79747 Microfinance in South Asia TOWARD FINANCIAL INCLUSION FOR THE POOR THE WORLD BANK This volume is a product of the staff of The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center, Inc.,222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, DC 20433, USA, fax 202-522-2422, e-mail pubrights@worldbank.org. 1818 H Street, N.W. Washington, D.C. 20043, U.S.A. www.worldbank.org Microfinance in South Asia Toward Financial Inclusion for the Poor DECEMBER 2006 This paper was written as part of a World Bank project in South Asia to celebrate the International Year of Microcredit 2005. It describes the emergence and development of the influential microfinance movement that has come to prominence in South Asia over the past 30 years and considers the issues and prospects that will face microfinance in the coming years. The team that wrote this paper was led by Sanjay Sinha (EDA Rural Systems) and Stephen Rasmussen (World Bank, SASFP) and included Amit Brar (EDA Rural Systems), Frances Sinha (EDA Rural Systems), Gautam Ivatury (CGAP), Imran Matin (BRAC), Niraj Verma (World Bank, SASFP), Stuart Rutherford (SafeSave), and Syed Hashemi (CGAP). In addition to the core team, a discussion group composed of experts on various aspects of microfinance in South Asia was established to comment on the paper at key stages. The discussion group included Naila Kabeer (Institute of Development Studies, University of Sussex), Nimal Fernando (Asian Development Bank), Mohini Malhotra (World Bank, WBI), M.S. Sriram (Indian Institute of Management, Bangalore), Vijayalakshmi Das (Friends of Womens World Banking), Vijay Mahajan (BASIX), Syed Mohsin Ahmad (Pakistan Microfinance Network), and Amjad Arbab (Microfinance Investment Support Facility for Afghanistan). This group contributed considerably to the debate of important issues and the synthesis of key results. Simon Bell (World Bank, SASFP Manager) first proposed that this paper be written and he provided guidance throughout the process. Invaluable suggestions about the organization and focus of the paper were provided by three reviewers: Elizabeth Littlefield (CGAP), Vijay Mahajan (BASIX), and Priya Basu (World Bank, SASFP). Logistical support was provided by Rubina Quamber (World Bank, SASFP) and Sakm Abdul Hye (World Bank, SASFP). ACKNOWLEDGMENTS Funding support to write this paper was provided by the World Bank South Asia Region Vice President's Office under a regional initiatives fund and by the South Asia Finance and Private Sector Development unit. iii Art and Visual Direction: Sumaira Sagheer Designed at Retroactive Studios Published at Pangraphics Copyrights 2006, The World Bank TABLE OF CONTENTS List of Abbreviations and Acronyms vi Executive Summary 1 1 The Financial Landscape and the Emergence of Microfinance 9 Poverty and Exclusion The Microfinance Response The Emergence of Microfinance 2 Limitations and Challenges 21 Financial Needs of Low-Income Families The Limits to Informal Financial Services Outreach Revisited 3 Institutional Structures and Delivery Systems 27 Institutional Structures Delivery Systems 4 Financing Structures 38 Afghanistan Bangladesh India Nepal Pakistan Sri Lanka Challenges for the Future 5 Product Diversity 51 Loan Products Deposit Products Compulsory savings Microinsurance Money Transfers Microleasing Conclusions on Microfinance Products 6 Transparency and Performance 62 Transparency Sustainability Depth of Outreach and Sustainability 7 Impact and Social Performance 75 Microfinance Impact Indicators Impact Assessment Methodologies and Drawbacks From Impact to Social Performance Social Rating Social Protection and Safety Nets iv 8 Systems That Support Microfinance 89 Microfinance Regulation in South Asia Links in South Asian Microfinance The Role and Potential of Technology 9 Conclusions and Future Perspective 106 Microfinance Today Future Perspectives Bibliography 110 LIST OF ABBREVIATIONS AND ACRONYMS a ABN FSS ABN Amro Bank Financial self-sufficiency ACLEDA FWWB ACLEDA Bank of Cambodia Friends of Women's World Banking, India ADB g GDP Asian Development Bank gross domestic product ADBN GNI Agricultural Development Bank of Nepal gross national income AKRSP GPS Aga Khan Rural Support Programme Grameen Pension Savings AMA GTZ Afghanistan Microfinance Association German Technical Cooperation AMAP i IASC Accelerated Microenterprise Advancement Project of USAID Indian Association for Savings and Credit APR IDB Annual Percentage Rate (charged by MFIs) Inter-American Development Bank ARMP IGVGD Afghanistan Rural Microfinance Programme Income Generation for Vulnerable Group Development ASA IMEC Association for Social Advancement Impact Monitoring and Evaluation Cell ATM INAFI Automated teller machine International Network for Alternative Financial Institutions b BASIX IRDA Bhartiya Samruddhi Investments and Consulting Services Ltd. Insurance Regulation and Development Agency, India BEES IRDP Bangladesh Extension Education Services Integrated Rural Development Programme, India BRDB IS Bangladesh Rural Development Board information system BURO KCC BURO Tangail k Kisan (farmer's) Credit Card, India BWDA MACS Bullockcart Workers' Development Association m Mutually Aided Cooperative Society, India c CAR MBT capital adequacy ratio Mutual Benefit Trust CBO MCDB community-based organization microcredit development bank CDF M-CRIL Credit & Development Forum, Bangladesh Micro-Credit Ratings International Limited ABBREVIATIONS AND ACRONYMS CERISE MDG Comite d'Echanges de Reflexion et d'Information sur les Millennium Development Goals Systemes d'Epargne-credit MFAC CGAP Microfinance Advisory Council (proposed), India Consultative Group to Assist the Poor MFI CMF microfinance institution Centre for Micro Finance, Nepal MFO CMFR microfinance organization Centre for Micro Finance Research, India MIS CRB management information system Cooperative Rural Bank MISFA CRISIL Microfinance Investment and Support Facility for Afghanistan v Credit Rating and Information Services India Limited MSS d DAB Manabik Shahajya Sangstha Da Afghanistan Bank n NABARD DCCB National Bank for Agriculture and Rural Development, India District Central Cooperative Bank NBFC DMFI Non-bank Finance Company, India Deposit-taking MFI, Afghanistan NBFI e EDA Non Bank Financial Institution EDA Ru0ral Systems Private Limited, India NDTF f FINGO National Development Trust Fund, Sri Lanka Financial Intermediary Non-Government Organization, Nepal NGO FISA nongovernmental organization Financial Intermediary Societies Act, Nepal 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor NRB SKS Nepal Rastra Bank, Nepal's central bank previously Swayam Krishi Sangam NRSP SML National Rural Support Programme, Pakistan SHARE Microfin Limited o OER SPM operating expense ratio social performance management OSS SPMS operational self-sufficiency social performance management system p PACS SSS Primary Agricultural Cooperative Society Society for Social Service, Bangladesh PAR SWDMACTS portfolio at risk Swayamkrushi Women's Development Mutually Aided PKSF Cooperative and Thrift Society Palli Karma Sahayak Foundation, Bangladesh t TCCS PMN Thrift and Credit Cooperative Society, Sri Lanka Pakistan Microfinance Network The MIX PPAF Microfinance Information Exchange, Washington, DC Pakistan Poverty Alleviation Fund TMSS PRA Thengamara Mohila Sabuj Sangha participatory rural appraisal TUP r RBI targeting the ultrapoor Reserve Bank of India u UCB/DCCB RDB Urban Cooperative Bank/District Central Cooperative Bank, India rural development bank USAID-AIMS RMDC United States Agency for International Development Assessing Rural Microfinance Development Centre, Nepal the Impacts of Microenterprise Interventions RMP w WEP Rural Maintenance Program Women's Empowerment Programme RMK WFP Rastriya Mahila Kosh, India World Food Programme ROA return on asset ROSCA Revolving savings and credit association RRB Regional Rural Bank, India CURRENCIES RRDB Regional Rural Development Bank, Sri Lanka Prs RSP Pakistan rupee rural support program Rs RSRF Indian rupee Rural Self-Reliance Fund, Nepal SL Re s SAARC Sri Lankan rupee South Asia Association for Regional Cooperation Tk SBP Bangladesh taka State Bank of Pakistan US$ SBS U.S. dollar Samurdhi Banking Society, Sri Lanka SCCS Savings and Credit Cooperative Society, Nepal SEEDS vi Sarvodaya Economic and Enterprise Development Services, Sri Lanka SEWA Bank Sri Mahila Sewa Sahakari Cooperative Bank, India SFMC SIDBI Foundation for Micro Credit SHG Self-Help Group, India SHPI Self-Help Promotion Institution, India SIDBI Small Industries Development Bank of India EXECUTIVE SUMMARY I n South Asia, the modern microfinance movement was born in Bangladesh in the 1970s as a response to the prevailing poverty financial services, and were it not for the advent of the microfinance movement, they would not have much recourse today. Most conditions among its vast rural population. South Asian countries have a reasonable Astonishing growth rates in Bangladesh, banking system in urban areas; however, particularly during the 1990s, created a new despite the fact that the majority of these dimension for microfinance worldwide as populations live in rural areas, the access of microfinance institutions grew to include rural populations to formal financial services millions of clients. For the first time, a remains limited. substantial proportion of the low-income families of a major developing country were By 2005, microfinance covered at least 35 served by the activity. The start of the twenty- million of some 270 million families in the first century reinforced this trend as the region and met around 15 percent of the Bangladesh numbers continued to grow overall credit requirements of low-income impressively; in India, a substantial families. Coverage was particularly impressive microfinance system based on self-help groups in Bangladesh and Sri Lanka, where (SHGs) developed. Other countries of the microfinance services reached more than 60 region made slower and later starts but have percent of the poor. In addition, the focus on since established active microfinance sectors. engaging women as essential contributors to economic and social well-being has had Comparing the genesis of microfinance in important spillover effects throughout the South Asia with Latin America (another region region. Even in a socially conservative country in which the microfinance movement began in such as Afghanistan, microfinance activity has the 1970s and has since become well focused on women, thereby according them established), it becomes apparent that the more explicit recognition as economic agents, industry in the two regions has developed while in India, the SHG movement has become distinct characteristics. In Latin America, the basis for programs promoting microfinance was typically urban rather than empowerment and overall improvement of the rural, was more focused on financial services status of women in society. In Bangladesh, for microenterprises than on poverty, and saw microfinance has become the basis for itself as a business, potentially as a branch of microenterprise promotion by some of the commercial banking. In South Asia, given that large microfinance institutions, although it also modern microfinance effectively started has been extended to the “ultra poor� through during a time in which poverty was extensively targeted programs. In both Pakistan and examined, it was perhaps inevitable that the Nepal, the potential of microfinance growth of microfinance would be rooted in the demonstrated by these experiences has poverty discourse. Apart from cooperatives, captured the attention of governments that the average low-income family in the region have created specific legal frameworks to before the 1970s had virtually no recourse to facilitate its growth. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor The Emergence Of Microfinance While informal sector financing systems can business of households. In addition, aggregate be traced to the era of Kautilya in the fourth calculations made for the number of poor century B.C.E., the era of organized sector families in the region indicate a substantial finance in much of South Asia (Bangladesh, shortfall in the availability of microcredit in the India, and Pakistan) is generally acknowledged region. It is suggested that formal financing to have started with the Cooperative Credit channels meet only 15 percent of the needs of Societies Act of 1904. The act's objectives the poor in South Asia, with the proportion make it clear that the cooperative movement in ranging from 2 percent in Afghanistan to 55 South Asia was initiated to reach out to those percent in Bangladesh. who were otherwise excluded by the formal financial system–farmers, artisans, and other Outreach is highly variable across the region. persons of limited means. The failure of The six countries can be classified into high cooperatives to serve this purpose adequately (Bangladesh and Sri Lanka), medium (Nepal is noteworthy because some seven decades and increasingly India), and low (Pakistan and later, in the 1970s, it was still thought Afghanistan) coverage levels. The very high necessary to nationalize commercial banks coverage in Bangladesh is based on the throughout the region, and the first attempts programs of a few specialized institutions. At were made to launch microfinance as we know the end of 2004, some 73 percent of the it today. Both initiatives responded to the quest microfinance clients in the country were for outreach, although the paths taken were borrowing from the four largest institutions, quite different. The banks, now owned by which count their clients in the millions, and governments, undertook the benevolent, statist only 12 nongovernmental organization (NGO) path of creating a supply of products designed MFIs had more than 100,000 clients. High by bureaucrats ostensibly to maximize the outreach in Sri Lanka is largely based on an welfare of the excluded groups. Conversely, the extensive network of community-based microfinance initiators experimented with organizations (CBOs) that receive considerable ways of providing capital to those who needed government subsidies. India saw a substantial it. The key concerns were to make capital increase in the outreach of microfinance available in small amounts, at convenient times services in recent years not only because of and locations, and at the lowest possible cost. the phenomenal growth of the bank-SHG link It is on such principles that Grameen Bank was program, but also because of the substantial born and that BRAC and the Sri Mahila Sewa growth of NGO-MFIs; this outreach, however, Sahakari Cooperative (SEWA) Bank's early is concentrated in a few southern states. The experiments were undertaken. concentration of microfinance in India is matched by Nepal, where the delivery of Although the microfinance movement in South microfinance services by regional development Asia has permanently changed the face of the banks, NGO-MFIs, and cooperatives is financial sector through innovation and confined largely to the southern plain and the 02 challenges to conventional thinking, the limits Kathmandu valley. In Pakistan, outreach is of the microfinance model become evident estimated to account for no more than 5 to 10 when it comes to serving many more poor percent of the potential market, with services people who are still excluded and to capturing being provided by NGO-MFIs and specialized a larger share of the financial service business microfinance banks. Given the recent of the existing clientele. Recent research shows emergence of microfinance activity in that although microfinance institution (MFI) Afghanistan, the low coverage of poor clients outreach among various categories of the poor is consistent with the early stage of has been impressive, MFIs took a rather small development of the microfinance sector. proportion (15 percent) of the microfinance However, the era of benevolent, statist A wide range of delivery systems is employed intervention in support of financially excluded by these many different types of institutions, sections of the population has given some but the main methodologies can be classified ground to a recognition of the need to create into the following five types: structures that cater to the financial needs of the poorer segments of society. This process is ■ Grameen Model–a delivery methodology gradually leading to structures that may be pioneered by Grameen Bank of Bangladesh. Joint able to integrate microfinance service liability is the key factor in ensuring repayment, providers into the broader financial landscape. although there is no formal documentation of this, and accounts are maintained in the individual names of clients. Institutional structures and delivery systems ■ Self-Help Group–operations of 15 to 25 member Given the early establishment and deep roots SHGs are based on the principle of revolving the of the cooperative movement in South Asia, it members' own savings. is perhaps not surprising that CBOs, including ■ Cooperative Programs–entailing the provision of cooperatives, are an important pillar of financial services by MFIs to individual clients microfinance in the region. Together with the organized into credit and savings cooperatives. In ubiquitous NGO-MFI, such organizations cooperatives, all borrowers are members of the deliver virtually all of the recorded outreach of organization, either directly or indirectly, by financial services available to low-income being members of associations in which they clients in the region. Only a small amount of hold shares. additional microfinance outreach is provided ■ Mixed Model–some MFIs started with the by the retail operations of the banking system, Grameen model but later on mixed that with an the activities of post office banks, and, to a SHG model or another model, adapting their lesser but growing extent, insurance approach to prevailing market conditions. companies. Despite the importance of the CBO ■ Rural Support Programs–Pakistan makes a as a delivery mechanism, diverse institutional unique contribution to this discussion in that a links channel microfinance services from number of the NGO-MFIs and, indeed, one of the funders to clients and some variation in microfinance development banks, have evolved delivery systems exist, which means that out of multidimensional programs based on almost every conceivable type of microfinance establishing and strengthening village EXECUTIVE SUMMARY activity in the world is available in South Asia. organizations to manage their own development. Financing Structures MFIs essentially perform the role of sizes are small, it typically has taken three to intermediating financial resources and services seven years for leading MFIs to become 03 between (1) investors, banks, donors, and financially strong enough to attract commercial depositors, and (2) the poor. Like any other risk capital. As a result, donor funding has had financial intermediary, MFIs need risk capital to play the key role of “venture capital� in that can be leveraged to add to their funding stimulating microfinance investment and base for operations and on-lending to low- promoting microfinance markets. income clients, either through debt finance or by raising additional deposits. Unlike To the extent that MFIs address market failure commercial financial institutions, MFIs in and help to develop the financial sector by South Asia have evolved largely from nonprofit providing new avenues for low-income clients entities. Given that the transaction costs of to access financial services, this role is justified microfinance delivery are high and account and has a clear “public good� element 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor associated with it. Conversely, shares More recently, attempts to provide much more constitute the risk capital that forms the flexible loan products have been noticeable, backbone of commercial investments in although not easy to implement, because of the financial institutions. Even in terms of debt tension between the client's need for flexibility from lenders, MFIs in South Asia generally and the MFI's need for uniformity and have relied on borrowing from specialized standardization. development finance institutions rather than from mainstream financial institutions and Services to enable clients to deposit savings are banks, although the extent of dependence and an area of significant interest and innovation nature of financing from such institutions for MFIs. Deposit services are a potential varies by country. minefield, however, because of the risk of loss in the intermediation process. In practice, most The level of current donor financing is high in NGO-MFIs have been forced by regulatory Pakistan and in Afghanistan's fledgling restraints to limit deposit-taking to credit- microfinance sector. Bangladesh still has linked products, while CBOs can offer such significant donor financing, but this is mainly services because of their relatively informal historical: in recent years, the emphasis has nature and the fact that they operate within a been largely on subsidized debt financing by mutually supporting group with a small the apex institution, retained earnings, and number of members. accumulated compulsory deposits built up by leading MFIs. The broad trend in the region has Microinsurance is drawing increased attention, been a gradual move from donor-funded although it is largely in an experimental stage microfinance toward subsidized debt and and the implications for costs and for delivery compulsory deposits, and then to near- systems are little understood by either MFIs or commercial debt and social equity funding insurance companies. In Bangladesh, before financing by commercial sources (like microinsurance was introduced as an extension banks and voluntary deposits) takes over. This of the microcredit revolution. In India, a key trend is noticeable in all countries of the factor stimulating the growth of region, although the pace of graduation varies microinsurance is the regulator's stipulation by country. that insurance companies must offer a certain proportion of their policies to rural clients. The challenges everywhere are surprisingly This requirement has driven insurance similar. MFIs must develop management companies operating in India to work with capacity at every level, which will enable them MFIs in order to access their ready pool of to run efficient operations to attract potential clients, thereby limiting their commercial finance from equity investors, transaction costs. financial institutions, and voluntary depositors in the long term, thereby enabling microfinance Money transfers are increasingly discussed but services to reach increasing proportions of the have drawn little attention in the region. large number of low-income families in the Informal transfer systems are still dominant in 04 region. most countries, although the use of post office money orders for remittances to low-income families from migrant relatives had become a Diversity of products tradition in the region more than half a century ago. Some MFIs have recently begun to From the beginning, microfinance service experiment with providing transfer services, a providers have focused on providing loans. trend that is likely to grow given the high Some approaches, however, included small dependence of poor families on this source of amounts of required savings tied to loan income. products, so relatively rigid credit services continue to be the major microfinance activity. Microleasing is an underutilized tool in rural rates as being high without reference to the and microfinance, largely because of a lack of clear economies of scale in microfinance experience with this financial tool. But this is service delivery. In reality, South Asian MFIs beginning to change as MFIs add leasing charge rates that are low by international services to their repertoire and mainstream standards but in line with their historical and leasing companies move into the microleasing philosophical poverty reduction agenda. market. The overall financial performance of MFIs in As discussed above, microfinance outreach to the region is improving as the awareness of the genuinely poor is just 17 percent for South sustainability grows. However, the speed of Asia as a whole. One reason for this low level improvement varies among countries at of outreach is product rigidity. Poor clients different points in time and is dictated by need products that provide them with the political pressures and the regulatory flexibility to deposit money and to borrow very environment as much as by the awareness of small sums of money almost daily. Except for good practices. SafeSave's famous experiment in Bangladesh, this type of product has not been provided by The link between depth of outreach and MFIs. The debate about standard products financial sustainability is apparent, and the versus product variety continues, although the view often held by government, some donors, increasing concern for social performance in and the public that reaching poorer people microfinance is likely to result in a greater requires subsidies may not always be true. In focus on product relevance to meet the needs fact, evidence shows that well-managed of the poorest. profitable organizations that remain committed to the double bottom line are doing more to increase the depth of outreach than MFIs with MFI performance substantial subsidies. The leading microfinance service providers in the region are also “best practice� institutions. Impact and social performance Countries in the region have relatively few institutions that provide microfinance services The power of the microfinance ideal lies in its on a sustainable basis, but in general, the potential to combine financial sustainability sustainable institutions are also the largest with social performance, or meeting the so- EXECUTIVE SUMMARY institutions in which substantial proportions of called double bottom line. Until recently, social the microfinance clients in each country are performance has been understood primarily in concentrated. terms of impact or change that can be at least plausibly associated with, if not attributed to, a All of the countries in South Asia have high microfinance program. And changes levels of subsidy from foreign donors associated with microfinance relate 05 (Afghanistan, Bangladesh, and Pakistan), from significantly to several of the Millennium governments (Sri Lanka and, to some extent, Development Goals, particularly to reducing India), or from eroding net worth of poverty, promoting women's empowerment, cooperatives (India and Nepal). Problems with and contributing to universal primary microfinance service delivery, mostly in terms education and improved health. of ineffective management and control systems, and poor recovery performance, are More recent studies with relatively robust compounded by “social control� of interest research methodologies provide evidence that rates. Politicians and bureaucrats in these the overall impact of microfinance is positive, countries periodically create misconceptions although nuanced. Small loans have enabled about microfinance by targeting the interest client households to reduce their dependence 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor on irregular income sources, helped to smooth toward managing and reporting the steps that consumption, and reduced vulnerability, while are likely to lead to positive social outcomes. they have also led to increases in income and These steps include mission clarity and assets for many households. These changes systems alignment (targeting, staff incentives, have been especially significant for poorer reporting, and product design), client profiling, households, in some cases leading to market segmentation, and market research movement out of poverty. But the overall (analyzing microfinance services in relation to evidence for direct poverty reduction varies; client needs, client cash flows, and market such change takes time and depends on the competition). Change at the client household starting point, or relative poverty level, of each level may be assessed through simpler research client household when a client joins a techniques, including poverty scoring, which microfinance program. Conversely, indirect microfinance service providers can use to poverty reduction is possible through assess whether they are achieving their social employment of the poor in the enterprises of objectives. This approach has led to the better-off clients that are supported by introduction of social performance microcredit and through wider market link management by MFIs and social rating by effects. specialist rating agencies, both approaches complementing the now-established systems Recently, microfinance has shifted away from for financial performance management and traditional impact studies toward a new credit rating. These initiatives are still definition of social performance that retains somewhat experimental, but as they develop impact as the overall goal but specifically they are likely to provide an invaluable and unpacks the steps to get there. The focus of relatively low-cost means of tracking and these studies shifts away from proving impact reporting on the achievement of social mission. Systems that support microfinance Support structures and systems are variable across South Asia. Nepal and Pakistan have introduced microfinance-specific regulatory frameworks, while other countries are at various stages of discussion. All countries have well-established apex funding and networking organizations, and rating activities are relatively well established. With respect to regulation, the countries of South Asia lie along a continuum, ranging from little more than the limited regulation of cooperatives in Sri Lanka to a substantial degree of regulation in Nepal, in the latter case at least by law if not in practice. Figure 1. Relative Microfinance Regulation in South Asia Sri Lanka India Bangladesh Afghanistan Pakistan Nepal 06 Unregulated Regulated Source: Authors' creation. Overall, microfinance regulation in South Asia resulting only in a niche market for financial has been primarily concerned with the poverty services for low-income clients rather than an agenda. In a long-term context, this approach inclusive financial landscape. In the long run, presages an emerging concern for the “missing allowing and enabling freedom in pricing, for middle� in which microenterprise finance banks as well as MFIs, and competitive market becomes as important as capital formation for development for financial services has greater low-income families. To this extent, the concept potential. of tiered regulation may be counterproductive, Microfinance apex funding institutions have rating agencies have entered the microfinance played a significant role in the development of rating business, one in Pakistan and one in the industry in South Asia, primarily by India. This puts South Asia in a good position providing loan funds as well as operational to further facilitate links between MFIs and grants, mostly to NGO-MFIs. They also investors. provided capacity building support to MFIs and played a role in setting standards for the Technology has considerable potential to industry, in some cases acting as a quasi- reduce delivery costs and expand the scale of regulator for the sector. With the exception of financial services for poor people. Using low- some of the Indian apexes, all of these funds cost hardware and ubiquitous mobile phone were established by governments and most networks, banks and MFIs may find it possible have received significant donor support. While to deliver financial services less expensively these apexes play a significant role, have large than was possible earlier, even in rural areas. amounts of funding, and even have become In a few countries outside South Asia, such sustainable entities themselves, it is dangerous initiatives appear to have had success at to their continue for too long in the mold in including more low-income people in the which they were created. If the original mainstream banking system, and these purpose was to overcome a market failure and examples are attracting attention from jump-start the growth of microfinance, commercially oriented microfinance providers transition strategies need to be considered. in South Asia. The main issue with the Except partly in the Indian case, there is little introduction of technology is the extent of the evidence thus far that, having played their efficiency gain achieved from the technology original valuable role, apex funding institutions relative to the cost incurred. In the limited have done much to help MFIs become market experiments undertaken to date costs have players that no longer require subsidized funds. outweighed gains, but this is rapidly changing. Five countries in South Asia already have national microfinance associations, while Sri Lanka is in the early stages of a second Future perspectives attempt to form a viable national association. During the past 25 years, the microfinance All of these associations have taken on the role movement has challenged conventional of industry advocates with various degrees of financial sector and government thinking, in skill and success. While the associations have EXECUTIVE SUMMARY the process fundamentally altering the emerged out of the NGO-MFI sector, it is clear financial landscape. Today, it provides most of that they will have to evolve if they are to keep the access to financial services available to up with the changes, increase their value to the low-income people in South Asia, but it is still industry, and strengthen their ability to largely a separate part of the financial system, influence positive change. The evolution with few examples of direct service provision includes broadening their vision to create to the poor by mainstream commercial 07 inclusive financial sectors–for example, institutions. Despite the growing discussion including regulated commercial financial about and enthusiasm for developing a institutions–and playing a greater role in seamless and inclusive financial sector, there is promoting transparency and setting standards little evidence that this has happened yet. of conduct. Over the next few years, most of the growth in South Asia is a worldwide pioneer in the field microfinance will come from a few large, of MFI ratings; Micro-Credit Ratings profitable, specialized institutions that might in International Limited (M-CRIL), based in India, some ways rival small banks. These institutions is one of the first three international will provide a range of diversified and flexible microfinance raters. Since then, two corporate 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor products and will do more to reach out to even poorer people. These dominant institutions will make more use of commercial funding, both debt and equity from commercial banks and the growing number of social investment funds. If competition is allowed to flourish and interest rates are not capped at levels that stunt growth and sustainability, effective interest rates could settle at 21 to 24 percent per year and outreach could expand to reach 50 to 60 percent of poor households across South Asia within a decade. Many initiatives in promoting regulation for the microfinance sector, as well as initiatives that encourage banks to do more to serve poorer people, promise to increasingly mainstream the microfinance movement. New technologies could lead to new ways to improve efficiency and expand outreach even faster. Another step in the region's financial liberalization could occur if the wider political and social environment changes to recognize that economies of scale exist in financial service delivery–cost is inversely proportional to the size of the accounts. Central banks and finance professionals will need to take the lead to urge politicians and media to help change the conservative economic environment relative to the poor. Without such liberalization, the process of microfinance evolution is likely to slow down as it hits the barrier of sustainability, particularly if the formal sector reaches a point at which the marginal return to corporate social responsibility falls below the losses associated with microfinance service providers and low- income clients. That point has not been reached yet, although in India some banks are already testing its limits. As long as 08 engagement with low-income clients in South Asia is largely a matter of social responsibility, financial inclusion will remain a dream. CHAPTER 1 The Financial Landscape and the Emergence of Microfinance: Formal sector exclusion and the quest for new approaches S omething distinctive about the microfinance discourse in South Asia1 is reflected in the way the sector has developed and how the products As a result of the different conditions under which the first MFIs were founded, the industry in the two regions developed have evolved. A recent paper explores the distinctive characteristics. In the beginning, differences in the discursive foundations of the by comparison with Bangladesh, the Bolivian idea behind microfinance in South Asia and intervention was typically urban rather than Latin America, relating it to the situation in rural, less concerned with poverty and more each region.2 The paper argues that focused on micro-enterprise. It targeted the microfinance developed in South Asia under “economically active poor�–people with very different ideological, political, and established businesses that needed capital to economic conditions than in Latin America. grow…from the start, Bolivian microcredit was The difference can be illustrated by a brief itself seen as a business, potentially as a branch comparison of two of the most famous and of commercial banking.3 influential microfinance institutions (MFIs): Grameen Bank of Bangladesh and Banco Sol of Many of these differences still characterize the Bolivia. Modern microfinance was born in industry and the microfinance discourse in the Bangladesh in the 1970s, in the aftermath of two regions today. South Asian microfinance is the country's war of independence, when primarily focused on poverty alleviation, while Professor Muhammad Yunus began an Latin American microfinance is more oriented experimental research project providing credit toward the inclusion of microentrepreneurs in to the rural poor, an experiment that was the financial system. driven by a strong sense of developmental idealism. In contrast, a collapsing populist regime in Bolivia led to widespread unemployment, and Banco Sol was created to address the problem of urban unemployment and provide credit to the cash-strapped informal sector. The notion of commercial profitability was embraced relatively early in this approach. 1 This paper includes discussion about microfinance in six of the eight South Asia Association for Regional Cooperation (SAARC) countries: Afghanistan, Bangladesh, India, Nepal, Pakistan, and Sri Lanka. Maldives and Bhutan are excluded from the discussion because they do not have microfinance sectors as such. In both countries, a few attempts have been made to provide some microcredit services as part of integrated development projects, but these have never amounted to much. The Bank of Maldives, however, has become quite active recently with a “development banking� program that is expanding to provide savings and credit services to underserved populations. 2 Montgomery and Weiss 2005. 3 Rutherford, 2003. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Poverty and Exclusion Given that modern microfinance in South Asia with more than 70,000 bank branches has a effectively started in the 1970s, during a time reasonable ratio of around 15,000 people per in which regional poverty was being examined, branch, which is similar to Sri Lanka. In Nepal, it is perhaps inevitable that the growth of access to banking facilities is restricted microfinance was rooted in the poverty because of topography constraints and the discourse. Although cooperatives were formed consequent lack of infrastructure; in in the region in the early part of the twentieth Afghanistan, the banking system currently is in century, considerably more attention was paid the early stages of revival after many years of to the formation of agricultural cooperatives civil war and is still largely confined to Kabul than nonagricultural ones, a fact that was and a few other large cities. remarked upon repeatedly by review committees and in amendments to the original Even where bank branches exist, access is not 1904 Cooperative Act of the Government of easy for low-income families. A recent study of India. Nevertheless, the Indian scene continues alternative financial sources to microfinance in to be dominated by the Primary Agricultural India found that, despite the reasonable Cooperative Societies, while throughout South distribution of bank branches, the typical Asia, cooperatives are generally seen as a microfinance client finds it difficult to use the failure. In Bangladesh, cooperatives were banking system. According to EDA Rural typically used to promote green revolution Systems Private Limited, technologies (seed, fertilizer, and irrigation Focus Group Discussions reveal that most clients tools) among farmers; however, a large chunk and non-clients find it difficult to deal with of the poor were omitted and the greater banks due to high transaction costs: delays, concern was to capture state agricultural corruption and formalities. The survey results subsidies than to develop pro-poor institutional show that despite bank credit being cheaper, mechanisms to ensure sustainable access to 83% of clients and non-clients have never financial services. For the most part, approached a bank for a loan. Those who do are cooperatives do not reach the poorer sections more likely to be better off, as we have seen, of the population because they were designed including women, in the South, who approach to serve the needs of cultivators rather than banks for 'gold' loans. Banks may be at some farm workers. distance (2-5 km) but people say that this is less of a problem than the transaction costs of Apart from cooperatives, the average low- dealing with banks.4 income family in the region before the 1970s had no recourse to financial services and, were it not for the advent of the microfinance movement, they would not have much recourse today. Most South Asian countries have a reasonable banking system in urban areas; 10 however, despite the fact that the majority of these populations live in rural areas, their access to formal financial services is limited. Bangladesh, with a population in excess of 140 million, has just 6,000 bank branches; Pakistan, with 155 million people, has fewer than 8,000 bank branches, and this number is shrinking. Of the larger countries, only India 4 EDA 2003, chapter 9. Table 1.1 summarizes the reasons why, in spite of bank credit being cheaper, low-income families dislike dealing with banks. Table 1.1. Why Low-Income Families Like/Dislike Banks in India LIKES DISLIKES  Very low interest rates  Bank loans involve multiple time-consuming  In the south, large loans easily obtained against gold formalities  Very little or no follow up on the loans and little  Mainly accessible to those with contacts or who can pressure to repay bribe officials  Likely waiver of the loans by the government because  For subsidized loans under priority sector schemes, the of political reasons local panchayatsb decide the list of beneficiaries, which a is subject to favoritism  The Kisan Credit Card (KCC) enables easy access to credit for farmers for at least the first year  The poor do not have anything to offer as collateral (land or gold) and, therefore, cannot obtain regular bank loans  Poorer women (especially in the north) lack confidence, contacts, and understanding of bank procedures Source: EDA 2003. Note: a. Local governance councils (the poor are not usually effectively represented on them). b. An agricultural line of credit available to virtually anyone with a land holding and a good credit record with the banks. The net effect of these impediments is significant proportion of low-income families, deterrence in the use of banking services, partly because of policy lending sponsored by higher effective costs to borrowers, and the government. In addition, the cooperative consequent credit rationing. rural banks and the SANASA Development Bank, which services the cooperatives, have Similar findings emerged from the World developed out of the cooperative movement. Banksponsored study on rural access to As a result, the need for commercial banks to financial services in the two major states of serve the needs of poor people is lower. Andhra Pradesh and Uttar Pradesh in India.5 From the perspective of small rural borrowers In much of the region, cooperatives failed the survey showed that the following: because of their domination by rural land- owning elites whose short-term interests would ■ Banks do not provide flexible products and be threatened by a more enlightened approach services to meet the income and expenditure to financial outreach. In much of the formal patterns of small borrowers. financial system, the lack of innovation in ■ The transactions costs of dealing with the banks developing alternative methodologies that CHAPTER 1 are high resulting not only from the significant consider the constraints (lack of traditional travel time to bank branches but also from collateral, illiteracy, nature of enterprises of the cumbersome procedures and the need to pay poor, nature of the financial needs of the poor) hefty bribes (10 to 20 percent of the loan and strengths (strong horizontal social capital, amount) in a significant number of cases. 