34164 CGAP Phase III Strategy 2003 - 2008 JANUARY 2003 Building financial systems that work for the poor Photographs, front cover: (background, then left to right): Two women holding money, Cambodia (Tim Hall/Getty Images); Women removing fish traps, Okavango River, Botswana (Peter Johnson/Getty Images); Farmer on carriage, Egypt (Hisham F. Ibrahim/Getty Images); Woman selling flowers at market stand, Ecuador (Corbis); Bulls pulling carts on a rainy day, India (Corbis). Photographs, back cover (background, then left to right): Outdoor market, Bombay, India (Eyewire Collection/Getty Images); People making food, Burkina Faso (©1993, The World Bank Photo Library/Curt Carnemark); Woman weaving, Kenya (© The World Bank Photo Library); Man with water buffalo cart, Philippines (©1975, The World Bank Photo Library/Edwin G. Huffman). Consultative Group to Assist the Poor Tel: (202) 473-9594 c/o The World Bank Fax: (202) 522-3744 1818 H Street, N.W. email: cgap@worldbank.org. Room Q4-400 Web: www.cgap.org Washington, D.C. 20433 Phase III Strategy 2003 - 2008 Building financial systems that work for the poor CGAP III Strategy FOREWORD This Strategy Paper sets out the broad directions and priorities that will guide the third phase (2003-2008) of CGAP, together with plans for implementing the strategy. The strategy was prepared on the basis of extensive discussions between the Consultative Group of member donors, the Policy Advisory Group, the CGAP Secretariat, and a large number of other leaders in the microfinance industry through vision statements for the microfinance industry and other mechanisms. A strategic outline prepared by the Executive Committee and the Secretariat set the framework for this document. As a five-year strategy, it will be complemented by detailed annual workplans of proposed activities to be submitted each year to the Executive Committee. Plans for the future institutionalization of CGAP or its activities beyond 2008 will be considered in 2005. This paper defines the role of microfinance in the development agenda and discusses the key challenges of expanding financial services to the poor on a much larger and more sustainable scale. The paper proposes ways in which the donor community ­ individually as well as collectively ­ can best promote the development of financial services to the poor and, specifically, how CGAP as a donor consortium can assist donors in this effort. 3 CGAP III Strategy INTRODUCTION nies, insurance companies, and other financial insti- tutions. The Vision for Microfinance in 2008 Increasing competition among products and institu- With an estimated untapped market of nearly a tions will result in greater efficiency, benefiting both billion poor people, microfinance now stands at a financial institutions and clients. Advances in tech- crucial crossroad. Successful microfinance NGOs nology will lead to reduced transaction costs, have proved that financial services can be an effec- enabling volumes to grow and marginal costs to tive and powerful instrument for poverty reduction decline. New technologies will also improve client by enhancing the ability of poor people to increase information and asset and liability management, incomes, build assets, and reduce their vulnerability reducing risk and thus costs. In this vision, national in times of economic stress. There is greater consen- policymakers understand that financial systems can sus than ever before about what is needed to make and should work for all levels of society, especially microfinance sustainable. Yet with most poor people for the poor who constitute the overwhelming still lacking access to basic financial services, micro- majority of their populations. finance has yet to reach its full potential. The overarching goal of CGAP in this vision is to Over the next decade, microfinance will either support the development of financial systems that realize its vast potential for improving the lives of work for the poor. This approach requires that we large numbers of the poor ­ or it will remain an remove the walls ­ real and imaginary ­ that sepa- unfulfilled promise. Much depends on the extent to rate the microfinance community from the much which the international development and financial broader world of financial systems, markets, and communities can partner with social entrepreneurs development. It requires that we refuse to accept a and governments in developing countries to develop status quo in which it is considered normal for a financial systems for the poor that are far broader country's financial system to serve only a tiny than those that currently exist. Of course, macro- minority of its population, while the vast majority economic policies and individual sector improve- remains outside the system. It requires recognizing ments will need to underpin the development of the vast differences between poor people and under- such financial systems: finance alone is clearly not standing that very different delivery organizations enough. with varied but complementary objectives will be needed to serve them all. Several successful institu- This new vision is a world in which diverse poor tions have proved that even the very poor can be people enjoy permanent access to a wide range of reached sustainably. financial services, delivered through a variety of convenient mechanisms by different types of insti- This vision embraces institutions that are motivated tutions. The concept of financial services to the to provide sustainable financial services to the poor poor will no longer be dominated by microcredit, because it makes economic sense, as well as those but will recognize the importance of such other driven by the objectives of poverty alleviation and/or services as savings, payment services, and insurance. job creation. Encouraging a more diverse range of Providers will include not only non-governmental organizations with different objectives, and different microfinance institutions (MFIs), but also savings needs for subsidy, will enable outreach to a broader and credit cooperatives, commercial banks, commu- range of poor clients, from growing urban microen- nity finance institutions, consumer credit compa- terprises to very poor rural households. 5 CGAP III Strategy This transformation of perspective is urgent, as the microfinance and other financial services blurred. growth of poverty and unrealized human potential We recognize that the microfinance world as it has outpaces the incremental growth of microfinance. been narrowly defined is but a small segment of the This transformation is also within our reach because universe of financial services to poor people. many of the necessary elements needed to scale up Traditional microfinance has encountered several microfinance are already in place. Banks and other core challenges to a number of its basic premises: institutions with nationwide distribution systems are beginning to take interest in reaching poorer · Not all the poor run growing microenterprises, clients. A great deal of the knowledge about the but all poor people need, use, and benefit from requirements of sustainable microfinance already different kinds of financial services. In fact, poor exists. Advances in information technology have people are extremely diverse and their needs vary never been so promising to lower the cost and risk of widely with their circumstances. delivery mechanisms. The challenge before us is to · Supply-driven credit methodologies have mobilize this knowledge and apply it on a much reached a relatively narrow band of potential vaster scale. clients within the spectrum of the poor, often leaving behind both extremely poor and remote Before tackling this enormous challenge, however, it clients, and the less-poor with larger enterprises. is important to address the basic question of what · The types of financial services needed by poor microfinance is, why it is important, and how it people extend far beyond working capital loans, contributes to development. encompassing an array of savings, credit, insur- What is Microfinance? ance, and money transfer services. Convenient, safe and secure deposit services are a particularly As recently as a few years ago, the term "microfi- crucial need. nance" was easily understood: a credit methodology · NGOs, while crucial for experimenting with that employs effective collateral substitutes to deliver new models and conducting research and devel- and recover short-term, working capital loans to opment, face challenges in governance, legal microentrepreneurs (or potential microentrepre- frameworks, and cost structures. More