or items of value from one agents were robbed in 2009 (CGAP 2012). location to another. This can include the transport Outsourcing security requirements can help to of cash and valuables from bank branches and prevent the possibility of theft, although it can smaller district offices to headquarters as well as significantly increase the costs of doing business. the transport of cash from ATMs or agent loca- The direct cost of outsourcing services must be tions. In some countries cash-in-transit compa- balanced against the benefits accrued from addi- nies fall under transport and security legislation, tional security, mainly less money lost from theft while in others they fall under municipal police or or damage. local authorities. Regulation often focuses on security and logistics. For example, cash-in-tran- sit companies are often restricted in the number Notes of firearms staff can carry, the types of vehicles  1. http://www.waterforafrica.org.uk/go/ used, and the number of staff per vehicle. more-information/ The importance of sound security and cash- water-and-sanitation-facts/. in-transit procedures continues to increase as  2. www.swift.com/alliancelite. mobile banking becomes more prominent.  3. http://www.gsm.org/technology/gsm/index Robbery and theft of agents are serious con- .htm. cerns. In a survey conducted by the Consultative  4. Additional technical information on mobile Group to Assist the Poor of mobile banking technology can be found at http://www.gsm agents in several key markets that included .org/technology/index.htm. questions related to security, 93 percent of  5. This section draws heavily from Demirgüç- agents in Brazil reported that being an agent Kunt and Kane (2001) and Demirgüç-Kunt, increases the risk of being robbed and 25 percent Karacaovali, and Laeven (2005). said that they had been robbed at least once dur-  6. This section was contributed by Candace ing the past three years. One aggregator for Nelson. Infrastructure and Outsourced Support Services 455  7. Adapted from Campion and Valenzuela (2001); ———. 2011a. “Credit Reporting at the Base of the Making Finance Work for Africa (http://www Pyramid: Key Issues and Success Factors.” .mfw4a.org/financial-infrastructure/ Access to Finance Forum 1, CGAP and IFC, credit-bureaus.html). Washington, DC, September.  8. Credit bureaus tend to be private, while credit ———. 2011b. “Technology Program Country Note: registries tend to be public or government- West African Economic and Monetary Union sponsored entities. (WAEMU).” CGAP, Washington, DC.  9. This section draws heavily from the following ———. 2012. “Security Risk and Mobile Banking: two sources: Making Finance Work for Africa Living with Robbery in Brazil.” CGAP, (http://www.mfw4a.org/financial- Washington, DC. http://www.cgap.org/p/ infrastructure/credit-bureaus.html); CGAP site/c/template.rc/1.26.15535. (2011a). Christen, Robert Peck, Kate Lauer, Timothy R. 10. Summarized from Making Finance Work for Lyman, and Richard Rosenberg. 2011. “A Guide Africa (http://www.mfw4a.org/financial- to Regulation and Supervision of infrastructure/collateral-registries Microfinance.” Microfinance Consensus .html). Guidelines, CGAP, Washington, DC. 11. https://www.mfw4a.org/financial- Demirgüç-Kunt, Aslı, and Edward J. Kane. infrastructure/collateral-registries.html. 2001. “Deposit Insurance around the Globe: Where Does It Work?” Policy Research Working Paper 2679, World Bank, References and Further Reading Washington, DC. ACCION. 2008. “Best Practices in Collection Demirgüç-Kunt, Aslı, Baybars Karacaovali, and Strategies.” In Sight 26, ACCION, Boston, Luc Laeven. 2005. “Deposit Insurance around November. the World: A Comprehensive Database.” Policy Aga Khan Agency for Microfinance. 2011. “Case Research Working Paper 3628, World Bank, Study: Syria.” Aga Khan Agency for Washington, DC. Microfinance, Geneva. Frankiewicz, Cheryl, and Craig Churchill. 2006. Alvarez de la Campa, Alejandro, Everett T. Making Microfinance Work: Managing for Wohlers, Yair Barnes, and Sevi Simavi. 2010. Improved Performance. Geneva: ILO. “Secured Transaction Systems and Collateral ———. 2011. Making Microfinance Work: Managing Registries.” IFC and World Bank, Washington, Product Diversification. Geneva: ILO. DC. Frederick, Laura I. 2008. “Information Bhatnager, Subhash. 2011. “India’s Unique Technology Innovations That Extend Rural Identification System.” East Asia Forum, Microfinance Outreach.” In New Partnerships October 22. for Innovation in Microfinance, ed. Ingrid Bridge, David, and Ignacio Mas. 2008. “Rural Matthaus-Maier and J. D. von Pischke, ch. 10. Connectivity Options for Microfinance Berlin: Springer. Institutions.” CGAP, Washington, DC. Glisovic, Jasmina, Mayada El-Zoghbi, and Sarah Campion, Anita, and Liza Valenzuela. 2001. Foster. 2010. Advancing Savings Services: “Credit Bureaus: A Necessity for Resource Guide for Funders. Washington, DC: Microfinance?” USAID, Office of Microfinance CGAP and the World Bank. Development, Washington, DC, October. Helms, Brigit. 2006. “Access for All: Building CGAP (Consultative Group to Assist the Poor). Inclusive Financial Systems.” CGAP, 1998. “External Audits of Microfinance Washington, DC. Institutions: A Handbook.” Technical Tool Isern, Jennifer, Julie Abrams, and Matthew Series 3, CGAP, Washington, DC. Brown. 2008. “Appraisal Guide for 456 The New Microfinance Handbook Microfinance Institutions.” CGAP, Washington, Matthaus-Maier, Ingrid, and J. D. von Pischke, eds. DC, March. 2008. New Partnerships for Innovation in Ivatury, Gautam. 2008. “Using Technology to Build Microfinance. Berlin: Springer. Inclusive Financial Systems.” In New Simbaqueba, Lilian. 2006. “The Role of a Partnerships for Innovation in Microfinance, ed. Microfinance Bureau.” PowerPoint presenta- Ingrid Matthaus-Maier and J. D. von Pischke, tion at the regional conference “Credit ch. 9. Berlin: Springer. Reporting Systems in Africa,” LiSim, Bogotá, Keepper, Kevin. 2011. “How to Save Rural Colombia. www.lisim.com. Kenyan Farmers $200 per Year.” Next Billion, Tiwari, Akhrand J., Anurodh Giri, and Priyank March 22. Mishra. 2011. “Leveraging Unique Krugel, Gavin Troy. 2007. “Mobile Banking Identification (UID) for Mobile Banking in Technology Options.” August. FinMark Trust. India.” Focus Note 70, MicroSave India. Infrastructure and Outsourced Support Services 457 CHAPTER 19 Building Inclusive Financial Markets David Ferrand Over the last 18 chapters many aspects of finan- drives the process. Building on this, the idea of cial inclusion have been discussed in depth. This “making markets work for the poor” is explored chapter seeks to draw these various threads further and distinguished from the two diametri- together and examine how the system as a whole cally opposed approaches to financial inclusion develops and what can be done to influence it. In policy that have dominated debates in the past. the Introduction the aspiration was established: One, belonging to a wider tradition of public “Full financial inclusion is a state in which all peo- intervention in the economy, advocates direct ple who can use them have access to a full suite of provision by government to substitute for the quality financial services, provided at affordable market. The other, based on a belief in the efficacy prices in a convenient manner, and with dignity of unfettered markets in solving economic supply for the clients. Financial services are delivered by problems, urges governments to get out of the a range of providers, most of them private, and way of the private sector and focus on eliminating reach everyone who can use them, including dis- any putative distortion in incentives from regula- abled, poor, and rural populations.” tion, taxation, or subsidy. By contrast a market The starting point here is to examine the systems approach seeks to harness the pow- empirical evidence on the development of mar- er-of-markets solutions to deliver services at kets and inclusion before turning to look, briefly, scale and sustainably. Trying to resist or replace at some of the theory that seeks to explain what market forces is rarely effective. However, it also Building Inclusive Financial Markets 459 recognizes that how markets develop and who is Growth and Inclusion reached is not predetermined. Much can be achieved by influencing the trajectory of market Financial Depth development toward a more inclusive direction. Evidence points to a strong relationship between Systematic market development needs to be economic development and the depth of financial grounded in understanding the current state of markets. Examining the patterns of financial mar- the market, its dynamics, and potential futures. ket development over different contexts and Although the more pragmatic approach to times shows very wide variations, as illustrated in building inclusive financial markets suggested by figure 19.1, which plots domestic credit provided this analysis emphasizes the importance of exam- by the banking system as a percentage of gross ining the specific circumstances in each market domestic product (GDP) against gross national system, various broad, generic challenges can be income (GNI) per capita. Despite a GNI per capita identified. These cover retail capacity, connected of US$7,650, Gabon has domestic credit provided business services markets, the enabling environ- by the banking system of only 8 percent; by con- ment, and coordinating market development. trast Bangladesh with GNI per capita of US$700 Based on a better understanding of the potential has domestic credit provided by the banking sys- and challenges to market development, the more tem of 47 percent. An important conclusion to be concrete questions of how practically to inter- drawn from this evidence is that the state of finan- vene effectively can be considered, and some cial market development is not a simple function practical principles are suggested. of the wider state of economic development. Figure 19.1  Variation of Credit Provision with GNI per Capita 300 250 Domestic credit to private 200 sector (% of GDP) 150 100 50 0 100 1,000 10,000 100,000 –50 GNI per capita current US$ (logarithmic scale) Sources: World Bank Global Financial Inclusion Database (2012): World Bank national accounts data, and OECD National Accounts data files; International Monetary Fund, International Financial Statistics and data files and World Bank and OECD GDP estimates. Note: GDP = gross domestic product; GNI = gross national income. 460 The New Microfinance Handbook Inclusion increased economic development, there is little to Data on the development of financial inclusion suggest that improved inclusion inexorably fol- are weak, but using proxies we again see very sig- lows growth. The extent of the variation seen nificant variations in the level of inclusion with implies that there are other factors at work in economic development indicators, as illustrated determining a particular economy’s level of finan- in figure 19.2. Taking GNI per capita as a proxy for cial inclusion. economic development, at a given level of eco- It is important to be clear, however, that the nomic development wide variations are found in data also leave little doubt that economic devel- the levels of financial inclusion measured by the opment and financial inclusion are associated. proportion of the adult population with accounts Attempts have been made to determine the at a formal financial institution. Sri Lanka has a direction of causality. Based on detailed econo- GNI per capita of US$2,240 and has relatively metric analysis of time-series data, the consen- high access with 68.5 percent of those aged 15 and sus view among economists studying financial over reporting having an account. By contrast markets is that there is a causal relationship; Mexico with nearly four times the level of income financial sector development helps to drive eco- per capita (GNI per capita of US$8,930) has only nomic growth. Some, more tentative, evidence 27.4 percent reporting having a formal account. suggests that financial inclusion does also lead to Although the data clearly show a strong associa- improved economic development indicators. It tion between rising levels of inclusion and certainly seems hard to avoid the conclusion that Figure 19.2  Variation of Formal Financial Inclusion with GNI per Capita 120 100 Account at a formal financial 80 institution (% age 15+) 60 40 20 0 100 1,000 10,000 100,000 –20 GNI per capita current US$ (logarithmic scale) Source: World Bank Global Financial Inclusion Database (2012): World Bank national accounts data, and OECD National Accounts data files; International Monetary Fund, International Financial Statistics and data files and World Bank and OECD GDP estimates. Note: GNI = gross national income. Building Inclusive Financial Markets 461 there is an interaction. Drawing on the data avail- the differing levels of inclusion across economies? able, we find no examples of industrially The weakness in detailed data (until recently) advanced economies that do not have both rela- makes it difficult to rely on econometric tech- tively well-developed financial systems and high niques to isolate the potential drivers of variances levels of financial inclusion relative to develop- across economies. Moreover even if the data were ing economies. It would seem hard to argue that available, it is not obvious how much light could causality does not also run in the other direction. be shed on the story by simply looking at the As economies expand and average wealth levels ­ aggregates. To understand what is going on it is rise, inevitably more customers can be expected necessary to consider the mechanisms of market to become viable customers for banks and other development.1 financial service providers at a given level of effi- An obvious starting point is to look more ciency of financial intermediation. It can be closely at the actions of providers and consumers anticipated that inclusion will to some extent of financial services and what determines that naturally tend to rise with wealth. The develop- market behavior. To make modeling tractable, ment of financial markets, and specifically the orthodox economic theory makes simplifying expansion of inclusion, has to be seen as endoge- assumptions about the way in which participants nous to the market system. Nevertheless the in an economy behave. Rational economic man, important conclusion to be drawn from the data homo economicus, is assumed perfectly rational— is that the future possibilities for market devel- seeking to maximize his or her own utility on the opment are not foreclosed by a particular level of basis of complete or perfect information regard- economic development. ing the available choices and, crucially, the impli- cations. Although plainly unrealistic on any common-sense view, these assumptions were Understanding Markets never intended to predict individual action but At the heart of the market systems approach, in rather to approximate how, in aggregate, eco- which this book is grounded, is the importance of nomic actors make choices. Unfortunately, as trying to understand what is really going on in highlighted by the emerging and complementary markets. Mainstream economic thinking centers behavioral and new institutional economics, on the role of decision making by participants in these simplifying assumptions also lose sight of the economy. Incentives play a fundamental role. some of the important drivers of differences in Where opportunities exist to profitably expand markets and economic outcomes. markets it is anticipated that players will invest to take advantage of these opportunities. Similarly Behavior and Strategy on the demand side consumers will take advan- Behavioral economics focuses on the extent to tage of financial products and services that are which actual individual decision making departs beneficial—in the language of economics, those from the earlier idealized notions of rationality. that improve their utility. However, if the match- Although the field covers numerous aspects of ing of supply and demand were all that mattered, behavior, three broad aspects are emphasized: the then the result would surely be a much greater boundaries of rationality, willpower, and self-­ degree of convergence than currently seen across interest as a motivator. The first of these, the financial systems (and, indeed, economies more notion of “bounded rationality,” is most immedi- broadly). Not much evidence appears to exist of a ately relevant to the question of understanding simple relationship between economic growth how markets develop. It simply reflects the impos- and financial inclusion. What, then, accounts for sibility of usefully processing the information 462 The New Microfinance Handbook available in a given situation. Although not from developing an entirely new strategy, finan- necessarily always actively conscious of it, most ­ cial institutions frequently revert to adopting consumers are familiar with the problem. For ­ what looks to be a proven business strategy within example, in well-developed financial systems, a particular sector. Although much attention is savers are confronted with a huge array of com- often given to innovation, for many market partic- peting offers from saving providers, which change ipants replication of what has been shown to frequently. Trying to maximize interest earnings work is probably the norm. It is not uncommon to while balancing this with an unpredictable need find commercial banks in developing economies for liquidity in the future can be surprisingly diffi- adopting the basic business strategies and models cult. Often savers will simply choose one account of financial institutions from industrialized econ- and remain with it for a sustained period because omies, despite the very considerable differences trying to capture and process all the options is in the market circumstances. simply too hard. The assumption that consumers The extent to which providers or consumers will necessarily be able to choose what is best for converge on broadly similar strategies can push them has to be abandoned. This frequently inter- markets in particular directions. Many different acts with the problem of willpower—in the exam- strategies can be conceived. How a particular ple, self-enforcement of a resolution to scan the dominant strategy emerges is likely to depend market periodically for better saving