11 information) of poor clientele has been the ■ Banks demand collateral, predominantly land, main reason that the poor are being excluded. which poor rural borrowers lack.6 In contrast to other South Asian countries, the cooperative movement in Sri Lanka along with Samurdhi banking societies has catered to a 5 World Bank 2004. This is the first “access to finance� household survey conducted by the World Bank in South Asia, with similar surveys expected to follow in three more South Asian countries in 200607. The India study confirms the low level of access to financial services of poor people and describes the barriers to access in detail. 6 Srivastava and Basu 2004. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor The Microfinance Response The basic principle on which microfinance is the region made slower and later starts but based has been described as a process in have since established active microfinance which poor families borrow large amounts (or sectors that provide more widespread access to lump sums) of money at one time and repay the financial services. amount in a stream of small, manageable payments over a realistic time period using Overall, microfinance has become a significant social collateral in the short run and part of the economic landscape of South Asia. institutional credit history in the long run.7 By 2005, microfinance in the region covered at Families can reborrow slightly bigger amounts least 35 million of some 270 million families in upon repayment in a predictable and reliable the region and met some 15 percent of the way. This is a fundamental and robust overall credit requirements of low-income innovation in the financial system, the families. In Bangladesh and Sri Lanka, simplicity of which has allowed it to be coverage was particularly impressive, with replicated widely, reaching a large number of more than 60 percent of the poor covered by low-income families globally as well as in microfinance services. The focus of the South Asia. movement on engaging women as essential contributors to economic and social well-being Astonishing growth rates in Bangladesh, has had important spillover effects throughout particularly during the 1990s, created a new the region. Thus, even in a socially dimension for microfinance worldwide conservative country such as Afghanistan, because, for the first time, a relatively formal microfinance activity has focused on women, system for providing financial services covered thereby, according them more explicit millions of clients and a substantial proportion recognition as economic agents; in India, the of low-income families of this major developing SHG movement has become the basis for country were served by the activity. The start programs to promote empowerment and of the twenty-first century reinforced this overall improvement of the status of women in trend as the Bangladesh numbers continued to society. In Bangladesh, microfinance has grow impressively and a substantial parallel become the basis for microenterprise microfinance system based on a self-help promotion by some of the large MFIs and for group (SHG) developed in India. In the past more specifically targeted programs for the few years, both countries have seen important “ultra poor.� In both Pakistan and Nepal, the moves toward product innovation, which, along potential of microfinance demonstrated by with the innovative links with the formal these experiences has captured the attention financial system (particularly in India), have of governments that have created specific legal firmly established their microfinance markets frameworks to facilitate its growth. as world leaders in the field. Other countries of 12 The Emergence of Microfinance While informal sector financing systems can to have started with the Cooperative Credit be traced to the era of Kautilya in the fourth Societies Act of 1904. The cooperative credit century B.C.E.,8 the era of organized sector societies were based on the models of the finance in much of South Asia (Bangladesh, German cooperative movement, in particular India, and Pakistan) is generally acknowledged the Raiffeisen and the Schulze-Delitsch 7 Rutherford 2000. 8 Rangarajan 1987. cooperatives. The objective of the Act was “to cost as possible. It is on such principles that facilitate promotion of cooperative societies, Grameen Bank was born and BRAC and Sri for the promotion of thrift and self-help among Mahila Sewa Sahakari Cooperative (SEWA) agriculturists, artisans and persons of limited Bank's first experiments were undertaken in means.� To the extent that the wording of this the early 1970s. objective could be applied to the objectives of many MFIs today, this Act is a true precursor The following sections consider issues to modern microfinance in the region. The surrounding the emergence of microfinance in cooperative movement in Sri Lanka was each of the countries of South Asia. The formalized through similar cooperative discussion begins with Bangladesh, which is legislation in 1911; in Nepal, formal financial widely considered to be the initiator of services only became available to small clients microfinance in the region, and continues with with the establishment of the credit countries in the order of the extent of their cooperatives in the 1950s. microfinance outreach. It is apparent from its objectives that the initiation of the cooperative movement in Bangladesh South Asia was a response to the perceived need for outreach to those who were In the early 1960s, the late Akhter Hameed otherwise excluded by the formal financial Khan started what became widely known as system–that is, farmers, artisans, and other the Comilla Project, which fostered the “persons of limited means.� It is noteworthy creation of village cooperatives through which that some seven decades later, in the 1970s, it small loans were provided to poor farmers as was still thought necessary to nationalize part of an effort to improve food production commercial banks throughout the region, and and reduce poverty. This work originated what the first fledgling attempts were made to is now known as the Bangladesh Rural launch microfinance as we know it today. Both Development Board, the largest government- initiatives were part of the quest for outreach, managed microfinance program in the country. although the paths taken were quite different. The banks, now owned by governments, Postindependence in 1971 marked the undertook the benevolent, statist path of beginning of the nongovernmental creating a supply of products designed by organization (NGO) movement that dominates bureaucrats ostensibly to maximize the welfare the microfinance sector today. This movement, of the excluded groups. This approach had an the famous story of what eventually became inexorable logic that led to the packaging of Grameen Bank in 1983, and the worldwide influence of the Grameen model of CHAPTER 1 credit products with a complex set of support programs and structures to promote the microfinance are well known and well economic activities of the intended clients. documented.9 The microfinance initiatives that These complex sets of programs came to be emerged during this process remain the basis 13 known as “integrated development programs,� of what is now called “mainstream while the intended clients were the microfinance.� “beneficiaries.� In the 1980s, several NGOs began to build their The microfinance initiators experimented with management capacity and emerge as large a means of providing capital to those who organizations with the capacity to scale up needed it. The key concerns were to make their microfinance programs. BRAC's seminal capital available in small amounts, at experience with taking a program to national convenient times and locations, and at as low a scale, although not a microfinance program, 9 While many publications narrate the history of microfinance in Bangladesh, there is a useful summary in Zaman 2004. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor began in the early 1980s. BRAC taught the BRAC experienced significant growth. In effective use of oral rehydration therapy to addition, a number of mid-size MFIs such as prevent childhood deaths from diarrhea to BURO Tangail, Thengamara Mohila Sabuj every mother in all villages in the country.10 Sangha (TMSS), and Society for Social Service The lessons learned and the confidence gained (SSS) have shown strong growth. from this experience were influential in scaling up other programs, including microfinance. In this development, Grameen Bank has been outstanding. Reacting to the difficulties it At the same time, from the 1980s onward, encountered in the late 1990s, Grameen Bank donors channeled large amounts of funding to developed Grameen II; and, in 2002, it began NGOs, helping them expand their microfinance to convert its branches to follow the new activities. By the mid-1990s, NGOs had approach, a process that was completed by the expanded the microfinance sector significantly end of 2003. In 2005, under this new program, by focusing on the simple and efficient model Grameen Bank added 100,000 active clients of mainstream microfinance pioneered by per month. The changes brought about with Grameen. This expansion was aided by Palli Grameen II have not directly affected the Karma Sahayak Foundation (PKSF), an apex environment in which its products are offered, financial institution that was established by the because clients are still served in groups that government in 1990 to provide wholesale meet weekly in their villages. But there have funding to microfinance NGOs. PKSF was later been two main changes. In the first, Grameen expanded through funding from the World has become a true intermediary by offering Bank and other donors. competitively priced savings products to the nonmember public as well as to its members. In the mid-1990s, faster expansion of NGO- This has led to a huge inflow of depositsby the MFI programs was supplemented by end of 2004, the value of Grameen's savings experiments with new and more flexible portfolio exceeded that of its loan portfolio for approaches to providing services to clients. It the first time in its history. Since 2003, new was also at this time that NGOs began to focus branches begin by mobilizing deposits rather more on the sustainability of their operations than by taking loan capital from headquarters, and on diversifying their sources of funding. and they only establish borrower groups when More recently, NGOs have become more they have first amassed their own capital. The innovative, introducing flexible savings models second major change was in the products and pioneering new ways to reach the poorest offered to members, which incorporate new and most marginalized people as well as savings instruments, including an extremely offering larger loans for microenterprises. popular commitment plan. On the lending side, a substantial flexibility was introduced, which In the last two to three years, and accelerating was shunned earlier because of administrative in 2005, portfolio sizes and client outreach complications for the service provider caused among the major NGO-MFIs, as well as by flexibility and the likelihood of such Grameen Bank, have experienced rapid growth complications increasing operating expenses. 14 accompanied by changes in the way business is conducted. As of late 2004, the four largest microfinance service providers were estimated to have 73 percent of the total client outreach. Grameen Bank, for example, grew from about 2 million members to more than 5 million from December 2002 to December 2005, while both Association for Social Advancement (ASA) and 10 This story and the lessons that were learned from it are described in Chowdhury, Mushtaque, and Cash 1996. 11 Rasmussen, Alamgir, Ahmad, and Ahamed 2005. India percent of each family's proposed investment cost in an income-generating activity, Although Bangladesh is widely recognized as prompting extensive misappropriation and the inspirational base of the microfinance misuse of funds. This situation led bankers to initiators in the region, India was for many regard the IRDP loan as a politically motivated years the fountainhead of statist wisdom. handout and they largely failed to follow up on Starting with the first wave of bank repayments due from borrowers. The net result nationalization in 1969 and reinforced by the was that estimates of the repayment rates in establishment of Regional Rural Banks (RRBs) the IRDP ranged from 25 to 33 percent. Not in 1976, directed credit became the mantra of surprisingly, the two decades of IRDP the Indian financial sector. In the meantime, experience in the 1980s and 1990s affected the the cooperative sector infrastructure had credibility of microborrowers in the view of developed over the years through the creation bankers and ultimately hindered the access of of an apex banking structure at the district and low-income clients to banking services. state levels to ensure the smooth flow of capital in the cooperative system. The entire Over the past 20 to 25 years, the resultant network of primary cooperatives in the vacuum in the financial system has started to country and the RRBs, established to meet the be filled, initially with the efforts of influential needs of the rural sector in general and the development organizations such as the SEWA poor in particular, has not proven to be Bank (Ahmedabad), Annapurna Mahila successful. The cooperatives suffered from Mandal (Mumbai), and Working Women's mismanagement, leadership by the privileged, Forum (Chennai). This movement gained and corruption, and gradually were smothered momentum in the 1990s with the entrance of by state patronage and protection, in many large numbers of NGOs into microfinance. And cases including management by ill-motivated since 1995, attempts to reform the cooperative government servants. Meanwhile, saddled with system have resulted in the creation of a new the burden of directed credit and a restrictive generation of cooperatives, the “mutually interest rate regime, the financial position of aided cooperatives societies� (MACS) that lie outside the purview of state control. Thus far, the RRBs deteriorated.12 five states have enacted MACS Acts. The new For many years, bankers and senior system guarantees independent management government officers in India were fond of and has resulted in the creation of hundreds of describing the Government of India's main MACS in Andhra Pradesh, for example, many poverty alleviation program, the Integrated of which are engaged directly in microfinance. Rural Development Programme (IRDP), as “the Current estimates of the number of NGOs and CHAPTER 1 world's largest microfinance program.� MACS engaged in mobilizing savings and Commercial banks gave loans of less than Rs providing microcredit services to the poor 15,000 ($330)13 to poor people, and over 20 exceed 1,000 organizations.15 years, provided financial assistance of around 15 Initially, many NGO-MFIs were funded by Rs 250 billion ($5.6 billion) to roughly 55 donor support in the form of revolving funds million families.14 The problem with IRDP was and operating grants. In recent years,16 apex that its design incorporated a substantial development finance institutions such as the element of subsidy, amounting to 25 to 50 National Bank for Agriculture and Rural 12 For a more detailed discussion, see Sinha 2000. 13 All dollars are U.S. dollars ($) unless otherwise noted. 14 This suggests that virtually all the 60 million or so poor families were covered by the IRDP. This was not the case, however, as the numbers include many cases of repeat assistance (deliberate) and perhaps even more cases of unjustified selection of “beneficiaries.� 15 This number includes all registered societies, trusts, a few NBFCs, and “new generation� cooperatives acting as financial intermediaries. It specifically excludes unregistered SHGs, which are usually established and facilitated by the NGOs; it also excludes conventional cooperatives. 16 Roughly since 1994. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Development (NABARD), Small Industries some 1.6 million SHGs. Development Bank of India (SIDBI), and microfinance promotion organizations such as Other than the bank-SHG link program, the the Rashtriya Mahila Kosh have provided involvement of commercial banks in wholesale loans to MFIs. This has resulted in microfinance continues to be negligible in MFIs becoming intermediaries between the relation to the current volume of microfinance largely public sector development finance and to their broader engagement in rural areas. institutions and retail borrowers composed of The total credit from the scheduled 18 groups of poor people or individual borrowers commercial banks to the “weaker sections� who live in rural areas or urban slums. In was estimated at Rs 323 billion ($7.2 billion) at another model, NABARD refinances the end of March 2004 compared with total commercial bank loans to SHGs to facilitate rural deposits of Rs 1,760 billion ($39 billion). relationships between the banks and poor Furthermore, the amount outstanding to SHGs borrowers. This latter movement, initiated by was just Rs 14 billion at this time, less than 0.5 the well-known NGO, MYRADA, and percent of the total outstanding loans of promoted by NABARD, has witnessed scheduled commercial banks. This loan significant progress since 1998. The bank-SHG amount for a potential clientele of around 40 link program greatly increased banking system percent of the population indicates the great outreach to otherwise unreached people and distance yet to be covered in obtaining initiated a change in the bank's outlook toward financial inclusion of underserved populations. low-income families from beneficiaries to customers. Sri Lanka Although the NGO microfinance sector has As with the rest of the region, microfinance in begun to provide user-friendly formal financial Sri Lanka originated in the cooperative services to the poor, its outreach is still tiny in movement that was formalized in 1911 comparison with need. Recent compilations of through the Cooperative Societies Ordinance. support provided by major financial institutions Financial services are provided through the show that the outstanding microfinance loans Cooperative Rural Banks (CRBs), which are of domestic financial institutions, including directly linked to multipurpose cooperative NGO-MFIs, did not exceed Rs 35 billion ($804 societies. The first CRB was established in million) by March 2005, with an outreach of 1964. Virtually in parallel, another set of about 15 million families, at best less than 25 cooperative finance institutions, the Thrift and percent of the 60 to 70 million poor families in Credit Cooperative Societies (TCCS), were the country. This includes the scheme for established. The TCCS started to expand linking SHGs directly with banks, with significantly in the 1980s when the SANASA available data showing around Rs 20 billion Development Bank was formed as an apex ($460 million) in outstanding loans to some 11 institution to support them. In the 1960s, million families at the end of March 2005.17 NGOs, such as Lanka Mahila Samithi and This bank-SHG link program, promoted by 16 Sarvodaya, began to form village organizations India's main apex bank responsible for rural on a large scale along with village societies of development, NABARD, started in 1992 and the integrated rural development programs. has grown phenomenally over the past few Since the 1980s, these groups have been the years. Cumulatively, the program had resulted primary tool of microfinance service delivery in lending by the major commercial banks, in Sri Lanka.19 regional rural banks, and cooperative banks to 17 Authors' estimate for the number of families. The information available on the bank-SHG link program does not cover amounts outstanding or the number of SHGs with outstanding loans. The numbers on the link have been estimated on the basis of data available on the NABARD Web site. 18 “Weaker sections� is official parlance for the poor and underprivileged sections of society. This includes all families officially classified as poor but also some non-poor who belong to the lower castes or to specified groups of religious minorities. 19 Charitonenko and de Silva 2002. Both the Bank of Ceylon and the People's Bank government subsidy in the system, the were established to provide financial services importance of community-based institutions in to small borrowers; however, because they the overall financial landscape of Sri Lanka were reaching only a tiny proportion of such demonstrates that its microfinance sector has a borrowers, the government began to establish much greater community orientation than Regional Rural Development Banks (RRDBs) other countries in the region. starting in 1985. These banks are owned by the central bank along with a number of state- owned banks and can be considered to be Pakistan microfinance providers because 80 percent of their portfolio is in loans of less than SL Re In Pakistan, too, it is the long history of the 100,000 ($101). cooperative movement and the large extent and rich diversity of informal credit systems In addition, there is a two-pronged that set the stage for the emergence of the microfinance activity under the government's modern microfinance sector. Both systems poverty reduction program. The Samurdhi were discredited over time through the Development Credit Scheme is a conventional exploitation of poor people, corruption, and in government lending program operated by the case of cooperatives, institutional failures state-owned banks and suffers from the usual resulting in lost savings for many investors. weaknesses of subsidized interest rates and These problems led the state and NGOs to high default rates. Conversely, the Samurdhi seek better ways to provide financial services, Banking Society (SBS) Program has grown fast particularly credit, to poorer people, many of and has recorded better performance. whom live in rural areas. Membership of SBS is limited to recipients of Samurdhi welfare benefits from government. The Aga Khan Rural Support Programme (AKRSP), an integrated rural development There are about 10 medium-size NGOs, led by program, began in 1982 in what was then the Sarvodaya Economic and Enterprise most remote and poorest part of the country, Development Services (SEEDS), and more than the high mountain districts in northern 100 other NGOs and community-based Pakistan.20 It could be said that AKRSP has organizations (CBOs) that have microfinance been the most influential microfinance portfolios but suffer from operational problems program in Pakistan since it spawned the rural and an excessive focus on social objectives, support program (RSP) movement, which which prevents them from being able to today accounts for nearly 70 percent of the function efficiently. Furthermore, a few of the NGO outreach in microfinance. AKRSP was private commercial banks, particularly Hatton also the first, and so far only, NGO to CHAPTER 1 National Bank and Seylan Bank, have ventured transform into a microfinance bank, the first into microfinance with small portfolios. Their privately owned microfinance bank in the engagement has been hampered by the country. AKRSP's microfinance program grew 17 extensive subsidized government programs, to be quite large through generous grant and they have tended to move upmarket to funding from bilateral donors. Eventually, it rural entrepreneurs who are not necessarily became operationally sustainable because of poor. investment income earned by investing the surplus funds that were accumulated from How sustainable this system is remains to be donor contributions, although its lending seen. Overall, Sri Lanka has one of the highest activities were not operationally sustainable. microfinance penetration rates in the world, While the AKRSP experience began the largely because of government programs that process, bilateral donor grant funding began to consume large subsidies. Despite the extent of 20 A history of AKRSP's microfinance program can be found in Hussein and Plateau 2006. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor flow to NGOs in significant amounts during A previously planned apex institution, the the early 1980s. It continued as the main PPAF, became operational in 2000 with source of support to NGO microfinance government and World Bank funding. This was programs until the late 1990s, when the consciously modeled on PKSF in Bangladesh government and donor-backed apex institution, and soon became the main source of funding the Pakistan Poverty Alleviation Fund (PPAF), for NGOs engaged in microfinance. In 2000, took over as the main source of funding. the government established Khushhali Bank, a microfinance bank set up through a special Although two other RSPs based on the AKRSP ordinance. The government invited state- model were formed in 1989 and 1992, the owned and private commercial banks, microfinance movement continued to be small including multinational banks, to contribute and not very visible. One of these RSPs, the capital and accepted a loan from the Asian National Rural Support Programme (NRSP), Development Bank (ADB) to help Khushhali which has the largest NGO microfinance Bank begin operations and grow quickly. The portfolio today, began its microfinance government's rationale for setting up this bank program with a line of credit from Habib Bank. was that the NGO microfinance programs were And although the NRSP is primarily dependent insignificant and that, to scale up quickly, a on subsidized funding from PPAF, it has always new kind of microfinance institution was included some commercial borrowing. Other needed. This effort was followed in late 2001 players also began to enter the market in the by the MFI Ordinance that allowed for the 1990s. Network Leasing Company was creation of microfinance banks under the established as a listed leasing company in 1994 supervision of the State Bank of Pakistan and, with some donor support, it began a (SBP), on the heels of which AKRSP and the microleasing program. The first commercial Aga Khan Fund for Economic Development set bank to begin a separate microfinance division, up the First MicroFinanceBank. Despite this in 1995, was the Bank of Khyber, owned by a attention accompanied by new opportunities provincial government.21 At about the same and much larger amounts of funding than were time, the government established the First previously available, the sector remains Women's Bank. In addition to supporting the relatively small and weak. Progress under the needs of women entrepreneurs, the bank tried microfinance ordinance has been slower than to establish a microfinance program, although expected and only six microfinance banks have it has never been successful. More NGOs been established thus far, four with national began to offer microcredit services during the licenses and two with district-level licenses. 1990s, the most significant being the Kashf Foundation, which was the first NGO Microfinance in Pakistan has a degree of established exclusively to provide microfinance prominence and well-meaning (if not always services and the first to be managed by women well-designed) state support that it does not and have only women clients. Kashf later enjoy elsewhere in South Asia. Prominence became the first MFI of any kind to be occurred as it captured the attention of the profitable after adjusting for subsidies. leadership as a special activity that could focus 18 its development strategy, although A major shift in Pakistani microfinance microfinance was not seen as an integral part occurred when President Musharraf came to of the financial sector. To an extent, the design power in late 1999 and the new government lacunae of the sector lies in the leaders' made microfinance promotion one of the inability to move beyond a social development pillars of its poverty reduction strategy. focus in considering the welfare of low-income Overnight this thrust the microfinance sector families. In the short to medium term, this into the national limelight and things began to government orientation is perpetuating parallel change rapidly. 21 See Arbab 2004 for a discussion about the Bank of Khyber's microfinance program. development rather than promoting financial Centre (RMDC), came into operation to inclusion. provide wholesale funds to potential and viable microfinance institutions for on-lending to the ultimate borrowers for undertaking their Nepal productive activities. Rather like Pakistan, over time, Nepal accorded microfinance some As in India, the origins of microfinance in degree of prominence through the Nepal lie in the credit cooperatives and later on establishment of an enabling framework and some of the government's welfare-oriented the provision of funding through apex rural development programs. In the 1950s, the institutions, because it was seen as a special first credit cooperatives in Nepal were initially activity with a social development focus. intended to provide credit to the agricultural sector. The Agricultural Development Bank of Nepal (ADBN) emerged as a result of a Afghanistan shortfall in the supply of funds for agricultural lending by the credit cooperatives. In 1975, the In early 2002, Afghanistan began to emerge Small Farmer Development Programme was from almost 25 years of devastating conflict. established to provide further impetus to There was no remaining formal financial agricultural lending by providing credit to small system, at least in any operational form, but groups of farmers on a group guarantee basis. microfinance came into the picture early on in In the 1990s, these farmers' groups evolved the reconstruction process, first as a means of into the Small Farmer Cooperatives Limited. social protection and employment promotion and later as part of the agenda for promoting The first major step in the development of “alternative livelihoods� to combat a growing microfinance in Nepal was taken with the opium economy. launch of the first gender-focused program, Production Credit for Rural Women, in 1982. Because there was almost no microfinance This program organized women into groups to expertise in Afghanistan, experienced enable group-based borrowing from the two international NGOs were invited and main commercial banks, Nepal Bank Limited supported to establish microfinance services. and Rastriya Banijya Bank, as well as from Notable among these were BRAC from ADBN. Beginning in 1994, the partial Bangladesh and the Aga Khan Development involvement of NGOs in this process Network, which relied on its experiences in stimulated their engagement as intermediaries Tajikistan and Pakistan. At the same time, the in financial service delivery. donors and government began to work on a CHAPTER 1 proposal to promote the development of a In 1992, another important initiative was taken microfinance sector in the country. In 2003, to augment the supply of microfinance when this led to the creation of the Microfinance the government established the first two Investment Support Facility for Afghanistan 19 Regional Rural Development Banks. These (MISFA), a multidonor-supported financing and banks were capitalized with government and capacity building apex institution, initially part central bank funds to replicate Grameen Bank of the Ministry of Rural Rehabilitation and of Bangladesh. By 1997, five such banks Development, which later registered as a covered each of the development regions of the private company. From the beginning, MISFA country. In parallel, the role of NGOs and focused on three objectives: scaling up cooperatives grew until 2001, when the outreach rapidly, supporting the development delivery of microfinance services in Nepal was of sustainable MFIs, and ensuring that adversely affected by the ongoing insurgency. It international NGO-managed microfinance was at this time that the ADB-funded apex operations become registered Afghan institution, Rural Microfinance Development microfinance institutions. By late 2005, MISFA 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor was supporting 12 NGOs with microfinance programs, and at least two more NGOs had small active programs that were reasonably well designed, although not supported by MISFA. In the absence of a widespread financial infrastructure, the independent MFIs currently constitute the only institutional means of access to financial services for the vast majority of the population outside a few major cities. Indeed, given the active establishment of MFIs at this early stage of development of a formal financial sector in the country, it is perhaps not surprising that the first commercial banking license granted in the country was for a microfinance bank, the Aga Khan–sponsored First MicroFinanceBank. The establishment of a commercial bank to provide microfinance services constitutes formal recognition of microfinance as an important and viable segment, if not yet an indistinguishable part, of the financial system. Significant similarities exist in the origins of microfinance in the countries of South Asia, although in more recent years the paths taken by each country are notably divergent. These paths range from the NGO-dominant growth of microfinance in Bangladesh to the widespread bank-SHG link model in India and the predominantly community-based but government-sponsored institutions of Sri Lanka. In Pakistan and Nepal, direct government interest in microfinance as a poverty reduction model has led to the establishment of “enabling� frameworks, while the war-devastated economy of Afghanistan has sought to make use of the microfinance experience of international NGOs. In a variety 20 of ways, microfinance has increasingly played a more important role in the evolution of poverty reduction programs in the region. CHAPTER 2 Limitations and Challenges: The unfinished agenda T he microfinance movement in South Asia has permanently changed the face of the financial sector by challenging conventional thinking and introducing innovations. The limits of the microfinance model emerge, however, when it comes to serving many more poor people who are still excluded and capturing a larger share of the financial service business of the existing clientele. Financial Needs of Low-Income Families Recent research shows that although MFI Other research in India has shown that, in a outreach among various categories of the poor sample of more than 3,000 MFI clients, the in Bangladesh has been impressive, the MFIs median outstanding amount owed to MFIs was took a rather small proportion (however $68. Conversely, for the 32 percent of clients measured) of the microfinance business of who had borrowed from friends and relatives, households.22 There were five times as many the median amount owed was $91, and for the interest-free loans as MFI loans reported 36 percent who had borrowed from during the year. Because almost all these MFIs moneylenders and other costly informal were following the classic Grameen model, this sources, the median amount owed was phenomenon can be understood as an outcome significantly higher at $159.23 of the fact that MFIs can give only one loan per year per client. Even so, this one MFI loan Another study of financial transactions could be expected to be significantly bigger undertaken by low-income households in India than the average informal loan, many of which showed that the frequency of transactions, might be assumed to be trivial matters of a both borrowing and lending, is far higher than few dollars passing between friends or the typical MFI methodology caters to. relatives. But this assumption turned out to be According to Ruthven (2001), false; the MFI share of the total transaction …the financial needs of the low income flow (their share of the $839 borrowed per respondents…entail frequent transactions–both household per year) was only 15 percent – inflows (borrowing and savings withdrawals) counting all outflows of loans and savings and outflows (repayments and savings withdrawals, and inflows of repayments and accumulations or deposits)–within a fairly saving deposits. It does not seem that the MFIs narrow range (in terms of amounts of money) feature strongly on the household balance which is closely related to the family's income sheets, because the MFI share of household level. An examination of the disaggregated financial assets at the end of the research year financial diary information shows that some of was just 13 percent and accounted for only 21 the transactions take place because people, percent of financial liabilities. invariably, try to minimize their costs and 22 Rutherford 2003. 23 EDA 2003, chapter 9. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor maximize their security (and returns) by shifting MFIs have added to the options available to money from one sort of financial device to low-income families and have contributed to another. This nimble, if economically rational, the diversity of the options they can access to financial behaviour of the diary respondents–and manage their financial assets. They have not the reasons for it–have been well covered in yet replaced the moneylender, however, nor are other papers emerging from this research.24 all MFIs, or the microfinance sector as a whole, able to affect poverty to the extent that some Essentially, when faced with an array of microfinance proponents would like to believe. financial devices with different characteristics Ideally, low-income families need financial in terms of costs, returns, security, services in small amounts, transacted accessibility, and flexibility, people opt for a frequently–a need that continues to be catered range that suits their needs at a given point of to by the village- and slum-level service time. Their tendency to shift between these provider–because more formal MFI operations devices over time is dependent on their (often have yet to develop the technology, systems, variable) income flows and expenditure needs and risk-spreading mechanisms to replace as well as on the accessibility and suitability of them. a particular device.25 The Limits to Informal Financial Services For the poor in South Asia, largely excluded Banks are not meeting microfinance demand to from the cooperative system and unwelcome at any significant extent, and MFIs are not yet the banks, the only recourses available (until able to satisfy the demand from low-income the advent of microfinance) were traditional families. In fact, aggregate calculations made informal sources of credit. These included for the number of poor families in the region personal sources, such as friends and relatives; indicate a substantial shortfall in the revolving savings and credit associations availability of microcredit in the region. The (ROSCAs) or chit funds; private non-bank estimated credit requirement for meeting the finance companies (NBFCs); and costly needs of poor families in the region are informal sources, such as pawn shops, presented in table 2.1. Compared with a total moneylenders, large landowners, and trade credit outstanding amount of some $2.3 billion creditors. The study cited earlier26 connects the from microfinance sources, the conservatively terms under which each of these options is estimated requirement to meet the immediate available to the typical microfinance client in (rather than long-term) investment needs of India. This study shows that for loans less than poor families in the region amounts to more Rs 25,000 ($550) the MFI (with a cost range of than $15 billion. This suggests that just 15 18 to 47 percent) is a cheaper alternative to percent of the total requirement to meet the 22 informal sources (for which the interest range needs of the poor is available in South Asia, is 26 to 200 percent) unless a family has with the proportion of needs being met sufficient social capital to borrow from friends ranging from 2 percent in Afghanistan to 55 and relatives (the cheapest source). Much the percent in Bangladesh.27 same pattern applies in other countries across the region. 24 Ruthven 2001; Patole and Ruthven 2001; and Ruthven and Kumar 2002. 25 EDA 2003, chapter 9. 26 EDA 2003, chapter 9. 