impor- neurs). The vision was that microenterprises of tantly, they generally have not reached massive clients would grow, increasing their incomes and scale, or independence from donors (although sometimes creating employment, lifting the poor there are major exceptions to this rule). out of poverty. The promise of sustainability meant · While they are few, several successful microfi- that microfinance could leverage relatively scarce nance NGOs have demonstrated that it is possi- donor funding by attracting much larger pools of ble to achieve financial self-sustainability while private capital, thus expanding outreach to massive reaching the very poor with extremely small loan numbers of the poor. The non-governmental organ- sizes, even the very poor in sparsely populated izations (NGOs) that pioneered this methodology areas. and have provided most of the microloans to date would grow, become independent from donors, and · Institutions with large existing infrastructures, possibly transform into banks for the poor, without such as commercial and state-owned banks, cred- losing their social mission. it union networks, financial cooperatives, and even retail chains, may offer a significant, if chal- Today the picture has become far less clear, the sto- lenging, "answer" to the problem of scaling up ryline more nuanced, and the boundary between financial services for the poor. 6 CGAP III Strategy These lessons learned point to an expanded view of for and funerals, as well as building income-generat- our task: microfinance is about diverse institutions ing potential by investing in their enterprises. providing massive, permanent access to a broad range of financial services for a broad range of The multiple roles of financial services for the poor clients. parallel the multiple dimensions of poverty captured in the Millennium Development Goals (MDGs) The Role of Microfinance in Reducing Poverty (see box below). The MDGs have galvanized the development community around measurable and At the core of microfinance is a fundamental belief concrete indicators of poverty reduction. that access to financial services protects and empowers the poor by mitigating them from risks Financial services put power into the hands of the and giving them choices. Financial services help poor to pursue their own strategies for building the poor cope with a common feature of their lives: human, physical, economic and social capital to vulnerability. Whether they save or borrow, evidence escape poverty. And because microfinance services can shows that when poor people have access to finan- be delivered sustainably within relatively short periods cial services in the absence of emergency conditions, of time, benefits can be delivered on a permanent they choose to invest their savings or loans in a basis, well beyond the duration of donor or govern- wide range of assets. These "assets" can be send- ment programs that rely on continuous subsidies. ing children to school, buying better medicines and more nutritious food, fixing a leaky roof, meet- Far from being a narrowly defined, specialized field ing social and cultural obligations like paying occupying a small corner of development thinking How does Microfinance Contribute to the Millennium Development Goals (MDGs)? A review of microfinance literature points to several specific conclusions about the impact of microfinance on poverty reduction and several other MDGs: Eradicate extreme poverty and hunger. Extensive evidence demonstrates that microfinance helps reduce poverty through increases in income, allowing the poor to build assets and reduce their vulnerability. Achieve universal education. Households that have access to microfinance spend more on education than non-client households. Improvements in school attendance and the provision of educational materials are widely reported in microfinance households. Participation in credit and savings programs has enabled many families to send several children at a time to school, and has reduced drop-out rates in higher primary grades. Promote gender equality and women's empowerment. Microfinance clients are overwhelmingly female. Microfinance has been widely credited for empowering women by increasing their contribution to house- hold income, the value of their assets, and control over decisions that affect their lives. Reduce child mortality, improve maternal health, and combat disease. Microfinance contributes to improved nutrition, housing, and health, especially among women clients. 7 CGAP III Strategy and practice, microfinance is an important founda- world to understand and judge the performance of tion for poverty alleviation and the wider develop- microfinance vis-ŕ-vis other financial and non- ment agenda. It supports other development efforts financial services and other development interven- and can make a significant difference in the way tions. It means governmental policies that promote poor people address those development problems on financial sector deepening and expansion. It means their own terms. seeing microfinance as greater than microcredit and microenterprises -- as financial services for the poor. Microfinance and Financial Sector Deepening It also means ensuring that the social values-driven Until now, microfinance has largely developed out- mission of microfinance is not un-intentionally side the realm of the formal financial sector on a compromised as a result of this integration. separate track that seldom interacts with established financial actors. When governments and donors The "financial systems approach" to microfinance address financial sector issues, broad concerns such has generally meant a focus on one dimension of as banking sector reform, capital market develop- this vision ­ the sustainability and formalization of ment, and corporate governance are generally at the microfinance institutions. True, the paucity of top of their agenda, not microfinance. For its part, strong retail institutions remains the principal bot- the microfinance community of practitioners, tleneck to meeting the massive demand for financial donors, and technical experts has argued, perhaps services among the poor. However, just as there is too convincingly, in favor of microfinance as a high- wide diversity in poor clients and their needs and ly specialized sector that needs separate standards, circumstances, so must there be a wide range of techniques and/or legal frameworks to be effective. service providers motivated by varied objectives. These arguments made sense at the time when the This vision upholds the essential principles of finan- need to professionalize microfinance into a more cial sustainability in order to allow for growth, and business-like activity became apparent. However, it calls for acknowledgement and clarification of the the efforts to make microfinance something separate role of subsidies in institutions and support organi- have also served to isolate it as a marginal sector zations that are doing work that merits subsidy. disconnected from the broader financial system. Current Actors in the Microfinance System It is becoming increasingly apparent that large-scale sustainable microfinance can be achieved only if Over the last 30 years, the microfinance industry financial services for the poor are integrated into the has grown to encompass many types of actors with overall financial system. This means that microfi- different objectives, roles, and comparative advan- nance, or financial services for the poor, becomes the tages. Clearly, no single organization has the means lower end of the entire financial sector, opening up or the capacity to achieve the expanded vision of access and markets to increasingly poor and microfinance on its own. Developing financial geographically remote clients. It means achieving systems that work for the poor will require financial sustainability not through high interest improved dialogue, coordination, and partnership rates alone, but by leveraging technology and among these different actors, as well as building bet- streamlining business processes to increase cost effi- ter linkages with other development sectors. ciency in the face of competition. It means attract- ing new players and new sources of commercial and Providers of financial services to the poor. quasi-commercial debt and equity capital. It means Microfinance suppliers can be divided into three promoting transparency that allows the outside broad categories: (i) traditional and informal 8 CGAP III Strategy providers, such as moneylenders, pawn shops, and for microfinance institutions to access their funds ­ rotating savings and credit associations (ROSCAs); can significantly affect the development of the sec- (ii) formal unlicensed institutions such as microfi- tor. Even as some financial service institutions "grad- nance NGOs; and (iii) licensed financial intermedi- uate" to commercial funding, there will always be a aries, including commercial and state-owned banks, role for donors to subsidize development work that credit unions, community finance institutions, con- is not commercially viable, either because of the risk sumer credit companies, and finance companies. or the cost. Donor subsidies, for example, can moti- Understanding the market penetration, growth, and vate new financial institutions to enter the market performance of these various delivery models is an by defraying development and technical assistance important part of assessing how the financial system costs. The role of subsidies in microfinance is impor- as a whole works for the poor. Better understanding tant, but needs to be more clearly defined, as does will reveal where the gaps are and what can be done the role of donors vis-ŕ-vis other, more commercial to meet the needs of those who are not being served. funding sources. Networks. Intermediary organizations have, and Private Investors. There is widespread recognition will continue, to play a critical role in microfinance. that in order to reach scale, microfinance needs to Such organizations include national associations of move from dependence on donor funding to microfinance institutions, regional or global net- reliance on more abundant commercial funding and works of MFIs or credit unions, and even some domestic savings. Most private capital that supports investment funds that provide governance and microfinance takes the form of institutional deposits technical assistance to MFIs. attracted by licensed institutions. While private capital still represents only a small fraction of total Networks serve several crucial functions in expand- funding, a range of private funders/investors ­from ing the delivery of financial services to the poor. commercial banks to socially responsible investors ­ First, they are an important voice in policy and are becoming increasingly interested in microfi- regulatory change, both within countries and across nance as more microfinance institutions demon- regions. Second, they can be an effective means of intermediating both capital and technical services strate the profitability of banking for the poor. An between donor agencies and service providers on the important requirement for attracting greater private ground. Third, they are a potent force for improving resources into microfinance is reliable information the performance of their members through peer on the performance of financial institutions serving learning, information exchange, and mutual the poor. Another important requirement is mecha- accountability. Fourth, networks that provide fund- nisms that can better match the demand for funds ing to members, such as through investment funds, on the part of well-performing or high-potential sometimes fulfill a governance function that is more institutions with the supply of available funds. effective and closer to true commercial governance than what donors provide. Governments. Depending on their approach, governments can either undermine or encourage the Donors. Virtually all donors, including private, development of microfinance. In general, the gov- local, bilateral, and multilateral donors, as well as ernment's role in microfinance should be to main- local and international NGOs, support microfi- tain or create an enabling environment that permits nance activities in some way: through grants, subsi- the growth of financial services for the poor and the dized loans, guarantees, or technical assistance. The integration of the poor in the broader economy. approach of donors ­ and the requirements they set Governments can do this by addressing broad legal 9 CGAP III Strategy and regulatory constraints ­ such as cumbersome convening platform, knowledge center, and stan- business registration procedures, corruption, or dard setter. Our comparative advantage in promot- inflexible property rights laws ­ which, while not ing financial services for the poor is based on our specific to the poor, may place an undue burden on multi-donor platform, our ability to influence key them. An important element of this strategy is a issues in microfinance through collective consensus, regulatory framework that allows a wide array of our relative objectivity and our flexibility to respond financial intermediaries to serve the poor. Interest to new opportunities and challenges. rate ceilings have to be relaxed or removed so that Background on CGAP I and II microlenders can cover their costs. Licensing rules need to be adjusted so that financially solid institu- Compelled by the enormous potential of microfi- tions can fund their lending activities with deposits nance to evolve into a full-fledged financial industry from the public. serving the poor, nine leading donors and practitioners formed CGAP in 1995 to develop and Governments should get out of the business of share best practices, set standards, and develop tools directly providing financial services to the poor, and models. Over time, CGAP has become a recog- eliminating subsidized and inefficient lending pro- nized center of excellence, providing services and grams that foster a culture of non-repayment on the information to a wide array of industry actors part of clients and undermine good microfinance engaged in building the microfinance industry. institutions. Depending on the size of the microfi- CGAP was originally established as a three-year nance sector, special attention should be paid to program with a mission to increase poor people's building the capacity of bank regulators to evaluate, access to financial services from sustainable institu- monitor, and supervise microfinance institutions in a way that ensures the overall soundness of the sector tions. In June 1998, CGAP was renewed for an without stifling its growth. additional five years and has now grown to 29 members, including bilateral and multilateral Technical Service Providers. As microfinance has agencies, as well as private foundations. CGAP II evolved, a private industry of service providers to focused on institution-building, poverty alleviation, support microfinance institutions has come into commercialization, policy and regulation, and being. This service industry encompasses technical donor mainstreaming. advisers, audit firms, credit bureaus, rating agencies, trainers or training institutes, technology and infor- Since its inception, CGAP has played a pivotal role mation systems specialists. The lack of local capaci- in developing a common language for the microfi- ty to provide these services has resulted in over- nance industry, catalyzing the movement towards reliance on international expertise and thus high best practice performance standards, and building costs for these services. Building both the market for consensus among its many and varied stakeholders. these services and the local human resource base to According to the recent external evaluation of meet market demand is a key condition for the CGAP II, "CGAP's work was central to the devel- development of a sustainable microfinance industry. opment of the microfinance industry during Phase II. The technical capability of the Secretariat was at CGAP. CGAP operates in partnership with many a very high level throughout the period, and its staff actors in this varied landscape through its operating members were respected throughout the industry arm, the CGAP Secretariat. CGAP is a resource cen- for their vision and leadership. The tools and reports ter for donors and the microfinance industry as a produced by the Secretariat were consistently excel- whole, serving as an information clearinghouse, lent. CGAP as a whole was also successful in this 10 CGAP III Strategy regard, with Member Donors continuing to provide studies. In others, it acts as a platform for dissemi- leadership in promoting sustainability of the indus- nation. In many cases, CGAP aims to incubate an try." Based on the positive evaluation and the idea, test it, and, pending positive results, spin it off demand of its stakeholders, CGAP will be extended to others in the industry. In all cases, consultations for an additional five years (Phase III, 2003­2008). with stakeholders is extensive. CGAP will continue to be selective in what it does, drawing on the work of others wherever possible. PHASE III