offers. Con­ on particular historical circumstances. Crucially, sumers often simply fail to take simple actions potential market opportunities may be ignored that would improve their financial position. simply because of the characteristics of the This limitation applies not only on the demand dominant sector strategy. The dominant busi- side but also to players on the supply side. ness strategy found in commercial banks across Financial providers are guided in complex deci- many developing economies failed to support sion making by their business strategies that help the type of services needed by many low-income them make sense of the wide array of information consumers. and uncertainties about the current and future state of the market in which they operate. Rules of the Game: Institutions Business strategies can be seen as implicitly rep- The need to find ways to guide decision making resenting applications of incomplete “theories” of and reduce uncertainty gives rise to the role of how a market will respond to various offers and structure in markets. “Rules of the game,” the evolve over time. The incompleteness of the “the- institutions of the new institutional economics, ory” may arise from either the sheer complexity play a key role in guiding economic decision of a market at a given point in time or the impos- making and improving the efficiency of markets. sibility of anticipating all possible future develop- These rules range from formal institutions, such ments. Even the most apparently stable market as laws and regulations, to informal social will be susceptible to developments in technol- conventions and cultural norms.2 From an eco- ogy. Financial markets in particular have under- nomic point of view, obtaining reliable informa- gone very considerable change as a consequence tion (about both conditions today and in the of developments in information and communica- future) to inform economic decisions is itself tions technology. The success or otherwise of a costly and contributes to the overall transaction business strategy is rarely instantly tested by the cost in a market. Reliable institutions can help market. Often it takes some time before it becomes tackle the problem of limited rationality—often clear whether a new strategy is succeeding or providing greater predictability and offering ­ failing. Given the potential difficulty and risks simplifications or “rules of thumb” to facilitate ­ Building Inclusive Financial Markets 463 decision making. In providing structure to guide beyond the reach of formal institutions. The effi- economic action, institutions help to address the cacy of rotating savings and credit associations problem of coordination and cooperation in depends on norms to honor commitments made markets. without reliance on legal contracts and prospec- Simple examples illustrate the significance of tive third-party enforcement through courts. institutions for financial markets. State-enforced Such norms are also drawn on by many microfi- regulation and insurance of deposits in deposit- nance institutions (MFIs) in solidarity group taking financial institutions allow savers to reli- lending. More powerfully, the rules of reciprocity ably assume that the risk to their savings placed found in many communities in developing econo- with such organizations is (relatively) very low. mies underpin more complex financial arrange- Simply seeing that an institution is permitted to ments (see chapter 2). These can create forms of describe itself as a “bank” (usually reserved in law informal insurance that can help to significantly for use only by regulated financial institutions) reduce vulnerability in low-income households. allows a saver to reasonably confidently make a Only rarely do formal institutions change rap- deposit without the need to undertake a detailed idly, far less so than informal ones. Rather, financial analysis of the institution concerned or changes happen at the margin, informed by the monitor on a regular basis. Without this institu- current rules of the game that set the incentives tion efficient small-value deposit taking at scale for the players involved. As a result there is path becomes impossible. dependency; the options for where a financial Another example, the sharing of information system can go tomorrow depends on where it is on loan defaulters, relates to solving a coopera- today. This may seem an obvious point, but expec- tion problem. It is in the collective interest of tations as to how financial inclusion could evolve most market players, both credit providers and in a given context need to be considered in terms consumers (with the notable exception of the of viable trajectories of market development. serial defaulter), to share information on credit Further­more institutional change will often reflect defaults. However, it is only of real value in reduc- the interests and relative bargaining power of the ing the costs of credit risk assessment and dis- various key players. There can be no assumption couraging default where the information covers that developments will necessarily result in more most of the market and can therefore be relied efficient arrangements either because it is not pos- on. The average consumer should obtain some sible to see the consequences (another implication modest benefit in improved access or cost of of limited rationality) or the balance of power credit if the system is sufficiently comprehensive. favors changes to support particular narrow vested However, this benefit may be hard to see and has interests. to be set against the possible downside that if the borrower should default, he or she may not be Making Markets Work for the Poor able to obtain credit again. Without establishing rules (whether through state-backed regulation The idea of making financial markets work for or an industry collective initiative) useful credit the poor builds on the premise that often real information sharing is unlikely to emerge sponta- options exist for influencing how financial inclu- neously, foregoing the potential efficiency gains sion develops within a particular market. For across the market. markets to develop successfully it is necessary to Informal institutions—socially embedded rules understand what is going on at the heart of and norms—are frequently more prominent in the market, where the incentives lie, and what the economies of the poor, which are often may constrain participants from moving in a 464 The New Microfinance Handbook ­ articular direction. This draws heavily on the p ­ector development theory and practice. The s insight that markets are structured by both for- approach advocated here is motivated by a more mal institutions (rules)—established by laws, reg- nuanced view of markets. Confusion may arise, ulations, and their enforcement—and the informal however, because often occasions arise when the norms, habits, and practices of market partici- policy prescriptions are similar. Where the impe- pants on both the demand and supply sides. tus for market development has already been Although participants are most often intention- established, doing nothing may be entirely con- ally rational, seeking to improve utility, the capac- sistent with a market development approach. Or ity to make optimizing choices is limited by where there are no exemplars of how to address a cognitive capacity, willpower, and the imperfect particular market segment successfully, investing alignment of rules (whether formal or informal) heavily in creating a demonstration case to mar- with the task at hand. Furthermore the prospect ket players could help to precipitate the market for development of one market is often con- development process. strained by the state of development of linked markets, which similarly do not respond instantly Interventionism and perfectly to opportunities. For example, the Interventionism in financial markets starts from capacity of labor markets to provide the skills the premise that if the market fails to reach par- needed to expand pro-poor finance is often lim- ticular target groups, then the appropriate ited. It is, however, frequently possible to influ- response is simply to substitute for the market ence the trajectory or speed of development by failure. If banks will not lend to smallholder farm- intervening to address constraints or improve the ers, then use public money (provided by develop- incentives for players to move in a particular ment partners or host governments) to establish direction. an agricultural lending institution that will. The idea is not to try to force a river to flow Alternatively if the banks claim that it is a risk uphill. Taking this analogy further, the incentives problem, then guarantee the loans. At first blush of players in the market correspond to the force of all this sounds reasonable. gravity pulling water downhill. Trying to work Rarely, however, does an interventionist against this will take considerable resources and approach pass what must be the two acid tests of is not sustainable; once the energy is removed the effective development: sustainability and scalabil- water will return to flowing downhill. Trying to ity. The developing world is strewn with expen- make markets work better for the poor is about sive publicly funded agricultural finance schemes trying to take advantage of the fundamental that either have failed or remain a significant fis- “gravitational impulsion” of market incentives cal drain. Causes of failure are varied and include but looking to influence the direction of travel to governance failures in schemes resulting in cor- move in a more advantageous way. At the right rupt lending practices, poor management and point even a relatively modest intervention can cost control, weak screening of borrowers, inef- change the flow of a river; at another it may mean fective risk control, and politically motivated cutting an entirely new channel. compromising of borrower incentives to repay. It is important to contrast the market systems At root there is usually a failure to start with approach with the major competing development the fundamental question: What is going on in the approaches applied to financial inclusion, which market? What would need to change for existing can usefully be characterized here as broadly the financial institutions to start addressing small- interventionist and the laissez faire. Both have holder farmers? Not infrequently the politically experienced their time in the sun in financial determined decision to reach particular target Building Inclusive Financial Markets 465 groups overrules any consideration of whether businesses, these market segments were seen as the group actually has any debt capacity. Providing highly unattractive, and banks often moved away credit to agricultural businesses (farms) that are from them with some relief. fundamentally unprofitable is unlikely to result in repayment rates that are viable for the lender. If Making Markets the public policy objective is in fact simply to A classic illustration of market development in transfer resources to poor households, then pro- practice can be found in the early history of mod- viding loans that turn into grants is rarely an inef- ern microfinance. It started with a quite simple ficient way to do it. Ironically it is also not idea that had simply not been demonstrated in a infrequently regressive; it is the richer more way that was compelling to financial institutions— empowered borrowers who are more likely to that it was possible to profitably lend to low-­ default while the poorer may further worsen income women in Bangladesh. Perhaps most their position by attempting to repay from other people in Bangladesh knew that the local money resources. lender was able to lend on a viable basis by lever- aging local knowledge and sometimes resorting to Laissez faire coercive practices to obtain repayment. However, Laissez faire, on the other hand, represents the the very high interest rates and sometimes dubi- opposite extreme. It supposes that any interven- ous business practices associated with the rela- tion in markets from public sector players beyond tively inefficient operation of the money lender that of setting the minimum formal rules of the scarcely encouraged formal providers to replicate game is bound to leave the market and partici- this approach. Mohammed Yunus’s great contri- pants in it worse off. This would be the case if bution was to simply demonstrate that a much markets did indeed consist of rational, utility more efficient form of lending was possible that maximizing agents with perfect information relied on leveraging existing social institutions to operating within complete connected markets. create incentives to ensure a sufficient level of Unfortunately only relatively rarely do market repayment at low delivery cost. It did not depend circumstances even begin to approximate to these on the existence of any technology hitherto conditions within developing economy contexts. unavailable. The important point to note here is The market-oriented reforms of the 1980s, that the private sector in Bangladesh and pretty seeking to reverse long periods of financial much every other poor country had failed to iden- repression found in many developing economies tify this market opportunity, which must have in the 1960s and 1970s, frequently produced dis- existed well before Professor Yunus’s pioneering appointing results—certainly from the perspec- experiments. Although Yunus himself has tended tive of financial inclusion. Simply removing the to take a somewhat ambiguous p ­ osition on the legal and regulatory constraints to financial mar- need for long-term subsidy in microfinance, the ket development did not lead mainstream com- explosion of highly profitable micro­ finance has mercial bankers to suddenly see low-income confirmed that there is indeed a real market oppor- households as a golden market opportunity. tunity. It illustrates the essential point that we can- Where regulation had required banks to devote a not afford to take a Panglossian, deterministic proportion of activity to underserved sectors approach to market development. Real market (agriculture being commonly targeted), liberal- opportunities that can impact on the lives of the ization often removed this requirement. Seen poor are often overlooked. Understanding why is through the lens of business models firmly aimed the starting point for making markets work for the at higher income groups and larger scale, formal poor. 466 The New Microfinance Handbook Market Potential simply fail to register as potential markets: They are outside the scope. It may be less a case of risk A wide range of reasons can be hypothesized as to aversion as simply not seeing the poor as a pro- why potentially profitable opportunities for spective market. Perhaps Yunus’s greater contri- expanding markets—and financial access—are bution to financial inclusion was not Grameen not taken by either existing financial sector play- Bank itself but helping to change the mind-set of ers or other investors. No attempt will be made the financial services industry across the develop- here to enumerate all the possibilities. Rather, the ing world. aim is to look at the ways in which markets can be More tangibly, the business models of many examined to understand where there may be financial institutions built to serve wealthier cli- potential and the constraints. Knowing what ent groups will be poorly aligned with the needs might stop a more rapid market expansion will of addressing lower-income groups. Cost struc- help in identifying the opportunities for market tures will reflect much higher average unit trans- development within a given economy. action sizes. Delivery channels—archetypically centered on marble-clad banking halls—are con- The Challenge of Technology Transfer structed to meet the needs and aspirations of the Underpinning the potential for rapid growth in upper income consumer. The mechanisms used developing or emerging economies is the premise to measure and appraise credit risk often reflect that the production or organizational technology the livelihoods and behavioral norms of those in required to improve productivity in the economy formal employment or running formal businesses. has already been developed in more advanced More than two decades of experimentation and economies. Because it is not necessary to invent development by MFIs were needed to find effec- the technology, simply transfer it. High growth tive ways to tackle these challenges. Development rates are there for the taking. Or so the argument of profitable microfinance continues to be ham- goes. Of course, the experience from many late pered by the effective lock-in of financial markets developing economies is that technology transfer geared toward a very different consumer base. is rarely that simple. Nevertheless, as recent his- Critical support service markets in areas as tory has shown in Asia, very rapid economic diverse as information systems, market research, growth can be achieved—at rates unprecedented training and human resource development, and in any of the earlier industrializing countries. management consulting have frequently devel- A major challenge in transferring technologies oped in response to demand from financial insti- from wealthier economies is that these technolo- tutions, which usually have very different needs gies were developed to fit very different economic from those of a typical microfinance provider. circumstances. These are often characterized by In such a complex web of interdependencies marked divergences in the relative prices of capi- one finds a temptation to quietism; the market tal and labor, the availability of required skills and system is so complex and interdependent that it is inputs from linked markets, and the characteris- impossible to engineer any meaningful change. tics of demand. One major hurdle faced in tack- However, the recent history of financial market ling financial exclusion in developing economies development shows frequent opportunities. Even is the extent to which the core of the financial sys- where the surrounding market infrastructure or tems has been built from a straight transplant of legal and regulatory environment is far from western banking models. Viewed through the aligned with the needs of a new market it is possi- lens of such business models, many low-income ble