27 In Sri Lanka's case, the proportion exceeds 100 percent because of the large number of borderline non-poor included in the figure for microcredit availability. Table 2.1. Estimate of Credit Requirement for Poor Families in South Asia Source: Authors' estimates based on M-CRIL and EDA studies and on secondary information. Note: The estimates in the table for poor families are based on the population of the country, the size of families in that country, and the poverty ratio as indicated in sources such as the World Development Report. Average credit outstanding for each country is estimated from M-CRIL's rating database and the credit requirement is based on a conservative estimate of the immediate (rather than long-term) investment needs of poor families in each country. a. poor families = families subsisting on less than government-defined poverty thresholds. The magnitude of the gap between the Although microfinance has taken great strides conservatively estimated requirement and the in South Asia over the past 30 years–in the present supply of microcredit is just one process, beginning to address a gap that other indication of the huge microfinance task that efforts had failed to address and contributing remains in South Asia, even without taking the much to the worldwide microfinance borderline non-poor into account. Including the movement–the unsatisfied financial services latter, which MFIs invariably do, not only is needs of those at the “bottom of the pyramid� desirable for the process of inclusion in the are enormous and much remains to be done. financial system, but also is necessary to meet the needs and reduce the vulnerability of families at this level. Outreach Revisited The discussion above has explained the origins necessarily be classified as poor, table 2.2. and growth of microfinance in South Asia and estimates that around 50 of the microfinance CHAPTER 2 outlined the nature of the microfinance activity clients in the country are poor. In many parts in the region, including a sense of the direction of Bangladesh, the operations of different MFIs in which it is moving. This section provides an overlap substantially, resulting in multiple overview of the numbers entailed in memberships by clients. This occurs despite 23 considering microfinance activity in South Asia the fact that, until recently, Bangladeshi MFIs and discusses the quality of that outreach in attempted to ensure exclusive participation in terms of the depth of coverage of poor (as their programs. Given this extensive overlap in opposed to low-income) clients. The outreach the membership of MFIs among microfinance information is summarized in table 2.2, which clients, the 62 percent estimate of coverage of relates the data to the estimated poverty ratios poor families appears realistic. In addition, this of each country. information suggests that significant numbers of clients with incomes above the poverty The Bangladesh situation is marked by very threshold, many of whom could be classified as high coverage by credit, if not deposit services. near-poor, are also receiving services from To the extent that microfinance clients cannot 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Table 2.2. Breadth of Microfinance Outreach in South Asia (estimates) South Asia 1,466 33 86.2 34.7 41 17 Source: Authors' estimates based on data available from ADB and others. Note: Poverty information for India and Bangladesh match World Bank information; informed estimates for other countries. Poverty outreach from EDA studies for Bangladesh and India; for other countries, informed estimates based on secondary sources. a. Population figures from World Bank Web site (updated from 2004 to 2005) b. poor families = families subsisting on less than government-defined poverty thresholds. Poor families are estimated using family size 5 for Sri Lanka; 5.5 for India, Bangladesh, and Nepal; 6 for Pakistan and Afghanistan.. Table 2.2 illustrates the fact that microfinance outreach is highly variable across the region. The six countries covered by the table can be classified into high- (Bangladesh and Sri Lanka), medium- (Nepal and, perhaps, India), and low-coverage countries (Afghanistan and Pakistan). MFIs, which are providing better coverage of extensive network of CBOs. This results in a the financial landscape in that country. broader canvas of coverage of the financial landscape than in any other country of the Despite the 700 plus MFIs listed in the region. statistical bulletin of the national network, Credit & Development Forum (CDF), the bulk In India, a substantial increase in the outreach of the outreach in Bangladesh is provided by a of microfinance services in recent years few large MFIs. At the end of 2004, some 73 occurred not only because of the phenomenal percent of the microfinance clients in the growth of the bank-SHG link program, but also country were borrowing from the four largest because of the substantial growth of NGO- institutions (Grameen Bank, BRAC, ASA, and MFIs. Within India, there is far greater Proshika),28 which count their clients in outreach of microfinance in the south, with an millions. Only 12 NGO-MFIs had more than estimated two-thirds of microfinance clients 100,000 29 clients. nationally residing in just three southern states (Andhra Pradesh, Tamil Nadu, and In Sri Lanka, exclusive membership conditions Karnataka).30 Key reasons for higher do not necessarily apply, particularly in the microfinance penetration in southern India 24 case of cooperatives. As a result, the 63 include the following: percent coverage of the poor encompasses not only extensive membership overlap but also ■ The origination of the bank-SHG link program in Karnataka largely through the initiatives of the significant outreach further up the income MYRADA, an NGO, and the consequent greater scale. Thus, substantial numbers of non-poor, participation of Karnataka-based banks such as otherwise not reached by the banking system, Syndicate and Canara Banks in the program have access to financial services through the 28 Rasmussen, Alamgir, Ahmad, and Ahamed 2005. 29 CDF 2004. 30 Author's estimate based on figures available from a large apex organization (SIDBI) and the M-CRIL database. ■ Better governance that has enabled the membership, it is again unlikely that development of a larger number of quality NGOs microfinance outreach in Nepal is entirely to that in turn have spawned MFIs the poor. It can safely be assumed that no more ■ More vibrant local economies in the southern than 15 percent of poor families are included. states compared with the less developed states in the north and east Given the recent emergence of microfinance activity in Afghanistan, the low coverage of ■ Higher literacy and participation rates of women microfinance clients in that country is not in the local economy, making them more suitable surprising. However, one institution, the well- clients for MFIs known Bangladeshi NGO, BRAC, which has It seems clear that members of different MFIs established microfinance operations in and SHGs in India overlap and that all members Afghanistan, has so far dominated the are not poor. There is substantial competition coverage of microfinance clients in the country. between MFIs in areas such as the Guntur BRAC Afghanistan accounts for about 80 region of Andhra Pradesh and Thiruchirapalli percent of total outreach by the 14 MFIs in Tamil Nadu, also resulting in membership operating there. Other MFIs are mainly local overlap. Furthermore, an extensive impact operations of international NGOs, many of study undertaken across 20 NGO-MFIs which had little previous experience of operating in different parts of India has found microfinance in similar conditions. These MFIs that, typically, only 35 percent of MFI clients are adapting their methodologies and systems in the country can strictly be classified as to suit local conditions. Conversely, BRAC has poor.31 This leads to the 9 percent outreach of registered growth rates on the order of 150 microfinance services to the poor indicated in percent per year and has already reached more table 2.2. Much of this is concentrated in rural than 100,000 active clients. MFIs were active areas where MFIs and SHGs tend to operate, in 18 of the 34 provinces in the country by the although there has been increasing interest in end of 2005 and are expected to provide urban areas in recent years. Among the NGO- services in all 34 provinces by 2008. MFIs, clientele is significantly concentrated–more than 70 percent of Pakistan's 580,000 microfinance clients are approximately 3 million borrowers from MFIs expected to grow to between 1.5 and 2 million are concentrated in the 10 largest by 2009, with the total demand variously organizations.32 estimated between 10 and 16 million clients. Some 7 million of these clients would be from The concentration of microfinance in India is families classified as living below the poverty matched by that in Nepal. There, the delivery line. The key characteristics of microfinance outreach in Pakistan are as follows: CHAPTER 2 of microfinance services by regional development banks, NGO-MFIs, and ■ Average loan size to gross national income (GNI) cooperatives is concentrated mainly in the terai per capita ratio is between 11 and 25 percent, (southern plain) and, to some extent, the which could suggest a high poverty outreach but 25 Kathmandu valley. To the extent that is partly due to limitations on loan size resulting microfinance services are available in the hills, from caps on loan size imposed by the main apex it occurs mainly through the diverse Savings funding institution (PPAF) and other donor and Credit Cooperative Societies (SCCSs) that incentives to provide smaller loans. operate largely in the villages of the lower hills ■ 84 percent of clients are concentrated with five of the western, central, and eastern regions. MFIs (one registered as a microfinance bank and Such institutions are relatively rare in the more four NGOs). remote midwestern and far-western regions of the country. Given open access to cooperative 31 EDA 2004. 32 M-CRIL database. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor ■ More than half the clients are male, unlike other providers is attributable to two large countries of the region where there is a organizations–Khushhali Bank and the NRSP . predominance of female clients. Again, the extent of poverty outreach in ■ Historically, microfinance began from rural Pakistani microfinance is unlikely to exceed areas, and coverage in urban areas is still low. one-third of the total number of microfinance clients. ■ Most of the outreach is attributed to multidimensional NGOs that focus on rural areas Overall, the information presented here is and provide credit as one of many inputs, roughly compatible with the data from the although much of the recent growth has been Microcredit Summit campaign that shows from specialized MFIs. penetration rates (clients as a percent of the The multidimensional RSPs that are population) in a number of South Asian predominant in Pakistan microfinance are countries (see table 2.3). Looking at cross- relatively slow-growing programs. In country data, the analysis suggests a threshold percentage terms, the fastest growing NGOs of 2 percent beyond which countries are able over the past two years have been smaller to scale up much more rapidly. In South Asia, organizations with more focused microfinance only Bangladesh and Sri Lanka meet this programs, although the bulk of the increase in criterion, although the recent rapid growth in numbers served by microfinance service India might challenge this proposition. Table 2.3. MFI Penetration Rates–Top Countries Source: Extracted from Honohan 2004. Note: Using the same approach to calculate microcredit penetration, the Maldives had a penetration rate of 8.7 percent at the end of 2005, giving it one of the top outreach ratios in the world. In a population of 300,000, more than 26,000 active borrowers had microloans valued at less than half of the gross domestic product (GDP) per capita amount. These loans are for a maximum amount of $1,200 and are provided without any collateral requirement, while GDP per capita is $2,500, the highest in South Asia. In fact, if the number of microdeposit accounts (accounts with a value of less than $1,000) is considered, the penetration rate is between 20 and 25 percent. Less than 15 percent of the population is considered to be poor, but it is estimated that the majority of these people are not yet covered by microcredit services. Thus, even the theoretical coverage of some 35 population has spurred recognition of the need million families in South Asia by microfinance to create structures that cater to the financial services is no more than 17 percent of the total needs of the economically poorer segments of number of poor families. Apart from Pakistan, society. Except in Sri Lanka, where the 26 financial services are now largely provided by cooperative system is already reasonably well specialized institutions that focus on providing served by the financial system, this process is microfinance services. The overall resulting in the creation of structures–apex concentration of microfinance in the region is institutions and enabling legal frameworks– on women clients based in rural areas, that eventually could integrate microfinance although in Bangladesh, and increasingly in service providers with other parts of the India, the growing focus is on urban clients. broader financial system. Given the still relatively low overall coverage of poor clients, The era of benevolent, statist intervention in in particular, there is still a long way to go. support of financially excluded sections of the CHAPTER 3 Institutional Structures and Delivery Systems: A diverse collage G iven the early establishment and deep roots of the cooperative movement in South Asia, it is perhaps not surprising that CBOs–including operations of development and commercial banks, the activities of post office banks, and, to an even lesser (but growing) extent, by cooperatives–are an important pillar of insurance companies. Despite the importance microfinance in the region. Together with the of CBOs as a delivery mechanism in the ubiquitous NGO-MFI, such organizations form microfinance landscape, diverse institutional the delivery interface for virtually all the links channel microfinance services from recorded outreach of financial services funders to clients and delivery systems vary, available to low-income clients in the region. meaning that South Asia has almost every Only a small amount of additional conceivable type of microfinance activity. A microfinance outreach is provided by the retail description of the diversity in the region follows. Institutional Structures Annex 3.1 shows the main institutional links in the importance of each type to the South Asian microfinance. The major microfinance delivery chain are identified in institutional types, the link of each type, and table 3.1. Table 3.1. Institutional Types and Links in the Microfinance Delivery Chain Source: Authors' compilation. Note: MFI = microfinance institution; NBFC = non-bank finance company; NGO = nongovernmental organization; SBS =Samurdhi Banking Society; SHG = self-help group. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Microfinance outreach in each country of the CBOs region, the approximate number of each type of institution, and an indication of each institution's role are provided in table 3.2. The Because Sri Lankan microfinance is dominated key institutional links in the delivery of by CBO activities–TCCSs, CRBs, and other microcredit in each country are illustrated in CBOs, such as Samurdhi Banking Societies–it figure 3.1. is deposit rather than credit services that form the core of their activities.33 Similarly, in Nepal, cooperatives not only form a significant part of NGO-MFIs the microfinance landscape, but also they are able to raise substantial deposits in relation to NGO-MFIs are dominant in Bangladesh, their overall funds. Community ownership and Pakistan, and Afghanistan and have a governance form the key to generating substantial market in India where the bank- sufficient confidence to mobilize significant SHG link is the dominant model (see table 3.2). amounts in deposits. As part of their activities, In each country, NGO-MFIs deliver microcredit some of the larger cooperative institutions also services but suffer limitations in their attempts offer credit guarantee-type insurance products to offer deposit services because of the lack of to their members. For the same reasons, India's a regulatory framework for these services, new MACS system, based on similar which makes the legitimacy of their activities principles, has grown strongly in recent years, doubtful in the eyes of governments and but it is geographically concentrated in the clients (or potential depositors). In Afghanistan state of Andhra Pradesh. It is now spreading (BRAC) and in Bangladesh and India, most slowly to the few other states–Bihar, MFIs have overcome this problem by packaging Jharkhand, Madhya Pradesh, and Orissa–that compulsory deposits with their credit delivery have enacted similar laws. mechanisms. In India, many NGO-MFIs have India's SHG link program enables commercial gone even further and become agents to large banks to engage with microclients without companies in the delivery of microinsurance having directly to undertake retail services. There is even the notable case of an microlending. Under this program, SHGs of NGO-MFI, Adhikar in Orissa, providing money low-income families are formed by NGOs transfer services to its clients who migrate to acting as self-help promotion institutions Gujarat to work in the salt mines. In Nepal, (SHPIs), government development agencies, or even NGOs that are licensed to raise deposits even bank branch staff. The SHGs are linked to are not particularly successful because of the local branch of any bank (commercial client concerns about their governance and bank, regional rural bank, or cooperative bank) financial stability. Savings are encouraged operating in the area through a savings account under the RSP model in Pakistan, but in this opened for the purpose of managing the case savings are held and invested by member deposits accumulated with the group. community organizations that deposit the When ready, as assessed on the basis of a 28 money in banks, not with the NGO, so no simple grading system, the SHPI assists the intermediation is possible. The few Sri Lankan group in obtaining a loan from the linked bank. NGOs are similar in characteristics to those in NABARD–India's apex bank for rural other South Asian countries, offering development activitiesprovides refinancing microfinance services through the medium of under this program to those retail banks that village-based community organizations. apply for it and sponsors training and exposure visits for bank, government, and NGO staff to enhance their ability to promote the program. 33 See, in particular, CGAP 2006 The SHG-bank link program has grown Consulting Services Ltd. (BASIX), also has a strongly in recent years and all government- local area bank that is specifically licensed to owned or -supported banks now participate in provide a range of banking services in the it. However, the program is substantially three districts in which it is permitted to concentrated (54 percent) in the southern operate. states of Karnataka (where it originated), Andhra Pradesh (where the SHG movement is India's 196 RRBs–each operating in two to particularly strong), and Tamil Nadu (where, three districts–were specifically constituted to along with Andhra Pradesh, the government provide financial services to the types of has played an especially active part in its clients served by MFIs. In practice, they promotion). Because of the lack of became a key instrument of the government's appropriately disaggregated information, it is garibi hatao (poverty removal) program and quite difficult to estimate the outreach of the fell victim to the largesse of subsidy and program. In cumulative terms, NABARD directed credit that this entailed. The reports that some 1.8 million SHGs had been consequential rationing of credit, accumulation assisted under the program by December 2005. of bad debt, and loss of bankers' faith in the In theory, with an average of 15 clients per creditworthiness of low-income clients is a SHG, this would amount to 27 million families classic case study in poor governance. The assisted. In practice, the cumulative figure ensuing collapse of the fortunes of such banks entails substantial double counting and meant that the revival efforts of most RRBs discounting of disbanded SHGs. An estimate of have resulted in a turning away from 11 million clients (see figure 3.1) is reasonable microlending and, indeed, the substantial based on the authors' understanding of the negation of even rural lending for many.35 findings of various studies of SHG operations.34 Microcredit services continue to be offered by RRBs under directed lending programs, but the retail numbers are now small. Significant Development banks and NBFCs engagement of RRBs with low-income clients now takes place mainly through the SHG-bank Nepal has an eclectic mix of institutional links link program. with the nine microfinance/regional development banks. These banks are emerging Another exciting innovation in the field of as the key institutional types in terms of microfinance is the advent of microleasing. outreach numbers. Although such banks can Bangladesh has seen some of its leading legitimately offer deposit services, client institutions (BRAC and Grameen) experiment concerns about their institutional stability and with microleasing products, a leasing company CHAPTER 3 sustainability still limit the relative use of such with a micro- and small enterprise focus has services. The six new licensed microfinance recently been established in Afghanistan, and banks in Pakistan are struggling with their Pakistan has as many as four leasing business models and have not yet been able to companies with microproducts (Orix Leasing 29 provide delivery channels that are easily and Network Leasing are engaged significantly accessible to clients. Khushhali Bank is the with the activity and have around 5,000 clients only one operating on a truly national level so each). far. In India, the six NBFCs engaged in Conventional banking products–of all sizes– microfinance are legally restricted from are, of course, offered throughout South Asia offering deposit services to their clients until through the branch networks of traditional they are able to obtain an investment grade agricultural or rural development banks. Thus, rating from a commercial rating company. One there are two agricultural banks in Bangladesh, of these, Bhartiya Samruddhi Investments and 34 Forthcoming paper by APMAS. 35 For a more detailed discussion, see Sinha, Chetan, Ruthven, and Pathak 2003. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Figure 3.1. Key Institutional Links in Microfinance Delivery Afghanistan 120,000 clients Apex fund - MISFA MFIs Bangladesh Grameen Bank, 11 million clients ASA, BRAC 40% of on-lending funds 5 million clients PKSF MFIs India 0.5 million clients Commercial banks MACS C L I E N T S 11 million clients SHGs Apex funds: 3 million clients MFIs NABARD, SFMC, et al. Cooperative 0.5 million clientsa PACS Banks M I C R O F I N A N C E Nepal 250,000 clients Microfinance/regional Commercial banks development banks Apex funds: NGO: 50,000 clients NGO-MFIs, Cooperatives Coops: 200,000 clients RMDC, RSRF Pakistan Commercial banks Microfinance banks Investors 350,000 clients NGO-MFIs PPAF Sri Lanka 0.25 million SANASA TCCSs Development Bank Cooperative 0.6 million clients Rural Banks Samurdhi 30 1.8 million Banking Regional Societies 0.1 million Development Banks 100,000 NDTF NGOs Commercial banks 25,000 Source: Authors' creation. Note: ASA = Association for Social Advancement; MACS = Mutually Aided Cooperative Society; MFI = microfinance institution; MISFA = Microfinance Investment and Support Facility for Afghanistan; NABARD = National Bank for Agriculture and Rural Development; NDTF = National Development Trust Fund; NGO = non-governmental organization; PACS = Primary Agricultural Cooperative Society ; PKSF = Palli Karma Sahayak Foundation; PPAF = Pakistan Poverty Alleviation Fund; RMDC = Rural Microfinance Development Centre; RSRF = Rural Self-Reliance Fund; SFMC = SIDBI Foundation for Micro Credit; SHG = self-help group; TCCS = Thrift and Credit Cooperative Society. a.Refers only to PACS microfinance clients, mainly to members of the 30,000 SHGs supported by Cooperative Banks. a network of hundreds of cooperative banks largest commercial bank in the country, has and RRBs (the latter with over 14,000 been in the forefront of this activity. A plethora branches) in India, one agricultural of innovative products, including securitization development bank in Nepal and one in and partnership arrangements, has emerged Pakistan, and a series of regional development from ICICI Bank for this purpose. Not to be left banks in Sri Lanka. All of these have some behind, a number of other banks (private and outreach to microfinance clients, but their government owned, Indian and foreign) are traditional mold of branch-based operations, now engaging in this activity. With lending bureaucratic functioning, and ill-motivated volumes in these programs now on the order of staff, in practice, restricts access to a select Rs 3 billion ($67 million) and outreach few clients who typically would be found at exceeding 1 million clients, these initiatives MFIs. now have a significant impact on the practice of microfinance in India. The emerging issues Finally, the fact that Grameen Bank–the in this program and the design of products are mother of Asian MFIs–is a specially discussed in chapters 4 and 5. constituted development bank is little known outside the region. Until recently, Grameen had Elsewhere, Bangladesh has seen similar action begun to acquire some of the characteristics of with one government-owned bank (Sonali, the a typical complacent and bureaucratic largest in the country) and one private bank government bank, but in 2002 it completely (Pubali) taking an interest in wholesale lending rethought its products and operations. The to MFIs through simple, relatively short-term launch of Grameen II appears to have lending products. In both cases, this interest revitalized this institution's leading to achieve was stimulated and catalyzed by the efforts of phenomenal growth that has moved it past its a foreign donor organization (the Swiss Agency main local NGO competitors (BRAC and ASA) for Development and Cooperation) through a to now reach some 5 million clients. low-interest loan (3 percent) up to the extent of one-third of their total lending to MFIs and by commissioning credit ratings of MFIs identified Commercial banks by the banks as potential borrowers. Figure 3.1 illustrates some retail engagement of A certain amount of similar lending activity commercial banks in Sri Lanka with has also taken place in Nepal and Pakistan microclients. The numbers, however, are barely where there is some (but very small amounts large enough (just over 1 percent of the total of) retail lending by commercial banks to estimated number of microclients in Sri Lanka) microclients. The wholesale lending volumes in both countries are very low, although the CHAPTER 3 to be noticeable. Despite India's long history of directed credit to poor people, as discussed banks have invested in the equity of above in the context of RRBs, the actual microfinance development banks. Such voluntary engagement of commercial investment is basically seen as social 31 banks–outside the purview of government responsibility–if not (as in Nepal) a response to development programs–would be minuscule in outright central bank coercion–and is not terms of clients served and negligible relative significant or remarkable as engagement with to the size of the overall market. A far more microfinance. interesting engagement of commercial banks in For a region that accounts for 40 percent of the Indian microfinance is the explosion of the past world's poor,36 it is remarkable that no two to three years of lending to (and through) commercial bank can be classified as having MFIs for on-lending to low-income clients. taken a major initiative to retail microfinance ICICI Bank, the largest private and the second services in the manner of Bank Rakyat 36 Living on less than $1 a day. See the Millennium Development Goals Web site of the World Bank Group, available at http://ddp-ext.worldbank.org. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Indonesia or Khan Bank of Mongolia. Nor, Program had as many as 2.5 million policies in indeed, is there an example of scaling up an 2001 with an average sum of just Rs 42,000 MFI into commercial banking à la ACLEDA (about $900).39 Bank of Cambodia. This situation could be attributed to conservatism in formal banking in Because of the lack of detailed information, it the region: the former to residual socialist is impossible to assess the microfinance notions of what interest rates are appropriate component of post office operations; however, to charge the poor–making it impossible for access to post offices is far easier than to banks to provide microfinance services banks in terms of physical distance and viably–and the latter to regulatory because of psychological factors such as the conservatism on minimum capital relationship between clients and staff. In this requirements and branch/area expansion norms situation, the small post office savings account that create huge obstacles to the is common among those who live in villages in transformation of MFIs into banks and their the region, and the use of post office money subsequent expansion to serve large numbers orders for remittances to relatives who migrated to other parts of the country or region has been a tradition for more than half a Post offices century. While the continued importance of post Despite their image as plodding government- offices for the average low-income client in owned bureaucracies, the regional post offices South Asia should not be discounted, recent are purveyors of financial products to many of institutional reforms have resulted in reducing those who traditionally had no access to any the number of branches, particularly in more other financial institution. Not a lot of remote locations. In India, at the least, the net information on post offices is available, but effect has resulted in some post offices closing their networks of branches far exceed the and others consequently reducing services. The numbers for banks. For instance, Bangladesh situation is such that a localized study of rural had some 9,400 post offices in 1999 (more financial services in northern India in 2002 than 8,700 of these in rural areas);37 the concluded the following: Pakistan Post Office has 12,000 branches, many more than the 6,000 to 8,000 bank Other than money orders…the physical outreach branches; and India had more than 155,000 of the post office is very limited. Besides the fact post offices in 2001 (with 89 percent in rural that the number of clients using the savings areas), more than twice as many as the 70,000 schemes of the (local) post office is very small commercial and rural bank branches in the and few of those would count amongst the poor, country. The Pakistan Post Office offers a wide almost all of its current clients are from the range of remittance, insurance, and savings village where the office is based.40 services; had more than 3.5 million financial service clients in 2004; and now earns more Unfortunately, many of the post office 32 revenue from its financial services than from accounts reported in the Consultative Group to postal services. The Indian Postal Savings Assist the Poor (CGAP) paper probably are Bank is the largest bank in the country in already defunct. Nonetheless, there are efforts terms of the frequency of deposits and the under way in India and being contemplated in numbers of accounts (124 million) with small Pakistan to restructure post offices and use balances.38 The Indian Postal Life Insurance their significant network to provide more 37 Bangladesh Post Office 1999. This is the latest information in the public domain at the time of writing. 38 CGAP 2004. More recent information suggests that there are 160 million accounts with deposit balances of Rs 2.6 trillion. However, this information is from a conference presentation with no indication of the date or primary source of the information (Department of Post, Government of India 2005). 39 Indian Postal Services 2006. 40 Sinha and Patole 2002. financial services more profitably. Efforts in financial services to SHGs, the consideration of India include pilot projects to establish finance partnerships with banks and insurance marts (shops and retail outlets) and provide companies, and the creation of a postal bank.41 Delivery Systems Diverse delivery systems are used by different types of institutions to deliver financial services to low-income families in the region. The main methodologies employed can be classified into the following five types: ■ Grameen Model–a delivery methodology pioneered by Grameen Bank of Bangladesh. These models undertake individual lending, but all borrowers are members of five-member groups that, in turn, get together with 7 to 10 other such groups from the same village or neighborhood to form a center. Within each center, joint liability is, in theory, the key factor in ensuring repayment, although there is no formal documentation and accounts are maintained in the individual names of clients. Savings are a compulsory component of the loan repayment schedule, but they do not determine the magnitude or timing of the loan. In a sense, this is a credit delivery rather than an empowerment model because the development implications arise from meeting the credit needs of clients rather than from enabling them to develop group interaction, leadership, or financial management experience and skills. This is the dominant methodology in Bangladesh where nearly all the NGOs use delivery systems similar to the Grameen Bank model. There are notable cases of the successful deployment of versions of this model in other countries of the region for example–20 of the leading MFIs in India, all of the retail development banks in Nepal, and major MFIs like the Kashf Foundation in Pakistan and BRAC in Afghanistan. In the meantime, as discussed in chapter 2, Grameen Bank itself has changed and many others in the mammoth NGO-MFI movement of Bangladesh have changed along with it. The rapid growth of the major and mid-size NGO-MFIs has increased competition and noticeably changed the way in which these organizations relate to their members: again this is a long-term trend that has accelerated particularly in the last year or two. Most organizations now allow new members to join and to borrow much more quickly than before (one week is now the standard waiting time between joining and getting a loan) and the initial loan size has risen (in rural CHAPTER 3 areas, the standard opening loan is now about $100). Organizations allow groups to vary in size, so that staff do not have to turn away a prospective 33 member because no place is open in the group (there are even Grameen groups with more than 100 members). As a result, the old brand loyalty that helped organizations retain their members is slipping away fast. Many rural people now regard NGO membership as a temporary rather than a long-run matter: they are prepared to join whatever NGO happens to be available whenever they need a loan, and then leave again when the tedium of the weekly meeting becomes a nuisance. At any point, they may be members of between one and four NGOs, or of none at all. There is a noticeable change in the composition of the membership. This change is driven by the larger loans offered, which attract much better-off people than was traditionally the case in Bangladesh. This point is particularly noticeable in the case of Grameen II, where it is not just the bigger loans, but also the attractively priced Grameen Pension Savings (GPS), a 41 Department of Posts, Government of India 2005. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor commitment savings product, and the higher education and mobile phone loans that are attracting the middle classes. It is now common to find the professional classes and wealthier farmers or traders placing their wives in Grameen to access these products: very often the wives do not attend the meetings but send the money along through a poorer relative. Because product conditions have become friendlier, it is now more possible for very poor people to join and remain in NGOs than before. In this, the change to open-access passbook savings and the facility to “top-up� loans part way through the term have been especially helpful in making loans easier to manage for those with fragile, seasonal, or unreliable incomes. ■ Self-Help Group–the dominant microfinance methodology in India. The operations of 15- to 25- member SHGs are based on the principle of revolving the members' own savings. External financial assistance (by MFIs or banks) augments the resources available to the group-operated revolving fund. Savings thus precede borrowing by the members. In many SHG programs, the volume of individual borrowing is determined by the volume of member savings or the savings of the group as a whole. Some NGOs operate microfinance programs by organizing federations of SHGs that act as the intermediary to obtain external loan funds in bulk, which are channeled to the members via the SHGs. SHGs aim to be an empowerment model that enables members to develop group interaction and financial management skills. At the same time, it is a far more time-consuming and expensive system to establish in a new area because fostering group cohesiveness takes substantial effort. In India, NABARD has facilitated and extensively supported a program that entails commercial bank lending directly to SHGs rather than via bulk loans to MFIs. NABARD provides some support to SHPIs to establish the SHGs and largely refinances the loans of the commercial banks to SHGs. The vast majority of MFIs in India have SHG-based programs.42 Some of these include MYRADA, SPMS of Tirupati, and groups organized by the DHAN Foundation, Madurai, and Chaitanya of Maharashtra. An important MFI in Bangladesh (Ashrai) is also well known for having followed this methodology and others like Afghanistan's CARE program and the Aga Khan Foundation, Afghanistan are experimenting with it. ■ Cooperative Programs–entail the provision by MFIs of financial services to individual clients organized into credit and savings cooperatives. In cooperatives, all borrowers are members of the organization either directly or indirectly by being members of primary cooperatives or associations in which they hold shares and which are, in turn, member/shareholders of the apex society. Creditworthiness and loan security are a function of cooperative membership within which member savings and peer pressure are assumed to be a key factor. Although the magnitude and timing of savings and loans are largely unrelated, a special effort is made to mobilize savings from members. As the above country illustration (figure 3.1) of links shows, cooperatives are the dominant 34 methodology in Sri Lanka with large numbers of CRBs, TCCSs, and SBSs accounting for more than 95 percent of the microfinance service delivery in the country. As discussed, a large number of “new generation� cooperative credit societies in India are devoted specifically to providing financial services. Most of these are located in the southern state of Andhra Pradesh, which was the first state to enact a law permitting mutually aided (as opposed to traditional government-assisted) cooperative societies. Elsewhere, a number of well- known programs such as the SEWA Bank in Ahmedabad, the Indian Cooperative Network for 42 50 of the 76 recently rated MFIs in M-CRIL's database. Women in Tamil Nadu, and the Annapurna Mahila Cooperative Credit Society in Mumbai have survived under the traditional cooperative laws. However, the more than 90,000 Primary Agricultural Credit Societies (PACS) in India are not usually mentioned in the context of microfinance, because generally they are regarded as not being particularly geared toward working with typical microfinance clients–that is, low-income families in their operational area. Nepal, too, has a large number (more than 2,300) of Savings and Credit Cooperative Societies (SCCS) with outreach to more than 100,000 members, but these societies are regarded largely in the manner of the Indian cooperatives and are not taken particularly seriously as channels of microfinance. Only 25 societies presently are or previously were licensed by the central bank to provide limited banking services in this context, but even these largely lend to borderline or non- poor farmers rather than to typical microfinance clients. ■ Mixed Model–some MFIs started with the Grameen model but converted to the SHG model at a later stage. However, they did not completely do away with Grameen-type lending and smaller groups, but rather are an equal mix of the SHG and Grameen model. Others have chosen to adapt either the Grameen or the SHG model to cater to their markets, while some organizations like BASIX in India use a number of delivery channels and methodologies (including joint liability groups of individual borrowers and lending through SHGs) to provide financial services. Such organizations can not be classified as SHG or Grameen model MFIs. Such MFIs are still relatively small in number; however, with increasing innovation becoming the norm in microfinance, their numbers are growing. ■ Rural Support Programs–Pakistan makes a unique contribution to this discussion in that a number of the NGO-MFIs (and, indeed, one of the microfinance development banks) have evolved out of multidimensional programs based on establishing and strengthening village organizations to manage their own development. RSPs are not microfinance specific and tend to maintain close relations with government because they are closely linked with government development programs. Their microfinance approach focuses on the provision of credit, although they also encourage voluntary savings that community organizations invest in banks. This program has evolved over time to a point at which it currently establishes groups of 15 to 20 people (all of whom take credit). Like the SHG system, this is a potentially empowering model, but the process of establishing it is equally resource intensive. Financing microfinance activity in the region and the diversity of products and services available CHAPTER 3 to microfinance clients are discussed in chapters 4 and 5. 