STRATEGY CGAP serves as a neutral convening platform for the industry as a whole, facilitating dialogue and CGAP is a consortium of donors working together interaction between different sets of actors and play- to build sustainable financial services for the poor. ers. At the same time, the CGAP Secretariat or the The mission of CGAP III is to expand and to accel- CGAP system as a whole can also use its position to erate their access to a broad range of convenient and take firm public positions on certain issues, such as sustainable financial services. We believe that access standards or policies. to financial services is an essential building block for poverty alleviation and economic development, and Promoting Institutional Diversity that financial services for the poor must be integrat- ed into the financial system of every country. To this Institutional diversity means that a variety of insti- end, the objective of CGAP in Phase III will be to tutions will provide financial services to the poor. help build financial systems that serve poor people These institutions will have different organizational with very different needs. objectives, different methodologies and approaches, and serve different kinds of poor people. With the The work of CGAP in Phase III will center on the exception of a few countries, microfinance has so far following four strategic priorities: (i) fostering a failed to reach massive scale (with notable excep- diversity of financial institutions that serve the poor; tions such as Bangladesh, where microfinance has (ii) facilitating the poor's access to a wide range of reached significant numbers of poor households). flexible, convenient financial services; (iii) improv- This drives an urgent need to explore and deploy ing the availability and quality of information on the new delivery mechanisms to complement existing performance of microfinance institutions and, (iv) strong MFIs. Using different types of institutions to promoting a sound policy and legal framework for provide financial services to the poor will allow microfinance. CGAP will work in each of these four financial systems to reach poorer clients, those living strategic areas by providing technical assistance, in remote areas, and greater numbers of urban developing and setting standards, advancing knowl- clients. Institutional diversity will also allow micro- edge and information sharing, and offering training finance to serve clients whose growing enterprises and capacity building services together with other require greater funding than that traditionally actors. provided by microfinance institutions. Partnership is essential to successfully leverage The strong NGOs that have built the microfinance CGAP's and others' efforts and resources. In every- industry to where it is today must continue to be thing it does, CGAP operates in partnership with its strengthened and their successes replicated wherever member donors, MFIs, and other stakeholders in possible. However, in some countries, reaching sig- microfinance. In some partnerships, CGAP works nificant scale will require moving beyond the NGO jointly with others to develop technical tools or case model and opportunistically tapping into a few 11 CGAP III Strategy selected large banking and financial institutions that successful or promising MFIs. However, a rare com- have extensive distribution networks already in place bination of political reform, technical know-how, in poor neighborhoods and villages. With their large and management commitment and expertise will regional and national networks, credit unions and have to be in place for sustainable microfinance to financial cooperatives are already a significant insti- prosper within these organizations. tutional channel for delivering financial services to poor and low-income populations. Despite their Mapping of financial services for the poor. The troubled history, state banks and rural banks are world knows little about what services poor people another distribution channel that needs to be con- receive from which institutions. Engaging the entire sidered to identify those few that have the potential spectrum of financial service providers to the poor to do more, particularly given their will involve capturing information on a vast range far-reaching infrastructure and mission to serve the of financial organizations that operate in a universe poor. Consumer credit companies are already far greater than that of the relatively well-delineated providing salaried employees as well as microenter- world of microfinance. To build a financial sector prises with financial products and, despite serious that is more accessible to the poor, we need to have a baseline estimate of the actual number of poor problems in several countries, may offer potential to people receiving financial services from different better serve the poor. Experiments with alternative sources so that we can monitor progress against that delivery mechanisms such as post offices, supermar- baseline. CGAP will focus first and foremost on a kets, beverage suppliers, and other models have stock-taking exercise. This exercise, to be carried out already begun and may offer additional prospects for in partnership with CGAP donors and other stake- reaching truly large numbers. holders, will give the microfinance community a To profit-maximizing organizations, microfinance better, but no doubt still incomplete, picture of the can be an attractive debt business where downside number of poor clients accessing financial services protection is the driver, but it is generally less through various providers such as credit unions and attractive as an equity business where upside profit cooperatives, banks, NGOs, and consumer credit potential is the driver. Thus, while many commer- companies. cial banks are lending to NGO/MFIs, few are likely to see microfinance as a strategically compelling Advancing industry knowledge. CGAP's most equity investment. That said, in some circum- significant contribution to exploring alternative stances, microfinance can offer an attractive way for means of delivering financial services to the poor profit-maximizing commercial and retail banks to will be to serve as a research and development diversify risk, leverage under-utilized branch infra- resource. In parallel to the mapping of microfinance structure, tap new markets when under competitive providers, CGAP plans to engage in action research pressure and enhance their image. In other cases, on different models that promise larger-scale cover- franchising and other partnership arrangements can age of different client groups in more cost-effective enable an MFI and a commercial bank to best ways. Through research and active prospecting, we exploit one another's competitive advantages. will provide donors with an inventory and assess- ment of different innovations taking place in the Some of these organizations, and others like them, sector, the conditions needed to make them have potential to be better leveraged to serve the succeed, and the timeframe required to make such poor populations in their countries, reaching activities sustainable. This research will include ana- unserved markets and complementing the work of lyzing the success stories of NGO MFIs such as ASA 12 CGAP III Strategy and BRAC to better understand factors leading to include reliable intermediation of donor funds and their scale and efficiency. In addition, CGAP will quasi-private sector funds (both for the capitaliza- work with member donors to build on this knowl- tion of members and as support for network-level edge to develop guidelines for how and when to services), the provision of technical services to and support alternative types of institutions. amongst members, and governance oversight. Providing technical advice. CGAP will seek CGAP will work in partnership with networks on opportunities to provide or arrange for strategic policy issues at national and global levels, as well as advice and technical assistance to existing financial to promote industry standards, transparency, and organizations that are developing new business lines dissemination of good practices. CGAP can also in varied financial services for the poor. In some play an important role in encouraging the differen- cases, these organizations will be entirely new to the tiation and strengthening of these intermediary microfinance field, but may possess significant dis- organizations by reinforcing the different roles they tribution infrastructures that might be better lever- play in a rapidly evolving industry. Increased donor aged to