to plant the seeds of change. When a new mar- households and smaller-scale informal ­businesses ket segment emerges, the demands on efficiency Building Inclusive Financial Markets 467 or product design are usually far less exacting then find that these accounts are used only a few than when it matures, competition strengthens, times a year, it is clear that there can be little and consumers become more demanding. The impact on managing the problem of smoothing early experience of microcredit showed that it day-to-day cash flows. This suggests an ongoing was possible to achieve sustainability on the basis weakness in service provision and an opportunity of products that later evidence from market to find improvements. Identifying the gaps in the research showed were not especially well market starts from this demand-side analysis. matched with the actual needs of many of the Studies in various countries have revealed the consumers targeted. However, in these early days prevalence of the use of a portfolio of financial of microfinance, in the absence of any better services. For example, in Kenya, a demand-side alternatives, simple short-term group based loans survey showed that very few consumers rely on were taken on by many clients with considerable formal services alone. Interestingly, despite a sig- enthusiasm. nificant expansion in formal service provision, the number of people using multiple sources, for- Mapping the Financial Landscape mal, semiformal, and informal, has increased in An obvious but sometimes surprisingly neglected recent years. The rationale is not difficult to starting point for understanding the potential for understand. Even in the most developed financial market development is a detailed mapping of the markets the needs of consumers or businesses are market as it currently exists. This requires both a rarely best met by a single institution.3 In a rap­ broad-based and detailed measurement and anal- idly developing market, formal providers are just ysis of both supply and demand sides. Building on starting to reach many new market segments. the points established in earlier chapters of this Just as these markets may only still be marginally book, the analysis on the supply side should not viable from the perspective of the provider, the be limited to a particular type of provider. In many added value to the consumer or business may also developing economies informal finance provides be marginal. a more significant source of services than the for- mal. Furthermore it may provide important The Financial Access Frontier insights into underlying needs not easily captured Based on a clear measurement of what the exist- through an analysis focused on conventional for- ing demand and supply of financial services looks mal sector–provided products. Although consid- like today in a given market, the next step is to erable caution is needed in attempting to leverage determine where the market development oppor- informal finance, effective ways to develop these tunities could lie. The financial access frontier mechanisms or link them to formal providers are (Porteous 2005) provides a useful way for think- starting to emerge. ing about the market as a whole (see figure 19.3). Turning to the demand side, only looking at The usage frontier is obviously defined by those access to services or possession of an account currently making use of financial services mea- gives a very limited picture of what is going on. It sured by demand-side studies. Beyond this are is not simply the quantity of access that matters in people who could potentially be reached now by a market but its quality. Although a clear consen- the financial services industry as it presently sus has yet to emerge on cross-comparable indi- exists (as measured by the supply-side research). cators of quality, one simple proxy is to examine This defines the access frontier. Market-enabling the level of usage. Finding that many low-income interventions (Porteous 2005) can be sought to households have a transaction account may sug- help providers reach these prospective consum- gest progress in reducing exclusion. But if we ers, closing the gap between the usage and access 468 The New Microfinance Handbook Figure 19.3  Financial Frontiers financial systems, populations remain who can- not realistically afford to use financial services. 5. Choose not to use Finally in any population there will be some (evi- dence from developed economies suggest a very small minority) who choose not to use financial 4. Beyond the reach of the Natural services at all (category 5 in figure 19.3). This sets market limit access the overall natural limit for the market. Future gap Scenario Analysis 3. Market can reach in the access Attempting to predict the future is usually a fool- Future frontier hardy undertaking. Rather than attempting to make definitive predictions, it is often more effec- Access usage tive to look at the various directions in which the 2. Market can reach now frontier financial sector could evolve by considering gap potential scenarios. These can be used to help establish the scope of future possibilities and bet- ter understand what will influence these differ- Usage 1. Have now frontier ent paths. In seeking to peer into the future we need to understand what is likely to drive the development of markets. Both economic and Source: Porteous 2005. noneconomic factors may impact on financial service access and usage. What will be the forces that could drive changes? First, clearly major frontier. It is here that the (relatively) low-hang- political and economic forces can be identified ing fruit for market development should lie. that will shape the entire future of a country. Simply providing data identifying the market Political and social stability, prudent macroeco- opportunities to existing players could produce nomic management, or the avoidance of major an impact. The next step is to determine those environmental catastrophes simply have to be consumers and businesses that could be reached taken as background assumptions that cannot be in the future by pushing out the access frontier. readily influenced; nor is it possible to put in place Market development initiatives may be needed to meaningful strategic contingencies (at least in the expand in a number of directions. Typically this context of tackling financial inclusion). Rather, might entail expanding the geographical reach of there is a need to look at those forces that impinge the system, reducing delivery costs, or improving more directly on the development of financial the relevance of service offers to new market seg- markets. These can be divided into those that are ments. Beyond this future access frontier are likely to change markets in ways that can be those beyond the reach of the market—referred anticipated with a reasonable degree of confi- to by Porteous as the “supra-market” group. dence and those that although clearly set to Bringing financial services to this supra-market impact could play out in very different ways. necessarily involves some redistribution or net What determines the way the latter uncertainties transfer whether through direct subsidy or play out will be at least in part exogenous to the embedded within government- or donor-financed financial system. Nevertheless identifying the social protection payments. Even in the wealthi- prospective range of outcomes is useful in estab- est countries with some of the most advanced lishing broadly where market development needs Building Inclusive Financial Markets 469 to focus its search for opportunities to support reflected throughout in terms of human resources, positive change at scale. delivery channels, infrastructure, market posi- Trying to exhaustively identify the full range tioning, and branding. Trying to create the space of potential future scenarios for financial access for effective microfinance may sometimes be in a given context will clearly be difficult even if a harder than creating an entirely new organiza- reasonable number of uncertainties have been tion. Nevertheless it is important not to underes- identified (leave aside those that have not been timate the challenges in establishing start-ups. In anticipated). Nevertheless it is useful to consider the early stages many of the resources needed to how inclusion could develop over a period draw- support rapid development are absent. Most ing on how the more significant uncertainties obviously many of the necessary skills are simply turn out. In many contexts technology is already not available in the market, and the organization starting to dramatically change markets. There has to develop its own staff. seems to be little doubt that this will continue; the Once the first demonstration cases have been urgent task in many markets is to think about the established, the focus needs to shift away from ways in which technology could affect inclusion individual institutions to working at an industry in the future. Necessarily this type of scenario level. The long-term objective should not be to analysis cannot attempt to cover all aspects of support specific champions—valuable those these financial inclusion but only to provide a sense of are—but to create an environment in which com- how the existing dynamics of change could play petition and innovation will thrive. This is not out. Understanding this better can help point to easy. Human capacity frequently lies at the heart possible opportunities for system-wide change. of driving industry development. Many of the skills can only be effectively developed through learning-by-doing within the framework of a Addressing the Key Challenges retail organization, potentially pulling the atten- Lack of Retail Capacity in the “Core” tion back into specific institutions. Similarly inno- The weakness in retail capacity is often seen as vation in the financial sector does not come the central challenge of developing inclusive through developing abstract patents but rolling financial markets. At the outset, where there is lit- out real products and services in the market. tle or no provision, demonstration models are Continued effort is needed to take advantage of needed to establish how low-income markets can the opportunities for creating capacity by work- be served on a sustainable basis. There is no single ing with institutions but always looking to bring “best practice” here. The early history of microfi- this back up to an industry level. nance was characterized by the creation of spe- As microfinance has increasingly become cialist MFIs. Mainstream commercial banks were understood as being about financial inclusion typically very skeptical.4 If it was possible to rather than a narrow focus on particular micro- engage them at all, the involvement was seen as credit products or MFIs, the scope of organiza- largely about corporate social responsibility tions addressed has expanded dramatically rather than seriously seeking to develop a new (as discussed at length in earlier chapters). On the strategic business area. It has often been found to one hand, this has increased the potential capacity be difficult to create effective microfinance within that can be drawn on to build a financial inclusive mainstream banking institutions. Frequently a system; on the other, it creates the need to work misalignment is found between the businesses of with a much broader range of organizational types microfinance and more mainstream banking, and needs. Retail commercial banks have started starting at the level of corporate culture and to realize the importance of reaching the next 470 The New Microfinance Handbook generation of clients with a need to find ways to Opportunities for market development at this adapt their existing products, operations, and level are increasingly about finding innovations channels to meet their needs. Credit unions or that can drive market expansion. Achieving this savings and credit cooperatives have often been usually means going beyond a simple design idea serving a lower income market, but capacity and to working with market partners to providing governance challenges tend to go hand-in-hand credible demonstrations to the market. Focal with their voluntarist roots. Community-based areas for innovation that are often (and necessar- finance has the potential to reach many low- ily) tackled simultaneously include the following: income consumers still far beyond the reach of 1. Organizational (for example, the creation of formal or even semiformal finance. Training the form of the specialist MFI) members in more robust models for community intermediation can significantly improve quality 2. Production (for example, introduction of and safety. Finally entirely new players are now incentive systems for loan officers) entering the field such as mobile network opera- 3. Channel (for example, development of viable tors, large retailers, and technology-based start- agent banking models) and ups. Although often coming with significant exper­tise in addressing mass retail markets, enter- 4. Product/service (for example, index-based ing a whole new industry creates a wide range of weather insurance). needs from basic understanding of the market to compliance with regulatory requirements. Building Business Service Markets The form of an organization can have a pro- (Supporting Functions) found impact on its ability to provide a particular Individual organizations need to be seen as part type of service. There is no single type of organiza- of a wider “production system.” Increased spe- tion that presents an optimal solution to reaching cialization, strategic alliances and partnerships, all market segments. According to market seg- out-sourcing of noncore functions, and collabora- ment and product area, the key characteristics of tive development of sectoral public goods (such organizational form have a varying impact on its as financial education)5 or sectoral quasi-public competitive advantage. In the more remote rural goods (such as the FinScope market surveys)6 all areas the low-cost structure of user-owned and offer the potential for considerable gains in effi- -managed community-based financial organiza- ciency and effectiveness of service provision. tions constitutes a significant advantage over the Information is the lifeblood of financial markets, more formalized centralized MFI or commercial and its production and dissemination often bank. However, these organizations often strug- depend on supports beyond the retail institutions gle to meet the financing needs of a rapidly grow- themselves. The creation of this industry infra- ing small business or the money management structure can come from either linked markets or needs of extended families straddling rural and specialist organizations established to address a urban areas. Crucially, organizational forms con- particular supporting function in the financial tinue to evolve with considerable crossover and market. Examples of the former include business cross-learning. Commercial banks with an orien- services that cover areas as diverse as training, tation to the low-income market are busy devel- market research, advertising, auditing, recruit- oping lower cost agent outlets to reach poorer ment, information systems development, and clients. MFIs have long understood the value of management consultancy. Meanwhile classic working with existing community-based groups examples of the latter are the industry member- to better reach more remote or rural clients. ship organizations often established in the first Building Inclusive Financial Markets 471 instance to represent the common interests of an because these are seen to more immediately trac- industry group—most obviously in dialogue with table, being shaped by government policy and the government. resulting formal institutions (laws, regulations, As markets develop, the market-making and enforcement practices). Nevertheless infor- agenda should logically start to shift to this level. mal habits and norms play a critical role in the The rationale for such a shift is related to both behavior of players in markets. There is now a need and impact. In a nascent market the extent growing consensus that behavioral factors played of collaboration and coordination between insti- a significant role in creating the conditions that tutions can be anticipated to be weak. Bridging gave rise to the recent global financial crisis. this gap can test options, deliver immediate bene- Arguably the only realistic way to protect con- fits, and help demonstrate where opportunities sumers from predatory or fraudulent financial lie. The prospective impact may be greater work- schemes that have appeared in many markets is to ing at a sector level because any intervention is develop societal norms that lead market partici- aimed at covering an entire industry group rather pants to question the credibility of such “offers.” than with an individual institution. It also has the At the formal level the three areas that are added benefit of reducing the execution risk and likely to most directly impinge on financial mar- mitigates the inherent risk of market distortion ket developments are prudential regulation, con- associated with working with single players. sumer protection, and competition policy. The Possible interventions at this mesolevel include last two have only relatively recently started to the following: attract serious attention in many developing economies. Starting with policy formulation this 1. Strengthening provision from support service is important not only insofar as it directly gives markets (for example, service provider capac- rise to specific laws and regulations but also ity building) because it helps to establish some predictability 2. Building linkages within the financial system over the laws and regulations that have yet to be (for example, finite credit guarantees to build discussed. The latter is highly significant for pro- confidence in the inter-institution financial spective investors in financial markets. market) Specific financial sector and related laws, regu- lations, and rules and their enforcement impact 3. Providing sectoral quasi-public goods (for directly on the market. From a pro-poor market example, building consumer financial capabil- development perspective developing appropriate ity, collating and publishing data in areas such regulation is vital. Well-designed regulation can as