35 Table 3.2. Institutional Structures for Microfinance in South Asia Indicators Afghanistan Bangladesh India Nepal Pakistan Sri Lanka Outreach: active borrowers ~120,000 a a ~500,000 ~580,000 2–3 million ~16 million ~15-16 million % of total number of 3.0% 62% 8% 11% 3% 63% families in population Cooperatives Some cooperatives, mostly 100,000 primaries 2,300 SCCS plus 19 licensed Some cooperatives, mostly 1,539 CRBs defunct plus 600 MACS defunct 7,400 TCCSs Other community-based 700,000 SHGs 1,036 SBSs organizations Nongovernmental 14 engaged in 721 listed in CDF statistics ~400 Unknown, 49 licensed 29 funded by PPAF ~200 NGOs organizations microfinance Non-bank finance Delta Life Insurance Co. 5 engaged specifically in 4 leasing companies, companies microfinance especially Orix Leasing Network Leasing Retail development banks; Grameen Bank, BRDB plus 2 196 RRBs 5 RRDBs Microfinance banks, SANASA, retail delivery programs agricultural development 400 DCCBs 4 MCDBs 6 licensed 6 RRDBs banks Wholesale development MISFA PKSF NABARD, SIDBI, RMK, FWWB RMDC, RSRF, Small Farmers PPAF NDTF, Susahana facility, banks/funds women’s and minorities Development Bank Isuru Fund development corporations Commercial banks Retailer: First Wholesalers to NGOs: Sonali Wholesalers: ICICI Bank plus Wholesalers to and investors Wholesalers: Several Some direct lending from 3 MicroFinance Bank Bank, Pubali Bank, BASIC other private commercial in development banks commercial banks private and 2 government Bank banks, plus some banks government banks Retailers (insignificant): four government banks Lenders to SHGs: All public sector banks plus RRBs and Investors in Khushhali DCCBs Bank: All significant Microfinance in South Asia commercial banks Source: Authors' compilation. Note: BASIX = Bhartiya Samruddhi Investments and Consulting Services Ltd.; BRDB = Bangladesh Rural Development Board; CDF = Credit & Development Forum; CRB = Cooperative Rural Bank; DCCB = District Central Cooperative Bank; Toward Financial Inclusion for the Poor FWWB = Friends of Women's World Banking; MACS = Mutually Aided Cooperative Society; MCDB = microcredit development bank; MISFA = Microfinance Investment and Support Facility for Afghanistan; NABARD = National Bank for Agriculture and Rural Development; NDTF = National Development Trust Fund; NGO = nongovernmental organization; PKSF = Palli Karma Sahayak Foundation; PPAF = Pakistan Poverty Alleviation Fund; RMDC = Rural Microfinance Development Centre; RMK = Rastriya Mahila Kosh; RRB = Regional Rural Bank; RRDB = Regional Rural Development Bank; RSRF = Rural Self-Reliance Fund; SCCS = Savings and Credit Cooperative Society; SHG = self-help group; 2006 SIDBI = Small Industries Development Bank of India; TCCS = Thrift and Credit Cooperative Society. a. Excludes primary cooperative societies. Annex 3.1. Institutional Links in South Asian Microfinance Commercial banks Retail Bd development Sonali Bank, banks/Companies Pubali Bank, Bd Cooperatives Grameen Bank India BASIC Bank PACS C L I E N T S India MACS India UCB/DCCBs, NBFCs Public Sector Banks, Nepal Nepal ICICI Bank, RRDB/MFDBs SCCS ABN Amro, Pak SL and many others MFI Banks CRBs TCCSs M I C R O F I N A N C E Nepal SL Public and private RDBS, SANASA commercial banks SL Hatton, Seylan, CBOs and Sampath Banks Wholesale development MFIs India SHGs banks/Funds MISFA Nonprofit SL SBS PKSF NGOs in all NABARD/ countries, Governments SIDBI including and donors RMDC/RSRF Afghanistan PPAF NDTF Source: Authors' compilation. CHAPTER 3 Note: ABN = ABN Amro Bank; Bd = Bangladesh; CBO = community-based organization; CRB = Cooperative Rural Bank; DCCB = District Central Cooperative Bank; MACS = Mutually Aided Cooperative Society; MFDB = microfinance development bank; MFI = microfinance institution; MISFA = Microfinance Investment and Support Facility for Afghanistan; NABARD = National Bank for Agriculture and Rural Development; NBFC = Non-bank Finance Company; NDTF = National Development Trust Fund; NGO = nongovernmental organization; PACS = Primary Agricultural Cooperative Society; PKSF = Palli Karma Sahayak Foundation; PPAF = Pakistan Poverty Alleviation Fund; RDB = rural development bank; RMDC = Rural Microfinance Development Centre; 37 RRDB = Regional Rural Development Bank; RSRF = Rural Self-Reliance Fund; SCCS = Savings and Credit Cooperative Society; SHG = self-help group; SIDBI = Small Industries Development Bank of India; SL = Sri Lanka; TCCS = Thrift and Credit Cooperative Society; UCB = Urban Cooperative Bank. CHAPTER 4 Financing Structures: From subsidy to overenthusiastic commercialism M FIs essentially perform the role of intermediating financial resources and services between (1) investors, banks, donors, and terms of providing new avenues for access to financial services for low-income clients, this role is justified and has a clear “public good� depositors, and (2) the poor. This section looks element associated with it. Conversely, in for- at the financing structures of MFIs in South profit companies, it is shares that constitute the Asia and discusses the issues and challenges risk capital that forms the backbone of with regard to financing that arise in each commercial investments in financial country in the region. The underlying premise institutions. To the extent that microfinance has of this discussion is that improving the quality evolved beyond the stage of proving itself to be and quantity of financial services to the poor is a beneficial and viable activity to improving its the goal of microfinance and, for this goal to performance in terms of efficiency, however, be attained, MFIs need to be financially the era of soft financing may be coming to an sustainable institutions. end. The growing recent activity of social investors in microfinance is a highly positive Like any other financial intermediary, MFIs trend that has already started to move the need risk capital that can be leveraged to add sector toward the market discipline of to the fund base (either through debt finance or commercial finance. Some large MFIs in India by raising additional deposits) for operations –including BASIX, SKS, and others–as well as and on-lending to low-income clients. However, the start-ups mentioned earlier have already unlike commercial financial institutions, MFIs benefited greatly from this trend. (except cooperatives) in South Asia have emerged from nonprofit entities. Additionally, In terms of debt from lenders, MFIs in South the transaction costs of microfinance delivery Asia generally have relied on borrowing from are high and account sizes are small, typically specialized development financial institutions resulting in MFIs taking three to seven years to as opposed to mainstream financial institutions become financially strong enough to attract and banks, although the extent of dependence commercial risk capital. As a result, it is mainly and nature of financing from such institutions donor funding that has played the key role of varies across countries in the region. “venture capital� in stimulating microfinance Commercial financing from banks is gaining investment and promoting microfinance importance, however, and has reached quite markets. Over the past couple of years, as significant levels in India. Elsewhere, debt social entrepreneurship (through the financing by banks is in its early stages but Bellwether Fund and others) has provided starting to acquire some momentum in venture capital for the establishment of a few Bangladesh; BRAC has completed one large new, professionally managed MFIs, such securitization deal as well. Regarding deposits funding has acquired some of the from clients, MFIs' dependence on this source characteristics of commercial capital. of financing is clouded by its ambiguous legality in most countries; as a result, a To the extent that MFIs address market failure significant proportion of this financing has and help to develop the financial sector in been in the form of “compulsory collections,� structures of MFIs from a sustainability which are closer in concept to cash collateral. perspective suggests the four country-level classifications noted in table 4.1. A worldwide consideration of the financing Table 4.1. Country-Level Classifications Source: Authors' compilation. Systematic data on the pattern of financing of subsidized debt financing by the apex MFIs in the region are of reasonable quality for institution (PKSF) and on the accumulated all countries except Sri Lanka. Table 4.2 and compulsory deposits built up by the leading figure 4.1 present a summary view of MFI MFIs that have been in business for a decade financing structures in the other five countries. and more. Some recent shift to voluntary These summaries show the high extent of deposits by Grameen Bank is also notable, current donor financing in the fledgling while the efforts of other leading MFIs (such as microfinance sector in Afghanistan and the ASA, BRAC, and BURO Tangail) to collect substantial levels of current donor financing in voluntary deposits reportedly have been Pakistan. Bangladesh still has significant donor stymied by the efforts of the central bank to financing, but this is mainly historical. In recent rein in this perceived flaunting of authority. years, the emphasis has been largely on Table 4.2. Financing Structure of MFIs in South Asia (percent of funds available) a CHAPTER 4 39 Sources: Data from M-CRIL, PMN, and NRB. Note: a. Subordinated debt; MISFA support classified as long-term liabilities. In India compulsory deposits are important, lending norm. Such debt has become the but, increasingly, it is loans from the wholesale dominant source of funding for Indian MFIs, development finance facility (SIDBI) that has while social investors have become active in driven the MFI financing activity. Riding on the contributing equity and supporting the back of SIDBI's success in financing MFIs, ICICI transformation of NGO-MFIs into NBFCs. Once Bank and other commercial banks have joined such NBFCs become established, and their the effort to increase their exposure to operations are able to obtain an acceptable microfinance and simultaneously to fulfill the rating, they will be able to intermediate central bank's directed “priority sector� voluntary deposits. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Figure 4.1. Financing Structure of MFIs in South Asia Although detailed financial information is not available for Sri Lanka, it is apparent from the 120.0% discussion in the previous section that the two 100.0% major channels of microfinance (the TCCS and the SBSs) have a substantial quantum of 80.0% voluntary deposits and share capital 60.0% contributed by their client members. The deposits with the TCCSs are intermediated by 40.0% the SANASA Development Bank. 20.0% On this basis, the six South Asian countries 0.0% with significant microfinance operations can Afghanistan* Bangladesh India Nepal Pakistan -20.0% be classified as follows. Accumulated profits/losses Donated equity Debt Paid-in Equity Deposits Source: Data from M-CRIL, PMN, MISFA, and NRB records. Table 4.3. Significant Microfinance Operations The development banking system in Nepal, coupled with the licensing of financial intermediary NGOs and of savings and credit cooperatives by the central bank, has created a framework enabling a relatively greater flow of deposits to MFIs as well as substantial debt Source: Author’s compilation funds from the near-commercial apex institution (RMDC) and commercial banks The following sections provide a more detailed keen to fulfill their directed credit picture of the financing structures of MFIs in requirements. Paid-in equity makes a each country discussed in this report. contribution here as in India. Afghanistan Microfinance was initiated in Afghanistan history of the microfinance sector, MISFA's through a World Bank-CGAP led multidonor- strategy from the start has been to financed project only as recently as 2003–04. significantly reduce the proportion of grant This project is being implemented through funds by the fourth or fifth year after the MFI MISFA, which is the main financier of MFIs. becomes operational and to substitute this Some 15 MFIs are now operational in the with debt funding. Compared with other country, with 2 or 3 that are much larger than countries in the region, this transition to debt the rest showing considerable potential to scale financing for MFIs is on a much faster up.43 trajectory (see Figure 4.2) and, if successful, 40 could become a broad blueprint for MFI The most significant funder of microfinance in financing in countries that are new to Afghanistan, thus far, has been MISFA, microfinance or have not transitioned although a few MFIs have raised donor funds adequately away from donor funds. By early directly or have invested some of their own 2006, $46 million had been provided in soft funds. MISFA has financed MFIs by providing loans and $27 million in grants. Over time, the grant funding as well as debt on soft terms, ratio of grant funds to total funds is expected both of which contribute to building the equity to decline steadily as MFIs stabilize the and fund base of MFIs. And despite the short financial positions and can raise commercial 43 funds from other sources. Within this group, too, BRAC Afghanistan leads the way by a distance. Figure 4.2. MISFA Strategy A related critical transition that the microfinance sector will need to ensure over Projected 5-Year MISFA Disbursements to Partners 120% the next three to five years is a movement 100% toward obtaining commercial debt finance 100% 90% from the banking sector in Afghanistan. Loan Fund Crowding in such commercial funding is likely MISFA Desbursements 80% 73% to occur if the performance of the MFIs stays 58% 57% 60% on the broad path that has been envisaged by Total Grant 40% 42% 43% and agreed upon with MISFA. Indeed, initial 27% discussions with a few banks about funding 20% 10% microfinance on commercial terms have 0% already been initiated. Furthermore, apart 0% Years 1 2 3 4 5 from commercial debt financing, investors may Source: Data from MISFA gain interest in Afghan MFIs over a three- to With the intention of “seeding� the five-year time span, given that at least two of microfinance sector in Afghanistan, MISFA has the MFIs, Afghanistan Rural Microfinance been financing operating expenses and fixed Programme and BRAC, are projected to reach asset purchases through grants and funds for significant scale44 over that period and have on-lending through loans, although over time already shown good progress toward reaching even the former category is funded operational sustainability. increasingly by long-term debt. What helps The financing strategy of MFIs in Afghanistan, MFIs manage their balance sheets is that the at least partly because of lessons learned from debt MFIs obtain from MISFA is really in the other countries, has been more clearly defined nature of quasi-soft equity, low-interest rates, than in any other country in the region. The and effectively long tenors, because the loans desired trajectory toward commercial financing are rolled over if performance targets are met. is ambitious. The improvement in the financial While the emphasis on sustainability has been and outreach performance of MFIs will be the built into the financing strategy by MISFA, the critical determinant in defining how the main challenge confronting the microfinance financing actually moves ahead and the extent sector in Afghanistan relates to MFIs achieving and rate at which increasingly commercial the requisite improvement in their own sources of funds contribute to the financing of financial performance. The challenge is that MFIs in the country. If all goes well, the MFIs need to be able to build on the grant country could become the definition of an equity and soft debt financing to build their appropriate financing strategy and the CHAPTER 4 own equity capital after the first few years of transition to commercial financing; however, operations and subsequently rely largely on for now, the uncertainties and challenges are debt financing. Without this happening, MFIs many before this stage is reached. One of the will not be able to transition as quickly to a greatest challenges will be whether the 41 debt-based strategy as may be necessary to government and donor consensus to support avoid donor fatigue. It is encouraging, however, the development of a large microfinance sector that initial trends in improvements in financial led by experienced international MFIs will performance for the larger MFIs has been remain in place long enough to support the quite good with Afghanistan Rural achievement of the desired outcomes–that is, Microfinance Programme (ARMP) recording scale with sustainability. Already, there are an operational self-sufficiency (OSS) in excess signs that this support might be pulled back of 100 percent for the first quarter of 2006 and midcourse, leaving the half-developed MFIs to BRAC making steady progress toward fend for themselves. sustainability. 44 Even by current global microfinance standards, top MFIs in Afghanistan according to projected numbers may reach an individual asset base of more than $50 to $75 million in three to five years. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Bangladesh Being the first country to have achieved scale large part of this includes compulsory deposits in terms of microfinance outreach, the case of that are genuine savings instruments in that the Bangladesh is of particular interest. MFIs pay an interest on the savings and clients Microfinance in the country has been funded are allowed to withdraw their savings when through significant contributions from the they leave the program. The neat design of this 45 donor community provided over the years, product, in fact, satisfies regulatory concerns although more recently donors have become a because it is either a fixed amount for all relatively less significant source of funds. clients or linked to the size of the loan and, Another important source of funding has been therefore, can also be described as cash PKSF, the government-funded, apex collateral. Data from the MIX Market show development finance institution, which has that only 3 of the 50 MFIs46 that have reported provided large volumes of debt to MFIs at to that database offer voluntary deposit subsidized rates of 4 percent (for all except the products. largest MFIs) compared with a commercial bank lending rate of 12 to 15 percent. Over the Regarding donor funding, examining the net years, this lower-than-market interest rate has, worth composition of MFIs provides a clearer in effect, contributed to the profitability of picture. While the data on net donor equity in MFIs and boosted their net worth. Debt table 4.1 show a little over one-fourth from financing from commercial banks has donor funds, table 4.4 from the same sample generated some interest but has been relatively of MFIs from M-CRIL's rating database shows insignificant, while some of the largest MFIs that, for the 14 Bangladesh MFIs rated, total now use donor capital to lend to smaller MFIs. donated equity received is nearly 1.4 times the total net worth of the MFI (by comparison, this Another important source of funding has been is almost twice the level of Indian MFIs in M- collections from members (see table 4.1). A CRIL's database). Table 4.4. Composition of Net Worth of MFIs in South Asia Source: Data from M-CRIL, MISFA, NRB, and PMN. 42 The availability of donor funds and soft PKSF growing microfinance sector. However, the funding in Bangladesh, particularly in the benefits of this capital accumulation appear to formative years for many MFIs, has likely met have been limited in that there has not been their desired objectives of enabling outreach by much leveraging of this capital to raise creating a very large, well-capitalized, and commercial or near-commercial debt financing.47 45 Donor funding has been made available to MFIs for on-lending purposes, acquisition of fixed assets, and covering operating expenses. The first two kinds of funding contribute to enhancing the net worth, while grant funds for operating expenses prevent an erosion of net worth. 46 The MIX Market list includes several of the largest MFIs in the country. 47 Including voluntary savings. Indeed, having achieved substantial outreach, excess of Tk 50 million or $800,000) are the next key challenge for the Bangladeshi typically underleveraged and, therefore, have financial sector, both MFIs and the commercial not managed capital efficiently. The MFIs rated financial institutions, is to increase the share of by M-CRIL had a weighted average capital commercial debt financing to fund operations adequacy ratio of 43 percent. Data from 30 and growth of MFIs. MFIs reporting to the MIX Market also show a high capital-to-assets ratio of more than 20 The data presented in table 4.5 from ratings percent (the capital adequacy ratio after risk 48 conducted by M-CRIL in Bangladesh show weighting would be higher). that mid- to large-size MFIs (with portfolios in Table 4.5. Capital Adequacy of MFIs in Bangladesh Source: M-CRIL database. Increasingly, MFIs in Bangladesh are moving deposits for expansion. Thus, it is their toward more commercial sources of finance. profitability that has enabled them to remain BRAC and ASA have already moved away from independent of PKSF, because the commercial the soft financing of PKSF, and a number of banks in Bangladesh continue to be, at best, others would like to move away as well. reluctant lenders to MFIs. To strengthen the Looking at the balance sheets of the two move toward commercial sources of financing, leading MFIs that have never relied on PKSF MFIs in Bangladesh need to focus on better funds–BURO Tangail and the Shakti transparency and sustained financial Foundation–it is interesting to note that their performance. The emerging regulatory CHAPTER 4 combined reliance on deposits is, in fact, not structure for microfinance could help to much more than that of the sample as a whole strengthen this trend by according 39 percent (compared with 36 percent for the microfinance a more legitimate legal status in sample). The key difference is in the profits the financial landscape, thereby increasing the 43 earned by these MFIs. This has reversed the 10 commercial banks' level of comfort in working percent negative contribution of surpluses to with them. usable funds (as indicated for Bangladeshi MFIs by the information in table 4.1); together If deposit mobilization is made legitimate BURO Tangail and the Shakti Foundation have under the impending regulatory changes, it is a 13 percent contribution of accumulated likely that the share of voluntary deposits will profits to their usable funds, thereby reducing increase; however, for this to happen, the their reliance on debt and the necessity to raise capacity of many MFIs for designing and offering deposit products and managing the 48 Although the M-CRIL sample is a relatively small one, it includes various sizes of MFIs, including MFIs from among the top 10 in the country and relatively new entrants to microfinance. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor funds efficiently needs to be enhanced. It is portfolio and is growing 1.5 times as fast.49 notable, in this context, that Grameen More efficient leveraging of the net worth and Bank–with its separate statute and changed transitioning to commercial sources of finance approach to product development–now has a constitute the financing challenge for the next savings portfolio that is larger than its loan phase of MFIs in Bangladesh. India In recent years, the financing pattern of Indian result, the capital adequacy of Indian MFIs has MFIs has become distinct from that in other fallen even as outreach has expanded at a fast South Asian countries. The main distinction is pace. This is apparent from the data on 15 that a substantial proportion of near- leading Indian MFIs presented in table 4.6. commercial debt funding has become the most Thus, the combined capital adequacy ratio important source of funds for on-lending by (CAR) of these 15 MFIs fell from 12.4 percent MFIs. As indicated above, Friends of Women's in financial year 2002–03 to just 8.9 percent in World Banking (FWWB) (a wholesale lender) 2004–05 even as their combined outreach grew and SIDBI (a development bank) have played an by 300 percent from 82,000 to more than important lead role in this and have been 360,000 clients. emulated by some of the commercial banks. The role of FWWB and SIDBI as apex While this has meant that the financing of institutions is described and discussed in Indian MFIs has been of a more commercial section 8.2. While donor funds have also nature than in countries like Bangladesh and played a part, relative to other countries, these Pakistan, in the absence of adequate risk and have had a relatively small role in India–except long-term capital, it may probably have an through the activities of the apex institutions. adverse impact in terms of the growth of As table 4.1 shows, while debt accounts for 61 outreach and scale. Indian MFIs are more percent of funds available to Indian MFIs, highly leveraged and have a higher cost of donor equity (before adjusting for accumulated funds relative to the lending rate of commercial losses) contributes just 13 percent. And, banks, than those in other countries in the increasingly, the role of donor funds in region, reducing their ability to generate financing MFIs is declining, probably at a faster surpluses for future on-lending. Regulatory rate and to a larger extent, than in other concerns have been considerable in India, countries. reducing the role of member deposits in the financing of MFI operations to just over 20 Debt financing for Indian MFIs was pioneered percent. by FWWB in the 1990s and, since 1999, was expanded significantly by SIDBI. The advent of The problem has been reinforced by another commercial banks50 into this field in the past trend over the past couple of years: some 44 few years has led to a rapid growth of such private commercial banks, having “discovered� financing for MFIs. While initially the capital microfinance, have become overenthusiastic in base of MFIs was adequate to leverage debt, their attempts to gain international recognition over time, this debt has grown much faster as supporters and innovators in the field. than the corresponding increase required in equity to sustain these high growth rates. As a 49 The resulting liquidity could pose its own fund management problems. At present, some of the additional liquidity goes to fund bigger “enterprise� loans (but some of these could prove risky because they are not accompanied by additional loan appraisal skills training for loan officers). 50 These include ICICI Bank, State Bank of India, HDFC Bank, UTI Bank, IDBI Bank, Andhra Bank, Oriental Bank of Commerce, and ABN Amro Bank; recent entrants include HSBC, Citibank, and Standard Chartered Bank. Table 4.6. Trends in the Leverage of 15 Leading Indian MFIs 12.4% 10.8% 8.9% 7.8% Source: M-CRIL 2005 from data sourced from MFI ratings. While this has greatly accelerated the flow of available only in limited volumes and finance to Indian MFIs, as debt and shareholders' capital is not available because securitization deals, it has also led to creative most MFIs are not structured as companies, moves, such as partnership financing, that keep and internal accruals of profits are constrained the loans on the books of the banks but offer by the fact that there are only a small number portfolio servicing by MFIs. The problem with of profit-making MFIs. Even for such MFIs, this is the temptation for some banks to profits alone cannot drive growth because maximize their microfinance portfolio by interest rate restraints affect their earning pushing out larger sums of money than the capacity. MFIs have the capacity to handle. The net result is that this arrangement all but ignores In this context, there have been two positive the prudence of capital adequacy norms developments over the past couple of years. because the banks' internally generated targets First, a number of initiatives have been take precedence over such prudence. Although undertaken by SIDBI and some small private the partnership model could be a solution to funds51 to invest in the equity of MFIs. Second, the equity constraint, it is only a short-term the Government of India has launched a panacea if the capacity and management Microfinance Development and Equity Fund limitations of MFIs are ignored and financing (housed at NABARD). These initiatives taken to several multiples of the amounts required to together may not be able to address the huge fuel the reasonable and manageable growth of equity gaps in the country, however, keeping in MFIs takes place. In the long term, a fall in mind the need to sustain high growth rates in terms of a couple of MFIs collapsing under the the provision of financial services to low- CHAPTER 4 weight of their own ambitions may be income families. Conservative estimates of imminent. Unfortunately, the effect of this equity requirements for the next five years collapse is likely to reach far beyond the exceed $100 million, which is several multiples affected MFIs and could damage the of the amount indicated so far by equity 45 funders. This situation provides an avenue for microfinance sector as a whole. development and commercial investors, in the The implications of this trend and the current public and private sectors, to play a role in levels of debt financing clearly are that, unless addressing the capital constraint in Indian the availability of risk capital increases, the microfinance. rate of growth of additional debt financing could taper off and even decline. The alternatives to this are limited. Grant funds are 51 Bellwether Fund, Lok Capital, venture capitalist Vinod Khosla, and UNITUS. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Nepal The financing structure of Nepal's MFIs is institutions, RMDC and RSRF (the Rural Self- almost paradoxical. With low outreach and a Reliance Fund), and in the former case, from general concern about portfolio quality in the RMDC and the commercial banks. To the context of the ongoing conflict, losses in extent that the funds are from RMDC, lending operations and overall subsidy orientation are is near-commercial, but both RSRF and expected. Yet, the pattern emerging from table commercial bank loans are subsidized. In the 4.1 is that of a more mature microfinance commercial bank case, it is their directed credit sector with a significant proportion of equity requirement52 that is placed with MFIs, which and substantial debt (more than 50 percent of are then required to invest the funds, not in total finance). microfinance but rather as fixed deposits with specified financial institutions, including Disaggregating this disposition of MFI funds finance companies. RSRF mitigates its high (8 by type of institution, table 4.7 shows the percent) interest rate by offering a 6 percent importance of debt as a source of funds for the development rebate for on-time repayment, development banks and the NGOs–in the latter resulting effectively in a capital subsidy to its case, the funds for NGOs come from the apex MFI borrowers. Table 4.7. Financing Pattern of Different Types of MFIs in Nepal (percent of funds available) Source: Data from NRB records compiled by the authors. Note: MCDB = microcredit development bank; MFI = microfinance institution; NGO = nongovernmental organization; RRDB = regional rural development bank. The objective of financing from the apex funds it is the loss-making RRDBs and the NGOs is to facilitate outreach; however, to the extent (many of which make operating losses) that that RSRF is lax in its follow up of delinquent have low capital adequacy and desperately loans, it is merely subsidizing inefficiency. need efficiency and portfolio quality However, commercial bank parking of improvements to strengthen their balance deprived sector funds is a different matter sheets and raise additional funds for growth. altogether. In this situation, MFIs acquire risky 46 assets with those loans, compromising their Overall, the failure of the commercial banks to capital adequacy without there being any engage with the microfinance sector and the addition to microfinance outreach. Although systemic inability of RSRF, which is housed at the impact of this device may not be the central bank, to function in a professional substantial at present, it certainly has the manner means that, while microfinance in dimensions of a growing trend. It is a matter of Nepal is not short of sources of funds, it is concern in the context of the marginal capital lacking efficient operations that would adequacy of all except the smallest MFIs in the facilitate robust growth and greatly increased country (see table 4.8). By type of institution, outreach. 52 “Deprived sector� lending requirement amounting to 3 percent of the loan portfolio. Table 4.8. Capital Adequacy of MFIs in Nepal Source: Data from NRB records compiled by the authors. Pakistan Microfinance in Pakistan is still in a nascent that, at least in terms of financial leverage, stage and the outreach of microfinance is quite there are no constraining factors. In fact, there limited (see chapter 6). While the reasons for is considerable scope for growth. MFIs in the this limited outreach of MFIs in Pakistan are country have high capital adequacy levels, found in a variety of factors, including the higher than perhaps in any other country in the country's relatively early stage of microfinance region, and there is a significant degree of development, an analysis of the financial data underleveraging of capital. As the PMN data in from the Pakistan Microfinance Network's table 4.9 indicate, capital adequacy levels have (PMN's) Performance Indicators Report shows reached a high of 45 percent. Table 4.9. Capital Adequacy of MFIs in Pakistan CHAPTER 4 47 Donor funds have been the primary source for demonstrate an adequate capacity to absorb building the capital base of MFIs in Pakistan funds, future growth can readily be funded has, although the specialized microfinance by commercial debt financing. At present, institutions have also relied on shareholder commercial liabilities account for a little more capital. Debt from apex development financial than half of the total debt raised by MFIs, so institutions–such as the PPAF–forms a major there is significant scope for increasing the source of funding. Because the extent of extent of commercial financing. A positive leverage is suboptimal at present, if the MFIs aspect of the financing structure of Pakistani 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor MFIs is the extent of financing received from time, deposits from members could become an voluntary deposits enabled by licensing under increasingly important source of funds for the Pakistan Microfinance Ordinance of 2002. licensed MFIs. While this is clearly a move in The concern in this situation is that one of the the right direction for the financing of MFIs, three specialized MFIs has a negative net supervisory oversight will be critical to protect worth but is still able to raise deposits, an the deposits of low-income families from fraud aspect that poses a problem for regulators. or failure that could impede the growth of the microfinance sector in Pakistan. Nonetheless, in overall terms, the key issue for MFIs in Pakistan is to optimize their capital Another important feature of microfinance in base effectively and to obtain increased debt Pakistan is the advent of microfinance banks. financing. Because subsidized debt funding is With the possible exception of one of the six likely to be available for some time, in the short licensed banks, none has investors who expect to medium term, it is likely that at least a part to receive a return on their investments at least of the incremental debt financing from lenders for the first five or more years. From a purely will be available on subsidized terms. Although financial perspective, this absence of a this is clearly desirable for MFIs and their requirement to pay returns to investors ability to generate profits, in the long term, constitutes a relatively large subsidy that more commercially financed debt is likely to parallels the soft funding received by NGO- provide the volumes required to fuel growth MFIs from PPAF . Only one of these, the First and increase outreach. MicrofinanceBank Ltd, has started deposit mobilization, with the bulk of its deposits For this growth and outreach to happen, MFIs coming from people who are not poor and, will need to ensure that they develop the therefore, would not be eligible for bank confidence of commercial lenders, improve loans.53 Just one of these banks has become a transparency (as indeed they have through listed company so far (49 percent of share PMN) and, most important, become more capital), but even those who purchase the solvent and profitable institutions. This process bank's shares on the market are told that they is likely to require significant capacity building will not receive any return for some time. efforts and appropriate policy guidance that These banks have found more than enough encourages and increases the interface of funding from subsidized sources to mobilize commercial financiers with MFIs. At the same deposits or commercial debt and equity. Sri Lanka As indicated earlier in this section and few years ago indicates the distribution of discussed previously, microfinance in Sri Lanka funding shown in table 4.10. Deposits are follows a completely different pattern than virtually all voluntary and lending by the other countries in South Asia. It is, however, SANASA Development Bank to the TCCSs is 48 the one country that, at the client interface, available at commercial rates of interest around most closely approximates commercialization. 12 to 13 percent. The overwhelming proportion–perhaps 95 percent–of microfinance is channeled through The concern with the financing of Sri Lanka's cooperative institutions and SBSs, which are mainly community-based MFIs is the uneven financed predominantly by member deposits performance within institutional types. Thus, and significantly by equity. While exact while large numbers of these institutions are numbers are not available, information from a reported to be doing well, a number of SBSs in 53 Although some 80 percent of its depositors are in fact low-income clients, the volume of their individual deposits is small relative to the average deposit size. the northern part of the country are said to must be to determine the extent to which the have low recovery rates and several hundred of government can afford to continue its subsidy the CRBs and TCCSs are “poorly programs. Because these program generally performing.�54 A continuation of this over an are seen in Sri Lanka as the key to the state's extended period of time could result in the social welfare program, it is likely that they will collapse of institutions and loss of public continue. confidence in these community-based institutions. Table 4.10. Estimated Distribution of Sources of Looking at Sri Lankan microfinance at a more Funds for Sri Lankan Microfinance holistic level, the link of the SBSs, RRDBs, and other banks to government programs does entail a large amount of government subsidy into these programs. Nevertheless, it could be argued that the high interest rates charged by the SBSs (3 percent per month) are sufficient to ensure long-term sustainability given that repayment rates are also high. In this situation, even if the government's development subsidy Source: Authors' compilation. were to be withdrawn, the program as a whole Note: CRB = cooperative rural bank; MFI = microfinance institution; NDTF = National Development Trust Fund; NGO = nongovernmental organization could be sustainable. The key to the future SBS = Samurdhi Banking Society; TCCS = thrift and credit cooperative society. . Challenges for the Future Microfinance around the world traces its roots commercial banks to engage with MFIs. At the largely to donor-driven and funded growth. same time, Nepal has suffered from significant This applies to much of South Asia that policy distortions and public subsidies, while receives substantial financing from donors Sri Lanka's system displays considerable either directly or through microfinance-focused commercial characteristics despite the wholesale financial institutions. The broad availability of substantial subsidies in the trend in the region has been a graduation over system. Pakistan, meanwhile, still has a high time from donor-funded microfinance to a element of donor funding, although the advent greater integration with mainstream financing, of an enabling regulatory mechanism could CHAPTER 4 as considerable innovation (through help change the situation in the future. securitization and partnership financing Afghanistan, understandably, is in an early models) has taken place. This trend is period of development in the field, but 49 noticeable in all countries of the region, encouraging signs of sustainable microfinance although the pace of the graduation varies and service provision are already emerging. the level that each country has reached is different. Thus, for example, while India has As the above discussion shows, each country graduated to near-commercial levels over the of the region faces challenges in the financing past few years, progress in Bangladesh has of microfinance. These challenges are been slow because of the subsidized loans summarized in table 4.11. available from PKSF and the reluctance of 54 Charitonenko and de Silva 2002 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Table 4.11. Challenges in the Financing of Microfinance Source: Authors' compilation. Thus, the financing structure of microfinance in South Asia runs the gamut of types from Afghanistan's early period finance to Pakistan and Bangladesh's weaning off of subsidized finance to Nepal's maturing microfinance. Meanwhile, the overenthusiastic commercialization currently seen in India is vastly different from the solid deposit-based institutionalization of formal microfinance in Sri Lanka. The challenges everywhere are surprisingly similar. The challenge is to develop the management capacity of MFIs at every level to enhance their ability to run efficient operations, which will attract commercial finance–from equity investors, financial institutions, and voluntary depositors–enabling microfinance services in the long term to reach increasing proportions of the large number of low-income families in the region. 50 CHAPTER 5 Product Diversity: A growing responsiveness to client needs M icrofinance is often used interchangeably with “microcredit.