provide services to the poor. CGAP plans to and private support for networks will require frame- take this approach specifically in large countries works for evaluating the roles and performance of with relatively underdeveloped traditional microfi- these organizations managing investment funds, nance sectors where experimentation with existing providing technical services, and fulfilling gover- or new delivery channels could have a major impact. nance functions. This work is likely to entail substantial human resource costs (CGAP staff, plus local and interna- Promoting Diverse Financial Services to a tional technical services) and will be carried out in Broad Range of Clients collaboration with other service organizations. There is enormous demographic diversity amongst Raising capital efficiently and effectively. Lack of the client group we call the poor. The poor can access to capital is a constraint for some promising include factory workers in middle-income formal MFIs with potential for significant scale. Often, the economies as well as landless laborers in sparsely financing required is a combination of instruments, populated agricultural economies. Some poor such as donor grants for skills development or regions have problems of aging populations, while administrative systems and loans for portfolio others have exploding populations that need to be expansion. CGAP will continue to encourage brought into the formal political economy. Wars donors to utilize its Appraisal and Monitoring and natural disasters have left some poor people re- Service in order to bring the right mix of funding building economic lives from nothing, while others instruments more efficiently and effectively for may have seen disease fundamentally alter their those strong MFIs for whom capital is a constraint. households' means of generating income. Some poor people are employees, some are employers. Working with networks. Global and local networks Some have growing businesses, others live off of sub- of microfinance institutions, investment funds, and sistence activities. other groupings of financial service providers are providing critical services in microfinance. These Great differences in circumstances mean that poor organizations vary from networks of MFIs united by people need different kinds of financial services. a common mission to organizations linked by a These services encompass planning for future house- common governance structure to investment funds hold expenditures, accessing funds in emergencies, that provide technical assistance. Their roles could protection against risk, receiving funds sent by rela- 13 CGAP III Strategy tives abroad, and investing in production inputs for complementary services. Given the proliferation of an enterprise or farm. As more players enter the hybrid programs in which financial services for the market and competition increases, microfinance poor are combined with non-financial services such will inevitably move away from the supply-led as education or health, there is an urgent need for approach that applied a narrow range of lending guidelines on including microfinance in multi-sec- methodologies to a wide range of contexts, towards tor projects. In some cases, such combinations have a demand-driven, client-oriented approach. shown positive results, but in far more cases it is necessary to de-link or better sequence financial and Microfinance will no longer principally mean non-financial services. For instance, new segments microcredit, but many financial services, including of very poor clients who have been excluded from various loan products, savings, insurance, and cash financial services can graduate into microfinance by transfers. Differentiated products should translate promoting better linkages between microfinance into broadened outreach, especially downward to and social safety net programs. Experimentation very poor clients but also upward to growing small with programs such as Bangladesh's Income enterprise clients, making microfinance accessible to Generation for Vulnerable Groups (IGVG) that different levels of the poor. By offering a wider range help graduate extremely the poor into future micro- of financial services, institutions will become more finance clients should be encouraged. stable and sustainable through portfolio diversifica- tion, greater client loyalty and retention, and fund CGAP will support the development of linkages mobilization. between microfinance and safety net programs by facilitating dialogue and partnerships between the Building industry knowledge. In recent years, microfinance community and other development there has been marked and welcome attention paid sectors and programs involved in poverty alleviation. to savings, insurance, and other financial services for CGAP will also provide technical and design advice the poor beyond microcredit. Given that many and funding, together with its donors, to underwrite others are working actively in this area and are closer to the field, CGAP's role will center on building experimental linkage programs. industry knowledge about new product innova- Incubating new models. CGAP will also promote tions, the contexts in which they are taking place, product diversification by providing, either directly and the success factors that make them most or in partnership, strategic advice, technical effective ­ both in terms of improving the lives of assistance and/or seed funding to various financial the poor and achieving sustainability. In particular, service providers that are testing new products, par- CGAP will focus on better understanding and ticularly in extremely challenging environments or documenting successful cases of savings mobiliza- among vulnerable populations. Examples might tion to ensure that this activity does not remain include experiments with money transfers systems the "forgotten half" of microfinance. CGAP will also or mobile deposit-taking services. This work would continue to work with donors and other stakeholders to develop standards and guidelines on feed into the knowledge-building agenda as CGAP non-lending products such as savings and insurance. helps test innovations that offer workable models for the industry that can be adapted by other practi- Improving linkages between financial and non- tioners and supported by donors and private financial programs. Evidence shows that microfi- investors. To this effect, CGAP will continue, nance has greater impact on the poorer and more through its Appraisal and Monitoring Service, to disadvantaged when it is linked with or preceded by identify and coordinate the evaluation of promising 14 CGAP III Strategy institutions or models and to mobilize joint funding performance. Such information underpins the with member donors. development of the market for these financial serv- ices, raising the quality and lowering the cost of Deepening poverty outreach. CGAP remains com- supervision, audits, and ratings, and enabling com- mitted to improving the capacity of microfinance mercial and private funding. providers to increase their poverty outreach. As part this work, CGAP will continue to promote trans- To compete effectively, institutions also need to parency on the poverty levels of clients, disseminat- know about their own performance and where they ing practical tools to the industry such as the donor stand in relation to others, either within peer groups Poverty Assessment Tool and the Poverty Audit. We or on a global basis. Information about an MFI's will also document and disseminate field-level own performance enhances managers' ability and success in reaching very poor and vulnerable groups. interest in improving performance. The incentive to improve increases when managers and outsiders can Measuring social performance. CGAP wishes to compare an institution's results against the perform- achieve positive social impact to complement the ance of others, or against agreed standards and/or financial impact of microfinance. To this end, supervisory requirements, and determine where CGAP will work to help the industry measure social adjustments are needed. and development performance. Building on work others have done in this area, CGAP will help devel- There are many other contexts requiring transparency op a limited number of simple indicators linked to in microfinance besides transparency on financial per- the MDGs. Microfinance institutions will be formance. These include transparency on client pover- encouraged to report on this set of social perform- ty levels, customer credit histories, the cost of borrow- ance indicators in the MIX