financial and social performance, and con- dramatically reduce transaction costs by improving sumer product pricing) and predictability from the perspective of both finan- cial service providers and consumers. The primary 4. Investment in human resource development economic function of prudential regulation of (for example, developing new curricula for financial institutions is to reduce potential instabil- savings and credit cooperative training). ity and credibly signal this to the market. Mandating disclosure and transparency—a core pillar of con- Shaping an Enabling Environment (Rules) sumer protection—significantly improves market All market activity takes place within the rules of functioning, enabling buyers to reduce their costs the game that form the enabling environment. As in identifying services appropriate to their needs. discussed earlier these rules are both formal and Effective and efficient enforcement is vital in informal. The focus tends to be on the former all cases. The development of rules therefore has 472 The New Microfinance Handbook to go hand-in-hand with the design of enforce- financial education targeting improved finan- ment mechanisms. It seems doubtful, for exam- cial outcomes and greater dissemination of ple, that it would be viable to develop credible existing data and analysis). prudential supervision of community-based pro- It is important to emphasize that policy mak- viders based on the current orthodox regulatory ers and regulators must be understood as a part of model. Reliable supervision and enforcement is the market system. Because the enabling environ- simply difficult to achieve addressing a market of ment work may involve subsidizing a public many thousands of small organizations distrib- entity with public good objectives there can be a uted throughout a country. tendency to apply less rigor. But this should not The role of the facilitator is often related to be the case: In forming part of the market system, know-how here: helping the authorities better policy makers and regulators need to have long- understand the market—what it looks like and its term capacity that does not depend on a facilita- specific challenges—with the aim of building tor or a nonsustainable subsidy (that is, one that long-term internal capacity. Establishing and bro- does not have clear and reliable long-term public kering the linkages between a nascent industry financing). and policy makers and regulators is especially challenging. In a young industry it is not unusual to find one or two institutions dominating, and Coordinating Market Development inevitably their primary concern will be looking A final challenge is trying to align the various after their own needs rather than the wider activities of international development partners, industry. The facilitator has a role here in taking a nonprofit organizations, and local governments longer term view. around a market systems approach. In many This area is rightly emphasized as critical for markets this is not easy. The growing awareness wider market development and is clearly at the of the significance of financial inclusion to eco- heart of a wider economic reform agenda. From nomic and social development has attracted con- the specific perspective of making financial mar- siderable interest from a wide range of actors. kets work for the poor, various areas deserve Poor practice in the way in which support is attention: delivered can undermine the efforts of those seeking to support the emergence of long-term 1. Pro-poor policy analysis—supporting policy solutions through sustainable market systems. makers to understand the impact on financial The global association of microfinance donors, access (for example, analysis of options for the Consultative Group to Assist the Poor prudential regulation of bank channels) (CGAP), has invested heavily in raising aware- 2. Research—providing a real evidence base to ness of good practice among its members. Most support policy formulation (for example, of the world’s leading international donor orga- research into losses and problems actually nizations bound themselves to improve harmo- experienced by users of branchless banking nization of efforts with the Paris Declaration of services) Aid Effectiveness. The so-called pink book on Good Practice Guidelines for Funders of 3. Regulatory design (for example, support for Microfinance, which articulates a market sys- the development of new regulations and regu- tems approach, has been adopted by all 33 of latory authorities) and CGAP’s members. Nevertheless continued work 4. Broader public awareness and behavior is needed at country levels to ensure that these change initiatives (for example, support for high-level commitments translate into reality on Building Inclusive Financial Markets 473 the ground. The temptation to take shortcuts is need to be careful to avoid becoming players ever present. directly providing services in the core of the mar- ket, they are nevertheless still very much a part of the wider market system.7 By contrast the role of Intervening to Build Markets the market facilitator is purely as a change agent What then can be done practically to make or catalyst and should not become a long-term financial markets work for the poor? A skeptic part of the system. Where the market facilitator might insist that relatively little can be done to starts to play a role that is within the market sys- make markets work for the poor or indeed tem, then sustainability is compromised. Market anyone else. This leads back to one of two dia- ­ facilitation can, in principle, be sponsored by metrically opposed policy conclusions: Either international donors, national governments, and development agencies and governments should nonprofit organizations of various kinds (includ- simply get out of the way to allow markets to ing social impact investors). Regardless, an over- develop unhindered or accept that where mar- riding need exists to be able to establish a clear kets are not working there should be direct sub- degree of impartiality from any specific players in stitution for them. Both these arguments can be the market and a credible commitment to remain- rejected on the grounds that they fail to take ing outside the market (see chapter 4). account of the complexity of markets discussed In advocating this approach it should be earlier. Markets do not simply appear in a social emphasized that there is no sense of a simple and economic vacuum but are structured in template or blueprint here for accelerating finan- complex ways and evolve gradually over time; a cial inclusion. Strategies for increasing financial positive trajectory will move them toward lower inclusion need to be strongly conditioned by their transaction costs and greater inclusiveness. contexts, and market facilitators should be wary Starting with an understanding of how markets of trying to be too prescriptive in their plans. The operate and where and how they fail provides actual tools of engagement used in market sys- a better chance of addressing these failures tems approaches do not necessarily differ mark- successfully. edly from those that have long been used. Rather, Nevertheless the concern over causing more it is a question of how they are used and to what harm than good in intervening in markets is an end. A few key practical principles of how market important one. The role of those looking to facili- facilitation can be achieved should help to tate market development should be to look for clarify. opportunities and undertake finite initiatives to push or—better—simply nudge the market toward Identify the Exit a new more pro-poor trajectory. However, the Perhaps the single most important practical prin- first precept must be, following the Hippocratic ciple of market facilitation is determining how to Oath of doctors, to first do no harm. leave. The acid test of whether an intervention A distinction must always be maintained represents catalysis or not is whether there is a between participation in the market and facilita- convincing exit strategy. If there is not, the tion. Participants may be either on the demand chances are that the facilitator has become a side as clients or the supply side in various roles player, and whatever role is being played must be from retail providers through industry associa- regarded as a part of the market. An obvious prob- tions and players in linked markets to regulators lem is unwittingly creating dependency such that and policy makers. It is important to note that where the exit does inevitably occur, any progress although regulators and policy makers usually achieved is compromised. Providing long-term 474 The New Microfinance Handbook technical assistance to market players often runs desired change should not simply occur without this risk with technical specialists becoming any support. However, analysis of market failure coopted into management teams. From a practi- needs to be used with caution. It is not sufficient cal point of view there is also a danger of a grow- to simply identify why a market has failed, but ing reluctance to exit when things go well. how the failure can be addressed and a sustain- Inevitably benefits are found for any organization able market-based solution created. If there is no in being associated with success, and the tempta- way to credibly solve a particular failure, then tion is to continue. Here the problem can be a intervention at this stage would slip back to the distortion of the market, creating a long-term ­ market substitution model with limited prospects advantage for a single player and ultimately for sustainability. undermining the development of effective com- petition—often likely to be essential to achieving Proportionality the maximum impact on inclusion. Nascent markets are frequently fragile, and it is A relatively early exit can still produce good important to avoid using hammers to crack nuts. results. For example, the UK’s Department for Not only will this result in poor value for money International Development (DFID) provided in the use of scarce development resources, but it support to the mobile phone company Vodafone may also undermine the chances of achieving the plc in developing mobile-based solutions for objective. In general, very large scale interven- microfinance. At the end of the project period the tions carry a substantial risk of distorting incen- basic technology for the now famous M-PESA tives and retarding the long-term development of mobile money system had been developed, but a sustainable markets. convincing product had yet to be produced. It would have been tempting for DFID to remain Timing Is Everything engaged, but the terms of its challenge fund pro- The market development process is necessarily hibited this and it was not necessary. The team at dynamic, and whether a given type of interven- Vodafone and its Kenyan affiliate, Safaricom, had tion is appropriate depends strongly on the mar- the technology and, crucially, had engaged with ket’s stage of development. In the early stages of the market. Without further support they were developing microfinance around the world it was able to develop the M-PESA money transfer necessary to focus efforts on working with a rela- product, which three years later is used in more tively small number of MFIs. The aim was simply than 70 percent of Kenyan households and is to develop the know-how to create sustainable being rolled out in various other countries. institutions in many markets and provide the demonstration models for the next stage of devel- Defining the Underlying “Theory of opment. As the history of microfinance showed in Change” many contexts, this was not an easy undertaking. Alongside the question of exit, it is important to Attempting to support too many institutions at be clear how we expect an intervention to bring this point would have risked diluting the effort about a change measured in market terms. A “the- and failing to achieve the critical demonstration ory of change” is needed that sets out how the effect. However, once the demonstration has been market is expected to develop and the role of the provided, it is necessary to shift gears and look at intervention in bringing this about. The familiar what is needed to replicate the successes and economic concept of market failure is often use- build scale. Maintaining a narrow focus on indi- ful here in analyzing where the challenges lie in a vidual institutions may no longer be appropriate, market, addressing the question of why the and the emphasis needs to shift to a broader, Building Inclusive Financial Markets 475 ­ ector-wide approach. Maturation of markets will s and most vulnerable, the financial system may be associated with greater competition between offer the most efficient way to deliver these trans- players, and the risk grows of creating distortions fers. Although the costs here are ultimately met in working closely with individual institutions. through a government subsidy, this still provides a potentially sustainable way to provide a service. Taking Chances A key question is whether the political will and Pushing the frontier of financial inclusion fre- fiscal capacity to provide subsidies on a long-term quently entails moving into unknown territory. basis exists. Furthermore the emphasis should be The incentives are strong for prudent managers on ensuring that government buys these services of financial institutions to target existing consum- on a market basis—seeking the best offer from ers rather than try to develop new products and providers in the market and where possible pro- services in order to reach unbanked populations. viding choice to recipients. A potentially important role for market facilita- tion is to help explore and open up the frontier Concluding Thoughts markets. Greater emphasis should be more on trying to tackle uncertainty rather than simply Supporting a market systems approach to devel- bearing known risks. The former refers to situa- opment simultaneously calls for a strong degree tions where even the drivers of performance may of ambition and modesty. Ambition is needed be unknown. Small-holder index-based weather because developing markets is about achieving insurance, for example, is currently in its infancy; long-term permanent and significant change what drives the cost-income structure for these across an entire economy. Modesty because the products remains to be determined. Realistically, market facilitator can work only within the possi- without support it is unlikely that providers will bilities offered by many forces of change over invest in exploring these techniques. By contrast, which there can be little or no direct influence there is little need to help financial institutions and some of which may be very opaque. Finding enter the market for group-based, short-term routes to the end goal is not going to be about a microcredit. This is well understood, and although one-off analysis of markets and identification of risk certainly arises for the institution involved, relevant constraints and opportunities. The this is one for the investors to bear. whole market context is likely to change over time, initial evidence will turn out to be less accu- Pragmatism rate than originally hoped, experiments can It is important not to confuse the market systems reveal both failed ideas and unexpected suc- approach with naïve or doctrinaire market funda- cesses, successful execution of even small initia- mentalism. Markets frequently present effective tives will often throw up more challenges than opportunities to reach large numbers of poor peo- anticipated, and the speed of change is almost ple on a sustainable basis. The aim here is to make entirely unpredictable. Technology is already rev- markets work for the poor, not the reverse. Some olutionizing the market, and based on current households may have such a poor endowment in indications the pace of change is likely to acceler- financial, human, social, physical, natural, and ate rather than slacken. political capital that they may be beyond the mar- To keep a market development strategy on ket for the foreseeable future—even for informal track there has to be a constant process of mea- services. Opportunities can, however, arise to suring both market evolution and the actual suc- bring the poorest into the market. Where govern- cess and impact of interventions. Only through ments provide cash social transfers to the poorest creating an effective feedback loop between 476 The New Microfinance Handbook ­ heory and practice can one expect that progress t 4. It should, of course, be noted that one of the will be maintained. Research and analysis plays a standout successes in the early history of significant role here and needs to be undertaken modern microfinance was Bank Rakyat in a variety of ways, both quantitative and qualita- Indonesia, a state-owned commercial bank. tive. Large national-level quantitative surveys The success it achieved can, at least in part, be attributed to establishing a degree of separation mapping the landscape of access are essential to between the microfinance element (in Unit getting a good understanding of where the indus- Desas) and the main banking operation. try stands and what progress is being made. But 5. It is important to note the scope of financial in-depth studies such as financial diaries are consumer education can be very broad. needed to deliver insights from the field into the Practically it is sometimes simply an element of financial lives of the poor. Unless the market is marketing and therefore fails the test of a grounded in the realities of its ultimate stakehold- public good. However, the broader awareness ers it will founder. of the value of how to use financial services Tremendous progress has been made over the appropriately and avoiding inappropriate last 30 years in developing financial inclusion. behaviors passes the test. Interestingly, this Although concerns will—quite rightly—persist does not necessarily entail that the best entry over just how finance impacts on development, the point for delivering financial education is evidence remains firm that financial inclusion is a through jointly funded programs. Recent vital part of bringing the poor into the economic evidence from a study of M-PESA suggests that financial capability may be most effectively and social mainstream. With a concerted effort to