� However, it is now well understood that the poor (or low-income based on a presumption of weekly cash flows from such activities. Elsewhere, particularly in many SHG and cooperative-based programs, families) normally classified as the target more flexible approaches emerged as the clients of microfinance need, and use, more agrarian basis of cash flows was taken into financial services than just microloans. account for designing products. Therefore, it is advisable to use “microfinance� to more accurately describe financial services Even in the Grameen-type system, starting of any sort provided in very small (micro-) with some rather rigid credit products amounts. Thus, for the purpose of this paper, designed to simplify delivery for the MFI rather in addition to microcredit, microfinance covers than to reduce transactions costs for clients, a the following: more diverse product range is now offered, particularly in countries like India and ■ Deposit services (or savings facilities for clients) Bangladesh that have a number of years of microfinance experience and a solid base from ■ Insurance for microclients which to add new products. In other countries ■ Money transfer (or remittance) services (for example, Afghanistan and Pakistan), most MFIs still lack depth of experience and, ■ Microleasing therefore, focus on already-proven products before a transition to more flexible and diverse The discussion in chapter 1 about the products and services takes place. The fundamental difference between the origins financial services offered by MFIs in the region and basis of the microfinance movement in are described and discussed in this chapter. South Asia compared with that in Latin America relates directly to the nature and suitability of the design of products offered. While products in Latin America were designed to address the need to scale up microenterprises in urban settings, from the start, the practice of microfinance in South Asia was firmly rooted in rural, agrarian economies. Paradoxically, because Professor Yunus' early experiment was undertaken with landless, poor women, the design of the early products was based not on the seasonality of agriculture but rather on microtrading and service activities undertaken through door-to- door selling or haat-based (marketplace-based) entrepreneurship at the village level. Thus, product design in the Grameen model was 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Loan Products Loan products act as the vanguard of financial In practice, however, many borrowers do repay service providers' initiatives (although SHGs occasionally during the loan term with the and other CBOs often start by offering mutual remaining amount paid in a lump sum at the savings products before revolving the funds as end of the term. This loan product is a loans). Thus, relatively rigid credit services microfinance analyst's nightmare: there are no originally were, and continue to be, the major fixed installments, no repayment schedule, and activity in microfinance initiatives, although only a loose understanding of the loan term. increasingly diverse and flexible arrangements Quite often repayments that are made many are developing. The major types of loan months after the end of a loan term do not products offered are discussed below. attract an interest penalty. It takes a heroic level of assumption to estimate a portfolio quality measure and determine the expected General loan yield (or annual percentage rate, APR). General loans are the most common product. For the typical rural client, depending on the These loans usually are presented as enterprise agrarian economy, this product (along with a support loans, but they are widely voluntary savings account with the SHG) has acknowledged as being general-purpose loans, the ultimate features of flexibility that meet which often (but not always) are used for borrowers' financial needs. Essentially, they productive investments.55 It is usually the first are able to save and withdraw from their loan product offered to clients after they join voluntary savings when they please and to an MFI. The amount of the loan is limited by a deposit loan repayments when they have funds ceiling that increases from one loan cycle to that exceed immediate needs. Only a loose the next and generally varies from $30 to understanding of loan term sets some $300. Typically, repayment cycles are annual, boundaries on financial behavior.56 This loan with 50 regular weekly or 10 to 12 monthly product works for the MFI (or bank) because it installments. Many MFIs charge loan is based on the SHG partly intermediating its processing fees and, in addition, most MFIs own members' deposits within the group and using the Grameen delivery system levy using MFI (or bank) funds largely as a interest as a flat charge on the disbursed supplement to the member deposits. Then, amount. Other MFIs, most CBOs and SHG- even high portfolio-at-risk (PAR) levels of 30 based MFIs, charge on declining balances. percent or more do not upset the system as Grameen-type organizations run loan long as the SHG can meet its repayment utilization checks by credit officers, most obligations to the MFI (or bank) on time. others do not. CBO programs, especially those based on Supplementary loan 52 SHGs rather than cooperatives, have additional flexibility built into them. Loans have fixed Offered mainly by Grameen-type terms but not necessarily regular installment organizations, supplementary loans are obligations. Many SHG programs in India, in shorter-term loans (usually six-month terms in particular, do not expect any repayment during South Asia) intended to supplement the general the loan term as long as the principal plus loan for whatever purpose it was provided. interest is finally repaid at the end of the term. Apart from the loan term, other conditions are similar to those applied to the general loan. 55 Most frequently used in South Asia for animal husbandry but also extensively for trading, food processing, other microenterprise activities, and working capital for crop production. 56 Sinha and Patole (2002) analyze the daily financial needs of low-income families based on the financial diaries of such families in India and argue that it is really microlines of credit rather than fixed-term finance with regular repayment instalments that microclients need. Microenterprise loan 11,000 clients, of whom 70 percent are borrowers, has reached breakeven so far). Microenterprise loans are larger loans in the $300 to $5,000 range offered to individual clients on the basis of collateral (land title or, at Home loan best, the hypothecation of productive assets acquired with the loan) or guarantors. Very few MFIs offer home loans, mainly Examples from Bangladesh include BRAC's Grameen Bank in Bangladesh and the Indian microenterprise loan, Grameen's Association for Savings and Credit (IASC) in microenterprise loan, and Proshika's SEED. In India. Grameen Bank gives a housing loan for India, Spandana, SHARE Microfin, and up to Tk 15,000 ($250) to be repaid over a five- ASMITHA offer such loans, as does BASIX. year period in weekly installments. The The loan terms range from one to two years interest rate of 8 percent is cross-subsidized and interest rates and conditions are similar to with other loan products. IASC has loans those applied to the general loan. A few ranging from Rs 20,000 ($450) to Rs 54,000 MFIs–such as BURO Tangail in ($1,200) over loan terms of 7 to 15 years at an Bangladesh–have lines of credit and other interest rate of 15.5 percent. Unlike Grameen, similar products for microenterprises. which has weekly installments, IASC has monthly payments, because its clientele is drawn mainly from SHGs promoted by SHPIs Flexible loan that are active under the bank-link program. Designed for poor clients who have trouble meeting a rigid repayment schedule, ASA Special loan (Flexible Loan Program), SafeSave (flexible savings and borrowings), Grameen II (flexi- In Afghanistan, special loan products have loan), and BRAC (Income Generation for been designed to meet particular needs–for Vulnerable Group Development [IGVGD]) are example, refinancing the opium debt of small some of the prominent examples from farmers, or providing loans for nomadic Bangladesh. The common feature among these people, people with disabilities, and programs is that clients are not required to demobilized fighters. Shariah-compliant repay loans in fixed weekly installments. lending remains a challenge, especially in Instead, a variable amount can be paid, Afghanistan and Pakistan. The problem is although some have set a minimum amount usually resolved by levying service charges and equivalent to all of the outstanding interest and fixed fees instead of charging interest. CHAPTER 5 a portion of the outstanding principal. Loan sizes start small (Tk 500, less than $10) but typically range from $30 to $60. Unlike the Grameen II “mainstream� Grameen-type MFIs, most of 53 Given the seminal nature of Grameen Bank's the flexible programs do not have a compulsion that clients must borrow. It is not clear how early initiatives and the contribution it has successful these programs have been in made to microfinance in the region, the attracting and retaining very poor clients, changes it has made recently in its products maintaining flexibility (recent evidence from deserve closer examination. Grameen has Bangladesh shows that the scope of flexibility attempted to do away with the large array of multiple loan types it had earlier and to replace has had to be reduced),57 and achieving it with just one loan type: the basic loan. In financial sustainability (of the flexi- theory, members may now borrow for almost microfinance programs, only SafeSave with any term (minimum three months) and they 57 EDA 2005. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor may negotiate individual repayment schedules. of repayment for more than a certain number In practice, however, most basic loans are still of weeks. Here again, however, practice in the given for one year and repayments remain field differs. Most workers prefer not to issue equal and weekly. A creeping proliferation of flexi loans, and find other ways of managing loan types has surfaced again, as Grameen troubled loans. For example, a provision in struggles to meet the demand for bigger loans Grameen II “tops up� loans to their disbursed (and looks for profitable investment value (or even more) halfway through the term, opportunities for the huge inflow of deposits). and at the time of topping up, the loan term For example, business expansion loans are now can also be lengthened: so workers may available, ranging from about $300 up to choose to nudge a troubled borrower along to $3,000: these loans are more likely to have the point at which the loan can be topped up. terms longer than one year. On the whole, joint liability has disappeared, although bank workers prefer to collect all Another innovation in Grameen II is the rapid weekly payments at the meeting and are rescheduling of loans that get into trouble. prepared to keep members waiting until that is These contract or flexi loans are supposed to achieved. replace a basic loan as soon as it is in arrears Deposit Products Services that enable clients to deposit savings lax, has started to create a greater awareness are of significant interest and innovation for of prudential issues among MFIs. The main MFIs. However, they are also a potential deposit products available in microfinance may minefield because of the risk of loss in the be classified as follows. intermediation process–that is, use of the clients' deposits as part of the lending process. In practice, most NGO-MFIs have been forced Compulsory savings by regulatory restraints to limit deposit-taking to credit-linked products. CBOs are able to Compulsory savings are common among offer such services because of their relatively Grameen replicators in Bangladesh, India, informal nature and the limitation of their Nepal, and Pakistan, where some amount has activities within a mutually supportive group to be saved regularly as a condition for of a small number of members. Similarly, receiving loans. Each member saves $0.02 to cooperatives are legally permitted to do so on $0.30 per week (Indian Rs 5 to Rs 20), which the understanding that it is mainly member can only be withdrawn when the member funds that they revolve as loans. In Bangladesh, leaves the program. The transactions cost of such considerations have been less of a such deposits is limited by combining problem because NGO-MFIs have dominated collection with repayment installments and by 54 the rural financial system for some years. imposing limitations on withdrawals. Recent moves to establish a regulatory Alternatively, compulsory deposits in Grameen framework for microfinance are effectively programs are fixed at a proportion of the loan designed to regulate and supervise the practice size, in the range 5 to 12 percent of the of taking compulsory as well as voluntary principal repayment. Compulsory deposits deposits that have been undertaken without a earn annual interest close to (but usually more license from the central bank until now. Similar than) the prevailing bank rate on savings moves are being offered in India. The accounts (4 to 5 percent per year). introduction of regulatory frameworks, now in place in Pakistan as well as in Nepal, however Voluntary savings practice. Members do not receive interest on deposits but instead receive a share of the Voluntary (or passbook) savings accounts with profits earned from lending the savings to flexible deposit and withdrawal terms form the members or even nonmembers. backbone of the operations of most credit cooperatives. But, regulatory restraints on NGO-MFIs apply particularly to such products Grameen II and prevent voluntary deposits from commonly being offered. Typical products Grameen Bank has made extensive changes include regular deposits like recurring deposits in its own approach to deposits. Grameen II (that could be fixed on a monthly, weekly, or has done away with the old system of sometimes even daily basis) or time deposits pooling member savings and offers instead (fixed deposits). Interest paid is usually more individual passbook savings into which (by 100 to 200 basis points) than the rates paid members are encouraged to save regularly by banks on passbook deposits58 and each week, but from which they can withdrawals are allowed flexibly (subject to withdraw at will. A second savings account, minimum balances). Such products impose known as “special savings,� is opened for additional transactions costs on the MFI and all members who borrow: 2.5 percent of the expose them to the risk of provoking a disbursed value of all loans goes into this response from the central bank, unless they are account, but when the account is three offered by cooperatives or at the CBO level. years old, it can be drawn down to Tk 2,000 (about $30). A commitment (or Many MFIs in India have moved savings recurrent, or contractual) savings product, collection to separate institutions, wherever the GPS, is offered to all members and has local laws allow the formation of MACS proven to be very popular. A low-value GPS (Mutually Aided Cooperative Societies) or is mandatory for all borrowers who take MBTs (Mutual Benefit Trusts). These MFIs are loans of $120 or more. Deposits are made member-owned institutions that collect savings monthly and the term is usually 10 years, of Rs 5 to Rs 50 per month, usually without although there are some 5-year terms. For offering interest, although members can the 10-year term GPS, the interest rate borrow from the savings pool. In recent offered is 12 percent per year, so that the months, however, the collection of savings by matured sum is almost double the deposits. MFI staff on behalf of MBTs has been As a result of these changes, two-thirds of discontinued under the instructions of the the total savings portfolio at Grameen Bank Reserve Bank of India (RBI), because the belong to members–a characteristic that has CHAPTER 5 practice constituted a violation of the spirit (if brought this product much closer to that of not, strictly, the letter) of the regulatory many SHGs and, as argued earlier, has restrictions on unlicensed deposit collection. made it more suitable to the financial needs of low-income clients. 55 Group savings Like Grameen, most SHG programs as well as the SBS in Sri Lanka have fixed deposit installments. The group decides the rate of savings ($0.50 to $2.50 per month), collects the deposits, and rotates/lends the funds internally. Many cooperatives also follow this 58 Interest on passbook savings accounts held with commercial banks range from 3.5 percent in India up to around 8 percent in Bangladesh. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Microinsurance Microinsurance is a service now drawing ■ Full-service schemes (Grameen Kalyan, Delta increased attention; it is still in the Life in Bangladesh, Spandana in India): The experimental stages in India and, perhaps, is a institution offering the service carries the risk by itself and is able to achieve high outreach by little more established in Bangladesh. However, offering simple products. Claims processing is its implications for cost and delivery systems internal but the (contingent) risks are high, and are little understood by MFIs and insurance none of the providers have purchased companies. A key factor stimulating the reinsurance. growth of microinsurance in India is the regulator's (Insurance Regulation and ■ Partner-agent model (BASIX, SEWA, ASA Grama Development Agency, IRDA) stipulation that Vidiyal in India, BRAC in Bangladesh): Allows for rapid increase in outreach. MFIs can use the insurance companies must offer a certain expertise of established insurance companies to proportion of their policies to rural clients. design products and determine premium, Thus, life insurance companies with more than whereas the latter can piggyback on MFIs to six years' operations are required to place at enroll clients, collect premiums, and, most least 18 percent of their policies with rural important, facilitate the verification and clients. For general insurance, the maximum processing of claims. As an extension of this, stipulation is 5 percent of policies for three or FWWB (the Indian apex NGO) has organized more years' operations. This cost has driven seven of its partners under its Microinsurance insurance companies operating in India to work Project. Under this program, the partner with MFIs to limit their transactions costs organizations cover various risks–life, livestock, effectively by using the ready pool of potential health, dwellings–and link up with life and general insurance companies to provide a single clients available with the latter. composite product for their clients. Sometimes Insurance is available in Bangladesh and India the partners include benefits like funeral expenses and loans to meet medical expenses for a variety of risks and covers the following: from their own resources to meet client needs.59 ■ Life–of the client and (occasionally) her spouse– for natural and/or accidental death Life insurance – most successful ■ Health–of the client and her family Delta Life in Bangladesh is the best known of ■ Assets–dwellings as well as productive assets the microinsurance programs in the region. It with livestock often attracting separate cover covers nearly 800,000 policy holders–that is, Some interesting experiments in Bangladesh roughly one-third of all microinsurance policies and India include the following three types of in Bangladesh (by late 2004).60 Delta Life offers insurance models: two highly successful endowment products: 10- and 15-year endowment policies with sum ■ Community-based models (Swayamkrushi assured from $85 to $1,650. The bonus of 7 Women's Development Mutually Aided 56 Cooperative and Thrift Society [SWDMACTS] in percent per year paid at the end of the term Andhra Pradesh, India): Essentially, the group positions this as a long-term contractual pools the premium of its members and uses the savings account by low-income client funds to pay benefits when the need arises. This households. The innovation here is doorstep is possible only within cooperative structures in premium collection on a weekly, monthly, or which members know each other. It limits the biannual basis. coverage of risk (to the overall financial strength of the group) and the scope for expansion. 59 FWWB 2005. 60 McCord 2005. In India, VimoSEWA and Spandana's life Health insurance insurance are two of the largest microinsurance schemes. VimoSEWA, started Relatively few examples of health insurance in 1992, provides voluntary insurance covering schemes are available to low-income clients. A life (of the client, spouse, and children), couple in Bangladesh (Grameen Kalyan with accident, health, and asset protection. The 60,000 families and SSS with 45,000 families)64 scheme had an outreach of 106,000 clients by have relatively large outreach; however, these late 2004 but was not yet profitable.61 Its are not really insurance schemes but more like viability was affected by low renewal rates and subsidized health service provision. In this full coverage extended to higher-risk example, the NGO plays the dual role of insurer households. It was expected to take another and service provider. These programs have seven years to breakeven. received grants for start-up and continue to require ongoing support. Spandana runs a profitable microinsurance business in the Guntur region of Andhra In Pakistan, the rural support programs Pradesh through a compulsory life insurance recently linked up with Adamjee Insurance to scheme for borrowers. It offers a single product provide hospitalization insurance to members with no riders and a low claims processing of the community organizations with whom time with 75 percent of claims settled within they work. Thus far, about 130,000 members one week. The program is perhaps the largest have signed up for a program, which charges of its type and had reached more than 300,000 an annual premium of about $4 for clients by March 2005.62 However, it has been hospitalization coverage with a cap of about criticized for charging high premiums and $400. having low value to clients. In India, health insurance has been offered on As indicated above, although a number of the a small scale by a few NGO-MFIs (FWWB leading insurance companies in India have partners Shepherd and PSA) to about 6,000 become engaged in microinsurance through people.65 It is commonly acknowledged that the the partner-agent model, one insurance main hurdle to acquiring health insurance is not provider (TATA AIG) is experimenting with a the availability of the insurance service but the different model in which the company has availability of good health facilities for the decided to offer insurance services on its facilitating MFIs to link up with in rural areas. own.63 The insurer forms groups of village-level Shepherd's Uni-Micro Health Insurance, offered insurance sellers, only one of whom is a in conjunction with the United India Insurance registered insurance agent. The group of sellers Company Limited, provides for the risk of CHAPTER 5 is jointly required to ensure that there is no destruction of assets caused by fire and allied fraud or false claims. The premium collected perils, death or disability because of accident, by the group members is passed on to the and reimbursement of hospitalization insurance company, which pays them a expenses. Shepherd's Sugam (Health) Fund 57 commission. As of March 2005, 34,100 provides loans to meet medical expenses until policies had been sold under this scheme. the reimbursement is available from the insurance company. 61 Garand 2005. Coverage information from Devadasan 2005. 62 FWWB 2005. 63 Roth and Athrye 2005. 64 EDA 2005. 65 Roth, Churchill, Ramm, and Namerta 2005. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Weather insurance–a novel idea product. In rural, southern India little fraud was reported by MFIs.67 A leading Indian provider of financial services to low-income clients, BASIX, is piloting a weather insurance scheme as an alternative to Key lessons on microinsurance the traditional government-sponsored crop Following are the key lessons on insurance schemes that have failed across the microinsurance:68 region. Under this new scheme, launched in collaboration with a formal insurer (ICICI ■ Successful microinsurance schemes are most Lombard), farmers are entitled to a payout if likely to be run by insurance companies that also have a mainstream insurance product and that their crop production suffers because of poor are not looking for immediate profits from the rainfall or if it does not rain at the right time microinsurance sector. (affecting seed plantation and germination, for instance). This insurance currently is being ■ Insurance companies and MFIs often face a offered to castor and soy farmers in two mismatch while trying to form partnerships districts of Andhra Pradesh, India. By late because insurance companies cannot find March 2005, 657 customers were insured for progressive and trustworthy partners in rural areas. Conversely, the common problem faced by an average sum of Rs 6,000 ($133);66 305 the MFI partners is the lengthy and highly claims were settled, and the claim amount technical documentation required by insurance presently exceeds the total premiums companies. This results in delays in the collected. processing of claims. ■ Most microinsurance schemes cover clients (who Livestock insurance–few takers are usually women), whereas the real need reported by low-income families is to cover the breadwinner (usually a husband or son). Many FWWB partners in India offer livestock insurance. By August 2004, six FWWB ■ To reach large numbers of clients, a partners were offering this product to 6,700 microinsurance product must be simple, with easy-to-understand terms and conditions (riders customers. However, large-scale fraud was can be confusing and complicate claims reported in one northern MFI that offered this processing). Money Transfers Money transfers are increasingly talked about carriers in north India are prone to collect an but have still drawn little attention in the informal “delivery fee� on the order of 2 to 5 region. As discussed in section 3.1.5, the use percent from the low-income recipient as well, of the post office money order for remittances the cost of the service becomes prohibitive and to low-income families from migrant relatives results in the use of the money order only 58 has been a tradition for more than half a where and when there is no alternative. century. In the modern world, however, analysis shows that the money order imposes A couple of “alternative� experiments such as very high transaction costs on the remitter and Adhikar and ICICI Bank in India are in progress the family. In India, the post office charge for and a BRAC-Western Union collaboration has the money order amounts to 5 percent of the been launched in Bangladesh. Yet, the total remitted amount. Given that most postal value of domestic remittances (in-country 66 See http://www.basixindia.com/insurance.asp. 67 Roth, Churchill, Ramm, and Namerta 2005. 68 Culled from CGAP paper on microinsurance and Pathak 2005. transfers) in India alone is estimated to be $4 single account in a local commercial bank with trillion in 2000.69 branches in Orissa and Gujarat. Twice a week, this money is transferred internally between the In Pakistan, First MicroFinanceBank is one of bank's branches to the NGO account in Orissa. the key providers of the remittance service to Adhikar staff then deliver the money to the remitter's family in Orissa. Thus, Adhikar all kinds of clients. According to the SBP provides doorstep collection and delivery for a regulations, however, microfinance banks are 70 service fee of 3 percent. allowed only domestic remittances. Hence, transfers are generally made from major cities ■ As of September 2005, Adhikar offers this in Pakistan to upcountry areas (small towns or service in two districts of Gujarat (Surat and villages) by main earners for their families' Gandhidham) to a total of 960 clients and an household requirements (like living expenses, average amount of Rs 3,400 ($75) remitted per education fees, or hospitalization and other member. Costs in the Adhikar scheme are low because most of the migrants are from the same health needs). Remittance services of the bank district in Orissa where the NGO also runs its are also used by upcountry traders to pay microfinance operations. wholesale suppliers sending goods from city- based depots. ■ ICICI Bank has linked its international money transfer service (Money2India) with village-level Notable initiatives in the microremittance kiosks. This is expected to eliminate the need for market in India include the following: villagers to travel to towns or ICICI Bank branches. The kiosk operator will inform the ■ Adhikar, an NGO in the eastern Indian state of recipient when the money is transferred, and the Orissa, started a money transfer service (Shramik latter can collect at the kiosk (through a low-cost Sahajog, help for the worker) in 2002 targeting automated teller machine [ATM]) or at the local migrant Oriya laborers working in the western bank branch. The bank estimates that a kiosk can state of Gujarat. NGO staff collect remittances profitably service a village (or group of villages) from the workers in Gujarat and deposit it in a of 2,000 households. Microleasing Microleasing is an “underutilized tool�71 in paper, leasing facilitated just 7 percent of microfinance, especially in rural areas. As the overall productive investment in Pakistan and World Bank discussion paper notes, “Leasing an even lower 3 percent in India. South Asia has the potential of partially addressing the has few experiences with microleasing. market failure in rural credit…Apart from the CHAPTER 5 Grameen Bank has been offering microleases benefit of access to a means of financing in Bangladesh for more than 10 years, but no equipment, leasing is also likely to be more other major player in the market has followed affordable to rural enterprises than are their example. Grameen Bank has offered this loans.�72 Leasing overcomes most of the product since 1992 with an average lease 59 collateral constraints with low down payments amount of $364 and total outstanding lease and much lower equity (or borrower portfolio of $22 million in 200203. The lease contribution to the asset) than often required enables the purchase of equipment for rural by lenders. However, the growth of microenterprises. Lessees are selected among microleasing is constrained by an overall lack existing microfinance clients, which tend to be of experience with leasing as a tool in South those who are better off and have additional Asia. According to the World Bank discussion sources of income. No down payment is 69 Isern et al. 2005 70 By comparison, post office money orders in India cost 5 percent, there is no doorstep collection (although there is delivery) and there are problems with postal carriers expecting a “commission� on the remitted amount from the recipient. In practice, this effectively doubles the cost of the money order to the sender. 71 Nair, Kloeppinger-Todd, and Mulder 2004. 72 Ibid. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor required from the lessee and a 20 percent flat and 2,000 microclients, respectively. Network interest rate is charged. Flexible repayments Leasing has a greater focus on include allowing lessees to repay the entire microenterprises than Orix. amount if they wish. Greater focus on leasing is required to build n Two private companies in Pakistan, Orix these experiences and enhance the suitability Leasing and Network Leasing, offer specific of the product for microclients. microleasing products, and have around 5,000 Conclusions on Microfinance Products Despite the diversity of products offered in group South Asia, in practice, the average ■ A small pool of savings resulting from her or his microfinance client's relationship with an MFI compulsory deposit available to her or him if she can be defined by a fairly standard set of or he decides to withdraw from the program obligations: ■ In some cases (especially Grameen Bank in ■ Attendance at regular weekly (fortnightly or Bangladesh, CBOs in Sri Lanka, and monthly) meetings of the group microfinance development banks in Nepal and Pakistan), access to flexible and voluntary ■ Training in “loan utilization� or participation in deposit services discussions of development issues, such as social discrimination, gender awareness, health, ■ Insurance–provided by a risk fund or insurance sanitation, and education (optional) fund created by a few MFIs or by an insurance ■ Contribution of fixed amounts, termed company in collaboration with the MFI “savings,� to a fund managed by the group or by ■ In the case of SHGs and some cooperatives, a the MFI with direct access of the member limited degree of empowerment based on a sense of or even barred belonging to a group with similar social concerns ■ Repayment of fixed amounts as installments and reinforced by knowledge and understanding (weekly, fortnightly, or monthly) on any loan she of issues in the financial management of group or he obtains from the MFI or from the group funds ■ Visits from MFI staff or the institution's guests to verify loan utilization or to assess impactformally or informally (occasional) By and large, fulfilling these obligations results in enhancing the ability of the microfinance What the client actually receives in return for client to meet his or her need for funds for fulfilling these obligations are as follows: productive activities, health and education services, and life cycle events. Enhancing ability is not the same as enabling complete fulfillment of those needs, however, and 60 ■ Fixed amounts of loan apparently “for productive activities�with the size of the loan research studies have shown that most usually determined by the longevity of his or her microfinance clients have loans from other relationship with the MFI or, in the case of sources as well. One study of the programs of some cooperatives and CBOs, by the volume of 20 MFIs in India showed that 75 percent of MFI savings rather than by financial needs clients must also borrow from other sources73 ■ Emergency loans for “consumption�–in the case and that 58 percent of their total borrowings of some MFIs/CBOs–but relatively small are obtained from these other sources. Another amounts and subject to the approval of her study in Bangladesh shows that 31 percent of 73 EDA 2003. households borrow from sources other than a Although the practice of microfinance has single NGO-MFI, but these data are likely to be made some contribution to the lives of low- highly understated because there is income families in South Asia, questions still considerable apprehension (in Bangladesh) exist about the extent to which it fulfils its about reporting borrowing from multiple purpose. Ultimately, whether or not MFIs.74 microfinance has a substantive impact on a microfinance client's social and economic However, as discussed in chapter 2, status is a matter of debate. This debate is microfinance outreach to the genuinely poor is summarized in chapter 7 after a discussion of achieved among less than 15 percent of the MFI performance in chapter 6. population in all countries of South Asia except Bangladesh and Sri Lanka. The average for the region as a whole is just 17 percent. One reason for this poor outreach is the rigidity of products: poorer clients need products that provide them with the flexibility to deposit money and to borrow very small sums of money (equivalent to a few dollars at a time) almost on a daily basis. Except for SafeSave's famous experiment in Bangladesh, this model has not been tried by MFIs. Regarding the depth of outreach, even the results of SafeSave's experiments are mixed thus far; its client profile is doing little more than reflecting the overall income distribution of the slums in which it operates. While SafeSave has now reached sustainability, the 45 percent effective interest rate charged by it on borrowings (relative to 6 percent paid on deposits) is somewhat higher than the rates that are politically acceptable in the region.75 So, although a greater emphasis on deposit and insurance products may be the key to increasing depth of outreach in microfinance, balancing this emphasis with an equally CHAPTER 5 important concern for sustainability has not yet been achieved. Thus, the debate about “plain vanilla� (the Ford motor model of ASA in Bangladesh76 and of much of Pakistani 61 microfinance) versus product variety rages on; however, inevitably, the increasing concern for social performance in microfinance is likely to result in a greater focus on product relevance to meet the needs of the poorest. 75 EM–CRIL 2006. 76 Fernando and Meyer 2002. CHAPTER 6 Transparency and Performance: Seeking sustainability and depth in a complex environment T he effectiveness of institutions in providing financial services to low-income clients can be seen from a number of angles. These include Breadth of outreach and some broad indication of depth of coverage were discussed in chapter 2. The fourth and fifth angles (sustainability the following: and relationship between depth of outreach and sustainability) are discussed in this chapter. ■ Breadth of outreach–the extent to which low- More detailed coverage of depth of outreach income families are able to obtain financial services and the methodology for collection of data on this indicator are discussed in the following ■ Depth of coverage–the extent to which coverage chapter on the impact of microfinance. Chapter actually reaches the poor and poorest sections of 7 also covers means of obtaining feedback on the population client satisfaction and determining the scope and quality of services offered by microfinance ■ The scope and quality of services offered by providers. providers–the extent to which they are able to provide appropriate types of services and But first to transparency: judgments of the whether the needs of clients are met effectiveness of institutions engaged in ■ Sustainability–the longevity of financial services providing microfinance services can be made provision to low-income clients as determined by only if information on the performance of the sustainability of institutions providing such institutions is readily available in a usable form. services. This chapter begins with a discussion of the state of transparency in South Asia before ■ The relationship between depth of outreach and sustainability in serving the financial needs of discussing sustainability and depth of outreach. low-income clients. Transparency 77 All stakeholders in microfinance may need (or ■ Clients to determine the most reliable and use) product and performance information: convenient provider of financial services ■ Directors and managers to improve operations ■ Industry analysts to map sector performance, and planning institutional growth make interinstitutional comparisons, and establish performance benchmarks. ■ Investors and donors to make sound investment decisions and tracking subsequent performance The MIX Market has identified a continuum of information systems and processes that ■ Regulators to assess and ensure prudential performance provides for the production, testing, dissemination, and use of information about 77 The discussion in this section is based on The MIX 2006. This document emerged from a major initiative to document the state of transparency in the region sponsored by the World Bank as part of the Year of Microcredit Initiative in South Asia. the performance of MFIs. The components of which are validated by (3) external audits, the transparency spectrum are the essential leading to (4) performance measurement. This building blocks of standard reporting and facilitates (5) benchmarking against (6) disclosure. Figure 6.1 illustrates this spectrum performance standards and risk assessment from (1) primary information generation through (7) rating along with (8) supervision through the management information system, for risk management within reasonable limits. (2) quality assurance through internal controls, Figure 6.1. The MIX's Building Blocks of Transparency MIS Internal External Performance Benchmarking Performance Rating Supervision Control Audit Measurement Standards Source: The MIX 2006. Note: MIS = management information system. Industry reporting Audited statements fail to provide disclosures in keeping with international reporting norms, although this is not the case for the leading Microfinance service providers in South Asia MFIs, such as those registered as microfinance monitor their expansion in terms of numbers of banks in Pakistan and NBFCs in India. clients, disbursements, loan volumes, and funding sources. M-CRIL's experience, however, shows that even here borrower numbers and client numbers (in terms of Performance monitoring initiatives numbers of people who conduct deposit or Performance monitoring initiatives in South credit transactions with MFIs) are often Asia are undertaken by national networks and confused by inconsistencies in recording and apex finance institutions. The latter publish monitoring dropouts. This confusion is only aggregate data on outreach and portfolios combined with a lack of consistent data on with institutional data kept out of the public institutional performance (only the leading domain. This is the case for PKSF in MFIs tracking it consistently). As in the bank- Bangladesh (with its 200 plus partners) and CHAPTER 6 SHG link program, an undue emphasis is SIDBI in India with more than 40 partners. The placed on cumulative measures, following a MFI networks do collect and compile MFI project-based approach that fails to track the data, but the quality and coverage varies process of financial inclusion in an effective 63 greatly. These data include the directories of manner. the Nepali and Bangladeshi networks, the more analytical but limited effort of Sa-Dhan, the External audits Indian network, and the more comprehensive effort of the PMN's Per formance Indicators External audits generally are regular to comply Report, although this covers a much smaller with the requirements of donors or commercial microfinance sector. funders. However, these audits are useful only for assessing the extent to which appropriate The situation of rating and regulation in the accounting policies are followed and not for region is discussed in chapter 8. As The MIX's understanding the MFI's financial position. transparency report concludes, 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor a small and growing number of initiatives improving the performance of their are beginning to pierce the veil around institutions, (2) increase the likelihood of MFI performance in the region. In the appropriate investment, and (3) improve most highly leveraged sector–India–expert supervision by investors and regulators (where ratings offer investors an accurate picture applicable). As the report argues, these of performance and investment potential initiatives have a public and a private goods in microfinance. 78 element and greater support needs to be made to improve transparency because better According to the report, initiatives in Pakistan financial disclosures and information hubs and Bangladesh to improve and standardize “will secure the achievements of microfinance financial statement disclosures for for the region.