and to donors. They will ing, and on MFIs' social performance. CGAP's agen- be reported on periodically by CGAP. da under information quality will focus on financial transparency, while transparency on social perform- Improving Information Quality and ance is treated under the agenda on promoting finan- Availability cial services to a broad range of clients. Transparency within a financial system ensures that Building the information infrastructure. CGAP's customers and providers of capital can reliably assess comparative advantage in this area stems both from risk and return, and that auditors and supervisors its history of improving the quality and quantity of can oversee the system's safety. For financial service information on the performance of microfinance providers to the poor to reach significant numbers, service providers and from its role as a consortium of they need to be able to intermediate between donors who support microfinance. These efforts will domestic savers and borrowers, as donor funds have remain a cornerstone of CGAP's transparency work neither sufficient scale nor stability to support as CGAP continues to build the information infra- massive growth. One of the key challenges to the structure needed by financial institutions, donors, development and integration of financial services for private investors, government regulators, and the the poor is the lack of reliable information on the public at large to understand and judge the financial strength and performance of different performance of the industry. CGAP will continue to types of service providers. Poor people's deposits and promote the availability of information on the commercial loans should be available only to finan- performance of microfinance providers, as well as to cial institutions with accurate, complete, and com- bridge the information gap between supply (fun- parable information on their financial strength and ders) and demand (microfinance service providers). 15 CGAP III Strategy Much of CGAP's work in this area will be integrat- appropriate role as facilitators, rather than direct ed under a single information service, the providers of financial services for the poor. CGAP's Microfinance Information Exchange (MIX). goals in this area will be to: Developing financial reporting standards. The · Foster diversity of institutions and financial pro paucity of accurate data on the financial perform- ducts through a policy and legal regime that gives ance of institutions providing financial services to them equal treatment and is not biased in favor the poor highlights the need to place greater empha- of one institutional model or product; sis on financial monitoring and reporting using · Establish a supportive legal and regulatory frame- standardized ratios and reporting formats. At the work that safeguards poor people's money and forefront of CGAP's strategy is the development of promotes competition; and technical tools and standards to improve the quality · Develop the technical expertise of government and quantity of information on the performance of supervisory and regulatory authorities. MFIs. Prime among these efforts are the develop- ment of a streamlined format for reporting financial CGAP is in a strong position to support the information by microfinance service providers and development of a sound legal and regulatory envi- the harmonization of financial ratios. ronment for microfinance. Our comparative advan- tage in this area stems from our neutrality, our Building local expertise. Building the local expert- multi-donor platform, our relationship with the ise to analyze, collect, and report MFI financial World Bank, the IMF and regional development information is a key priority. To this end, CGAP will banks, and the leverage that these organizations have work in collaboration with local microfinance in addressing policy issues with government policy- networks, technical consultants, and others to devel- makers. In Phase III, CGAP will capitalize on these op types of training materials for MFI managers, comparative advantages much more than it has in bank regulators and supervisors, and auditors and the past, working with and through its member evaluators working in microfinance. In most cases, donors to improve the policy and regulatory these will need to be complemented by on-the- framework for financial services to the poor. Greater ground technical support provided by our partners. emphasis on policy will mean additional staff CGAP will also work with universities, training resources but will not have significant non-salary institutes, and other learning institutions to budget implications. mainstream microfinance knowledge and skills into their curriculum and programs, both to improve Engaging in multilateral policy consultations. public understanding of microfinance and to build a CGAP will continue to engage more systematically local supply of skilled, dedicated microfinance in policy consultations with the World Bank, the professionals. IMF, and other international financial organiza- tions. Inputs will be provided to key policy process- Fostering a Sound Policy and Legal es such as Country Assistance Strategies and Framework Financial Sector Assessment Programs (in coordina- tion with the Financial Sector of the World Bank) to As new solutions are found for the delivery of finan- help national authorities design better policies to cial products and services to the poor, and as these promote financial services for the poor. CGAP will systems become more integrated in the overall also selectively participate in other types of financial system, policy and legal frameworks will high-level policy fora that offer direct opportunities need to adapt so that governments can play their to influence real policy change. 16 CGAP III Strategy Supporting country-level policy dialogue. Upon officials through the IMF, the World Bank and other specific request, CGAP will also engage in country- such bodies, to longer technical courses for bank level policy consultations to educate policymakers supervisors on specific tools and approaches for ana- about the importance of financial services to the lyzing the soundness of MFIs. poor and the range of international experience in this sector. In certain countries, it will also support the development of policy frameworks such as THE ROLE OF DONORS Poverty Reduction Strategies to mainstream finan- cial services in national approaches to private sector The Challenge for Donors development. CGAP's approach will be to support the country-level work of CG members in alliances Donor funds have played a crucial role in support- with key government policymakers and the private ing microfinance over the past two decades and sector. In general, priority will be given to policy donors remain the most important external source work that concretely contributes to the establish- of funding for microfinance experimentation. ment of appropriate enabling environments or has However, the reality is that a significant proportion the potential to pre-empt the establishment of poli- of donor funding is ineffective, narrowly targeted to cies or programs that would adversely affect the a few countries and institutions, or poorly struc- development of the sector in a particular country. tured ­ languishing, for example, in apex facilities with inappropriate conditionality, application, and Facilitating development of policy and regulatory reporting requirements. standards. CGAP's role as an international and multi-donor organization makes it uniquely placed The evolution of microfinance towards a broader, to provide a platform where all stakeholders ­ diverse set of institutions and mechanisms integrat- donors, central banks and other regulatory bodies, ed into the financial sector poses even greater and microfinance practitioners ­ can discuss and challenges to donor effectiveness. Each agency and develop global and industry-wide standards and the donor community collectively must answer a guidelines for microfinance. A model for this role number of key questions: may be the Basel Committee for Banking Supervision. The objective would be to encourage · How do financial services for the poor fit into convergence towards common approaches and stan- each donor's development strategy? dards in policy, regulation, and supervision. · What is the appropriate role of subsidy? Developing technical tools, services, and training. · How much risk can an agency tolerate? At a technical level, CGAP will continue to develop · When should microfinance be used and when are technical tools and knowledge for