built through use of appropriate products harness the power of markets it should be possible rather than more structured financial educa- within far less than another 30 years to finally tion processes (Zollman and Collins 2010). build financial systems that work for the poor. 6. The term public good is often misused. A minimum requirement is that it should be Notes nonrival (consumption by one does not exclude consumption by others) and nonex- 1. This follows a methodological point made by cludable (if one person can consume, then it is Angus Deaton (2010). not possible to exclude others). Much informa- 2. Note that in this chapter, the term “institutions” tion is not strictly a public good insofar as it is is used in relation to new institutional econom- excludable. For FinScope data this is the case. ics, and not to refer to financial service provid- However, it can be argued that for the applica- ers as in previous chapters. tion of FinScope to public policy it must 3. Large financial service groups have necessarily be available to all interested or ­ enthusiastically embraced cross-selling and potentially interested parties and is therefore attempting to meet a broad range of financial nonexcludable. More difficult is human service needs of their customers. However, resource development. Here there is a free rarely will a single group provide the best offer rider problem because it is not possible for an to consumers across a diverse range of services. investor to secure the property rights to The emergence of “monoliners” focused on a investment in human capacity in another single narrow business area supports the individual (within the context of basic human contention that efficiency gains can be achieved rights). This produces a market failure. Only through such focus, and consumers are often occasionally is this overcome through strong best served by shopping around and choosing coordination among players who may invest the best institution for a particular need (Kay from the perspective of the collective good. In 2009). a nascent market it provides an opportunity Building Inclusive Financial Markets 477 for investment to encourage market Heyer, A., and S. Ouma 2011. “Financial Inclusion development. in Kenya: Results and Analysis from FinAccess 7. They are, to use the sports analogy, in the role 2009.” FSD Kenya, Nairobi. of the sporting authorities and referees Jack, W., and T. Suri. 2010. “The Economics of responsible for establishing and enforcing the M-PESA: An Update.” Georgetown University, rules of the game. Although a village football Washington, DC. match can be guided by mutual consent among Kay, J. 2009. The Long and Short of It. London: players who know one another, once the game Erasmus Press. becomes more serious and more is at stake, a Khandker, S. R. 1998. Fighting Poverty with form of disinterested third-party refereeing is Microcredit: Experience in Bangladesh. New inevitable if both sides are going to accept the York: Oxford University Press. result. In international matches rarely will the Levine, R. 2004. “Finance and Growth: Theory referee be of the same nationality of the teams and Evidence.” NBER Working Paper 10766, playing as a means to help ensure impartiality. NBER, Cambridge, MA. North, D. 1990. Institutions, Institutional Change References and Further Reading and Economic Performance. Cambridge: Cambridge University Press. Beck, T., S. M. Maimbo, I. Faye, and T. Triki. 2011. Porteous, D. 2005. “The Access Frontier as an Financing Africa—Through the Crisis and Approach and Tool in Making Markets Work Beyond. Washington, DC: World Bank. for the Poor.” DFID Policy Division Paper. Collins, D., J. Murdoch, S. Rutherford, and O. http://www.bankablefrontier.com/assets/pdfs/ Ruthven. 2009. Portfolios of the Poor: How the access-frontier-as-tool.pdf. World’s Poor Live on $2 a Day. Princeton: Ridley, J. 2011. “Facilitating Mobile Money for the Princeton University Press. Poor: The Contribution of Donors to Market Deaton, A. S. 2010. “Understanding the System Development.” M4P Hub Conference. Mechanisms of Economic Development.” http://www.m4phub.org/userfiles/ NBER Working Paper 15981, NBER, resources/212201194742847-Jonathon_ Cambridge, MA. Ridley_-_Mobile_Money_Paper.pdf. Demirgüç-Kunt, A., T. Beck, and P. Honohan. 2008. Roodman, D. 2012. “Due Diligence: An Finance for All? Policies and Pitfalls in Expanding Impertinent Inquiry into Microfinance.” Access. Washington, DC: World Bank. Center for Global Development, Demirgüç-Kunt, A., and L. Klapper. 2012. Washington, DC. “Measuring Financial Inclusion: The Global Springfield Centre. 2008. A Synthesis of the Findex.” Policy Research Paper 6025, World Making Markets Work for the Poor Approach. Bank, Washington, DC. Bern: Swiss Agency for Development and Gibson, A., H. Scott, and D. Ferrand. 2004. Cooperation. “Making Markets Work for the Poor: An Zollman, J., and D. Collins. 2010. “Financial Objective and an Approach for Government Capability and the Poor: Are We Missing the and Development Agencies.” ComMark Trust, Market?” FSD Insights 02, FSD Kenya, Woodmead, South Africa. Nairobi. 478 The New Microfinance Handbook INDEX Boxes, figures, notes, and tables are indicated by b, f, n, and t following the page number. A advocacy aadhaar (identification numbers), 449b financial inclusion and, 82–83, 86–88, 87b Aarogyasri, 264b financial landscapes and, 36 ABC (activity-based costing), 362 Afghanistan, e-money issuers in, 425 ABP (pension fund), 388b AFI. See Alliance for Financial Inclusion ABSA (bank), 123b African Development Bank, 386 access African Life Assurance Zambia, 123b to financial services, 3–4, 5b, 115 AfricapFund, 441b frontiers, 123, 124f, 417, 468–69, 469f Aga Khan Agency for Microfinance (AKAM), indicators of, 118 253–54b landscape studies and, 128 Aga Khan Foundation, 163b strands, 4f, 124–25, 124f, 125–26b Agence Française de Développement, 106 AccessBank, 90b, 400b agent banking, 422 AccessHolding, 191b, 394 agent networks, 38, 40–41, 290–95, 291b Access to Finance, Living Standards Measurement agriculture finance, 8, 235–51 Study (World Bank), 120–21 challenge of, 237–39 Acción Comunitaria del Perú (ACP), 387 client risk and financial services, 247–49, 250 ACCION International, 10n5, 89, 179, 191b, 334, 394 forward contracts, 248, 248b accounting systems, 326, 331, 368–69, 450 guarantee funds, 248–49 accumulating savings and credit associations insurance, 247–48, 263–66, 265–66b (ASCAs), 29, 64, 157, 157b, 158, 177, 205 lending for livestock, 249, 249b accumulating value products, 260 context of, 235–37 Acleda, 387 microfinance institutions and, 236, 249–50, 250b ACP (Acción Comunitaria del Perú), 387 value chain business models, 241–47, 242b action audits, 373 bill discounting and factoring, 244–45, 244b activity-based costing (ABC), 362 leasing, 246–47 ad hoc committees, 354 trade finance, 243–44 Advans, 191b, 394 warehouse receipts systems, 245–46, 245f, adverse selection, 267–68 246b, 248b advisory services, 450–52, 451–52b value chain finance, 239–41, 241f, 250 Index 479 “Agriculture Salary,” 213b of core banking systems, 453 AIMS Project, 360b external, 373–74, 450 Airtel Money, 43b internal, 366, 371–73, 372b AKAM (Aga Khan Agency for Microfinance), outsourcing and, 450 253–54b social, 345–46, 346b Akhuwat, 220b support, 326, 327b ALCOs (asset and liability committees), 339–40 Australia, money transfers in, 440b Alliance for Financial Inclusion (AFI), 83–84, 84b, automated information systems, 329–30 114b, 115, 117, 122b, 143n7 automated teller machines (ATMs) Alliance lite, 439–40 as delivery channels, 278–80, 281–82b Allianz, 195b financial linkages and, 193, 193b Alterfin funds, 392 infrastructure for, 438 ALW (third-party provider), 289b mobile branches and, 283 Amazon.com, 309 passbook savings accounts and, 211 AML/CFT. See anti-money-laundering and point-of-sale devices and, 283, 440 combating financing of terrorism security of, 454 Amui Djor settlement (Ghana), 232b Azerbaijan Andhra Pradesh Mahila Abhivruddhi microfinance banks in, 191b Society, 167 over-indebtedness in, 90b Angola, money transfer systems in, 155b Azerbaijan Microfinance Association, 90b animal husbandry, 249, 249b. See also livestock annual percentage rates (APRs), 75 B anti-money-laundering and combating financing of Babylon, 395 terrorism (AML/CFT), 82, 422, 431–32 “back-to-back” lending, 399–400 apex institutions, 177, 185, 395 balance sheets, 332 approval authorizations, 369 Banco Azteca, 183b APRs (annual percentage rates), 75 Banco Compartamos, 400b, 407b Arevalo, Ines, 9, 321 Banco de Crédito del Perú (BCP), 293 Armenia, disclosure requirements in, 74 Banco do Brasil, 291b ASCAs. See accumulating savings and credit Banco FIE, 387 associations BancoSol, 400b Asian Development Bank, 383, 386 Banco Solidario, 404b Asian financial crisis (1997), 189b Bangladesh assessment tools. See poverty assessment tools business owners in, 62 assets emergencies in, 57, 57b asset-liability management (ALM), 330, 339–40, financial diaries in, 28 347n10 financial portfolios in, 50–51 building of, 226, 228–32 financial services in, 22, 22b, 31b finance companies, 182 Grameen Bank in, 49, 359b physical control of, 369 income in, 55, 460 quality of, 336, 337t initial public offerings in, 407b Association of Rural Banks, 185 microfinance in, 62b, 102, 466 ATMs. See automated teller machines mobile network operators in, 197 attribution in quantitative research, 135 moneyguards in, 63 audits NGOs in, 179 action, 373 ROSCAs in, 61 committees, 354, 371–73 savings in, 212b 480 The New Microfinance Handbook slums in, 59 Bosnia and Herzegovina third-party platform providers in, 288, 290b microfinance in, 102, 420b Bank Agroniaga, 189b over-indebtedness and, 116b Bank of Africa, 389b Boulder Institute of Microfinance, 451b Bank of Ghana, 185, 191b, 441b Boulder Microfinance Training Program, 451b Bank of Tanzania, 84b “bounded rationality” concept, 462–63 Bank of Uganda, 83b, 180 BRAC, 22, 22b, 179, 249b, 290b, 404b Bank Rakyat Indonesia, 188, 189b, 222 branches (banking), 277–78, 283–84, 291b, 318 banks. See also specific banks branchless banking, 16, 38–44, 318 “bank runs,” 416 branding, 364 banks-on-wheels, 127b Brazil funding and, 388–89, 389b banking in, 68, 291b as institutional providers, 183–93 money transfer services in, 274 regulation of, 421–22, 421b, 423b, 427, 429 robbery in, 455 Bank Windhoek, 123b rural financing in, 248b Bansefi-Diconsa, 293b Bridge, David, 444 Barclays, 114b budgeting process, 331, 369, 370 Barefoot (solar lighting company), 438b Budget Law of 2010 (Mexico), 73b “barefoot bankers,” 279b burial societies, 58, 158 Basel Accords, 399b Burkina Faso, banking in, 43b Basel Committee on Banking Supervision (BCBS), BURO (microfinance institution), 55 81–82, 374n12, 431 business case development, 327 Basel Core Principles (Core Principles for Effective business models Banking Supervision), 82 for branchless banking, 41–44, 42–44b BCEAO West African countries, 425 buyer-driven, 242 BCP (Banco de Crédito del Perú), 293 credit bureaus and, 448 behavioral economics, 462–63 for financial management, 316–17 Bellwether, 392 producer-driven, 241 benefit ceilings, 257 value chain, 241–47, 242b Benin, financial service associations in, 169 Byte-Tech, 441b BFV-SG (Société Générale), 389b bilateral and multilateral agencies, 386 C bill discounting, 244–45 CAF (Development Bank of Latin America), 411n9 biometrics, 278, 282, 289b, 325, 330, 448 Caixa Federal, 291b bKash, 197, 288, 290b “Calculating Transparent Pricing Tool” “black lists,” 445 (mftransparency.org), 226 BlueOrchard Loans for Development 2007, 393b call centers, 453, 454b BlueOrchard Private Equity Fund, 392 call options, 406 Bluetooth, 282, 296nn8–9 CAMEL, 334 board committees, 354 Cameroon, commercial banks in, 191b boards of directors, 352–54 capacity building, 36, 78, 102, 451b. See also financial Bolivia capacity agriculture finance in, 249–50 capital adequacy requirements (CARs), 338, 338t, client focus in, 16 421b, 422, 423b, 433n17 Bolsa Familia, 274 capital markets, 396–97, 398–99 bonds, 398–99, 400b CARE, 98, 163b, 164b borrowing to save, 211, 212b, 314 CARs. See capital adequacy requirements Index 481 Carsey Institute, 451b CGAP. See Consultative Group to Assist the Poor case studies, 134 challenge funds, 108 cash flows Challenging the Frontiers of Poverty Reduction/ agriculture finance and, 239, 244 Targeting the Ultra Poor, 22b cash in/out points, 40, 305–6, 308, 316–17 character-based lending, 221 financial portfolios and, 50–51 checking accounts, 211 income irregularity and, 53–55b children, insurance and, 258 income smoothing and, 52–56 Chile individual lending and, 219 education finance in, 229b limits on, 369 savings banks in, 186 management of, 226–28 China, banking in, 185 statements, 332–33 chit funds, 156 cash-in-transit systems, 454–55 Churchill, Craig, 9, 249 cashless banks, 307 CIRRUS, 440 cash transfers, 22 Citi, 5b caste groups, 22–23, 23b, 165 Citibank, 187b catalytic funding Citigroup, 398, 404b capacity for, 100–101 clients and customers, 8, 49–70. See also consumer donors and, 98, 99–103, 110 protection focus of, 102–3 assessments of, 345 foundations and, 387 cash flow management and income smoothing for, incentives for, 101 52–56, 53–55b information on, 99–100 demands of, 27–29 on-lending and, 101–2 emergencies and anticipating risk of, 56–58 Catholic Relief Services, 163b “financial portfolios” and, 50–51 CAURIE, 195b financial service needs and problems, 50, 52 causality bias in quantitative research, financial services, creating better, 67–69 132b, 136 financial tools, quality of, 63–67 CBS (core banking systems), 322, 325–29 convenience and reliability, 63–64, 67–68 CBTs (community-based trainers), 162, 163b disciplined savings, 64–66 CCACN (Central de Cooperativas de Ahorro y social embeddedness, 66–67 Crèdito Financieras de Nicaragua), 213b information on, 312, 317, 325 CDD (customer due diligence), 431 know your customer (KYC), 42, 431, 448 CDMA (code division multiple access), 296n13 life-cycle events and, 58–63, 60b CDOs (collateralized debt obligations), 392, 393b money managers and, 51–52 cedula produto rural (rural finance notes), 248b relationship management systems, 308 cell phones. See mobile phones satisfaction, 345 CEMEX, 184b, 231 service channels for, 316, 316f Center for Financial Inclusion, 89 CLOs (collateralized loan obligations), 392 Central Bank of Brazil, 84b “cloud” hosting, 452 Central de Cooperativas de Ahorro y Crèdito code division multiple access (CDMA), 296n13 Financieras de Nicaragua (CCACN), 213b CODENSA, 257b Centre International de Développement et de collateral Recherche, 170 agriculture and, 237, 238–39 CERISE (Comité d’Echanges, de Réflexion et credit and, 314 d’Information sur les Systemes forward contracts and, 248 d’Êpargne-crédit), 346, 346b on loans, 221–22 482 The New Microfinance Handbook registries of, 449–50 Company’s Act of 1956 (India), 182b regulation and, 431 compensation and personnel committees, 354 collateralized debt obligations (CDOs), 392, 393b competitive neutrality principle, 418–19 collateralized loan obligations (CLOs), 392 complaint resolutions, 75, 89 collection agencies, 453–54, 455b compliance, industry’s role in, 90–92 Collins, Daryl, 8, 28, 49, 125 composite insurance, 266 collusion, institutional, 371 compulsory savings, 221–22, 226 Colombia CompuScan, 447b education finance in, 229b Confianza, 387 insurance in, 257b connectivity, 46n17, 442–44, 443b Patrimonio Hoy in, 184b ConsultASH, 232b Comisión Nacional Bancaria y de Valores Consultative Group to Assist the Poor (CGAP) (Mexico), 84b apex organizations and, 395 Comité d’Echanges, de Réflexion et d’Information on connectivity, 444 sur les Systemes d’Êpargne-crédit consumer protection and, 74 (CERISE), 346, 346b financial capability and, 76 commercial banks, 188, 190–93, 191b financial ecosystems, 1 commission structures, 295 on funding, 102, 410n1 commitments of donors, 102, 102f global supply surveys of, 116 Committee of Sponsoring Organizations of the on housing microfinance, 231 Treadway Commission (COSO), 367 industry guidelines of, 88 common shares, 405 management information systems and, 325 communications channels, 370–71, 441–44 market development and, 473 community banks, 184–85, 185b on microfinance, 10n4, 390b community-based providers, 8, 151–72 purpose of, 93n5 facilitated groups, 152, 158–70, 159t ratings and, 410b, 411n9 CVECAs, 158, 170 on security, 455 facilitating agencies and, 161–62, 167 consulting services, 451–52 financial linkages and, 163–64 Consumer Credit Association, 447b financial service associations (FSAs), 158, consumer credit companies, 182, 182–83b 169, 169b consumer protection other groups, 168–70 barriers to, 91t savings groups, 158, 160–64, 161–64b credit bureaus and, 448 self-help groups, 164–68, 165–66b, 168b disclosure requirements and, 74–75, 76b sustainability and replication of, 162–63 fair treatment and, 75, 89 technical assistance and, 166–67 government’s role in, 74–76 indigenous providers, 152, 153–58, 153t as policy objectives, 2 ASCAs (accumulating savings and credit rights and responsibilities of, 93n6 associations), 157, 157b Smart Campaign and, 89, 91 groups, 156–58 transparency and, 74, 75, 89, 90 individuals, 153–56 consumption loans, 228 microinsurers, 158 consumption smoothing, 52, 64. See also income ROSCAs (rotating savings and credit smoothing associations), 152, 156–57 contract farming, 242, 243 range of providers and, 29, 152f contractual savings accounts, 211, 212b community-based trainers (CBTs), 162, 163b control activities, 368–70 Comoros, credit outreach data in, 117 control environments, 367–68 Index 483 control groups, 134–36 products offered, 226–32 convenience asset building and productive investment, 226, of financial tools, 63–64, 67–68 228–32 of mobile money, 285b, 317 cash flow management and, 226–28 of payment services, 275 consumption loans, 228 convertible debt, 398 education loans, 228, 229b Co-Operative Bank of Kenya, 193b emergency loans, 228 coordination fixed asset loans, 228 of facilitators, 107 housing loans, 231–32, 232b of financial inclusion, 82–86, 83b leasing, 229–31, 230b financial landscapes and, 36 lines of credit, 227–28 copayment arrangements, 257 risk management and, 226, 228 core banking systems (CBS), 322, 325–29, salary loans, 228 442b, 452–53 top-up loans, 228 Core Principles for Effective Banking Supervision working capital loans, 227 (Basel