�79 microfinance (1) support MFI managers in Sustainability As the above discussion indicates, the leading 2006. Two MFIs reached the level of having microfinance service providers in the region sustainable operations during 2006 and the are also “best practice� institutions. Rather like overall indicators are quite positive with good outreach, there is a substantial concentration portfolio quality–most MFIs have a PAR of less of sustainable operations in a few, usually than one day (less than 1 percent) and a large, institutions. Each country has relatively sufficient service charge (32 to 50 percent) to few institutions that provide microfinance cover expenses and become sustainable within services on a sustainable basis. In general, the five years of beginning their operations. Only 1 sustainable institutions are also the largest of the 12 NGOs that have been funded so far institutions in which substantial proportions of by MISFA, however, can be said to be an the microfinance clients in each country are Afghan organization managed by Afghans. All concentrated. the MFIs plan to become Afghan organizations as soon as appropriate laws are in place and all As discussed earlier, microfinance in of them are investing in the development of Afghanistan has been promoted by a Afghan staff. multidonor facility known as the Microfinance Investment Support Facility for Afghanistan Evidence on sustainability from Bangladesh is (MISFA). The capital base for MFIs in the encouraging. Much of Bangladesh's reputation country has been created using MISFA (and as the home of microfinance (certainly in Asia) international NGO partners) grants to cover is based on the dramatic outreach achieved by start-up costs and operating expenses. The the four large organizations and by the large long-term vision of this process is to reduce numbers of MFIs (more than 700) in the grant funding gradually and for MFIs to cover country. Based on a sample of 16 MFIs expenses increasingly through operating (including ASA and BRAC and 14 other small- 64 profits. MISFA has been operating only since and medium-size NGO-MFIs), a recent study late 2003 and the trend so far has been confirms the picture of overall good encouraging: grant funding of operating performance.80 The study, using information expenses averaged about 70 percent of the reported by the 16 MFIs found that the combined income of assisted MFIs in the first following: year and 50 percent in the second year, and should decline to less than 25 percent during 78 Ibid. 79 Ibid. 80 Rasmussen, Alamgir, Ahmad, and Ahamed 2005. ■ Average loan sizes have increased over time, The M-CRIL information consists of weighted leading to greater efficiency and profitability. averages and does not cover the big four MFIs in Bangladesh, but it does include a number of ■ Operations are efficient with a cost ratio (total expenses divided by total amount disbursed in a the next-level MFIs (in terms of size), including year) of 9 to 10 percent (weighted average). ASA BURO Tangail, Shakti Foundation, Ashrai, MSS, leads the way with a cost ratio of only 3 percent. and Bangladesh Extension Education Services (BEES). ■ Portfolio quality appears to be good and consistent over time (on-time recovery rates Essentially, the MIX report and the M-CRIL exceed 97 percent). data described above confirm the overall ■ All the MFIs have profitable operations even after impression that Bangladeshi microfinance has adjusting for subsidies– made substantial progress over the years in terms of improved performance. The excellent ▶Return on assets (ROAs) for most MFIs are in performance of three of the big four the range of 5 to 7 percent (adjusted ROAs of 3 institutions as well as that of some of the next- to 4 percent), and level institutions like BURO Tangail, Shakti ▶Financial self-sufficiency (FSS) of 120 percent Foundation, and MSS, indicates that some 75 or higher (ASA greater than 170 percent). percent of microfinance clients in Bangladesh are served by sustainable institutions. It is also The difficulty of using self-reported true, however, that relatively high levels of information, however, is that definitional and subsidy still underpin many of the hundreds of accounting variations across organizations can MFIs in that country. This poses a challenge to cause result a more favorable impression to achieve full sustainability in Bangladeshi emerge than may be appropriate. An analysis microfinance and points to the unnecessary of information from 14 MFIs undertaken by M- support of a number of less viable, loss-making CRIL using information collected and verified institutions. by its analysts (mainly during 2003 and 2004) presents a modified picture. The 14 More clearly, the performance of the Bangladeshi MFIs rated or assessed by M-CRIL microfinance sector in India is less encouraging demonstrated the following characteristics:81 if viewed from the perspective of the typical MFI, but the largest institutions that account ■ A high weighted average OSS of 92 percent, with for the bulk of the clients perform a lot better. 5 of the 14 having OSS less than 80 percent. This By late December 2004, M-CRIL had indicates that the three best performing MFIs were also the largest, serving (among them) more undertaken 206 ratings of 131 MFIs in India. than 70 percent of the number of total clients. The average portfolio size of these MFIs was $1.1 million (Rs 50 million) and the average CHAPTER 6 ■ A relatively high degree of subsidy, which is loan size to clients was $90 (Rs 4,029). Using a indicated by their average FSS being 71 percent sample of 73 Indian MFIs rated between (and only two, Manabik Shahajya Sangstha January 2002 and December 2004, the [MSS] and BURO, with FSS higher than 100 65 performance of typical Indian MFIs, become percent). apparent: ■ Average unadjusted ROAs of -5.1 percent with ■ MFIs following the Grameen and individual only five reporting positive returns. lending models are close to reaching OSS with an ■ Portfolio quality, measured by the PAR ratio average of 95 percent and 101 percent, (more than 60 days) at fairly good levels with just respectively. Those working with SHGs perform 5 of the 14 having PAR60 in excess of 5 percent. less well. The average OSS of a typical MFI is 78 percent, indicating that many MFIs are not able to cover their expenses. The average OSS of SHG 81 Information from the M-CRIL database. This sample does not include BRAC or ASA. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor MFIs82 is low at 61 percent but shows Although many MFIs in India have a weak improvement from a year ago (48 percent in June equity base, their sustainability is being 2003). considerably enhanced by the aggressive ■ The older (mature) MFIs following the Grameen tactics of some of the leading private Indian model are most likely to feature among the and foreign banks, which are providing them commercially viable MFIs. Also, the older MFIs with substantial funds to manage portfolios with links to NGOs are among the most that are carried on the banks' balance sheets. profitable (because most of the group promotion This “partnership model� enables the MFIs to and support costs are absorbed by the NGO). increase their incomes substantially and circumvent the prudential concern of ■ Although there are a large number of loss-making MFIs and relatively few viable ones, one-third of mobilizing sufficient equity to maintain an the MFIs earn profits (unadjusted ROA less than acceptable (~15 percent) CAR.83 0) and four have returns greater than 5 percent of their total assets. The largest MFIs account for A recent overview of the microfinance sector more than 70 percent of MFI clients in India. in Nepal found an equally difficult situation relative to sustainability.84 The nine RRDBs and ■ As the portfolio size increases, MFIs become the microcredit development banks (MCDBs) more capable of covering their costs through together account for half of the total number of revenues and their dependence on grants and other subsidies tends to decrease. clients reached by MFIs in the country. The four MCDBs are profit-making institutions with ■ Political and social restrictions have constrained ROAs on the order of 1.5 to 2.0 percent, while many MFIs from setting cost-recovering interest three of the five RRDBs are also making rates, which affects their performance. MFIs profits, albeit partly on the back of fund with small loans (less than $100) are unable to arbitrage–that is, “deprived sector� borrowing achieve sustainability at the 18 to 24 percent from commercial banks that is then reinvested APRs typically charged. in banks or finance companies at higher rates ■ There are encouraging trends over time, because of interest–resulting in a positive ROA on the rating updates reveal a picture of a mature and order of 1 percent. The midwestern and far- increasingly professional microfinance sector– western banks, however, are reported to be in dire straits, although these banks are much ■ Substantial increase (46 percent) in the outreach smaller with borrower outreach at less than of MFIs during the 18 months or so between ratings; 10,000 each. Despite their profits, the retail development banks are struggling against ■ An increase in staff productivity and portfolio deteriorating portfolio quality (necessitating quality during this period results the following in increasing loan loss reserves now in excess of 5 increased profitability: percent) and stagnating outreach as the ▶Improved portfolio quality (PAR60 declined political situation in the country takes its toll. from 16 to 12 percent), The financial intermediary NGOs (Financial Intermediary Nongovernmental Organizations ▶Portfolio per staff member increased from [FINGOs]) and SCCSs report varied 66 $6,600 to $13,700, although the average performance: a number of these organizations number of clients per staff member decreased are experiencing losses and situations from 336 to 311, and deteriorated as defaults increased along with ▶OSS increased by 23 percent and FSS the worsening political situation in 2003. increased significantly by an average of 34 percent between ratings. 82 These MFIs channel microfinance services through SHGs. The quality and performance of SHGs as a group of institutions is equally an issue but cannot be definitively discussed for lack of detailed data. 83 For a further discussion of the issue of equity and leverage in Indian MFIs, see M-CRIL 2005a. 84 ADB 2004. The context and history of Pakistan have made market size, more subsidized donor funds have the provision of microfinance on a sustainable gone into the sector in Pakistan over the past basis particularly challenging, partly because five years, if not even before that, than perhaps of considerable pressure from government in any other country in South Asia. This is a officials, elected representatives, and the press function of the relatively early stage of to have low interest rates. Whatever interest development of microfinance in Pakistan. rates MFIs might say they are charging, Nevertheless, most MFIs have not used these nominal yield on gross portfolio numbers from funds wisely to build sustainable operations 2004 for the larger MFIs shows that only three from the start, so that subsidies were recycled (all NGOs) had yields that were as high as into their own equity to build strong commonly found in Bangladesh. The others organizations over time. Most of the subsidy had yields below 18 percent, a level that is has, instead, been passed on to borrowers more than 10 percent below that typically through the relatively low interest rates. found in Bangladesh. At this level, it is quite difficult for MFIs to cover all their costs. Recent In Sri Lanka, the more than 1,500 CRBs and analysis of performance trends in the sector 7,400 registered primary societies of the from 1999–2005 shows that the main factor TCCSs account for nearly half the market in that must change if MFIs are to become terms of numbers of active borrowers, but financially sustainable is to increase yields on many of these banks are unsustainable. The portfolios to levels that will allow for CRBs are regarded as among the more sustainability.85 commercialized microfinance providers in the country and 80 percent of these are apparently Another issue with respect to sustainability, estimated by the cooperative department to be which is more pronounced in Pakistan than in profitable and to supply about one-third of the many countries, is that almost all the NGOs country's total microcredit. A “substantial have multidimensional programs that provide a proportion of the primary societies of the range of services to poor people. This often TCCSs (which collectively supply about 15 makes it difficult to allocate costs among percent of the total outstanding microloans) functions to analyze financial performance by provide microfinance on a profitable basis.�86 each function. However, while “many of the larger and more established cooperatives have achieved The only MFI that, to date, has become fully profitability, most remain small and financially sustainable, with a positive adjusted ROA, is fragile.�87 Accounting practices in such the Kashf Foundation. Kashf had a clear vision institutions are not standardized, and it is not from the beginning that it would focus on known how many of these institutions would CHAPTER 6 microfinance only, be managed mainly by be profitable after appropriate adjustments for women for women, and target financial loan loss provisions, write-offs, and subsidies sustainability within five years of starting up. It are made. became financially sustainable in its fifth year. 67 This is in contrast to the larger, older The other large microfinance program is the organizations, including AKRSP (converted Samurdhi Programme, the government's main into First MicroFinanceBank in 2001) and the poverty reduction activity. This is partly a Orangi Pilot Project, which still have not conventional government lending program achieved financially sustainable microfinance operated by state-owned banks, and it suffers operations. from the usual weaknesses of government programs: subsidized interest rates and high Donors also influence sustainability. Relative to default rates (of 30 to 50 percent). This results 85 Burki, Bano, and Chen 2006. 86 Charitonenko and de Silva 2003. 87 Ibid. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor from the high degree of political influence in desirable objective, the evidence suggests that the credit decision-making process. The other this cannot be effectively or efficiently part of this program consists of the accomplished simply by imposing interest rate approximately 1,000 SBSs with some 1.8 caps–whether mandated or socially imposed. million members. The scheme as a whole is The usual response of microfinance service reported to have an impressive number of providers to perceived limits on interest is to active loans (some 350,000) and high on-time maximize their yield on portfolio by recovery rates, and to charge interest rates of introducing complex variations in pricing, around 3 percent per month, which should ■ Establishing methods of calculating the interest cover operating costs. Although recovery rates rate–reducing balance or flat charge are uneven, the scheme has a credit guarantee scheme and two insurance schemes to secure ■ Charging upfront fees such as loan processing its operations.88 fees or passbook charges Overall for South Asia, the MFI level is ■ Varying the payment frequency–monthly, variable. All countries have high levels of fortnightly, weekl –which affects the effective yield obtained from the loan subsidy from foreign donors (Afghanistan, Bangladesh, and Pakistan) or from ■ Expecting security deposits from clients for governments (Sri Lanka and, to some extent, which they pay low or no interest India) and eroding net worth of cooperatives (India and Nepal). Problems with efficiency in In practice, therefore, while attempts to microfinance service delivery, particularly in impose such caps have created some terms of ineffective management and control downward pressure on the pricing of systems as well as poor recovery performance, microfinance loans, the actual effect has been are compounded throughout the region by limited. Thus, although MFIs in India have, for “social control� of interest rates. Politicians a number of years, felt the pressure to reduce (and bureaucrats) in all countries are known their nominal interest rates and certainly to periodically to raise the bogey of “high� limit such rates to around 20 percent per year, interest rates in microfinance without reference M-CRIL's database shows that, across 89 of the to the clear economies of scale in microfinance leading MFIs, the effective interest rate service delivery. charged is in the range 12 to 36 percent with the typical MFI charging 24.6 percent and the Currently, action against MFIs resulting largely weighted average effective interest rate from the interest rate bogey has become a amounting to 25.2 percent per year. major impediment to the growth of microfinance in India's leading state of Andhra In Bangladesh, in January 2005 the apex Pradesh and is an area of concern in other wholesaler (PKSF) capped on-lending interest countries of the region as well. Pressure on rates for its MFI partners at a 12.5 percent flat microfinance interest rates has come in recent rate compared with the country's average flat years from politicians in Bangladesh and rate for microfinance of 15 percent. All except 68 Pakistan and from the Maoist insurgents in PKSF's two largest partners, BRAC and ASA, Nepal. In this context, it is perhaps not accepted the new ceiling. Together, however, surprising that there is no flagship commercial these two large MFIs constituted almost two- bank in the region, such as Bank Rakyat thirds of PKSF's portfolio and more than 40 Indonesia, Khan Bank of Mongolia, or ACLEDA percent of the overall market in Bangladesh. Bank of Cambodia. The net effect of this has been the emergence of a three-level interest rate structure in that To the extent that achieving an overall country, with Grameen Bank at the lowest rate reduction in interest rates in microfinance is a of 10 percent flat, PKSF partners at 12.5 88 Ibid. percent flat, and BRAC and ASA at 15 percent sufficient ability to reduce rates� in terms of the flat.89 The 14 Bangladeshi MFIs rated by M- relationship between their yield and CRIL typically charge an effective rate of 32 operational efficiency. 92 percent with a weighted average of nearly 29 percent in the range (24 to 45 percent). Despite the impression of culpability created by their problems with interest rate pressure, Although the average interest rate charged has South Asian MFIs do, in fact, charge rates that declined slightly in Bangladesh as a result of are low by international standards. This is in PKSF's cap, there has not been a significant line with their historical and philosophical decline in the overall interest rate paid by poverty reduction agenda. In the context of clients. The most likely result of the interest sustainability, therefore, these microfinance rate cap (expected by Bangladeshi MFI practitioners can draw some encouragement leaders) is that MFIs will fail to reduce the from a recent survey undertaken by the number of service providers in the market. This Washington-based MIX Market. Information would result in the average MFI in Bangladesh collected from 121 MFIs by the MIX is being larger and more efficient but lacking a presented in figure 6.2. The survey shows that, guarantee that the benefits would be passed based on the information submitted by MFIs, on to clients in terms of lower rates. According to the MFIs interviewed for the CGAP Focus as with total outreach, Bangladeshi MFIs Note, “do not expect microcredit interest rates lead the sector in profitable outreach, and to decline much in the next five years.�90 profitability is not confined to a few market leaders. In a sample of 43 Essentially, Bangladesh is a market with institutions, 35 earned positive returns, substantial competition and heavy overlapping representing 96 percent of total outreach. of operational areas, but relatively little price Those that did not cover costs served far competition. However, the CGAP study fewer clients. In India, Sri Lanka, and concludes that price is not the only Nepal, profitable MFIs represent a smaller consideration for clients who place a lot of majority of clients, on average 75 percent value on quality of service, flexible product of the respective totals.93 characteristics, and the availability of small loans. According to the MIX survey, Imposed price controls are risky because In Pakistan and Afghanistan, the majority they limit the flexibility of providers to of clients in this sample lack access to offer appropriate products to a diverse sustainable institutions. Youth and range of clients. Indeed, if prices are set program design explain much of this CHAPTER 6 too low, providers are likely to avoid dearth. In the two years since making smaller loans to poorer clients or microfinance first took hold in to exit the market altogether.91 Afghanistan, no institution has yet broken even, even though one–BRAC Afghanistan 69 The Focus Note's analysis of competition in –currently has a large, growing national three markets, Bolivia, Uganda, and base of clients…(where as) only 42 Bangladesh, indicates that “to achieve a percent of Pakistani MFI (clients) covered sustained interest rate decline, sufficiently large in this sample had access to sustainable providers must have sufficient incentive and microfinance service providers.94 89 Porteous 2006. 90 Ibid. 91 Ibid. 92 Ibid. 93 The MIX 2006. 94 Ibid. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Thus, although the performance at the MFIs that are achieving substantial growth and individual MFI level may be problematic, serving larger and larger proportions of MFI perhaps inevitably it is the more sustainable clients over time. Figure 6.2. Sustainability and Outreach in South Asian Microfinance 100% 75% 50% 25% 0% Africa EAP ECA LAC MENA S. Asia Afghani - Bangla- India Nepal Pakistan Sri stan desh Lanka Borrowers served by profitable MFIs Borrowers served by unprofitable MFIs Source: The MIX 2006. Note: EAP = East Asia and Pacific; ECA = Europe and Central Asia; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa. Information on three of the big four MFIs in Based on information emerging from an Bangladesh–available from the MIX and intimate knowledge of most of these presented in table 6.1–shows ASA and BRAC institutions,95 it becomes apparent that the key reporting excellent performance, while even to their success lies in an interplay of factors, that for Grameen Bank indicates positive including the quality of leadership, governance, returns. Information for leading MFIs from and management, on the one hand, and the other countries of the region is also presented nature of the political and regulatory in the table. Most of the leading independent environment, on the other. Without a microfinance service providers in the region supportive political and regulatory are sustainable and performing well. Both environment, it is impossible for MFIs to Khushhali Bank and NRSP in Pakistan are provide sustainable financial services. MFI government-related institutions, constrained by leaders must have the vision to aim for growth political compulsions, while SEEDS in Sri and sustainability as well as the capability to Lanka operates in a political environment that oversee the development of the products and is even more highly charged than elsewhere in systems necessary to handle larger numbers of the region. In each country, these are not only clients and volumes of funds in an effective the largest MFIs but also among the fastest and efficient manner.96 70 growing institutions accounting for significant proportions of the overall clientele. The picture of financial health emerging from this table, therefore, puts the future of microfinance in a number of countries of the region in a positive perspective. 95 Based on ratings conducted by M-CRIL in all five countries, evaluation and appraisal studies of BRAC, and considerable exposure to the activities of ASA. 96 Such systems include MIS, tracking of overdue loans, internal audits, and other controls, cash management, and financial planning. Table 6.1. Performance Indicators for the Leading MFIs in South Asia Source: Authors' compilation. Note: ASA = Association for Social Advancement; BASIX = Bhartiya Samruddhi Investments and Consulting Services Ltd.; MFI = microfinance institution; NRSP = National Rural Support Programme; OER = operating expense ratio; OSS = operational self-sufficiency; PAR = portfolio at risk; ROA = return on asset; SBS = Samurdhi Banking Society; SEEDS = Sarvodaya Economic and Enterprise Development Services; SKS = previously Swayam Krishi Sangam; SML = SHARE Microfin Limited. To conclude, in the practice of microfinance, improving as the awareness of the concept of the lessons from the South Asian experience sustainability in microfinance grows. However, are that a reliance on subsidized funding is the speed of the improvement varies among inevitable in the early stages of the activity (as countries at different points in time and is CHAPTER 6 indeed are start-up losses in any new venture). dictated by political pressures and the Based on the performance of hundreds of regulatory environment as much as by the MFIs in the region, if the environment and awareness of good practices. Over the next leadership conditions (indicated above) are in few years, because the effort to create 71 place, an MFI is most likely to become awareness of good practice is well advanced, profitable after some three years' operations, the immediate challenge for microfinance in serving some 20,000 clients and resulting in a the region is posed by the political portfolio between $2 and $3 million. The environment. This issue is discussed further in overall performance of MFIs in the region is later chapters. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Depth of Outreach and Sustainability Data on the poverty profile of microfinance critical question will be to determine the clients are not readily available because optimum proportion of clients of different definitions and measures of poverty are not so poverty levels that ensures long-term clear. Most analysis has relied on proxy sustainability and the mission to include the indicators (such as loan size) or rested on the poor. assumption that all those outside the formal financial sector are the target group for Figure 6.3. Poverty Profile of Recently Joined microfinance. Microfinance Clients in India The Rural Financial Access Study 39% 35% International 'dollar a day' commissioned by the World Bank in India poverty line examined data from SHGs in the two states of 26% Andhra Pradesh and Uttar Pradesh. Based on statistical analysis, the study concluded that there was a “positive relationship� between poorer households–the second and third quintile from the bottom–and SHG membership. It also found a positive poor & very poor vulnerable non - poor non - poor relationship between SHG membership and the Source: Sinha and Brar 2005. poorest households (although this was not statistically significant).97 Financial sustainability and poverty outreach data collected from 20 MFIs in India (in 2002 Another major study of the impact of MFI and 2003) as part of the Rural Financial Access operations in India used qualitative Study and 6 MFIs in Bangladesh during 2004 (participatory rural appraisal [PRA] wealth are presented in figure 6.4. Poverty outreach is ranking) and quantitative methods (index- shown in percentage terms (as a proportion of based ranking, income estimate) of poverty recent clients). The quadrants are shown with assessment to report on the poverty profile of FSS at 75 percent or “near financial recent clients (less than two years old) from 20 sustainability� and poverty outreach at 40 MFIs across 9 Indian states.98 A little over one- percent. The data, excluding the outliers, do third of client households were estimated to be not show a significant correlation between FSS living below the international “dollar a day� and depth of outreach.99 poverty line (see figure 6.3). MFIs in India were reaching a mixed clientele that included poor Extending financial services to the poor does and non-poor in similar proportions as not appear to affect FSS adversely, because at reflected in the local community profile (for least 8 of the 26 MFIs are approaching example, in a sample village, where 22 to 28 financial sustainability and have deep outreach. 72 percent of the households are poor, around 25 Five of these MFIs are Grameen model MFIs percent of the MFIs clients in that village are (four from India and one from Bangladesh). poor). The remaining three are SHG model MFIs from India. For MFIs seeking sustainable poverty outreach, the strategy to diversify into poor and non- From this perspective, it is interesting to poor households is practical. As more MFIs consider what factors support an effective commercialize and scale up their services, the combination of poverty outreach and sound 97 Srivastava and Basu 2004. 98 EDA 2004. 99 This discussion is extracted from Sinha and Brar 2005. financial performance. As discussed earlier, Alternately, large MFIs (more than 50,000 the economic profile of an MFI's clientele tends borrowers) serve substantial numbers of poor to reflect the local community profile. MFIs clients (more than 5,000) by virtue of their size with a high proportion of poor clients are of operations. These MFIs may not have located in poorer regions, or, if located in a specific targeting criteria but succeed in more developed region (such as the south of including poor as well as non-poor among their India), their focus is on poorer rural areas or clients. In the above sample, three such urban slums. The two MFIs with the deepest organizations (two Grameen model and one outreach are located in two of the poorest SHG model) have 9,000 to 15,000 poor clients. regions of north/northeast India (Eastern Uttar Pradesh and Assam). Figure 6.4. Comparing Depth of Outreach and Financial Sustainability 100% MFIs with sound financials and deep outreach 80% FSS=75% MFIs with sound financials Proportion of (recent) poor clients Other MFIs 60% Depth=40% 40% 20% 0% 0% 20% 40% 60% 80% 100% 120% 140% 160% Financial self sufficiency CHAPTER 6 Source: Sinha and Brar 2005. Note: FSS = financial self-sufficiency; depth = 40 percent poor or an estimated total number of poor clients greater than 5,000. Table 6.2 summarizes the key operational parameters for the three categories of MFIs included in 73 figure 6.3. The data show that MFIs that combine deep outreach and strong financials, on average, charge higher interest rates to their clients (with an average APR of 29 percent compared to an average APR of 22 percent for other MFIs). This is combined with more efficient operations (a high staff productivity ratio and, consequently, a lower operating expense ratio with a larger clientele) and excellent portfolio quality. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Thus, M-CRIL's data from MFIs in India and substantial number of poor clients within a large Bangladesh indicate the following: overall program; (criteria for household targeting does not appear to be implemented consistently ■ There is no clear trade-off between FSS and enough to make a difference). poverty outreach. A number of MFIs are close to reaching financial sustainability without ■ Small loan sizes and lower interest rates do not achieving this level of poverty outreach. At least ensure poverty outreach; and, because the an equal number have achieved–or are close to majority of households in South Asia do not have achieving–both, especially if the numbers of poor access to formal financial services, this lack of likely to be served by larger programs are access by itself is not a strong enough indicator included. of poverty. ■ Two different MFI strategies appear to enhance ■ MFIs that balance poverty outreach with sound depth of outreach: the location of operations in financial performance can run efficient poorer areas and scaling up to include a operations with excellent portfolio quality. Table 6.2. Comparing Key Operational Parameters Source: Sinha and Brar 2005. It is apparent from this discussion of the link Equally important, is the provision of all the between depth of outreach and financial types of services that low-income clients need sustainability suggests that the view often held (deposits, insurance, money transfers, by government, some donors, and the public pensions, or, indeed, credit) and the that reaching poorer people requires subsidies appropriate design of such services to serve may not always be true. In fact, well-managed those needs in a way that makes a real profitable organizations (such as BRAC and contribution to improving client's lives and Kashf) that are committed to the double livelihoods. Efforts to determine the extent to bottom line are doing more to increase the which this takes place and the extent to which depth of outreach than other MFIs, even those low-income clients are actually reached are 74 with substantial subsidies. Ultimately, what made through studies of the impact of may be required to increase the depth of microfinance programs. The world of outreach are not subsidies, generally and microfinance is increasingly focused on indiscriminately applied to large poverty conscious measures to assess and improve the reduction programs, but rather “smart social impact of these programs. Experience subsidies� that can be used by efficient MFIs to with impact studies and social performance cross-subsidize services specifically designed measures is discussed in chapter 7. to serve the poorest families. CHAPTER 7 Impact and Social Performance: Seeking the double bottom line M icrofinance is promoted as a service that has the potential to make a significant impact on the reduction of poverty in all its dimensions. ■ Present credible evidence from studies that use fairly rigorous research methods and avoid bias in the results, impact being defined as change that can be at least plausibly associated with, if The facility of small savings deposits, small and not attributed to, involvement in a microfinance increasing amounts of credit available at a program. reasonable cost with easy repayment installments, microinsurance for loans and life ■ Demonstrate the contribution of microfinance as well as for crops and health care, and programs in different countries toward attainment transfer services all support the growth of of the MDGs. Much of the evidence reported enterprises, increase employment and incomes, here comes from India, Bangladesh, and Pakistan. There were two studies available from smooth consumption, and strengthen coping Sri Lanka101 and one published impact study from strategies. Given the fact that women are the Nepal. majority client, microfinance can promote women's empowerment in a context in which ■ Reflect current impact findings from more recent men usually are the financial agents. These research work, with the exception of some aspects relate to poverty reduction, important studies from Bangladesh. understood not only in terms of income or expenditure levels, but also in terms of social Many of the studies focus on microcredit and dimensions, reduced vulnerability, and new therefore may be seen as an assessment of the opportunities. They also relate to the impact of loans rather than of the range of Millennium Development Goals (MDGs), thus financial services now associated with microfinance is often cited as a key part of the microfinance. However, at the time these global strategy to meet the MDGs. studies were undertaken, microcredit was the focus of most microfinance programs. Savings This chapter presents the evidence for such products were less of a service and more a impact, briefly discusses some drawbacks in compulsory feature, with withdrawals allowed research methodology to measure impact, and only when a client left the program. Voluntary considers recent trends in the approach to withdrawable savings, insurance, and other impact assessment and social performance financial services are a relatively recent assessment. introductions. The increasing range and variety of microfinance services will indeed add to the A survey of microfinance programs in South methodological challenges of assessing and Asia yields a long list of impact studies.100 But differentiating their impact. impact data used in this chapter are drawn fairly selectively with a view toward the There is also increasing interest in assessing following: the impact of microfinance linked to other 100 A recent detailed review of microfinance impact studies worldwide can be found in a study sponsored by Grameen Foundation USA (Goldberg 2005). 101 The two impact assessments from Sri Lanka cover the Agromart Microfinance Program (funded by HIVOS) and SEEDS (funded by NOVIB). Findings and limitations were similar to those discussed in this chapter. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor nonfinancial services, exploring whether such program (the more underdeveloped its services are necessary to enhance the effects operational area and the poorer its clients), the of a financial service. Few studies consider more relevant provision of a package of this, partly because few microfinance services will be (such as business links and programs have, until now, provided such support, skill development, and health and services or links to a significant number of education inputs), although such services will their clients. Nevertheless, it seems most likely not necessarily be provided directly by the that the deeper the outreach of a microfinance MFI. Microfinance Impact Indicators The MDGs provide a useful framework to ability to maintain consumption levels despite measure and report on impact.102 Table 7.1 fluctuations in overall income. Both of these shows how the set of poverty reduction approaches are important, with the first outcomes articulated in the MDGs can be depending on a longer time frame for impact related to commonly used indicators in and the second able to capture shorter-term microfinance impact studies. This is especially effects of microfinance. A few studies are true of the first indicator (eradicate extreme based on examining dropouts who may poverty and hunger), to the extent that represent “missed opportunities.� microfinance does reach the poor and the “extreme poor� directly or indirectly, and the Studies from the 1990s of MFIs in Bangladesh third (promote gender equality and empower (ASA, BRAC, Grameen, and other MFIs using women), because the majority of microfinance the Grameen model) reported that client clients are women. The indicators relate to households in both rural and urban areas direct outputs of microfinance services improved income levels by 8 to 40 percent as a (accumulation of savings, use of credit, use of result of the use of microcredit and acquired special loans, insurance) as well as to the physical assets (productive and household) and potential effects of increased income resulting financial assets (cash savings) in significantly from the productive use of microfinance. higher proportions than nonclients.103 Similar results emerged from a World Bank study using panel data from a 1991–92 baseline followed Impact of microfinance on poverty by a 1998–99 resurvey of clients from three major microfinance programs (Grameen Bank, The poverty impact of microfinance is BRAC, and the Bangladesh Rural Development approached in a number of ways. One approach Board) to calculate increased annual household is to look at a reduction in overall household expenditure of Tk 20 on each additional Tk poverty by using a measure of household 100 of credit provided to women.104 The same income or expenditure or by applying a broader study showed (1) a small reduction in poverty, measure such as wealth ranking by (2) an 18 percent decline in poverty in program 76 incorporating different indicators to reflect areas compared with a 13 percent decline in various dimensions of poverty. A second nonprogram areas, and (3) a substantial approach is based on an understanding of the contribution to consumption smoothening, vulnerability to risk and shock of poor with microcredit reducing variability of households and investigates a household's consumption across lean seasons for 50 102 The MDGs are as follows: (1) eradicate extreme poverty and hunger; (2) achieve universal primary education; (3) promote gender equality and empower women; (4) reduce child mortality; (5) improve maternal health; (6) combat HIV/AIDS, malaria, and other diseases; (7) ensure environmental sustainability; and (8) develop a global partnership for development. 103 For example, BIDS 1990, IMEC 1995, Rahman 1996. 104 Khandker 2005, updating Khandker 1998. By comparison, the study found that male borrowing did not increase household expenditure at all, which seems surprising. Are men perhaps less likely than women to report their expenditure fully? percent of clients, although the overall raised household income by increasing consumption level of clients remained the revenues of microenterprises supported by same. 105 loans. Over the two years, fewer clients than nonclients reported reduction in consumption An impact study of the SEWA Bank in India levels. Yet, while some client households moved compared client household incomes between out of poverty, some slipped back, resulting in 1998 and 2000. It showed that credit services a slightly increased poverty rate (40.9 percent Table 7.1. Microfinance Impact Indicators CHAPTER 7 77 Source: Authors' compilation. Note: a.These may be the direct effect of microfinance (use of a microloan, withdrawal of savings, or, in the case of health expenditure, microinsurance) or the result of increased income, or both. b.Not yet documented. 105 Pitt and Khandker 1998; Morduch 1998. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor in 2000 compared to 39 percent in 1998).106 the Grameen model, which combines substantial poverty outreach with a focus on A more recent study107 of 20 MFIs in India credit for direct investment. In MFIs that offer reported that on practically all indicators of a larger loans through an individual banking comparison with nonclients showed significant approach catering to relatively better-off benefits to clients, with a more significant clientele, the use of microcredit in small impact on poorer households (see table 7.2). enterprises that hire nonfamily labor can have an indirect poverty effect by supporting income-earning opportunities for nonclients. Table 7.2. Poverty-Reducing Effects of Microfinance (poor The study also found that 25 percent of clients of Indian MFIs) supported enterprises in such MFIs were employing hired labor. Results compiled from various impact studies of the SHG-bank link program in India report a substantial economic benefit accrued to member households, although a comparison with a control group of nonmembers is made in only one of the three studies cited.108 In all three studies, SHG members reported that the average increase in family savings and household asset values was between 30 and 50 percent two to three years after joining the group. Another study of the clients of a Grameen model MFI documents a marked shift Source: EDA 2005. a. Total number of members per earner in the household. in employment patterns of clients, from irregular, low-paid daily labor to more In 4 of the 20 MFIs, it was possible to compare diversified family business as a result of the wealth ranks of long-term clients with SHARE loans.109 Using microcredit, livestock recent clients. The comparison indicates a was the most widely acquired productive asset movement of client households into less poor in client households. wealth rank categories. Nevertheless, 30 percent of long-term clients (averaging five In Pakistan, a survey of around 3,000 clients years with a microfinance program) were still and nonclients of Khushhali Bank reported poor, confirming that the potential effects of higher incomes and sales for rural clients moving out of poverty do not accrue to all dependent on agriculture and for urban clients clients and can take considerable time. And with family-run microenterprises, compared dropout rates were slightly higher for the very with nonclient households. In rural nonfarm poor (8 percent) compared with other wealth and animal enterprises, clients showed higher ranks (less than 6 percent). value assets but no increase in income.110 78 Another survey of PPAF clients showed a small The same study, which covered different reported increase in income of borrowing models of microfinance (SHG, Grameen, and households compared with nonborrowers.111 individual banking), suggests that direct Higher incomes enabled the borrowers to poverty-reducing effects are more evident in 106 Chen and Snodgrass 2001. 107 EDA 2005. 108 GTZ 2005. 109 Todd 2001. 110 Montgomery 2004. 