those who play a other instruments more appropriate? policy, regulatory and supervisory role in microfi- · How can disbursement pressure be avoided or nance. Wherever possible, these will be developed in diminished? partnership with other providers. Complementing · How flexible are the available instruments? this work, CGAP and its partners will develop and deliver training courses for government policymak- · Does staff have sufficient expertise to design ers, bank regulators and supervisors, and donor staff effective programs in this area? on legal and regulatory issues in microfinance. These · Are internal processes, procedures, and practices courses may range from short high-level sensitiza- consistent with sound practices? tion sessions delivered to central bankers and senior 17 CGAP III Strategy Donors can improve their effectiveness in microfi- Donors can play an important role in building nance by addressing these questions head on. financial systems that work for the poor by address- Further, donors should identify their comparative ing those challenges in a pro-active way and com- advantage compared to one another and to more mitting to the following actions: commercial sources of funds. Some donors may find their best role in capacity building, while others may Develop strategic clarity. Donors should develop a establish a niche in expanding the financial frontier clear and coherent strategy for microfinance that is in, for instance, remote rural areas. consistent with their own development agendas while remaining true to accepted good practices. For One thing is certain: the latest vision of microfi- instance, it is not uncommon for staff to view nance will require significant innovation, experi- microfinance as an input into agricultural develop- mentation, and human resource development. ment, a tool for empowerment, or a way to deepen It will also need funding, but probably less for the financial sector ­ all within the same agency. capitalization of loan funds and more for technical Each of these approaches has very different implica- assistance than was previously the case. New institu- tions for whether good practices will be applied at tions entering the field will already have their own the operational level. Donors need to clarify how funding sources and some of the newer services ­ microfinance can fit into their institution's major such as deposits ­ will not need to be funded. priorities for growth and poverty alleviation as a Donors will continue to be important players in cross-cutting issue and how it forms an integral part microfinance, but in a much more leveraged and of the financial sector. strategic way than in the past. Intensify collaboration. The international develop- Specifically, donors should take more risks on ment community is moving toward more collabora- promising but not yet proven institutions and tive approaches, for instance by concentrating on the mechanisms, leaving the more commercially viable Millennium Development Goals and focusing on the MFIs to graduate to private investors. They should work of the Development Assistance Committee of adjust their country-level programming approach to the OECD. Better collaboration and cooperation in also facilitate funding of global or multi-country microfinance, both globally and at the country level, microfinance networks and other intermediaries. will improve each donor's capacity to adhere to mutu- And they should support industry-wide measures ally agreed standards. It will also help donors to avoid that promote transparency and build critical infra- undermining each other or inadvertently squelching structure such as performance standards and the the engagement of the private sector in supporting application of technology to financial services for financial systems for the poor. the poor. Improve understanding on the role of subsidies. The donor community can play a catalytic role in There is an important need for greater clarity bringing about the next revolution in financial on the role donor subsidies in supporting financial systems for the poor. Their careful, strategic use services for the poor. When is it appropriate of subsidies could push microfinance over the to use subsidies? For how long? At what point threshold into the new era of financial services, should public sector support be phased out? When where poor people are widely accepted as legitimate should the private sector take over? Donors need customers within a diverse, deep, and multi-faceted to work towards reaching consensus on when financial sector. and how subsidies should be used to support microfinance and when other instruments would be 18 CGAP III Strategy more appropriate. This crucial question will be part Establish a focal unit for microfinance. In many of the process of defining each donor's comparative agencies, microfinance operations are scattered in advantage, both with respect to each other and the different departments such as infrastructure, food private sector. security, or community development, and can be difficult to track. Donors committed to pursuing Support innovation. Donors should take risks by microfinance should establish a focal unit with working with smaller, less well-known but promis- strong technical expertise and authority to provide ing institutions of all kinds that have the potential to proper review and quality control of all proposed provide financial services to the poor in cost- microfinance activities. The focal unit would also effective ways. Donors can contribute to product engage in mainstreaming good practices among diversification and innovation by offering grants or non-microfinance specialists in their agency. subsidies on a limited basis to institutions that develop or test new products or technologies, or that Build staff skills. Experience shows that donors attempt expansion into difficult "frontier" markets with higher levels of staff technical competence in like remote rural areas. Special efforts should go microfinance more consistently produce programs toward encouraging MFIs that develop savings- that adhere to good practices. This correlation based products. between staff skills and sound practice persists even when most project development and implementa- Ensure accountability for results. Donors should tion work is contracted out. Donors should commit commit to disclose the size and composition of to investing in the staff skills needed to design and their microfinance portfolio, the performance of the supervise microfinance operations effectively. Staff institutions they support, and whether or not their should have a broad range of skills and experience in agencies conform with recognized good microfi- promoting financial services for the poor through nance practices. Donors can also promote the devel- different types of institutions, including NGOs, opment of a culture of transparency by requiring commercial banks, credit unions, finance compa- that the institutions they support publicly disclose nies, postal savings banks, or insurance companies. financial, social, and depth of outreach information How can CGAP support Donors? and by employing performance-based funding instruments. CGAP will intensify its work with member donors to address the challenges faced by them. Specifically, Introduce appropriate instruments. The develop- CGAP will work with member donors to improve ment of financial systems that truly address the the effectiveness, efficiency, and accountability of needs of the poor will require the application of their operations in microfinance by: (i) building on flexible instruments for research and development, and catalyzing a sense of urgency and commitment capacity-building, and initial operational subsidies. to better microfinance programming; (ii) support- These instruments should target appropriate, ing donor agencies to promote organizational professional implementing partners, have a long- changes within their agencies required to apply good term time horizon, and include performance-based practices in microfinance; and (iii) encouraging funding mechanisms. In addition, donors should mutual support and cross-learning among donor promote global or multi-country initiatives that agencies. To accomplish this goal, CGAP will offer promote transparency and build support infrastruc- responsive, high-quality services to its donor mem- ture, such as local technical service providers, bers in the areas of standards building, information improved technology, and performance standards. dissemination, training, and technical assistance. 