Core Principles), 82 ratings, 404b, 408–9, 409b, 445 Corporación Financiera Nacional, 404b scoring and history, 219, 314–15, 445–48, 446–47b corporate social responsibility (CSR), 387, 389 credit bureaus, 73, 445–48 correspondent banking, 192 credit cards, 314, 440 COSO (Committee of Sponsoring Organizations of credit life insurance, 259 the Treadway Commission), 367 Credit Rating Agency of Bangladesh, 404b Costa Rica, Patrimonio Hoy in, 184b Credit Report (credit bureau), 446b cost-based method of product pricing, 362 credit unions, 65, 334, 440b costing of products, 361–62, 363f critical illness coverage, 262 covariance risks, 219, 235, 264 crop insurance, 131, 247 credit, 8, 217–33 “crowding in” of funding, 103, 110, 384, 386 credit risk, 336 “crowding out” of funding, 2, 103, 238 creditworthiness, 219–20, 245, 409 CSR (corporate social responsibility), 387, 389 effective rates calculations, 225–26, 227b Currency Exchange Fund N.V. (TCX), 402b financial management tools and, 314–15 currency funding, 399–402, 401–2b information markets, 430 currency risks, 340 product characteristics, 217–25 current accounts, 211 character-based lending, 221 custom-built applications, 286 client visits, 221 customer due diligence (CDD), 431 compulsory savings, 221–22, 226 customers. See clients fees and service charges, 225 customization of management information group guarantees, 221 systems, 328 group lending, 218–19 CVECAs (caisses villageoises d’épargne et de crédit individual lending, 219–20 autogérées), 158, 170 interest rate calculations, 222–25, 223–25b Islamic lending, 220–21, 220b D lending methodology, 218–21 damage-based insurance, 247 loan collateral, 221–22 databases, global, 118–19b, 118–20 loan pricing, 222–25 data communications, 441–44 loan size and term, 217–18 data preparation and extraction, 328 personal guarantees, 222 debit cards, 314, 440 repayment terms, 218 debt collection, 453–54, 455b 484 The New Microfinance Handbook debt funding, 338, 397–99, 399b financial market systems and, 98f, 100, 100f, 105b declining balance methods of interest rate FinScope surveys and, 123 calculation, 222–26, 224–25b, 227b funding instruments, 2, 103–4, 107–10 De Derby Green Ventures Capital (DGV), 244b equity or quasi-equity, 109–10 deductibles, 257 grants, 103, 108–9 deferred payments, 310–12, 311f, 315 guarantees, 103–4, 109 delegated supervision, 415 loans to governments, 110 delinquency rates, 17b technical assistance, 107–8 delivery channels, 329–30, 467. See also payment incentives of, 101, 103 services and delivery channels downscaling, 188, 190 demand-based pricing, 363–64 DrumNet Project, 242b demand-side research, 115, 120–27 dual controls, 369 Demirgüç-Kunt, Asli, 121 Dual Return Fund, 390 Department for International Development (DFID), Dunavant (banking venture), 114b 106, 106b, 475 Dupas, Pascaline, 206b deposit account management, 326 DWM (Developing World Markets), 400b deposit collectors, 154, 154b, 209 deposit insurance, 33b, 444–45 E deposits. See savings services Earne, Julie, 8, 9, 217, 379, 437 detective controls, 371 EASL (Ecobank-ACCION Savings and Loans Deutsche Bank, 389b Company), 191b Developing World Markets (DWM), 400b EasyPaisa, 43b Development Bank of Latin America (CAF), e-banking banking, 287–88 411n9 EBRD (European Bank for Reconstruction and Development Credit Authority, 104, 109 Development), 383, 386 development finance institutions (DFIs), 98, 102–3, EC (European Commission), 386 107, 386, 394, 405 Ecobank, 43b, 191b Dexia Micro-Credit Fund, 390 Ecobank-ACCION Savings and Loans Company DFID. See Department for International (EASL), 191b Development Economic and Monetary Community of Central DFIs. See development finance institutions Africa, 420b DGV (De Derby Green Ventures Capital), Ecuador, credit reporting in, 446b 244b EDGE, 442 diaries. See financial diaries education disaster recovery, 370b, 453 fees for, 211, 212b discipline in savings, 64–66, 302, 305b financial, 78, 92, 92b, 159–60, 268. See also disclosure requirements, 74–75, 76b financial literacy dividends, 405 loans for, 228, 229b d.light, 438b effective interest rates (EIRs), 75, 76b documents design, 369 e-floats, 292–93, 425 Dominican Republic, Patrimonio Hoy in, 184b EFSE (European Fund for Southeast Europe), 391 donors, 8, 97–111 EFT (electronic funds transfer), 195–96, 440 commitments of, 102, 102f EIRs (effective interest rates), 75, 76b financial inclusion support by, 97–107, 99t. See also Eko, 289b financial inclusion electricity sources, 439 catalytic funding and, 98, 99–103, 110 electronic funds transfer (EFT), 195–96, 440–41, 442 facilitators and, 103, 104–7, 106b, 110 electronic payment cards, 279–80, 281b Index 485 Elektrafin, 183b factoring in agriculture finance, 244–45, 244b Elewa Pesa (Understand Your Money), 92b fair treatment in consumer protection, 75, 89 El-Zoghbi, Mayada, 8, 97 Family Bank, 405 embedded finance, 240 family structures, 19, 19b emergencies, financial, 56–58 farming. See agriculture finance emergency loans, 228 FAS. See Financial Access Survey e-money, 284, 290, 292–93, 425–26, 433n21. See also FATF. See Financial Action Task Force mobile money Faulu Kenya, 92, 92b E-Money Directive (EU), 433n23 feedback loops, 365, 368, 476–77 enabling environments, 472–73 fee-for-service models, 162, 163b, 192 endowment policies, 260–61 fees environmental, social, and corporate governance in agent networks, 294–95, 294f (ESG), 408b effective rates and, 227b e-payment platforms, 307 school, 211, 212b, 301, 312 Equifax, 446b service charges and, 225 equity FEMSA, 44b funding, 392, 394, 404–6, 406f, 407b Ferlo, 441b quasi-equity and, 109–10 Ferrand, David, 9, 459 Equity Bank, 43b, 164b, 361b, 407b FG Vavilon, 292b ESG (environmental, social, and corporate field officers, 278, 279b governance), 408b FinAccess, 30, 114b, 125b e-switch system, 441b finance committees, 354 Ethiopia, credit outreach data in, 117 finance companies, 182, 182–83b Eurobonds, 400b Financial Access Survey (FAS), 72, 78, 115, European Bank for Reconstruction and Development 116–17, 122b (EBRD), 383, 386 Financial Action Task Force (FATF), 81, European Commission (EC), 386 82, 431–32 European Fund for Southeast Europe financial and social performance, 9, 321–49 (EFSE), 391 financial management, 330–33 European Investment Fund, 404b business planning, 330–31 European Microfinance Programme, 451b portfolio reports, 333 European Union, e-money issuers in, 425 reporting, 331 evaluation of financial inclusion, 128–31 statements, 331–33 executive committees, 354 management information systems, 322–30, exit strategies, 474–75 323–24b Experian, 447b accounting, 326 Expert Decision Systems, 447b audit support, 326, 327b Express Pay, 292b core banking systems, 322, 325–29 eXtensible Business Reporting Language (XBRL), customer information, 325 296n12 customization, 328 external risks, 355, 366 data preparation and extraction, 328 delivery channel and systems upgrading, F 329–30 facilitated value chain models, 242, 242b deposit account management, 326 facilitators group management, 325 donors and, 103, 104–7, 106b, 110 installation of, 328–29 facilitating agencies, 161–62, 167 loan portfolio tracking, 325–26 486 The New Microfinance Handbook reporting, 326 financial capacity, 76–78, 77b system provider identification, 327–28 infrastructure support, 73 training, 328–29 legal mandates, 79–81 transaction processing, 326 rule making, 72–73, 92–93n1 user acceptance testing, 329 savings promotion, 73, 73b monitoring and risk management, 334–40, standards setting, 81–82 347n9 strategies, 77–78b, 78–79, 80b, 80f asset-liability management (ALM), 330, industry’s role in, 71, 88–92 339–40, 347n10 compliance, 90–92 asset quality, 336, 337t MicroFinance Transparency, 90 capital adequacy, 338, 338t Smart Campaign, 88, 89–90, 91 efficiency and productivity, 334, 335t Social Performance Task Force, 88–89 liquidity management, 330, 338–39, 339t standards and guidelines, 88–90, 91t profitability indicators, 334, 336t insurance and, 122b, 266–68 social performance management (SPM), measurement of, 113–46. See also financial 340–46, 341b inclusion, measurement of assessment tools, 345–46 microfinance and, 1, 17b balanced approach, 341–42, 342t objectives of, 6–7 client assessment, 345 savings groups and, 163 indicators, 343–44, 343f, 344t technology and, 2 process of, 342–43, 343f financial inclusion, measurement of, 8, 113–46 social audits, 345–46, 346b data for, 114b social ratings, 345 demand-side research, 115, 120–27 standard report, 344–45, 344t financial diaries, 125, 127, 127b, 128 financial capability, 77b, 78, 92 FinScope, 115, 121–25, 123b, 124f financial capacity, 76–78, 77b. See also capacity Global Financial Inclusion (Findex), 115, building 121, 122b financial cooperatives, 29, 177–78, 178b, 352, 422–24 global databases for, 118–19b, 118–20 financial diaries landscape data, 121b clients and, 28, 50–53, 55, 57–59, 57b, 60b, 61, 63 landscape studies, 127–28, 129–30b in demand-side research, 125, 127, 127b, 128 logic models and, 129–30, 130f, 131b, 143n18 financial inclusion, 8, 71–95 monitoring and evaluation, 128–31 advocacy for, 82–83, 86–88, 87b impact assessments, 130–31, 132b coordination of, 82–86, 83b participatory rapid assessments (PRAs), Alliance for Financial Inclusion (AFI), 134, 135b 83–84, 84b poverty assessment tools for, 138, 140–41t, Global Partnership for Financial Inclusion, 140–42 84–85, 85b research on, 131–38 Responsible Finance Forum, 84, 85–86 approaches to, 133–38, 139t donors and, 97–111. See also donors indicator selection, 133 ecosystems for, 426b mixed methods, 138 facilitated groups and, 159 qualitative, 132, 134, 138 financial markets and, 459–78. See also financial quantitative, 132, 134–36, 138 markets randomized control trials (RCTs), 120, 135–38 gap, 304 supply-side research, 115–18 government’s role in, 71–82 global supply surveys, 116–17 consumer protection, 74–76 national supply surveys, 117–18 Index 487 Financial Inclusion Data Working Group (AFI), 117 interventionism, 465–66 financial landscapes, 7–8, 15–48 laissez faire, 465, 466 branchless banking, 16, 38–44 market development, 466 actors in, 40–41 potential of, 467–70 agent networks, 38, 40–41 access frontiers, 468–69, 469f business models for, 41–44, 42–44b financial landscape mapping, 468, 477 microfinance institutions and, 44 scenario analysis, 469–70 mobile network operators (MNOs), 38, 40, technology transfer, 467–68 41–42 understanding of, 462–64 client focus, 16–25, 17b behavior and strategy, 462–63 age, life-cycle, and family structure, 16, institutional rules, 463–64, 472–73 18–19, 18–19b Financial Sector Adjustment Credit Program ethnicity, caste, and religion, 22–23, 23b (World Bank), 189b gender, 23–25, 24b, 25t Financial Sector Deepening Kenya, 106–7, livelihoods, geography, and income levels, 106b, 169b 19–22, 20f, 21b, 22b Financial Sector Development (FSD) Kenya, 129b ecosystem of, 5b, 6–7, 25–38 financial service associations (FSAs), 158, 169, 169b client demands, 27–29 financial service providers. See community-based core design, 26–32 providers; institutional providers; specific financial service providers, 29–31, 29f, 30b institutions market system functions, 26, 27f, 28b Financial Services Board (South Africa), 123b players and facilitators, 36–38, 37f, financial statements, 331–33, 373, 445 38t, 39f Financiera Compartamos, 400b products in, 31–33, 31b, 32t Financiera El Comercio, 455b rules in, 26, 33–35, 33–35b financiers, 182 supporting functions in, 26, 35–36 financing activities, 333 studies of, 127–28, 129–30b FINCA, 395 financial leases, 229–30, 230b FINCA Microfinance Holdings (FMH), 395 financial literacy, 76b, 77, 77b Findex. See Global Financial Inclusion financial markets, 9, 459–78 FinMark Trust, 105b, 108, 121–22 challenges for, 470–74 FINO, 289b business service markets, 471–72 FinScope, 108–9, 114b, 115, 121–25, 123b, 124f, 477n6 enabling environments, 472–73 first-loss funds, 397 market development, 473–74, 476–77 First MicroFinance Institution Syria (FMFI-S), 454b retail capacity, 470–71 “fit and proper tests,” 353 depth of, 460, 460f Fitch, 409b failures, 415–16, 475 5 Cs of loan analysis, 238–39 inclusion and, 461–62, 461f fixed asset loans, 228 interventions, 474–76 fixed deposit accounts, 257 exit strategies, 474–75 flat-rate methods of interest rate calculation, 222, proportionality and, 475 223b, 225–26, 225b, 227b risk taking, 476 flexibility in regulation, 419 “theory of change,” 475 FMFI-S (First MicroFinance Institution Syria), 454b timing and, 475–76 FMH (FINCA Microfinance Holdings), 395 mature, 104, 106 FMO (Dutch development bank), 386, 402b, 404b nascent, 104, 108, 472, 475 focus groups, 134, 138 the poor and, 464–66 Focus Note (CGAP), 1 488 The New Microfinance Handbook FONDECO (Community Development Fund), development finance institutions (DFIs), 386, 249–50, 250b 394, 405 Ford Foundation, 360b foundations, 387 Ford Motor Company, 387 individual investors, 389 forward contracts, 248, 248b institutional investors, 387–88, 388b Foundation for International Community Assistance nongovernmental organizations, 387 (FINCA), 142 private, 383–84, 384t, 386–89 foundations as funders, 387 public, 384, 384t, 385–86 4G protocols, 442 funeral insurance, 58, 260 fragmentation of savings, 302, 316 fungibility Frankfurt School Micro and SME Banking Summer of loans, 226 Academy, 451b in quantitative research, 132b, 136 FSAs. See financial service associations funding, 9, 379–412. See also catalytic funding G concentration of, 395, 396b G-20, 85, 85b “crowding in” of, 103, 110, 384, 386 Gabon, domestic credit in, 460 “crowding out” of, 2, 103, 238 Gähwiler, Barbara, 8, 97 financial landscapes and, 36 The Gambia glossary of terms, 380–82b CVECAs in, 170 instruments, 103–4, 107–10. See also specific family structures in, 19b instruments (e.g., grants) Garand, D., 267 investing practices, 406–8, 408b Gates Foundation, 106 microfinance investment intermediaries (MIIs), GDP (gross domestic product), 460 383, 389–95 gender, 23–25, 24b, 25t. See also men; women apex organizations, 395 general packet radio service (GPRS), 282, holding companies, 394–95, 394t 296n11, 442 microfinance investment vehicles (MIVs), Ghana 389–94, 390–91b, 393b, 410, 410b banking in, 43b, 185, 185b, 191b peer-to-peer aggregators, 395 debt collection in, 75 ratings, 408–10, 409–10b e-switch system in, 441b role of, 382–83 financial capability in, 77b tools for, 395–406 health insurance in, 263 bonds, 398–99, 400b housing in, 232b currency funding, 399–402, 401–2b insurance in, 256 debt, 397–99 interest rates in, 75 deposits, 402 over-indebtedness and, 116b equity, 404–6, 406f, 407b susu collectors in, 154b grants, 397 Gibson, Alan, 8, 15 guarantees, 403–4 giro transfers, 196 securitization, 404, 404b Global Financial Inclusion (Findex), 3, 115, 121, senior term loans, 397–98 122b, 151 structured finance, 402–4 Global Impact Investing Network, 388b subordinated debt, 398, 399b Global Microfinance Investment Program, 388b syndicated loans, 398 Global Partnership for Financial Inclusion (G-20), types of, 383–89, 385f 83, 84–85, 114, 143n8 banks, 388–89, 389b Global Policy Forum (2009), 114b bilateral and multilateral agencies, 386 global supply surveys, 116–17 Index 489 Global System for Mobile (GSM), 280, 284–85, Grameen Foundation, 142, 345 296n13, 442 Grameen Generalized System (Grameen II), 359b Globe Funder, 395 Grameen Phone, 290b GNI (gross national income), 460–61, 460–61f grants, 103, 108–9, 167, 179, 397 Good Practice Guidelines for Funders of Grassroots Capital, 388b Microfinance, 473 greenfielding and greenfield institutions, 180, 188, Good Return, 395 190–92, 191b, 382, 389b, 452 governance and managing operations, 9, 351–76 Green Planet, 438b governance, 351–55 gross domestic product (GDP), 460 board of directors, 352–54 gross national income (GNI), 460–61, 460–61f strategic considerations for, 354–55 group guarantees, 221, 237 human resource management, 355–58 group lending, 218–19 control activities and, 369 Grupo Elektra, 182, 183b performance management, 357–58 GSM. See Global System for Mobile policies for, 356–57 G2P. See government transfer payments recruitment and screening, 356 guarantees salary and incentives, 356–57, 357b in agriculture finance, 248–49 training and development, 356 as funding instruments, 103–4, 109 operational risks, 366–74 as funding tools, 403–4 control activities, 368–70 group guarantees, 221, 237 control environment, 367–68 NGO microfinance institutions and, 179 external audits, 373–74 partial credit, 401, 403 information and communications, 370–71 personal guarantees, 222, 237 internal audits, 366, 371–73, 372b Guatemala, factoring in, 244b internal controls, 365, 366–67f, 367–71, guidelines. See standards and guidelines 370b Guinea, financial service associations in, 169 monitoring, 370 risk assessment, 368 H product management, 358–64, 359b Hatton Nation Bank (HNB), 279b costing, 361–62, 363f hawala systems, 155b development, 358, 360–61, 360–61b HCC (Human Capital Contract), 229b marketing, 364 health pricing, 362–64 care costs, 250 risk management, 364–74, 365t, 366f insurance, 193, 253–54b, 261–63, 263–64b, 274b Government Savings Bank (Thailand), 186 money transfer services and, 275b government transfer payments (G2P), 73, 272, 274, out-of-pocket payments and, 249 275b, 289b, 291b shocks, 206b GPRS. See general packet radio service Heifer International, 249b Grameen Bank hire-purchase companies, 181 “economically active poor” and, 49 HIV/AIDS, 267–68 field officers and, 278 HNB (Hatton Nation Bank), 279b financial inclusion and, 467 holding companies, 190, 394–95, 394t group lending and, 66, 218 homeownership, financing of, 59 loan top ups and, 56b hospital cash, 262, 263b long-term savings products from, 214b housing loans, 231–32 product management and, 359b HSBC Amanah, 220b repayment schedules of, 67, 68 Human Capital Contract (HCC), 229b 490 The New Microfinance Handbook human errors, 371 initial public offerings in, 407b human resource management, 33b, 355–58 insurance in, 255b, 260, 261t, 263, 264b, 266, 269 microfinance market in, 5b, 102 I mobile network operators in, 197 IAIS. See International Association of Insurance non-bank financial institutions in, 182b Supervisors Rajan Committee in, 93n7 IDB (Inter-American Development Bank), 411n9 religion and caste in, 23b identification, unique, 448–49, 449b savings patterns in, 205b IFAD. See International Fund for Agricultural self-help groups in, 3, 