111 PPAF 2004. invest more in their houses and spend more reduction goal, women are seen as more likely than two times as much on house repairs than men to use their earnings for the benefit compared with nonborrowers. of their household. The latter would clearly depend on whether women do increase their The abovementioned studies report evidence “own� earnings and make decisions on the use of the role of small loans in enabling clients to of those earnings. reduce their dependence on irregular income sources and improve their ability to sustain Several studies have focused on the impact of consumption when faced with income shocks. financial services on South Asian women, Thus, there is evidence for the contribution of although with varying interpretations, microfinance to the reduced vulnerability of reflecting a tension among different measures client households, although evidence for overall of empowerment. Indicators such as self- 112 poverty reduction is less clear-cut. In general, confidence, status in the family, and role in however, and this is not usually quantified, the decision making are positive but difficult to contribution of microfinance depends on the assess in practice, being subjective and liable starting point, or relative poverty level, of each to change with age and family status. Other client household as well as the type and indicators appear to be more objective, for quantity of microfinance accessed. Context example, “control� over the loan and issues affect the impact of a financial service ownership of assets, but these indicators alone, for example, risks faced by low-income reflect a more individualized notion of households (monsoon in India's rainfed women's empowerment and have less positive regions, floods in Bangladesh, illness and the results in much of South Asia where a strong high cost of medical care, and the high cost of patriarchal culture limits women's roles. social obligations, such as dowry), differences in economic sectors and market access, and Studies in Bangladesh have documented a the challenges of building higher earnings, positive impact for women, personally, within especially for women. the household, and in terms of community participation.113 Indicators of empowerment include personal mobility, ability to make small and large purchases, involvement in household Impact of microfinance on gender equality decisions, communication between husband and women's empowerment and wife, political and legal awareness, and MFIs in South Asia have mainly targeted involvement in as well as access to social women, and this strategy may in part be networks. Generally speaking, a woman's instrumental in empowering women. Men are contribution to household income and CHAPTER 7 not attracted by small amounts of savings and ownership of assets has been a significant credit, while women are interested and willing contributing factor toward her increased self- to attend group meetings, and also are perhaps worth and improved family status. more amenable to thrift and repayment 79 Other studies114 have looked at the issue of discipline. Nevertheless, there is an underlying women's “control� over loans and their assumption that providing women, rather than involvement in microenterprises, and men, access to financial services, especially as challenged the notion of empowerment part of a mutually supportive group, is in and through microcredit. This approach is reflected of itself a step toward gender equality, with an in a review of impact studies from Pakistan expectation that this can, in turn, be that found that most women borrowers have empowering. In the context of the poverty 112 Compare Zaman 2004. 113 Pitt, Khandker, and Cartwright 2003; Kabeer 1998; Hashemi, Schuler, and Riley 1996; Todd 1996. 114 Goetz and Sen Gupta 1996. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor only partial control over loans or hand them country compared with the north, and less over entirely to male relatives.115 The review restrictive in urban areas. This study also also compares microcredit programs with comments on the fact that programs that women and men clients and comments on the include women and men clients lend more to much smaller number and amount of loans men than to women, something that women provided to women. This may not mean, clients also noted. however, that benefits are nonexistent. Some researchers emphasize the idea that household A study from Nepal also considers a SHG members, men as well as women, pool their approach under the Women's Empowerment investments and may jointly participate in Programme (WEP), which combined savings- investment and other decisions. Within existing led microfinance with a strong literacy socioeconomic structures, women benefit curriculum that covered group strengthening, from being one of the channels of credit to the business development, empowerment, and household, even if the credit is employed in a community activism. The evaluation found that male-run enterprise in which women may have more than two-thirds of women reported an little involvement. Studies of Grameen and increase in their household decision-making BRAC borrowers suggest that even if women role (sending a daughter to school, buying and do not have control over the loan amount, they selling property, family planning, and children's are still “more empowered� than women who marriage). This increased role was attributed have not borrowed at all.116 However, other to WEP meetings held several times a week researchers who define empowerment as “an that used literacy materials to emphasize the expansion in the range of potential choices potential for change. The majority (90 percent) available to women� rule out the automatic were engaged in an income-generating activity assumption of a direct correlation between after joining WEP, usually a household enterprise rather than an individual enterprise, empowerment and women's access to credit.117 compared with less than one-third before In India, studies of the SHG-bank link membership in the group.120 program118 report an increase in the self- Evidence of social action through women's confidence and decision-making ability of groups comes from a forthcoming study of women after participation in group credit and SHGs in India that reports examples, at the savings activities. More women members were village level and across village clusters, of self-confident after joining the groups and were women who are gaining the confidence to able to make a greater contribution to the become involved in community affairs family income compared with nonmembers. (lobbying for and managing village Similarly, a baseline study of 20 MFIs119 in India infrastructure, water supply, and schools) and comments on the supportive approach of the taking action on issues of social justice SHG model in which women members may (dowry, widow remarriage, bigamy)121. Such develop the capacity to manage group financial actions are possible when the supporting transactions themselves, with opportunities for agency promotes awareness on social issues, 80 social networking. Nevertheless, cultural providing guidance on options and group differences were found to affect the scope for strategies to facilitate mobilization across women's empowerment and economic activity, SHGs, as in the newly forming federations. being less restrictive in the south of the 115 Hussein and Hussain 2003. 116 Hashemi, Schuler, and Riley 1996. 117 Personal communication with Naila Kabeer. 118 GTZ 2005; Holvoet 2004. 119 EDA 2005. 120 Ash and Parrott 2002. 121 Frances Sinha, et al 2006a. Studies from different countries of the region Studies from India122 report slightly higher report increasing decision-making roles of enrollment and literacy levels of sons and women clients, and the beginning of social daughters of women borrowers, in comparison networking and group-based action at the with children of nonclients. This appears to be community level, especially in the SHG model, more significant at the primary school level although neither outcome is automatic. At the and for the very poor, with some evidence that household level, earlier concerns of whether women's group membership can lead, in women own their savings or control (or are at particular, to more daughters attending school. least involved in) the use of their microloans are being replaced by a more fundamental In Pakistan, the study of microfinance clients realization of the barriers that women face in of Khushhali Bank shows higher expenditure accessing markets and of the low returns to on schooling, especially for girls, and children their labor, relative to men. In other words, of clients were more likely to remain enrolled in microfinance is contributing to some increase schools longer than their counterparts in in women's role within existing patriarchal nonclient households.123 However, this positive limits. Gender equality will have to wait; impact was not found for all borrowers, but however, if more girls are sent to school, then only for women borrowers in NGO-supported another useful contribution will be made. groups, where the NGO also ran an education program. This finding reflects some of the Indian studies and underlines the relevance of Impact of microfinance on children's “microfinance plus� and the availability of a education school for girls. Does microfinance contribute to building the Although few in number, the evidence from human capital of the next generation by different studies indicates that microfinance making it possible for poor families to send can boost children's education in low-income their children to school? Evidence that is does households, especially for girls, if schools are is by and large positive, although school available. This is an indirect contribution of attendance is affected by the proximity of microfinance rather than directly linked to the schools, especially schools for girls. The provision of microloans or savings products available studies also predate the availability of specifically to meet the costs of schooling, microfinance products, specifically for although there is some “fungible� use of credit education (for example, education loans or for this purpose. savings products). CHAPTER 7 A 1996 study of two villages in Bangladesh showed that all of the girls from Grameen Bank client households had received some schooling, compared with 60 percent in 81 nonclient households. A longitudinal study conducted in BRAC's operational areas from 1992 to 1995 also reported a higher rate of improvement in basic competency of children in BRAC member households compared with nonmembers. 122 EDA 2005; Chen and Snodgrass 2001; Holvoet 2004. 123 Montgomery 2004. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Impact of microfinance on health strengthened through clearer analysis of different starting points, or the level of poverty of a client's household when she joins a Assessing health outcomes is a specialized program. Where such analysis has shown exercise that microfinance impact studies relatively lower benefits for the very poor, if usually have not attempted. One or two studies not their exclusion, this has led to the have assessed household nutrition and a few development of new programs outside have explored links between microfinance and microfinance, for example, BRAC's IGVGD and the use of health services or expenditure on targeting the ultrapoor (TUP) programs, as medical care as a proxy or strategy for well as the design of more flexible services improving health. within microfinance. Drawing on the World Bank longitudinal data Poverty is complex and its reduction is likely to set from Bangladesh (referred to in section take place only over the long term and from a 7.2), an analysis of the health component combination of factors. Expectations for what showed that microcredit to women had a microfinance can or cannot achieve should be significant impact on two out of the three realistic and open to the fact that microfinance measures of nutritional status of girls and boys may not only work directly through targeting (height for age and upper-arm the poor as clients, but also indirectly through circumference)124. In another study, the number building the enterprises of the relatively better- of BRAC client households using sanitary off who employ the poor and contribute to latrines increased from 9 percent in 1993 to 26 market growth, although impact studies do not percent in 1996, compared with nonclient use show the latter largely because of the emphasis staying at 9 to 10 percent.125 on the direct approach. In either case, The study on SHGs in India126 reported that contextual factors such as physical security, SHG members accessed better health care functioning institutions, and macroeconomic facilities after joining the program, resulting in stability, even timing of monsoons in the higher expenditure for medical care. The study region, can critically influence the scale of of Khushhali Bank clients in Pakistan shows impact that can be achieved through the similar results. Client households have provision of savings and credit services. Similar significantly higher expenditures to access contextual and cultural issues apply to the goal medical services from trained doctors of gender equality, although this does not compared with nonclients. emerge from the literature as a key concern. In summary, the evidence shows that access to microfinance has led to a number of positive outcomes, including building financial and social capital of women clients and their families, contributing to household coping strategies in case of vulnerability or shocks, 82 and supporting women's empowerment within existing social structures. In terms of poverty reduction, there is positive evidence on a number of dimensions, economic and social, although that evidence needs to be 124 Pitt, Khandker, Chowdhury, and Millimet 2003. The same positive findings were not found for men, for whom, as noted earlier, the data did not show an increase in household expenditure as a result of borrowing. 125 Hussain 1998. 126 GTZ 2005. Impact Assessment Methodologies and Drawbacks Despite the large number of impact studies impact study from Pakistan reported a difference recently conducted in the region, only data of 3 percent between the mean income of from a select few have been cited in this borrowers and nonborrowers. The difference report. Issues of methodology, analysis, and may be statistically significant because of the size of the sample, but it is hardly substantial. attribution continue to be the bane of most impact studies. Common pitfalls in impact ■ Impact versus Output–It is important to research that are discussed in the literature distinguish conceptually between impact and were repeated in most studies surveyed for this outputs of microfinance. For example, if a client 127 paper and need not be repeated, but in uses microcredit to purchase a buffalo, the addition, the following points that can animal is certainly a new asset and a potential undermine analysis are often overlooked. source of additional income, but it represents an output, not an impact, as long as the loan is not ■ Control Group and Selection Bias–Impact is repaid.128 statistically defined as the difference between a treatment group (microfinance clients) and a ■ Impact on Whom?–A subgroup analysis of nontreatment group (a control group of clients often reveals a more in-depth and nuanced nonclients), assuming that on all factors other picture. Many studies do not relate impact than the treatment the two groups are the same. findings to the key parameter of interest (the However, this “sameness� is difficult to establish household poverty level). All the clients are given the likelihood of selection bias. Clients self- assumed to be poor, which, as seen in the select and may have certain unobservable previous chapter, is not usually true. To be characteristics, such as entrepreneurial aptitude, meaningful, and especially to interpret the that incline them to join a microfinance program results in terms of poverty reduction, impact in the first place, in addition to which there might findings must be disaggregated to reflect be “nonrandom� program placement in that differences between poor and non-poor clients MFIs select the areas in which they operate. It is and analyze reasons for observed differences. A important to correct for selection bias and this similar disaggregation of nonclients as a can best be done through econometric analysis comparison group also reduces selection bias. using panel data. Panel data, however, are not easy to come by. Many studies rely on a single ■ What about the Utility?–The econometric visit, comparing clients with a control group of analysis in the most rigorous impact studies is nonclients at one point in time, thereby complex and often disputed, is too expensive to increasing the risk of selection bias. Other be carried out regularly, and takes too long to studies rely on recall, comparing now with before have any meaningful influence on the program. joining the program, often over a long period of Apart from this, however rigorous and robust the findings, the relationship or impact pathway CHAPTER 7 three years or more, which carries its own risks of inaccuracy and possible bias. mapping the various components of the microfinance process to the impact domains is ■ Statistical Analysis–Many studies do not report not well specified or researched. Thus, rather tests to establish statistical validity of the results, generalized conclusions are reached about 83 that is, whether the difference observed between microfinance impacts that serve an important client and control groups is by chance or is a function as far as “proving� is concerned, but difference due to the provision of financial they fail to throw much light on what type of services. microfinance (model, product, and so on) is more important for which dimension of poverty ■ Significant versus Substantial Differences–Even alleviation and impact. The relationship between when statistical tests are reported, for the results program activities and impact indicators is often to be meaningful, one must see whether the not made explicitly. Thus, such research fails to difference is substantive. For example, a recent be helpful in providing inputs for programmatic actions to attain the desired impacts or in 127 enhancing them. Meyer 2002; Hulme 1999; Ravallion 2005. 128 See conceptual framework in figure 7.1. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Recent trends in assessing the impact of loans and some savings. microfinance point in two directions: ■ Practitioner Focused–This trend reflects a break away from proving techniques to an approach ■ Researcher Focused–This approach continues the that focuses on the elements that are likely to tradition of external, donor-funded studies using lead to improved impact. The emphasis is on sophisticated econometric methods. It differs practical, focused, and simpler research guided from earlier studies by using a randomized study and used by the microfinance service provider to design to account for possible biases that affect assess whether they are achieving their social study results.129 This rigorous approach addresses objectives. It includes a client monitoring and all possible biases by randomly selecting market research approach to profile different treatment groups (those who receive client segments and to understand client needs microfinance) and control groups from a and capacities, feeding into a process of tracking potential population of microfinance clients outreach to target specific groups and of (those who are selected but delay joining to allow designing services that meet client needs the study to take place). This is an important tool appropriately. This trend started with the design for assessing impact and may be particularly of the United States Agency for International relevant for assessing the impact of microfinance Development–Assessing the Impacts of innovations. However, a drawback is inherent in Microenterprise Interventions (USAID-AIMS) the design: it may be difficult to keep the time tools, continued with the development of market difference between baseline and end-line stages research tools for microfinance by MicroSave, between one and two years. For example, a and has developed as a framework for Social study currently under way in India is limited to Performance Management by MFIs by the Imp- one year. This will limit the extent of possible Act Consortium.130 impact and will be measurable to one or two From Impact to Social Performance Traditional impact studies, although still likely to provide an invaluable and relatively important and relevant in certain low-cost means of keeping track of and circumstances, are costly and time-consuming, reporting on social mission in microfinance. and often result in findings that are too general, Two of these recent approaches are discussed although they nevertheless do not go below. undisputed. Rather than trying to prove an end result, an alternative approach is to unpack the A social performance management (SPM) pathway to impact, shifting the focus to system is owned and implemented by the MFI. managing and reporting on the steps that are SPM includes regular tracking of three social likely to lead to positive social outcomes. This goals: reaching target clients, meeting client idea is linked to the concept of “social needs in line with their capacities, and performance� defined as “the effective achieving change, or impact, through the 84 translation of mission into practice�131 and is application of relatively simple research and intended to complement the now-established monitoring tools. The information collected is systems for financial performance. Initiatives reported to the organization for decision around social performance and social making to align procedures and policies and reporting are currently somewhat adapt services to improve performance if experimental, but as they develop, they are necessary (see figure 7.1). 129 Duflo and Kremer 2005. 130 The Imp-Act Program was supported by the Ford Foundation and CGAP, and led by the Institute of Development Studies, University of Sussex, United Kingdom, working with 30 MFIs around the world. The Imp-Act approach is currently promoted by a consortium, which includes the following: in Asia, EDA Rural Systems and Reach India in India; CARD in the Philippines and elsewhere; IDEAS and the Microfinance Centre, Warsaw. 131 Sign-on letter of the Social Performance Task Force 2005. Figure 7.1. Framework for Social Performance Management in an MFI Monitorin g Use Mission Reaching Objective goals Target Clients Systems & Services Change Meeting Client Needs Use t Assessmen Intent Management Outputs Effects/Impact Source: Authors Client-level data allow an MFI to weigh its A few of the more established MFIs already performance against its social mission and have this sort of tracking system in place: objectives. A key element of SPM involves the Cashpor is well known for its housing index, systematic tracking of social and economic Grameen has used 10 indicators of poverty, conditions of clients at the time they join the and BRAC has a well-established research MFI. For a poverty-focused MFI, such a system division from which a number of studies have allows the organization to monitor its client emerged. Under the Imp-Act program, MFIs in entry profile. Simplified poverty measurement Nepal and India have used their own client- tools are being introduced for MFIs to assess level research to compare poverty outreach client poverty levels at entry (for depth of across different branches and to reassess their outreach) and over time (for change).132 In the objectives and services with reference to their context of rapidly scaling up MFIs, this could target clients' needs.133 In these examples, the prove invaluable to track the mission. core social mission of the organization is poverty reduction and SPM enables them to track progress toward this goal. CHAPTER 7 Social Rating While SPM systems are internal to the organization's social mission and systems, organization, social rating is a recently depth of outreach (poverty level of clients, 85 introduced tool for external appraisal of social operations in less developed areas), and performance. It covers all the steps of the feedback from clients on MFI products and impact pathway shown in figure 7.1 and is services. By covering the steps leading to based on the premise that most MFIs (and the change, the social rating is a good predictor of donors and investors who support them) have a impact. Social rating also includes an social mission. A social rating covers the steps assessment of “client protection� and involved in translating this social mission into transparency as an important dimension of practice. The different steps evaluated are the social responsibility. 132 For example by the Grameen Foundation, United States, through its Poverty Progress Index, derived from national household expenditure surveys in each country. 133 Copestake, Greeley, Johnson, Kabeer, and Simanowitz 2005. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Together, social ratings and credit ratings allow Lanka.134 Other specialist rating agencies, for an assessment of performance against the including Microfinanza and Planet Rating, are so-called double bottom line. By benchmarking developing such a service and have undertaken social mission and systems of different a few ratings in other parts of the world.135 organizations, social ratings, alongside credit ratings, will contribute to increased In the future, as more MFIs introduce SPM, transparency in the microfinance sector. Social social rating could be used to audit the SPM investors and donors can use these ratings to process and findings to verify that it is done facilitate the flow of funds to MFIs that are systematically, the information is valid, and starting up or relatively weak on financial there is effective reporting within the parameters but strong on social parameters. M- organization, and to advise whether the CRIL in India is the first rating agency to process can be improved. At present, until provide a specifically designed social rating more MFIs introduce SPM, social rating can service to MFIs. M-CRIL has now undertaken provide an independent assessment of poverty seven social ratings and is likely to undertake outreach and appropriateness of products and several more in South Asia in the near future, services based on a field sample of clients.136 including in Afghanistan, Pakistan, and Sri Social Protection and Safety Nets As discussed above, financial services for low- responsive products have been promising.137 income clients are an important tool to be used Yet, it is also increasingly evident that many of in consumption smoothening for vulnerable the very poorest may not be able to use credit families and to enable the poor to take effectively. Loans to those who are trapped in advantage of new livelihood opportunities. But extreme poverty may not immediately help to microfinance by itself is not a panacea for establish sustainable livelihoods that generate poverty. With some notable exceptions, enough earnings to meet repayments, possibly microfinance has been limited in its reach and leading to further impoverishment, increased usually has not provided services to the vulnerability, and overindebtedness. Savings poorest and the destitute. The destitute, products may be more appropriate for helping people without means of sustainable livelihood such households manage their money better, who are so vulnerable that they require food but on their own it is unlikely they would break aid or employment, have until now mostly been the vicious cycle of poverty. excluded. The poorest clients that microfinance has Recent efforts to increase the depth of difficulty reaching are precisely the focus of outreach through effective targeting, better another important development strategy, understanding of client needs, and more client safety nets. Although considerable overlap 86 134 Samples of M-CRIL's social ratings and the importance and impact of linking it with credit rating can be seen from the samples of the first such report undertaken for Bullockcart Workers' Development Association (BWDA), an MFI in South India, and may be found on the M-CRIL Web site (available at www.m-cril.com). 135 Various approaches for social reporting and rating have been developed separately and include those of Comite d'Echanges de Reflexion et d'Information sur les Systemes d'Epargne-credit (CERISE), Social Performance Indicators Initiative (www.cerise.com ); USAID (under its Accelerated Microenterprise Advancement Project); and Accion International. 136 As reflected in the Global Reporting Initiative. Available at www.cerise.com. 137 The evidence, however, of the promise of more client responsive products delivering on better depth of poverty outreach is sketchy. A recent study comparing the depth of poverty outreach of an urban microfinance provider in Bangladesh offering a range of flexible financial products and more traditional microfinance providers working in the same area does not find much difference (Cortijo 2005). Another recent study (Sinha et al 2006a) on poverty outreach of a set of microfinance institutions in Bangladesh, which designed new products to target the extreme poor, finds that around 11 percent of the clients are extremely poor, which is not significantly different from the industry average in Bangladesh (Matin 2006). These results could be specific to the Bangladesh context given a generally good depth of poverty outreach performances of the industry from which further deepening of poverty outreach through microfinance only route could be difficult. exists among the people that microfinance and The link model safety nets seek to serve, the microfinance discourse has generally ignored safety nets. The premise of the link model is that the Microfinance practitioners often equate safety destitute, and even the very poor, need grants nets to grants and subsidies that distort for survival. These people additionally require markets and hamper efforts to become financial services, however, just like anyone sustainable. In turn, safety net experts else. Although time bound, finite grants commonly associate microfinance with credit provide the “breathing space� needed for that creates indebtedness and increases poor survival and exploring livelihood opportunities, people's vulnerability. There is, however, a real and savings services build up microinvestment possibility of harnessing the creative funds. Some programs provide skills training experiences of these two development during this period. As the grant program strategies through a “link model.� phases out, participants are prepared to pursue Microfinance from the top going down and independent economic activities and safety nets from the bottom going up create “graduate� to become clients of regular the potential space to reach the poorest. microfinance programs. The following two Deliberately and carefully linking microfinance examples of successful links between and safety nets offers some scope for reducing microfinance and safety nets in Bangladesh poverty among the absolute poor. demonstrate how the link model could work. Case 1: Combining Public Works Employment with Financial Services The Rural Maintenance Program (RMP) of business activities with appropriate skills and CARE Bangladesh was started in 1982 as a some seed capital. public works program that provided employment to destitute rural women. Women More than 40,000 women are engaged in the are recruited for a fixed four-year period. They RMP at any one time and around 10,000 exit receive wages and participate in a compulsory every year. While not all women succeed as savings plan, setting aside a portion of their microentrepreneurs, the RMP has an wages as savings. During the four years, impressive track record. Three years after the women receive training in numeracy, human end of the program cycle, 79 percent of rights, gender equity, health, nutrition, graduates continue to be self-employed in business management, and income-generating microenterprise activities. A CARE activities. Women also receive information on Bangladesh Household Security Survey, CHAPTER 7 microfinance and on local MFIs and are conducted in early 2005, indicates that 63 encouraged to approach MFIs for working percent of RMP graduates remain members of capital and expansion needs after they NGOs even three years after graduation.138 complete the RMP . 87 Some of the key lessons learned from this CARE has successfully met the twin challenges program are as follows: of targeting the poorest and successfully ■ Start with an employment program first, a labor- graduating participants. The lower-than- intensive public works program useful to the market wage rate paid to the women serves as community a screening mechanism to ensure that only the ■ Set wages lower than market rates to screen the neediest apply. The intensive training coupled target group with the savings requirement and microfinance information prepares women to start small ■ Start collecting savings early in the program ■ Provide complementary training/life skills 138 E-mail from Dr. Phillip Tanner, Program Coordinator, RMP. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Case 2: Linking Food Aid to Microfinance The IGVGD Program, a collaborative food professional distribution agency, not by a security intervention of the Government of financial institution Bangladesh, the World Food Program (WFP), ■ Start collecting savings early in the program and BRAC, targets destitute rural women who cycle have little or no income-earning opportunities. The IGVGD Program is built on a government ■ Provide complementary training/life skills safety net program that provides free food ■ Provide very small loans for simple, easy grains for an 18-month period to destitute, economic activities female-headed households that are at the highest risk of hunger. BRAC organizes the These two cases suggest ways in which links women into groups, collects savings, and can be established between grants and provides skills training. Program participants microfinance programs. They show how the receive small loans ($50) when their skill appropriate sequencing of activities can lead to training is completed so that they can try out positive development outcomes. Starting with small income-generating activities. By the time grants to meet immediate consumption needs the cycle of free food grains ends, participants and building microassets, these programs then have accumulated savings that can be used as link to financial services, enabling destitute capital for investment, received training, client groups to move up a ladder of managed credit, and engaged in some kind of incrementally cumulative livelihood gains. entrepreneurial activity. In addition, they will have gained confidence through group Each partner in these linked programs has its participation. own comparative advantage. Mixing functions will compromise the effectiveness of the link The results of the IGVGD Program are model. A safety net institution or a program impressive. In all, the program has provided that provides grants would not have the food grain assistance in connection with the technical knowledge to provide sustainable government safety net program, savings financial services. Similarly, an MFI must services, and credit services to 1.6 million impose strict financial discipline to become destitute women since its inception. Nearly sustainable. Providing grants that do not two-thirds of these participants have require repayment would send mixed signals to graduated from absolute poverty to become MFI clients, who are constantly reminded of microfinance clients who have not slipped back the need for on-time repayments. The link into requiring further government assistance. model works only when each partner Surveys of IGVGD clients report increases in concentrates on its area of expertise, but does client incomes and basic material assets, and a so with a common understanding of the needs reduction in begging.139 of vulnerable and destitute clients. Success in such a program is about being operationally 88 Some of the key lessons learned from this separate but conceptually joint. program are as follows: ■ Use appropriate screening to ensure that only the destitute are targeted, especially female-headed households ■ Start with food aid, although food aid distribution should be handled by a separate 139 Matin and Yasmin 2006; Hashemi 2001. CHAPTER 8 Systems That Support Microfinance: Toward a democratic, inclusive financial sector A s discussed in chapter 1, microfinance in South Asia grew out of a concern for poverty and a desire to provide the poor with the augments the flow of funds in microfinance is likely to be affected by links with the formal financial systeman aspect that would entail a means to accumulate productive assets. Yet, support infrastructure such as rating systems, after nearly 30 years of a gradually growing credit bureaus, and apex funding organizations. but lately intensive effort, microfinance has And to reinforce the activities of microfinance reached a poverty coverage of only 17 percent service providers, reduce the cost of of the poor families in the region (see table operations, and increase outreach to areas 2.2). While this outreach level is high in a lacking conventional physical infrastructure, couple of countries, the overall performance is technology can play a catalyzing if not a undoubtedly low. It is apparent that to make revolutionizing role. To understand this, the microfinance more effective, and to increase role of technology in the growth of its outreach in increasing incomes of poor microfinance in South Asia needs to be families (or at least providing them with relief), examined. microfinance must have an effective set of support structures and systems. Today, in South Asia, the status of appropriate support structures is highly variable: Nepal Because stable financial systems are the and Pakistan have introduced microfinance- backbone of modern economies, the provision specific regulatory frameworks while other of financial services is invariably controlled by countries are at various stages of discussion. the central banks of each country, albeit to All countries have well-established apex various degrees. Access to microfinance organizations, although their coverage is far services is likely to be influenced by the vigor higher in Bangladesh, in particular, and India; of central banks in controlling that system and Pakistan and India have particularly active by the facilitative provisions of the regulatory microfinance networking organizations. mechanism. The extent to which that system Although rating activities are well established facilitates its use can be influenced by the in the region, coverage is extensive mainly in activities of networking organizations and India and, to some extent, in Bangladesh. In their ability to lobby for supportive regulation. each country, some aspect of these support structures needs to be built and developed Similarly, the extent to which the flow of funds further (and occasionally created from within the financial system reaches and scratch). Figure 8.1 Relative Microfinance Regulation in South Asia Sri Lanka India Bangladesh Afghanistan Pakistan Nepal Unregulated Regulated Source: Authors' creation. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Microfinance Regulation in South Asia In the matter of regulation, the countries of The DMFI regulations mention a variety of South Asia lie along a continuum. As indicated institutions, including NGOs, finance by the regulations in place, the position of the companies, credit unions, and cooperatives. So six countries covered by this paper relative to far, though, the only existing institutions that each other is depicted in figure 8.1. The mobilize voluntary deposits are the credit continuum ranges from virtual laissez faire in unions. But given the peculiar nature of credit Afghanistan to a substantial degree of unions, it is not clear how they can fit under regulation (at least on the statute book) in the DMFI regulations and ultimately it might be Nepal. better to establish other regulations specific to credit unions as has been done in many other Afghanistan countries. In the past, DAB considered preparing an NBFI framework law, under Even at this early stage in the development of which MFIs as well as other financial the microfinance sector in Afghanistan, there institutions could be registered; for now, is considerable diversity in the types of however, it has opted to go with the DMFI organizations that provide services. While regulations under the Banking Act. The much of the focus has been on NGOs, one Ministry of Finance is not in favor of such a commercial bank provides microfinance framework regulation for a disparate range of services (and two more plan to enter the financial institutions and instead would like to sector), a single leasing company provides see specific laws for each type of financial some microleasing services, a private company activity (cooperatives, insurance, leasing, and has provided microfinance services through so on). support to agriculture input supply dealers, and The Banking Act requires that banks first be a few credit unions have been established. formed as Afghan companies before they can The current legal framework for financial receive a banking license, so each type of services outside of licensed commercial banks organization that applies under the DMFI is incomplete, and leasing, credit unions, and regulations will require some form of finance companies exist in a legal vacuum. The underlying legal entity. The NGOs that central bank, Da Afghanistan Bank (DAB), has dominate the microfinance sector are already so far concentrated most of its limited registered under the new NGO law adopted in resources on establishing and regulating a 2005, but given the growing negative public commercial banking sector. There is a banking perception of NGOs in Afghanistan, the law under which 13 local and international government had a strong preference that NGO- banks have been licensed, but other financial MFIs be established as “companies.