19 CGAP III Strategy CGAP understands that change must emanate from reach beyond annual CG meetings to encompass within the donor agencies themselves and cannot be more intensive work on specialized topics of interest driven by the CGAP Secretariat. For this reason, to them, both through formal Working Groups and CGAP can best leverage its limited resources by other mechanisms such as listserve discussions or working through a committed focal point within videoconferences. Also, CGAP will move forward each donor agency. Moreover, to maximize efficien- on supporting selected in-country donor coordina- cy, CGAP will emphasize those tools and services tion (ICDC) groups with technical and information that can be used by multiple agencies. services. That said, CGAP recognizes the diversity among its Developing operational guidelines. CGAP will member donor agencies. Different agencies require work with member donors to develop operational very different support, and different people within guidelines to address a range of issues facing donors, each agency have different informational needs. such as how to support savings mobilization; when CGAP also recognizes the fact that the majority to withdraw support to poorly performing institu- of staff manage wide-ranging portfolios with limited tions; how to properly sequence subsidies, grants, time and resources directed specifically to microfi- loans and other instruments; when to support apex nance. Where committed focal points are in place, institutions; and when to support multi-sectoral CGAP will focus on providing tailored and timely programs. These operational guidelines would build support, services, and information according to the on the Peer Reviews and other opportunities for needs of different staff and managers within donor joint learning and would likely launch a process agencies. resulting in a new version of the Pink Book. CGAP will pursue several different methods for Developing technical tools and providing just-in- increasing interaction with member donors and time information. Based on improved knowledge enhancing its understanding of their support needs. of donor needs, CGAP will build upon its informa- First, the Donor Peer Reviews currently underway tion dissemination capacity and technology plat- and continuing throughout the early phase of forms to develop timely relevant technical tools, CGAP III will provide many new opportunities for services, and information products appropriate for the Secretariat to support member donors. Second, donor staff. Information will be packaged in formats the establishment of an office in Paris will greatly and delivery channels that different types of donor facilitate interaction between CGAP and European staff can use and will address several key issues, such donors, as well as among European-based donors. as understanding microfinance in the broader Third, CGAP will intensify the relationship manag- context of development, advancing diverse financial er function and introduce a new donor staff services, supporting diverse institutions, the impact Helpdesk to respond to donor staff in a more agile of microfinance on the poor, and developing sound manner, both within and outside of the technical programming and operations. Concrete, concise focal unit. Fourth, a permanent position will be case studies and models of good donor practices will established in Washington for short-term member comprise an important component of these infor- donor staff rotations at the Secretariat. mation services. Facilitating donor interaction. Reflecting the Building staff skills. Evidence suggests that staff essence of its mission, CGAP will exploit every capacity in microfinance is a strong determinant of opportunity to facilitate information flows and col- effective donor operations. CGAP will place laboration among its donor agencies. This work will increased emphasis on building donor staff skills 20 CGAP III Strategy both at headquarters and field office levels. CGAP The CGAP Secretariat will remain housed at the will continue to offer training services to donor World Bank with its headquarters in Washington, agencies with an increased focus on non-microfi- DC, and a representative office focusing on donor nance specialists, both at management levels and work in Paris, France. Individual Secretariat staff among operational staff. This training will be may be located elsewhere, such as in donor agency provided to groups of donor staff, but CGAP will offices in the field, or in CGAP capacity building also explore leveraging its resources by partnering hubs, as may be justified by business opportunities. with in-house training units with a view toward Additional offices for CGAP in the field are not strengthening their own microfinance training envisaged at this time, but may be considered by capacity and, in the long term, their ability to meet management and the Board in the future. A perma- internal demand. nent position will be established in Washington, DC, for short-term member donor staff exchanges. Tailored technical assistance. On a selective basis, CGAP will offer direct technical assistance to In line with these priorities, the technical work of individual donor agencies where it affords the most the Secretariat will be organized along five teams, leverage and has the most potential for impact. This four of which are already in place: assistance will include the following services: assisting in the implementation of recommendations of the Microfinance Industry Team/Transparency. The Peer Reviews; reviewing project or policy documents; scope of the Microfinance Industry Team's work and facilitating internal workshops or strategy sessions. includes the broad transparency agenda and global- level activities aimed at improving the quality and quantity of information on microfinance providers. RESOURCES It also includes the exchange of industry knowledge and information through web-based services such as Implementation and Organization the Microfinance Gateway. The strategic priorities outlined for Phase III will be End-Client Team/Diversity of Products and reflected and incorporated in the organizational Services. The objective of the End-Client Team is to structure and operations of the CGAP Secretariat. deepen understanding of the financial needs of the The Secretariat will selectively expand its staff as poor and their access to existing financial services, to recommended by the evaluation team to enable it to improve the capacity of institutions to deliver a meet the needs of CGAP's new and expanded broad range of financial services to the poor, and to agenda. In particular, top talent will need to be ensure greater depth and breadth of outreach by acquired with expertise in the broader range of exploring diverse approaches and models. financial products (e.g. savings) and financial insti- tutions (i.e. cooperatives) encompassed by the new Financial Institutions Team/Diversity of vision. Additional senior staff will also be necessary Institutions. The purpose of the Financial in the policy area. In all cases and consistent with Institutions Team is to explore alternative means of the rest of CGAP's strategy, diversity will be a key delivering financial services to the poor, primarily driver in our human resources CGAP will thus con- through action research on different models and tinue to aim to attract and recruit exceptionally support of innovation through strategic funding in talented individuals of diverse expertise, back- conjunction with member donors (e.g. Appraisal grounds, and views. and Monitoring Service). The focus of the team will 21 CGAP III Strategy be significantly broadened to a more diverse range of financial institutions. Policy Team. To enable CGAP to play the role sought by its member donors and other stakeholders in policy work, a small team dedicated to policy and regulatory issues will be created in the near future. This team will focus on working with multilateral organizations and supporting in-country donors and other technical people to help sensitize govern- ments and create supportive legal and regulatory environments for microfinance. Donor Team. The recent creation of a Donor Team within the CGAP Secretariat underscores the importance of donor support as a core CGAP activ- ity. The objective of the Donor Team is to work with member donors to improve the effectiveness, efficiency, and accountability of their operations in microfinance through standards building, informa- tion, training, and technical assistance services. 22 NOTES 23 NOTES 24 CGAP c/o The World Bank 1818 H Street, N.W. Room Q4-400 Washington, D.C. 20433