65, 152, 158, 164, 165, 165b, Development 168, 168b, 170nn7–9 IFC. See International Finance Corporation third-party providers in, 289b IFFCO-Tokio, 255b indicator selections, 133 IFMR Trust, 303b indigenous financial providers, 152, 153–58, 153t ijarah leasing contracts, 230–31 individual investors, 389 Iko Pesa, 43b indivisibility of individual savings, 302 ILO. See International Labour Organisation Indonesia IMF (International Monetary Fund), 116–17, 122b banking in, 185, 189b impact assessments, 130–31, 132b, 418, 418b consumer protection in, 74 ImpAct Consortium, 341b, 345, 346b e-money issuers in, 425 impact investing, 379, 387, 388b Indonesian Stock Exchange, 189b incentives information asymmetries, 99, 416 of donors, 101, 103 information technology (IT), 369–70, 370b, 452–53 financial, 356–57, 357b infrastructure, 9, 437–50. See also outsourced support inclusion, financial. See financial inclusion services income for cash exchange, 305, 317 irregularity, 52, 53–55b collateral registries, 449–50 levels, 19–22, 20f, 21b, 22b credit bureaus, 445–48 seasonal, 52–53, 55b benefits of, 446–47 statements, 332 challenges to growth, 447–48, 447b income smoothing, 52–56, 53–55b. See also operation and oversight, 445–46, 446b consumption smoothing deposit insurance, 444–45 index-based insurance, 247–48, 264, 265–66b, 476 financial landscapes and, 36 India government support of, 73 agriculture debt waivers in, 237 payment, clearing, and settlement systems, 439–41 ASCAs in, 157b national and international, 439–40, 440b, 441b banking in, 68, 167, 185, 186b, 278, 303, 303–4b, 388 retail processors, 440 chit funds in, 156 payment integrators, 441–42, 442b community-based trainers in, 163b physical, 438–39, 438b consulting services in, 452 regulation of financial, 430–31 debt collection in, 75 unique identification, 448–49, 449b emergencies in, 57 voice and data communications, 441–44 equity funds in, 392 connectivity and, 442–44, 443b financial diaries in, 28 smartphones, 443 financial inclusion in, 80b initial public offerings (IPOs), 405, 407b financial portfolios in, 50 inpatient coverage, 262 identification systems in, 449b Institute for Financial Management and income in, 55, 55b Research, 156 Index 491 Institute of Internal Auditors, 371 mutual insurers, 193 institutional investors, 387–88, 388b need for, 250–53 institutional providers, 8, 173–99 NGO providers, 193–94 banks, 183–93 policy makers and, 76b agency relationships and partnerships and, product options, 253–59 192–93, 193b claims, 258–59 downscaling and, 188, 190 coverage terms and pricing, 256–57 greenfielding and, 188, 190–92, 191b eligibility, 258 postal savings, 186, 186–87b group or individual, 253–54b, 253–55 private commercial, 188, 190–93, 191b premium payment mechanisms, rural and community, 184–85, 185b 257–58, 257b savings, 185–86 voluntary or mandatory, 255–56, 255b, 268 state, 186, 188, 189b product types, 259–66 characteristics of, 174–76, 175–76t property, 263 deposit-taking microfinance institutions, 180, 181b providers, 193 financial cooperatives, 177–78, 178b regulation of, 426–27, 428–29b insurance companies, 193–94 reinsurers, 194 commercial insurance providers, 193–94, 195b savings completion, 260–61, 262b mutual insurers, 193 savings groups and, 161 NGO insurance providers, 193–94 standards for, 82 NGO microfinance institutions, 173–74, sustainability of, 174 179–80, 181b yield-based, 247 other non-bank financial institutions (NBFIs), Insurance Core Principles (IAIS), 82 180–83 integrated value chain models, 242 finance and consumer credit companies, 182, interactive voice response (IVR), 442–43 182–83b Inter-American Development Bank (IDB), 411n9 leasing companies, 181–82 interest rates, 222–25, 223–25b, 236, 340 suppliers and buyers, 182–83, 184b internal controls, 365, 366–67f, 367–71, 370b. See also payment service providers, 194–97, 196b audits range of providers and, 174f internal risks, 354 insurance, 9, 249–70 International Accounting Standards, 373 agriculture and, 247–48, 263–66, 265–66b International Association of Insurance Supervisors commercial providers, 193–94, 195b (IAIS), 81, 82, 426 composite, 266 International Association of Microfinance crop, 131, 247 Institutions, 408 damage-based, 247 International Bank for Reconstruction and deposit, 33b, 431, 444–45 Development, 386 emergencies and, 56, 57–58 International Finance Corporation (IFC), 103, 191b, financial inclusion and, 122b, 266–68 205b, 383, 386, 403, 438b funeral, 58, 260 International Financial Reporting Standards, 373 future predictions, 268–69 International Fund for Agricultural Development health, 193, 253–54b, 261–63, 263–64b, 274b (IFAD), 103, 169, 386 index-based, 247–48, 264, 265–66b, 476 International Labour Organisation (ILO), 249, informal, 158 450, 452b information asymmetries and, 416 International Monetary Fund (IMF), 116–17, 122b key terms in, 251–52b International Remittances Network (IRnet), 440b life, 259–61, 261t Internet banking, 287–88 492 The New Microfinance Handbook interoperability in payment services, 288–90, Kenya Post Office Savings Bank, 187b 289–90b, 439 KfW. See Kreditanstalt für Wiederaufbau interventionism, 465–66 Khan Bank, 189b interviews, in-depth, 134, 138 Kilimo Salama, 265–66b investments. See small-business investments Kiva, 395 investors. See institutional investors; individual Klapper, Leora, 121 investors know-how, 107–8 IPOs (initial public offerings), 405, 407b know your customer (KYC), 42, 431, 448 IRIS Centre, 348n15 Kreditanstalt für Wiederaufbau (KfW), 191b, 386, IRnet (International Remittances Network), 440b 402b, 403, 404b, 441b Islamic lending, 22–23, 34, 220–21, 220b K-Rep Development Agency (KDA), 169b, 230b Islamic Relief, 220b Kshetriya Gramin Financial Services (KGFS), 278, IT. See information technology 303, 303–4b IVR (interactive voice response), 442–43 KYC. See know your customer Kyrgyzstan J currency depreciation in, 401b J. P. Morgan, 388b microfinance laws in, 420b jewelry as savings mechanism, 204–5 Jipange Kusave (JKS), 212b L Johnson, Susan, 8, 45n11, 49 laissez faire, 465, 466 Jordan, health insurance in, 263b landscape data, 121b landscapes, financial. See financial landscapes K Lauer, Kate, 9, 413 Kalaignar (health insurance program), 264b leasing, 181–82, 229–31, 230b, 246–47 Karim, Nimrah, 22 Ledgerwood, Joanna Kashf Foundation, 398 on credit, 8, 217 KDA (K-Rep Development Agency), 169b, 230b on effective rates, 226 Kenya on financial and social performance, 9, 321 agriculture insurance in, 265–66b on financial inclusion measurement, 8, 113 ATMs in, 281–82b on financial landscapes, 8, 15 banking in, 43b, 114b, 186, 187b, 193b on institutional providers, 8, 173 facilitators in, 106–7, 106b on payment services and delivery channels, 9, 271 factoring in, 244b on savings services, 8, 203 financial education in, 92b legal mandates for financial inclusion, 79–81 financial portfolios in, 30–31, 468 legislatures, rule making and, 72–73 financial service associations in, 169, 169b Lehman, Joyce, 9, 271 gender norms in, 24b lending. See credit identification cards in, 448 leverage, 338 initial public offerings in, 407b LFS Financial Systems GmbH, 191b landscape research in, 129b Liber, Dominic, 158 microfinance market in, 102 Liberia, microfinance banks in, 191b mobile network operators in, 197, 284, 285b licensing requirements, 414 person-to-person payments in, 312 life annuities, 260 savings in, 162–63b, 206b, 212b life-cycle events, 52, 58–63, 60b, 65b, 77, 228 solar lighting in, 438b life insurance, 259–61, 261t supply chains in, 242b Life Insurance Corporation of India, 266 transactional accounts in, 309 Lighting Africa, 438b Index 493 lines of credit, 227–28 material misstatements, 373 liquidity mature markets, 104, 106 commitment and, 312 maturity mismatches, 340 foreign currency and, 340 Mauritania, financial service associations in, 169 management of, 330, 338–39, 339t Mauritius, credit outreach data in, 117 options for, 313–14 Maya Declaration (AFI), 84, 84b requirements for, 423b McConaghy, Peter, 9, 351, 437 savings discipline and, 301 McCord, Michael, 158 social capital and, 315 MDBs (multilateral development banks), 386 Listening to Clients series, 360b MEF (Microfinance Enhancement Facility), 391 livelihood landscape studies, 130b men livestock, 204–5, 230, 230b, 249, 249b financial services and, 24b loan loss reserve and provision, 333 household resources and, 50 loans. See credit; specific loan types ROSCAs and, 156 (e.g., education loans) mental labeling of savings, 302 logic models, 129–30, 130f, 131b, 143n18 Me2Me payments, 310, 311, 316 long-term contractual savings (LTCS), 214, 214b Mexico Los Cabos Summit (2012), 143n8 education finance in, 229b Luminis, 410b finance companies in, 182, 183b Lumni, 229b financial inclusion in, 78b Luxembourg Fund Labeling Agency, 410b financial services in, 21b LuxFLAG Microfinance Label, 410b government payments in, 73b housing in, 184b, 231 M income in, 461 Madagascar initial public offerings in, 407b banking in, 43b, 191b managing liquidity in, 293b credit outreach data in, 117 MFIs. See microfinance institutions Maestro, 440 MFRS. See Microfinance Financial Reporting Making Microfinance Work Program, 452b Standards Malawi mftransparency.org, 226 financial diaries in, 127b MiBanco, 400b school fees in, 212b MicroBanking Bulletin (MIX), 119b Malaysia, e-money issuers in, 425 MicroCred, 191b, 388b, 394 Mali, CVECAs in, 170 Micro Credit Rating International, 345 management information systems (MIS), 322–30, Microcredit Summit, 118, 119 323–24b micro-deposit-taking institutions, 180 management service contracts, 452 microfinance, 1–11 managing operations. See governance and managing book structure, 7–9 operations current state of, 1–3 manual information systems, 329 measuring progress of, 3–5, 4f, 5b MAPFRE Insurance, 257b redefining objectives of, 6–7, 6b market-based methods of product pricing, 362–63 Microfinance Centre, 346, 346b market failures, 415–16, 475 Microfinance Deposit-Taking Institutions Act of 2003 marketing, 364 (Uganda), 420b markets, financial. See financial markets Microfinance Enhancement Facility (MEF), 391 Mas, Ignacio, 9, 299, 444 Microfinance Financial Reporting Standards (MFRS), MasterCard, 279, 440 334, 335–39t, 339, 347n8 494 The New Microfinance Handbook Microfinance Handbook (Ledgerwood), 1, 3, 6–7, 15, MicroFinanza Rating, 345 17b, 249 Microfund for Women’s Caregiver insurance Microfinance Information eXchange (MIX), 30b, 115, product, 263b 116, 118, 118–19b, 120, 325 microinsurance. See insurance microfinance institutions (MFIs) Microinsurance Innovation Facility, 249 agency relationships and, 192–93 Microinsurance Network, 249 agent networks and, 40–41 microLINKS wiki, 34, 45n10 agriculture finance and, 236, 249–50, 250b micropensions, 213–14 board of directors and, 353, 353b MicroPlace, 395 branchless banking and, 44 MicroRate, 345, 410b consumer protection and, 74 MicroSave, 205b, 341b, 345, 346, 360b convenience of, 64, 68 Microsoft, 387 credit-only, 424, 432n13 Microsoft Excel, 322 credit ratings and, 409b “micro-warrants,” 246 deposit-taking, 29, 180, 181b, 325, 424 migrants, 155, 196b, 272, 295n2 facilitated groups and, 160 MIIs (microfinance investment intermediaries), as financial institutions, 173 383, 389–95 funding and, 102 Miller, Calvin, 8, 235 global supply surveys and, 117 MIS (management information systems), 322–30, grants and, 108 323–24b group lending and, 66 MIVs. See microfinance investment vehicles insurance and, 194 MIX. See Microfinance Information eXchange investment-ready, 2 MIX Market, 118–19b, 341b, 344 loan repayment, 61 M-Kesho, 43b loan uses from, 59, 62b mobile banking, 39, 42b management information systems and, 322, 325 mobile money, 39, 45n11. See also e-money Microfinance Information eXchange and, 118, mobile network operators (MNOs) 118–19b branchless banking and, 38, 40, 41–42, 44, 318 in nascent markets, 104 connectivity and, 46n17 nongovernmental organizations and, 6, 173–74, delivery services and, 272 179–80, 181b, 424–25 infrastructure and, 440 passbook savings and, 55 interoperability and, 288, 290 poverty alleviation and, 15 mobile banking and, 42b ratings of, 408, 411n7 mobile phones and, 284–87 regulation and, 419–20, 424–25 payment services and, 195, 197, 271 reliability of, 67 regulation and, 425 retail capacity and, 470–71 in rural areas, 30 small-business investment, 51, 62, 62b telecommunications and, 442 warehouse receipt financing, 246 mobile phones, 9, 299–318 microfinance investment intermediaries (MIIs), 383, ATMs and, 280 389–95 banking and, 68, 164b microfinance investment vehicles (MIVs), 389–94, branchless banking and, 39 390–91b, 393b, 410, 410b connectivity and, 442 Microfinance Opportunities, 93n18, 127b, 360b as delivery channels, 284–87, 285–86b, 287f Microfinance Rating and Assessment Fund, 411n9 financial access and, 317–18 Microfinance Regulatory Council, 447b as financial management tool, 300, 309–17 Microfinance Transparency, 88, 90, 119 business model for, 316–17 Index 495 mobile phones (continued ) development of, 475 credit and, 314–15 financial capability and, 477n5 customer information, 312, 317 financial inclusion and, 114b customer service channels, 316, 316f identification cards and, 448 deferred payments, 310–12, 311f, 315 index insurance and, 265b liquidity options, 313–14 men and, 24b liquidity versus commitment, 312 mobile money and, 284, 285b, 305b social capital, 315 person-to-person transfers and, 272 time dimension in, 310 security and, 455 financial services delivery and, 300, 304–9, 305b usage of, 126b current state of, 309 MTN Uganda, 291–92, 294 elements of, 304–6 multilateral and bilateral agencies, 386 platform for, 306–7, 307f, 317 multilateral development banks (MDBs), 386 reasons for, 308–9 murabaha sales, 220–21, 220b single-user experience, 307–8, 309 musharaka equity participation, 220–21 insurance and, 257–58, 274b mutual funds, 390 payment services and, 274 Mwangi, James, 361b personal finance management and, 300–304 Mzansi accounts, 4 discipline-building mechanisms, 302 inflexible banking products and, 302–3 N Kshetriya Gramin Financial Services model Namibia, FinScope survey in, 123b and, 303, 303–4b nascent markets, 104, 108, 472, 475 psychology of, 300–302, 310 National Bank for Agriculture and Rural prepaid cards and, 280 Development (NABARD), 165, 168b mobile wallets, 284, 290b National Bank of Cambodia, 74 Model Regulations for Credit Unions, 433n27 National Bank of Rwanda, 84b MoneyGram, 192, 196b, 440b National Bank of Tajikistan, 292b moneyguards, 53, 55, 56b, 63, 64, 154, 209 National Credit Act (South Africa), 74 moneylending, 66, 153 National Development Plan for 2007–12 money transfer providers, 155, 155b, 192, 194–97, 196b. (Mexico), 78b See also payment services and delivery National Loans Register (South Africa), 447b channels National Partnership for Financial Inclusion Mongolia, state banks in, 189b (Central Bank of Brazil), 84b monitoring and evaluation of financial inclusion, national supply surveys, 117–18 128–31 NBFIs. See non-bank financial institutions “monoliners,” 477n3 Nelson, Candace, 8, 71, 151 Moody’s, 409b Netherlands, microfinance investment in, 392 Morocco New India Assurance, 266 microfinance market in, 102 New Microfinance Handbook (Ledgerwood), 7–9 women in, 23, 25 NGOs. See nongovernmental organizations mortgages, 63–64, 231 Nicaragua Mozambique, microfinance institutions in, 420b credit unions in, 213b M-PESA platform housing in, 231 agent network of, 291, 295 Patrimonio Hoy in, 184b ATMs and, 281–82b Niger borrowing to save and, 212b savings groups in, 160 branchless banking and, 43b warehouse receipt systems in, 246b 496 The New Microfinance Handbook Nigeria, banking in, 185, 191b Orange Money, 43b, 164b, 292 Niyazov, Dilshod, 292b organizational structures, 355–56 nominating committees, 354 Oriental Bank of Commerce, 165b non-bank financial institutions (NBFIs), 29, 173–74, outgrower schemes, 242 180–83, 422, 429–30 outpatient coverage, 262–63 nongovernmental organizations (NGOs) outreach in microfinance, 2, 3 board of directors and, 353, 353b outsourced support services, 9, 450–57. See also deposit-taking institutions and, 181b infrastructure; third-party platform providers donors and, 98–99 auditing and accountancy, 450 equity and, 405 call centers, 453, 454b facilitated providers and, 152, 158 debt collection, 453–54, 455b as financial institutions, 29, 173–74 efficiency of, 437 financial statements and, 373 security and cash-in-transit, 454–55 funding and, 386–87 software as a service (SaaS), 452–53 global supply surveys and, 117 training and advisory services, 450–52, 451–52b governance and, 351–52 over-indebtedness, 17b, 89, 90, 90b, 116, 116b, 152, 446 holding companies and, 394 Overseas Private Investment Corporation, 104 as insurance providers, 193–94 ownership requirements for banks, 421b, 422, 423b management information systems and, 322 Oxxo, 43–44b as microfinance institutions, 6, 173–74, 179–80, 181b, 424–25 P savings groups and, 65–66, 160, 161b, 170n2 Pakistan self-help groups and, 164 branchless banking in, 43b Norway, UN-Habitat and, 232b health insurance in, 253–54b Islamic lending in, 220b O payment platforms in, 288 OECD countries, 447–48 prepaid cards in, 280, 281b “OECD Principles and Good Practices for Financial syndicated loans in, 398 Awareness and Education,” 88 Papua New Guinea, mobile money in, 275b OIBM (Opportunity International Bank of Malawi), Paraguay, debt collection in, 455b 127, 127b Paris Declaration of Aid Effectiveness, 473 Oikocredit, 392 partial credit guarantees (PCGs), 401, 403 O’Keeffe, Geraldine, 9, 321, 437 participatory rapid assessments (PRAs), 134, 135b Omni, 281b, 288 passbook savings, 55, 64, 68, 211 on-lending, 101–2, 110, 167, 240 path dependencies, 464 open door policies, 371 Patrimonio Hoy, 183, 184b, 231 Open Sky, 283b PATs. See poverty assessment tools operating activities, 332–33 pawnbrokers, 63, 154 operating leases, 230–31 payment and clearing systems, 430–31 operating plans, 331 payment integrators, 441–42, 442b “operating self-sufficiency,” 143n10 payment services and delivery channels, 9, 271–98 operational risks, 366–74 agent networks, 290–95, 291b operations management. See governance and building of, 291–92, 292b managing operations costs and fees, 294–95, 294f Opportunity International, 179, 394 managing channels, 294 Opportunity International Bank of Malawi (OIBM), managing liquidity, 292–93, 293b 127, 127b, 212b delivery channels, 272, 275–88 Index 497 payment services and delivery channels (continued ) Philippines automated teller machines, 278–80, banking in, 185 281–82b e-money issuers in, 425 branches, 277–78, 283–84, 291b insurance in, 269, 274b electronic payment cards, 279–80, 281b interest rates in, 75 field officers, 278, 279b ROSCAs in, 59 glossary of terms, 276–77b phones. See mobile phones Internet banking, 287–88 pilot testing, 360–61, 361b mobile branches, 283–84, 283b PINs. See personal identification numbers mobile phones, 284–87, 285–86b, 287f PlaNet Guarantee, 195b payment terminals, 280, 282b, 292b Planet Rating, 334, 345 point-of-sale devices, 280, 282–83 P9 (savings-and-loan service), 212b interoperability and, 288–90, 289–90b point-of-sale devices (POS), 273, 278, 280, 282–83, payment services, 271–75 296nn7–8, 440 government transfer payments (G2P), 272, policy making 274, 275b, 289b, 291b coordination of, 83 person-to-business transfers (P2B), 272, government’s role in, 72 273–74, 274b, 286b institutional capacity and, 207 person-to-person transfers (P2P), 272–73, pro-poor, 473 273b, 286b, 289b, 291b the poor value of, 274–75 financial market benefits for, 464–66 providers, 194–97, 196b policy making and, 473 regulation and, 416 portfolios of, 50–51 payment terminals, 280, 282b, 292b savings services and, 203, 204f Paynet Kenya, 281b unbanked poor, 49, 196, 219 PCGs (partial credit guarantees), 401, 403 Porteous, D., 469 PEARLS, 334, 347n8 portfolios peer pressure, 313, 315 analysis of, 336 peer-to-peer aggregators, 395 funding and, 382 pension funds, 387 loan tracking for, 325–26 pensions, 213–14 of poor people, 50–51 performance, financial and social. See financial and regulation and, 430 social performance reports, 333 personal guarantees, 222, 237 Portfolios of the Poor (Rutherford, Collins and personal identification numbers (PINs), 279–80, Johnson), 8, 16, 28, 45n4, 50 281b, 283, 286b POS. See point-of-sale devices personnel and compensation committees, 354 postal savings banks, 186, 186–87b person-to-business transfers (P2B), 272, 273–74, poverty assessment tools (PATs), 138, 140–41t, 274b, 286b 140–42, 345, 348n15 person-to-person transfers (P2P), 272–73, 273b, PowerPoint, 360b 286b, 289b, 291b, 440 PPI. See Progress out of Poverty Index Peru pragmatism in financial markets, 476 disclosure requirements in, 76b PRAs. See participatory rapid assessments education finance in, 229b preexisting conditions, 267–68 interest rates in, 75 preferred shares, 405 PesaPoint, 281–82b prepaid cards, 279–80 pharmaceutical coverage, 262 price-based signaling, 111n4 498 The New Microfinance Handbook pricing of microloans, 90 recordkeeping, 167, 322. See also accounting Principles for Investors in Inclusive Finance, 407 systems privacy of client data, 89 recruitment of staff, 356 private funders, 383–84, 384t, 386–89 Regional MSME Investment Fund for Sub-Saharan process mapping, 368 Africa (REGMIFA), 393b ProCredit, 191b, 388b, 395 registration requirements, 414 ProCredit Bank Bulgaria, 404b regulation, 9, 413–35 ProCredit Holding, 394 AML/CFT requirements, 431–32 Prodel, 231 enabling environments and, 472–73 productive investment, 226, 228–32 financial infrastructure, 430–31 product management, 358–64, 359b financial services providers, 420–30 profitability indicators, 334, 336t banks, 421–22, 421b, 423b, 427, 429 ProFund, 392, 394 financial cooperatives, 422–24 Progress out of Poverty Index (PPI), 142, 345, microinsurance, 426–27, 428–29b 347–48n14 microlending institutions, 424–25 property insurance, 263 non-bank deposit-taking institutions, 422, proportionality 429–30 in financial markets, 475 payment service providers and e-money in regulation, 417–18 issuers, 425–26, 426b psychology of savings and goal setting, 300–302, 310 overview, 413–15 psychometric testing, 220 principles of, 417–19, 418b P2B. See person-to-business transfers rationale and objectives of, 415–17, 417t P2P. See person-to-person transfers structures for, 419–20, 420b public funders, 384, 384t, 385–86 “regulatory arbitrage,” 419 public goods, 471, 473, 477n56 regulatory impact assessments (RIAs), 418, 418b public-private partnerships, 264b, 393b Reille, Xavier, 22 put options, 406 reinsurers, 194 reliability of financial tools, 63–64, 67–68 Q religion, 22–23, 23b Qiwi, 282b remittances, 19b, 272, 273b, 295n2, 440b qualitative research, 132, 134, 138 Remittances Prices Worldwide (RPW), 273b quality of financial services, 115, 128–29 renewable term arrangements, 256 quantitative research, 132, 134–36, 138 repayment terms on loans, 218 replicability of savings groups, 162–63, 162b R reputational risks, 354 randomized control trials (RCTs), 3, 120, 135–38, requests for proposals, 327–28 144n22 requirements analyses, 327 Rashtriya Swasthya Bima Yojana (RSBY) health Reserve Bank of India, 80b, 168b insurance program, 264b Reserve Bank of Malawi, 84b Rating Fund II, 411n9 responsAbility Global Microfinance Fund, 390 ratings responsible finance, 2, 80b, 86b credit, 404b, 408–9, 409b, 445 Responsible Finance Forum, 84, 85–86 for funding mechanisms, 408–10, 409–10b Responsible Investor Principles, 408b RCTs. See randomized control trials retail capacity, 470–71 real-time alerts, 330 retail payment processors, 440 real-time communications, 308 RFR (Rural Finance Network), 446b real-time gross settlement (RTGS), 440 RIAs (regulatory impact assessments), 418, 418b Index 499 risk management Rural Finance Network (RFR), 446b committees, 354 Rural Impulse Microfinance Fund, 391–92 credit products and, 226, 228 Russian Federation emergencies and, 56–58 financial literacy in, 77b financial services and, 52 payment terminals in, 282b, 292b guarantees and, 109 Rutherford, Stuart, 8, 49, 212b operational risks and, 366–74 Rwanda risk-sharing facilities, 403–4 credit outreach data in, 117 roads, 438 health insurance in, 263 Robinson, Jonathan, 206b mobile branches in, 283b Robinson, Marguerite, 203, 207 rotating savings and credit associations (ROSCAs) S disciplined savings and, 64–65 SaaS (software as a service), 452–53 as financial service providers, 29 SACCO Link, 193b as indigenous providers, 152, 156–57 SACCOs. See savings and credit cooperatives items purchased through, 170n1 Safaricom, 43b, 114b, 265b, 284, 285b, 291, life-cycle events and, 59, 61, 65b 294, 475 reliability of, 68 SafeSave, 31b, 212b savings groups and, 162b salaries, 356–57, 357b security of, 205 salary loans, 228 social embeddedness and, 66 Sankat Haran insurance policy, 255b women and, 24b, 156 Save the Children, 281b youth services and, 18b savings and credit cooperatives (SACCOs), 24b, 118, Roth, Jim, 158 126, 129b, 177, 192–93, 193b RPW (Remittances Prices Worldwide), 273b savings banks, 185–86, 421–22 RSA Capital, 404b savings completion insurance, 260–61, 262b RSBY (Rashtriya Swasthya Bima Yojana) health savings groups (SGs) insurance program, 264b audits and, 373 RTGS (real-time gross settlement), 440 as community-based providers, 158, 160–64, rule making for financial inclusion, 72–73, 92–93n1 161–64b, 163b rural areas facilitating agencies and, 161–62, 170n5 banking in, 184–86, 185b, 189b, 218, 278, 283 family structure and, 19b commercial insurance in, 195b financial education and, 78 connectivity in, 443 financial linkages and, 163–64, 164b CVECAs in, 170 as financial service providers, 29 delivery services in, 277–78 global supply surveys and, 117 financial cooperatives in, 177 group lending and, 219 financial services in, 3, 20–21 information systems and, 322 grants in, 108 methodology of, 160–61 mobile network operators in, 30 mobile wallets and, 284 money transfer services in, 275b as movement, 65 roads in, 438 nongovernmental organizations and, 65–66 rural finance, 235, 279b. See also agriculture performance monitoring of, 323–24b, 323t finance research on, 138 savings groups in, 161b sustainability and replication of, 162–63, 162b self-help groups in, 168 Savings Groups Information Exchange (SAVIX), 118, stretcher clubs in, 158 119, 120, 120b, 162, 163, 322 500 The New Microfinance Handbook savings services, 8, 203–15 SGs. See savings groups in communities, 204–5, 205b shareholding companies, 352 improving lives of poor by, 203, 204f shareholding limits, 421b, 422, 423b institutional, 205–10, 206b share-outs, 160, 163 capacity and, 206–8 Sharia, 22–23, 220, 220b, 231 management skills and, 207–8 Sherk, Lisa, 9, 379 managing operations, 208–9, 208b SHGs. See self-help groups pricing savings products, 209–10 shop owners as individual providers, 154 products offered, 210–14, 210b short messaging service (SMS), 285–86, 287, 442–43 contractual savings accounts, 211, 212b SIDA (Swedish International Development current accounts, 211 Cooperation Agency), 106, 385 long-term contractual savings (LTCS), 214, Sierra Leone, financial service associations in, 169 214b signature requirements, 369 long-term savings and micropensions, 213–14 SIM cards. See subscriber identity module passbook savings accounts, 211 simple object access protocol (SOAP), 330 time deposits, 213, 213b single-user experiences, 307–8, 309 SAVIX. See Savings Groups Information Exchange SKS, 407b school fees, 211, 212b, 301, 312 small-business investments, 51, 62, 62b School of African Microfinance, 451b Small Enterprise Education and Promotion (SEEP) screening of staff, 356 Network, 87b, 119b, 334, 345, 360b seasonal income, 52–53, 55b Smart Campaign on Client Protection Principles, 88, securitization, 404, 404b 89–90, 91, 341b SEEP Network. See Small Enterprise Education smartcards, 279 and Promotion SMART GIRAFE rating system, 334 segregation of duties, 369, 370 SMART (specific, measurable, achievable, realistic, selection bias in quantitative research, 132b, 136 and time-bound) objectives, 133, 358 Self-Employed Women’s Association (SEWA), 266 smartphones, 287–88, 322, 443 Self-Help Group Bank Linkage Program, 165 SMS. See short messaging service self-help groups (SHGs) SOAP (simple object access protocol), 330 challenges of, 167–68 social embeddedness, 66–67 as community-based providers, 164–68, 165–66b, socially responsible investing (SRI), 387 168b social networks, 315 facilitated providers and, 152, 158, 165–66b social performance. See financial and social as financial service providers, 29 performance formation and technical assistance, 166–67 social performance management (SPM), 340–46, group lending and, 219 341b, 355 information systems and, 322 Social Performance Task Force, 88–89, 90, 119b, 120, methodology of, 165–66 341, 341b, 342, 344 participation in, 3 social ratings, 345, 409–10 rural banks and, 185 Society for Worldwide Interbank Financial success of, 65 Telecommunication (SWIFT), 439–40 self-regulation, 415 soft law, 81 Senegal, commercial insurance in, 195b software application controls, 327b senior term loans, 397–98 software as a service (SaaS), 452–53 Separ, 387 solar lighting, 438b, 439 service charges, 225 solidarity groups, 218, 278, 464 SEWA (Self-Employed Women’s Association), 266 Sonam, 388b Index 501 South Africa surveys in research, 116–18, 134. See also specific banking in, 4, 93n8, 105b surveys business owners in, 62 sustainability consumer protection in, 74 in microfinance, 2–3 credit bureaus in, 447b savings groups, 162–63, 162b emergencies in, 57, 58 Sustainable Microenterprise and Development financial diaries in, 28 Program, 451b financial portfolios in, 50 swaps, 400–401 FinScope survey in, 123b Sweden, UN-Habitat and, 232b homes in, 59 Swedish International Development Cooperation income in, 53–54b, 55 Agency (SIDA), 106, 385 insurance in, 260, 269 SWIFT (Society for Worldwide Interbank Financial life-cycle events in, 60b Telecommunication), 439–40 third-party providers in, 289b Swisscontact, 230b special purpose vehicles (SPVs), 404 Swiss Post Pension Fund, 388b spillovers in research, 136 switches for electronic payments, 440–41, 441–42b SPM. See social performance management Symbiotics, 390, 390b, 392 SPVs (special purpose vehicles), 404 syndicated loans, 398 SRI (socially responsible investing), 387 Syngenta Foundation, 265b Sri Lanka Syria, call centers in, 454b gross national income in, 461 rural finance in, 279b T staff turnover, 371 tablet computers, 287, 296n14 Stanbic Bank, 187b Tajikistan, microfinance in, 191b, 420b Standard & Poor’s, 393b, 409b takaful insurers, 193 standards and guidelines Tameer Bank, 43b government’s role in, 81–82 TAMSUF institution, 232b industry’s role in, 88–90, 91t Tanzania Star Allied Insurance, 264b banking in, 191b Staschen, Stefan, 8, 9, 71, 413 savings groups in, 163b state banks, 186, 188, 189b Tarazi, Michael, 22 strategic plans, 330–31 TCP (transmission control protocol), 330 stretcher clubs, 158 TCX (Currency Exchange Fund N.V.), 402b structured finance, 392, 393b, 402–4 technical assistance, 107–8, 167, 179, 192, 397 Sub-K, 197, 289b technology transfer, 467–68 Sub-Saharan Africa, financial inclusion in, 30b TechnoServe, 438b subscriber identity module (SIM) cards, 280, 284, Telenor, 43b 286, 288, 290, 296n13, 442 telephones. See mobile phones Summa, 244b term life insurance, 259–60 Superintendency of Banks and Insurance (Peru), terrorism. See anti-money-laundering and combating 84b, 121b financing of terrorism supervision of financial institutions, 414–15 text messages, 285–86. See also short messaging suppliers and buyers, credit from, 182–83, 184b service supply-side research, 115–18 Thailand, savings banks in, 186 support services. See outsourced support services third-party platform providers, 288, 289b. See also “supra-market” groups, 469 outsourced support services surrender values, 260 3G protocols, 442 502 The New Microfinance Handbook TIAA-CREF, 388b UNCDF (United Nations Capital Development Fund), tiered approach to regulation, 419–20, 420b, 427 410n2 time deposits, 213, 213b Understand Your Money (Elewa Pesa), 92b timing issues UN-Habitat, 232b for ASCAs, 157 unified supervision structures, 415 for facilitators, 106 Unique Identification Authority of India (UIDAI), financial management tools and, 310 449b financial markets and, 475–76 United Bank Limited (UBL), 280, 281b, 288 Top Image, 294 United Kingdom, UN-Habitat and, 232b top-up loans, 56b, 228, 359b United Nations, 385, 386 trade finance, 243–44 United Nations Capital Development Fund (UNCDF), traders as credit providers, 154 410n2 training “United Nations Principles for Investors in Inclusive human resource management and, 356 Finance,” 88 on management information systems, 328–29 United Nations Principles for Responsible outsourcing of, 450–52, 451–52b Investment, 407, 410b transfer pricing, 210 United States transmission control protocol (TCP), 330 bank branches in, 278 transparency education finance in, 229b consumer protection and, 74, 75, 89, 90 money transfers in, 440b deposit-taking institutions and, 181b Universal Standards for Social Performance financial inclusion and, 71 Management, 341, 341b in investing practices, 407 University Libre de Bruxelles, 451b in Islamic lending, 221 University of New Hampshire, 451b of remittances, 273b unstructured supplementary service data (USSD), of savings groups, 161 285–86, 287, 443 of social performance, 344 UOB, 387 of transfer pricing, 210 urban areas TransUnion, 447b banking in, 39, 188, 189b Travelex, 440b connectivity in, 443 Triodos SICAV, 390 delivery services in, 277 trustworthiness in savings services, 208, 208b housing in, 184b Tsogolo Langa (savings account), 212b indigenous providers and, 156 TUW SKOK, 262b money transfer services in, 196b, 275b twin-peaks supervision structures, 415 roads in, 438 Urwego Opportunity Bank, 283b U U.S. Agency for International Development UAP (insurance company), 265b (USAID) UBL. See United Bank Limited AIMS Project of, 360b Uganda bonds and, 400b financial service associations in, 169 guarantees and, 109 microfinance law in, 83b, 420b Khan Bank and, 189n savings in, 69n9, 163b poverty assessment tool of, 142, 345, 348n15 UIDAI (Unique Identification Authority of India), as public funder, 385 449b user acceptance testing, 329 UK Charted Institute of Housing, 232b user interfaces, 300, 308 unbanked poor, 49, 196, 219 USSD. See unstructured supplementary service data Index 503 V property rights and, 237 value chains religion and, 23 agriculture finance and, 239–41, 241f, 250 ROSCAs and, 24b, 156 business models for, 241–47, 242b savings and, 162b, 204, 206b supplier credit and, 183 self-help groups and, 164–65 Vietnam, ROSCAs in, 59 Women’s World Banking, 19b Vigo Remittance Corporation, 440b working capital loans, 227 village banks, 218, 278 World Bank VimoSEWA, 266 demand-side research of, 120–21 Vincze, Joakim, 9, 437 on financial institutions, 3 virtual private networks (VPNs), 444 Financial Sector Deepening Trust and, 106 Visa, 279, 290b, 440 funding and, 383, 385 Vodacom Tanzania, 293 global supply surveys and, 116 Vodafone plc, 475 Khan Bank and, 189b voice communications, 441–44 Lighting Africa and, 438b VSL Associates and Software Group, 323b loans from, 103 on mortgages, 231 W remittances and, 273b warehouse receipts systems, 245–46, 245f, 246b, on world incomes, 52 248b “World Bank Draft Guidelines for Consumer warrantage. See warehouse receipts systems Financial Protection,” 88 warrants, 246, 406 World Bank Group, 116 welfare, financial services and, 115, 129 World Council of Credit Unions (WOCCU), 118, 119, West African Economic and Monetary Union, 441b 334, 433n27, 440b Western Union, 192, 196b World Food Programme (WFP), 22b, 281b WFP (World Food Programme), 22b, 281b World Savings Banks Institute, 118, 119, 185 “white label” arrangements, 280, 281–82b World Vision, 98 Wi-Fi, 282, 296n10 WWB Cali, 400b Wiz Kids, 289b Wizzit, 289b X WOCCU. See World Council of Credit Unions XBRL (eXtensible Business Reporting Language), women 296n12 in agriculture, 238, 249 banks-on-wheels and, 127b Y caste and, 23b yield-based insurance, 247 deposit collectors and, 154b youth financial services, 18b family structure and, 19b Yunus, Muhammad, 49, 359b, 466, 467 Grameen Bank and, 359b household resources and, 50 Z insurance and, 195b, 254b, 256, 258 Zain, 294 microfinance and, 466 Zambia mobile phones and, 280 banking in, 114b, 191b mobility of, 23, 25 FinScope survey in, 123b physical infrastructure and, 438–39 Zambia National Commercial Bank, 114b 504 The New Microfinance Handbook ECO-AUDIT Environmental Benefits Statement The World Bank is committed to preserving Saved: endangered forests and natural resources. 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