� Because sector laws will take time. In the meantime, new regulations governing the establishment of some of the 14 MFIs that have active programs companies are still under consideration, the 90 are mobilizing deposits from their members government made a special decision in early and recycling these funds in their loan 2006 to allow NGO-MFIs to be set up as portfolios. In July 2006, DAB approved “nondistributive� companies under the existing deposit-taking MFI (DMFI) regulations under 1955 Commercial Code (although this code the “exceptions clause� in the Banking Act. makes no mention of “nondistributive� These DMFI regulations were developed in companies) and to register with the consultation with the microfinance sector and Afghanistan Investment Support Agency. This apply only to MFIs that are mobilizing suits government interests, because it means voluntary deposits, not to those with that the MFIs will not legally be NGOs, compulsory savings that act as collateral for something that the government would like to loans. avoid, and also addresses the MFIs' interests in Given that many NGOs have large being categorized as entities that can migrate microfinance programs, that the laws under over time to become DMFIs regulated by the which they are established are not intended to central bank, or even commercial banks with a cover financial service activities, and that the microfinance focus. authorities presently have little capacity to oversee these NGOs, creating a new legal environment will provide a stronger legal base Bangladesh for NGO-MFI activities. This should facilitate their access to commercial funding and In 2000, Bangladesh formed a committee to improve their transparency and accountability. oversee the drafting of a regulation for At the same time, some elected representatives microfinance. The committee was chaired by and government officials would like to reign in the governor of Bangladesh Bank and included the NGOs, which would not be conducive to leaders from some of the best-known MFIs. A scaling up and improving the performance of draft regulation was submitted to the the microfinance sector. government in March 2005 and was eventually recommended to Parliament, although in a Some stakeholders in Bangladesh see the next considerably altered form. In July 2006, the step in the evolution of the sector as allowing Parliament approved the Micro Credit MFIs to mobilize public deposits (voluntary Regulatory Authority Act under which a deposits from nonmembers) rather than separate regulatory authority will be depending on other sources of funds to scale established to oversee the operations of NGO- up. NGO-MFIs already mobilize large amounts MFIs. This act also provides legal cover, which of deposits from their members, but becoming was previously missing, for the microfinance a microfinance bank would enable MFIs to activities currently being undertaken by NGO- mobilize deposits from the general public, MFIs, including mobilizing deposits from something that Grameen Bank has done members. successfully. While the cabinet has expressed concerns about opening the door for The committee proposed a regulation that microfinance banks, experience from Nepal, would cover the microfinance activities of Pakistan, and Cambodia shows that, in the NGOs and microfinance programs of restrictive conditions normally applied to such government ministries, while allowing for the separate microfinance regulation, there is little creation of microfinance banks. It proposed incentive for entities without a commitment to five tiers for banks, from the national level microfinance to enter the field. Thus, the down to the district level, the former requiring danger of the regulator being overwhelmed by CHAPTER 8 paid-up capital equivalent to an NBFI and the entities that qualify for such regulation is latter requiring very little paid-up capital. Both minimal. the NGOs and the microfinance banks would be regulated by a new regulatory commission, 91 India not by the central bank. The cabinet, however, decided to leave government ministry The past six to seven years have seen programs out of the regulation and did not substantial advocacy for microfinance favor the creation of microfinance banks, regulation in India. Starting with the formation believing that this could open the door to of Sa-Dhan, an association of microfinance unscrupulous operators and questioning the institutions in 1999, advocacy for microfinance capability of any regulator to oversee a large regulation intensified over the years until the number of small institutions. Thus, the act that finance minister's 2005 budget speech formally was approved in 2006 only includes committed the government to present a requirements for NGO-MFIs. microfinance legal framework to Parliament. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor The drafting of this framework is in its final this happen, the regulator would get the blame. stages and it will be presented to Parliament in As it is, the central bank has its hands full the winter session of 2006-07. regulating and supervising large numbers of financial institutions, including the following: The framework, earlier proposed as an amendment to the NABARD Act,140 is now to ■ 27 scheduled commercial banks in the public be presented as a standalone piece of sector with some 45,000 branches legislation. The proposed Act mandates the ■ 55 private Indian and foreign commercial banks establishment of a Micro Finance Development with some 5,000 branches Council (MFDC) “for promotion, development and orderly growth of the micro finance ■ 196 RRBs with another 14,000 branches – as sector…� It also mandates the creation of a rural subsidiaries of the public sector commercial category of microfinance service provider – banks the microfinance organization (MFO) – ■ 1,800 (single-town) urban cooperative banks, recognized, regulated, supervised, and more than two dozen state-level cooperative promoted by NABARD. The MFDC would banks at the apex of more than 350 district advise NABARD on the formulation of policies cooperative banks and nearly 100,000 primary and measures to ensure the orderly growth and (village-level) cooperative societies development of the microfinance sector. MFOs ■ As many as 7,000 registered NBFCs would be NGOs (societies, trusts, and cooperatives) that are “formed for the purpose of providing micro finance services…� and According to the RBI, allowing for the creation have net owned funds (net worth) of at least of regulated microfinance entities would open Rs 500,000 ($11,100). The supervision the floodgates to large numbers of institutions, proposed consists mainly of “setting sector increasing the magnitude of its task and related benchmarks and performance multiplying the risk to the financial system if standards pertaining to methods of operation, the operations of existing MFIs are accorded management and governance, including model the legitimacy implied by the central bank. codes of conduct of business for Micro Finance Against this backdrop, the government's Organisations engaged in the provision of thrift acceptance of a limited regulation of MFIs that services and micro finance services.� For now, offer thrift services to members rather than the both types of companies (for-profit NBFCs and public is a promotional measure that could not-for-profit Section 25 companies) have been have far-reaching implications for the financial omitted from the Act on the grounds that inclusion of many more poor people. However, these are already under the ambit of regulation the exclusion of companies from this by the RBI. Coverage of these under the new legislation means that a dual regulatory regime Act, therefore, is deemed by the government to is likely to emerge whereby the best MFIs be unnecessary. transform into NBFCs in order to have access to the equity and large volume of debt funds During the long process of discussing, and available to such institutions while the less 92 agreeing on, a regulatory framework for successful MFIs are subject to a relatively lax microfinance in India, the RBI's main concern regulatory regime that inspires limited was with the need to control the entry of confidence. Discussions on the proposed Act unscrupulous operators into the formal are ongoing at the time of writing (November financial system. The RBI was concerned that 2006) and the final form of the legislation is such operators would creep in through the yet to be fully determined. backdoor as microfinance operators, and collect and then embezzle the deposits of the At the same time, the Indian government's public, especially low-income families. Should engagement with the issue of microfinance and 140 This statute established the National Bank for Agriculture and Rural Development in 1982 the need to increase the outreach of banking the eastern region was sufficient to generate services to low-income clients has led to the interest in more development banks being RBI investing more energy in new ideas. In established and led to the introduction of the January 2006, the RBI officially floated the Development Banks Act 1996. This act allowed idea of “business correspondents� for the for the creation of more such banks with banking sector in India to disburse and recover private equity and established the Nirdhan “small value credit,� collection of small Utthan Bank as the first private development deposits, microinsurance, and pension bank in Nepal. There are now four such private products as well as remittances and other retail development banks, all established by payment instruments.141 The circular leading NGOs and all operating in the terai. specifically lists NGOs-MFIs as the entities that may act as business correspondents and The promulgation of FISA in 1999 came as a provides for the banks to pay a reasonable fee logical extension of this development. FISA to them while prohibiting them from charging was intended to introduce the concept of the customers any fees for services rendered “limited banking license� as a way to directly by correspondents. In some other legitimize the financial services activities of countries, for example Brazil, this approach has NGOs registered as societies or cooperatives. considerably expanded outreach of financial The limited banking license gives its holder the services to poor and underserved households. right to provide microcredit to “low-income families� and to collect the savings of such families described as “members.� There were Nepal 49 NGOs and 19 cooperative societies holding limited banking licenses under the provisions Nepal was the first country in the region to of this law in late 2005. introduce specific regulations for the microfinance sector: the Development Banks FISA has been a major source of confusion in Act was passed by Parliament in 1996 and the the regulation of microfinance in Nepal. The first Financial Intermediary Societies Act act says nothing about the collection of savings (FISA) was passed in 1999. Unfortunately, from the general public and has led to Nepal's attempts at regulation have been confusion with the Cooperatives Act, which is characterized more by confusion than by more liberal regarding membership and does clarity in its strategy to pursue a poverty not include income or account size limitations. agenda. Microfinance regulation evolved from It specifically prohibits the collection of official attempts to promote a poverty agenda deposits from nonmembers, which FISA does through the Nepal Rastra Bank's (NRB's) not. This has placed cooperatives that are CHAPTER 8 sponsorship of the five RRDBs. The RRDBs limited banking license holders in a legal limbo were established beginning in 1992, initially with regard to deposit-taking. The main under the Commercial Banks Act, and had attraction of the limited banking license for majority NRB shareholding and significant cooperatives has been the stamp of legitimacy 93 contributions from the commercial banking conferred by central bank supervision. At the sector, albeit virtually on the instructions of same time, this stamp of assurance does not the central bank. seem to have benefited NGOs, which have not been successful at raising voluntary deposits The purpose of the RRDBs was to provide from members, let alone from the general financing to the poor in Nepal, initially in the public. terai (plains) areas, but with the hope that they would later be able to expand into the middle The original version of the act included a hills if not the high mountain areas. The clause that implied NRB underwriting of the potential demonstrated by the first RRDB in loans awarded to societies that were licensed 141 RBI 2006. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor by the act. This clause is thought to have been commercial banks are willing to lend. Recent introduced by the government under pressure modifications to the law made in 2006, from some of the leading international NGOs however, provide for greater flexibility and working in Nepal, although it was dropped in empower the regulator to continue to make 2003 after vociferous objections by the central changes as required.142 The ordinance bank. particularly aims at creating special microfinance banks at four levels–national, Whatever the history of regulation in Nepal, provincial, regional, and district–each with the advent of the licensing of microfinance different capital requirements that are well activities has not presented opportunities for below the requirement for commercial banks. fraudulent operators; the number of registered institutions is small and few have been shut The ordinance is not concerned with NGO down for financial impropriety. microfinance programs and relates only to MFIs that wish to mobilize deposits. The In the meantime, to compound the confusion, microfinance banks are licensed and regulated the central bank has recently proposed yet by the SBP under specially designed prudential another microfinance law that would result in regulations. The regulator has adopted an open the creation of a “super apex� organization to approach to the sector, including the creation be run entirely by government officials and be of a microfinance consultative group chaired responsible for a multitude of activities, by the SBP and composed of representatives including licensing, regulation, supervision, from the sector. financing, development promotion, research, and overall poverty alleviation through By late 2005, there were six microfinance microfinance. With conflicting functions and banks with more in the pipeline, although the overlapping responsibilities, such an institution largest of these banks, Khushhali Bank, was would place all MFIs and cooperatives at the established in 2000 under a special ordinance mercy of the proposed “Microfinance and for that purpose before the Microfinance Cooperative Center� with few safeguards to Institutions Ordinance was adopted. First mitigate the problems likely to arise. MicroFinanceBank was licensed immediately after the ordinance was passed in 2001 and, to date, it is the only case of an NGO program Pakistan “transforming� into a microfinance bank. Two district banks in Karachi district were licensed In 2000, microfinance was elevated to be a in late 2004 and are in the early stages of core aspect of the government's poverty establishing their operations. In August 2005, reduction program. Thus, the introduction of another national-level license was granted for a the Microfinance Institutions Ordinance 2001, bank that began operations in late 2005. In under which microfinance banks are licensed, early 2006, another national-level license was was driven by a poverty reduction agenda granted. rather than being focused on building an 94 inclusive financial sector to include poor The primary reason the government people in the mainstream. The ordinance encouraged microfinance banks was to more restricted microfinance banks to provide loans rapidly scale up microfinance outreach. So far, only to poor people, defined as those with however, only Khushhali Bank has achieved incomes below the income tax floor, and significant outreach, and the NGO sector still restricted loan size to a maximum of PRs has more loan clients than the microfinance 100,000 ($1,700), too low to enable clients to banks. But considering that demand is largely easily make a transition into the mainstream unmet, and that it will take huge amounts of financial sector and well below the amounts funding to satisfy that demand over the next 142 Ahmed 2006. decade or more, microfinance banks that to invest PRs 1.7 billion ($285 million) to mobilize deposits and can more easily access capitalize Khushhali Bank, and some commercial funding have the potential to take commercial bank executives have said that they a large share of the market, if they have good invested out of a sense of national business models. responsibility. Only one microfinance bank has begun to mobilize deposits to any extent, and even that Sri Lanka bank has found it costly to open flexible savings accounts for poor people. It is not clear The main issue in the practice of microfinance whether poor people want to retain liquid in Sri Lanka is the crowding out of private assets in any quantity; many seem to prefer sector initiatives and impediments on the path investments in livestock, housing to sustainability. These impediments result improvements, other fixed assets, and from a series of government-promoted consumption spending. Regarding loans, the development programs that back up the restrictions on loan size reduce the flexibility panoply of institutions (for example, SBSs and microfinance banks have to offer the same CRBs), which are characterized by operations range of products as commercial banks and supported by market-distorting subsidies. The other financial institutions. cooperatives, the largest suppliers of microcredit and savings services to low-income Other than Khushhali Bank, the microfinance clients, are inadequately regulated and banks have had more limited access to soft supervised and lack a legal framework in money than NGOs, and if they are profitable, which to legitimize or supervise the activities their profits are taxed at 43 percent, the same of NGOs. Even the ban on the supply of deposit as commercial banks. The fact that most of the services by unregulated NGOs is not enforced. investors are not looking for returns does The commercial banks, meanwhile, are only constitute a significant subsidy. Only one of the minimally engaged in microfinance. As a result, microfinance banks established thus far there is a high degree of laissez faire in the expects to generate much in the way of returns provision of microfinance services in the to investors for the foreseeable future. In fact, country. financial performance until now would not attract investors seeking even a modest return In 2006, the long-discussed Micro Finance on their investments. Neither of the banks that Institutions Act was finalized and will likely up have been operational for the past few years for approval soon. It provides a lot of flexibility had a positive adjusted return on equity in to establish various sizes of MFIs, which can 2004. Projections made for the most profitable CHAPTER 8 act as banks (for example, they will be able to MFI in Pakistan, an NGO that has been mobilize deposits). Barriers to entry, such as considering transformation into a microfinance minimum paid-up capital, have been set at low bank, show that internal rates of return would levels. The act allows for NGO-MFIs to 95 be around 5 percent annually, whereas even mobilize deposits once they have received the socially minded international investors usually regulator's permission. Furthermore, it states target returns of 10 percent. that the Central Bank will regulate cooperative societies that are engaged in microfinance. All Investors in Pakistan have largely been of this puts a large burden on the regulator. So motivated by “corporate social responsibility� far, however, no regulation beyond the existing or similar reasons, resulting in little motivation supervision by the societies' registrars is to act in a commercial manner or hold the proposed for the SBSs. These groups constitute microfinance banks accountable to achieve an important part of the government's better financial or outreach performance. The antipoverty agenda and are virtually an government encouraged the commercial banks untouchable element of the country's 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor development framework. Yet, because these considering a draft law (India and Sri Lanka), or societies dominate the microfinance have developed special regulations under the landscape, regulation that excludes them is banking law (Afghanistan). virtually meaningless. At the same time, the Central Bank has not shown a lot of Table 8.1 summarizes the status of regulation enthusiasm for regulating a microfinance of the major institutional types engaged in sector populated with a large number of providing microfinance services in South Asia. institutions that are not transparent or well As the table shows, only Nepal has a managed. comprehensive microfinance regulatory mechanism in place, however faulty it may be. Apart from Nepal, Bangladesh and Pakistan Conclusions on microfinance regulation in have specific microfinance frameworks in place, although only the latter allows for South Asia microfinance banks to set up. In India, the idea It has become fashionable in South Asia for the of allowing such banks has been specifically microfinance sector and governments to draft, rejected by the respective governments, consider, and adopt special microfinance whereas Sri Lanka's cooperative banks are regulations. All six of the larger countries in really independent initiatives without central the region have a microfinance regulation in bank oversight. place (Bangladesh, Nepal, and Pakistan), are Table 8.1. Regulation of Institutions Engaged in Microfinance in South Asia Source: Authors' compilation. Note: REG = already regulated; TBR = to be regulated in the foreseeable future (or under discussion); UNR = unregulated; n.a. = not applicable; = non-bank microfinance companies don't exist in these countries. a. Refers to cooperatives that are active as modern microfinance entities rather than conventional agricultural cooperatives. From a regulators' perspective, regulation financial products, and to ensure clear, 96 should take the broadest possible approach and transparent reporting and accountability. The not be based on narrow interests, particular regulatory approach in Latin America since the products, or narrowly defined special mid-1990s, for example, focuses on access, institutions. In fact, the main goal should be to allows for a wide range of financial service increase access, not limit it, maintaining a providers, sees financial service provision balance between the autonomy financial primarily as a business activity, and regulates institutions need to operate effectively and by exception, allowing service providers a fair sufficient accountability to ensure that financial amount of leeway until there is a proven need service institutions remain strong. The purpose to regulate exceptional circumstances. is to increase access, not be prescriptive about By contrast with Latin America, South Asia's of so-called banking activities, while at the approach to regulation focuses on the special same time, they are reluctant to get too microfinance niche that has emerged over the involved. As witnessed by the lack of central past 30 years. It is designed for special, bank regulation and any other form of relatively narrowly defined MFIs, views effective regulation of cooperatives, central microfinance as primarily being a socially bank regulators have historically been loathe to oriented poverty reduction tool, and uses an take on the regulation of a very large number extensive set of rules based on this particular of organizations, especially organizations they view of microfinance. In a sense, this approach do not understand well. Thus, Pakistan is recognizes the success of the microfinance reluctant to allow for too many microfinance sector in South Asia over the past 30 years as a banks and Bangladesh, India, Nepal, and Sri poverty alleviation tool and tries to embed that Lanka have created or are proposing to create history in the law and regulations. In the region special regulatory bodies, outside the central of the world with some 40 percent of the bank, just for microfinance. Yet, there is no world's poor, this is perhaps appropriate. example in the world of special regulatory bodies for microfinance having been Nevertheless, this approach is not particularly particularly successful. forward looking and does not consider the changes the sector will undergo with the All of this raises the questions of why introduction of new approaches, institutions, regulation is needed and at what stage of and technologies, for example, allowing evolution of the sector might it best be banking correspondent relationships as in India introduced. On the one hand, there is little or changing banking regulations to allow for reason to impose prudential regulations on mobile telephone banking. It focuses on a NGO microfinance service providers unless special niche market instead of looking at the they are taking and intermediating deposits. big picture, and it enshrines the importance of On the other hand, most countries already have MFIs instead of microfinance.143 The only several laws, such as banking, NBFI, and exception to this approach is Afghanistan, the cooperative laws, which were specifically most recent entrant to the microfinance intended to provide financial services to the industry and the only country that explicitly poor.144 Between these two approaches, there recognizes microfinance as a mainstream needs to be consideration of what else is financial activity. Afghan MFIs are but one needed to scale up, deepen, and diversify form of microfinance service provider in a outreach. New regulations for NGOs, primarily sector in which other mainstream financial because of deposit mobilization from institutions, including banks, leasing members, were adopted in 2006 in CHAPTER 8 companies, and credit unions, already provide Afghanistan and Bangladesh, and laws are microfinance services. being considered in India and Sri Lanka. Yet, there is an increasing sense worldwide that While it is still too early to judge the impact of MFIs mobilizing deposits from members need 97 this “rush to regulate,� the examples of the not be regulated like banks, since the risks are Pakistan and Nepal laws show that a specially considerably different and may not represent a designed microfinance banking regulation threat to the overall financial system because intended to rapidly scale up outreach and the institutions are typically very small. This introduce a wide range of microfinance has been taken into account by the regulator in services will not necessarily succeed in Afghanistan. achieving either one of those objectives. The growth in the number of microfinance service From the point of view of the MFIs, the main providers presents regulators with a dilemma. reason for wanting regulation is to mobilize In one sense, they want to control the practice deposits from the public, both to provide 143 To quote Vijay Mahajan, the head of BASIX in India, “microfinance is important, MFIs are trivial.� 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor savings services that poor clients value and to microfinance services through the business have a source of funds that is not dependent on correspondent option is unlikely to increase donors, government, or commercial any more significantly than it has through the organizations. If this is the main reason, link model. By November 2006, almost 11 however, it might be easier and more useful to months after the announcement of the business amend existing laws than to create new, correspondent option, the measure remained specialized laws. Both governments and dormant as banks were unable to obtain any central banks, although keen to pursue the serious response from potential poverty agenda through financial services to correspondents (NGOs, MFIs, and others) to low-income clients of MFIs, are fearful of the the low-value offers for such services. As with impact this could have on the security of the bank-SHG link model, it is likely that banks depositors' funds and on the public's will extend financial services via this model to perception of the government's commitment to the point at which the marginal real cost of its financial security, particularly in relation to operations equals the marginal return on the poor. They are, therefore, generally appearing to be a socially responsible unwilling to accede to any such measures. The institution; it is unlikely to go further. While one exception is Afghanistan, where lessons substantial numbers of low-income clients will learned from other countries are being applied be served, this does not negate the potential early in the evolution of microfinance, resulting value of facilitating the collection of deposits in more generalized regulations that fit into the by MFIs at the same time, leaving the overall financial sector. regulation conundrum unresolved. In theory, India's banking correspondent model The general consideration that has determined diminishes the argument for regulation to the agenda of the frameworks adopted in facilitate deposit collection by MFIs, because it Bangladesh and proposed in India is the fear of will make the service of small deposits, unscrupulous operators hijacking the measures particularly passbook savings accounts, proposed to siphon off the deposits of poor available to low-income clients, along with families. The experiences of Nepal over the microcredit and other microfinance services. In past seven years and, more recently, Pakistan practice, it will take some time to work out the do not portend any significant number of fly- mode of operations of the business by-night companies that would undermine the correspondent model because the level of fees credibility of genuine microfinance service and a series of rules governing such operations providers. will need to be determined. More important, the cost of business correspondents being Overall, microfinance regulation in South Asia borne by the banks substantially increases the has been primarily concerned with the poverty latter's operating expenses. Indeed, there is no agenda. A country's approach to regulation will reason to expect that the expenses incurred by have considerable impacts on the future of banks in financial service delivery to low- microfinance, not the least of which are how income clients will be any lower through the access will be increased, who will be reached, 98 business correspondent model than it is what services will be provided, what kinds of through the SHG-bank link model. On the institutions will provide those services, and contrary, to the extent that group liability and how an inclusive financial sector will take transparency of operations is a significant risk- shape. The rejection of microfinance mitigating factor in the link model, its absence development banks as important elements in in the business correspondent model could the financial system by the governments of become an important impediment to the Bangladesh and India, at this stage, can be latter's growth. The banks' outreach of seen as a reflection of the focus on the 144 India's Regional Rural Banks Act, 1976, is a specific law in this matter. poverty issue. Nevertheless, in a long-term landscape. In the long run, it may be far more context, this approach presages an emerging effective to allow and enable freedom in concern for the “missing middle,� where pricing for banks as well as MFIs and microenterprise finance becomes as important encourage competitive market development for as capital formation for low-income families. financial services. The combination of tiered To this extent, the concept of tiered regulation regulation and greater freedom in pricing gives may be counterproductive, resulting only in a Indonesia and the Philippines far more niche market for financial services for low- inclusive financial sectors than any country in income clients rather than an inclusive financial South Asia. The Role of National Microfinance Associations A recent paper estimates that national but it has not been a particularly visible or microfinance associations are active in more influential network. than 60 countries around the world and are playing an increasingly important part in the All of these associations have taken on the role development of national microfinance sectors. of advocates for the industry with various The paper describes four main roles that degrees of skill and success. This role has associations played over time: become even more important as most countries in the region are in the process of ■ Advocates: taking on a prominent role in creating new regulations for microfinance, dialogue with the financial sector, government although national associations have not always bodies, and organizations outside the country been organized to influence this process as ■ Standard-setters: proactively promoting financial much as might have been useful. Sa-Dhan and transparency and codes of conduct the PMN have been more successful in advocating for the industry because of their ■ Service providers: offering fee-based services to reputation and credibility with the government, members and nonmembers such as training, donors, and the main MFIs. Sa-Dhan, in credit bureau information, and technical particular, has achieved some success in assistance helping to move the Indian Government from a ■ Funding channels: directing funds to retail MFIs position of ignoring microfinance as an activity to the verge of a national regulatory Five countries in South Asia have national framework for microfinance. Bangladesh's associations, while Sri Lanka is in the early CDF, while being well known, has suffered CHAPTER 8 stages of a second attempt to form a viable from repeated management changes and has national association. The first such association not been able to establish the level of influence in South Asia was the Credit and Development enjoyed by the other two among decision Forum (CDF) in Bangladesh, established in makers in government, banks, and donor 99 1992. The Pakistan Microfinance Network agencies or even with their own members. The (PMN) was formed in 1997, the Centre for larger MFIs in Bangladesh have tended to take Micro Finance (CMF) started in Nepal in 1998, independent positions on microfinance and Sa-Dhan began in India in 1998, and the undertaken their own advocacy. nascent Afghanistan Microfinance Association (AMA) began in 2005. In addition, one The PMN's most important role so far has regional network, International Network for been as a standard-setter through, among Alternative Financial Institutions (INAFI), other activities, its Performance Indicators works out of Bangladesh and includes some of Report on member MFIs. Sa-Dhan has had a the national associations in its membership, standards subgroup from the start, has 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor published performance and transparency taking place, increase their value to the standards for its members, and has educated industry, and strengthen their ability to members on this topic. Other associations are influence positive change. moving into doing this as well, mostly in terms of promoting financial transparency. ■ First, they will need to broaden their vision to focus on the wider picture of creating inclusive The only association that has attempted to act financial sectors to address the gap in access that as a funding channel is CDF, which has worked still exists in most countries. with a commercial bank to channel funds to ■ Second, as different kinds of organizations enter small NGO-MFIs. CDF is best known for its the market, they will need to reach out to and annual microfinance statistics report that, in include new players, especially regulated, 2004, included more than 700 MFIs. commercial financial institutions of various kinds, if they are to continue to influence policy All have conducted research and published and practice at a national level. If they do not do position papers, as well as provided services to this, a dual association structure might emerge, MFIs and other institutions, primarily training. such as exists in Bolivia, with one association for While Nepal's CMF has attempted to perform regulated MFIs and another for NGOs, a situation that could weaken the influence a unified the advocacy and other roles, it has remained association can have. largely confined as a service provider, perhaps partly because it has more the character of a ■ Third, there is a growing sense of the need for consultancy company than a member-based associations to play a greater role in promoting association. While all the associations have transparency, especially financial transparency, played a service provision role, this role has and setting standards for conduct in the industry changed over time as more and more private to help improve MFI performance and sustainability as well as increase the sector service providers emerge. The larger, microfinance service providers' credibility with more active associations have all received the public, regulators, policy makers, donors, and donor funds, although they have also used investors. Since 2004, Sa-Dhan has been drawn service provision to generate income in into such a role as objections have arisen in the addition to generating small amounts of governments of some of the southern states of income from membership fees, but no India about the interest rates and collection association has been able to become practices adopted by a few of the leading MFIs. financially independent of donor funding. The national microfinance associations will need to play a more proactive and preemptive role in Each member-based association has its own such matters if such problems are to be rules for membership and has increased prevented. Until now, the tendency has been for membership over time. Membership is some associations to focus on easier roles of documentation, research, and capacity building commonly based around a core group of NGO- to the relative neglect of the essential role of MFIs, although some associations also include advocacy and adherence to codes of conduct individual members, organizations that provide affecting behavior and performance. services to MFIs, and even banks, government 100 officials, and regulators. The PMN includes commercial banks, microfinance banks, and leasing companies in its membership besides NGOs, because its goal is to represent all the main retail MFIs, not just NGOs. Sa-Dhan has a similar membership profile. While the associations in South Asia have emerged out of the NGO-MFI sector, it is clear that they will have to evolve in several ways if they are to keep up with the changes that are Source: Chen and Rasmussen 2005. Links in South Asian Microfinance Apex funding institutions NDTF, which has remained relatively small and has not been a particularly influential force in Microfinance apex institutions have played a Sri Lanka, and the politically vulnerable RMK significant role in the development of the as well as state-level institutions in India, sector in South Asia, primarily by providing apexes have played a relatively dominant role in loan funds as well as operational grants, the development of their respective national mostly to NGO-MFIs, although they have also microfinance sectors. In India, NABARD has provided capacity building support to MFIs and presided over the rise of the large SHG-bank played a role in setting standards for the link movement, while SFMC has played a key industry, in some cases acting as a quasi- role in the promotion of the microfinance regulator for the sector. sector, building on an agenda first established by FWWB. PKSF played a key role in the Several countries in South Asia have a history growth of the very large NGO microfinance of such apex institutions playing a role in the sector in Bangladesh, although by 2003 its development of the microfinance sector. What proportionate contribution to NGO revolving is now known as the National Development loan funds had declined to about 20 percent. Trust Fund (NDTF) was established in Sri PPAF came into existence at the same time the Lanka in 1990. The PKSF was set up in government elevated microfinance to national Bangladesh in 1991, the RSRF in 1993, the importance in Pakistan and became the RMDC in 2000 in Nepal, the PPAF in 1999, primary source of funding for NGO-MFIs. and MISFA in 2003. In India, a series of apex MISFA has, thus far, been hugely influential in funds was established by the national the start-up of the microfinance sector in government directly (Rashtriya Mahila Kosh, Afghanistan. the national women's fund), by state governments (state-level women's development There is little doubt that the key role played by corporations and minorities development the leading apex funding institutions was corporations), and by national development especially necessary and useful in the early banks (the SIDBI Fund for Micro Credit and the stages of the development of microfinance in Micro-finance Development Fund of South Asia. Their track record of performance NABARD). Each one was first established in their promotional roles has been mixed and sometime in the mid-1990s and evolved over questions about their continuing relevance have time into a full-fledged fund. Preceding all of been raised as the industry evolves. CHAPTER 8 these funds was the FWWB fund established by SEWA Bank in 1993. Most apex institutions have defined their primary role in terms of reducing poverty With the exception of some of the Indian rather than developing an integrated, inclusive 101 apexes, all of these funds were established by financial systems to serve poor people. This the government and most have received has been cast in the context of the poverty significant donor support. NDTF, PKSF, and agenda of national governments and has MISFA have focused exclusively on provided the justification for the large amounts microfinance, whereas PPAF has funded other of government and donor funding provided to kinds of development activities as well. SIDBI them. The often unstated premise has been and NABARD as national development banks that there is a market failure in terms of have played a much wider role in the financial financial services for the poor, requiring the sector, but SIDBI's SFMC, in particular, use of initial subsidies to stimulate the functions as a separate unit with an exclusive provision of microfinance services. Because microfinance role. With the exception of apexes were created by governments and 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor donors, even if some are legally and variety of service providers and offering a operationally autonomous, they tend to reflect much wider range of services than the limited the agendas of their founders more than the credit products that have been the bread and interests of the MFIs, poor clients, or the butter of apex programs. This becomes sector as a whole. For example, there was relevant as increasing numbers of MFIs become initially more focus on the sustainability of the profitable and are able to go to the market for apex than the MFIs, as well as the imposition their funding, and as technology changes the of high transaction costs. The use of extensive way services can be provided to poor people. reporting requirements based on apex, donor, or government “needs� sometimes is a Nevertheless, two leading Indian apexes may substitute for a clear focus on MFI demonstrate a way forward. As discussed in performance, especially financial performance. chapter 4, SFMC's role as the primary funder Examples of questionable apex policies and to India's NGO-MFIs has been largely practices include the following: overtaken by ICICI Bank and other private commercial banks, while SFMC has gradually ■ Use of subsidies beyond the needs of the start-up shifted its focus to promoting the start-up of phase. This can delay sustainability and make it smaller MFIs in some of the poorer parts of difficult to create a level playing field that might India. Simultaneously, SFMC has increasingly encourage other types of service providers and the use of market-based funding mechanisms encouraged the downscaling of NBFC and (most countries). cooperative bank portfolios, thus promoting greater inclusion in the financial sector and at ■ Interest rate caps (Bangladesh and Sri Lanka, the same time pursuing the poverty agenda with indirect pressure exerted in other countries) more effectively. Similarly, having initially ■ Low loan size caps (Pakistan, Sri Lanka, and encouraged the commercial banks to become Bangladesh) engaged with SHG lending, and having provided refinance as well as capacity building While these apexes play a significant role in support to them, NABARD now finds that supporting the initial growth of microfinance refinance is in much less demand. The program outreach, in most cases have large amounts of continues to grow under its own steam, funding, and have even become sustainable however, because government-owned entities themselves, there is a danger of commercial banks are keen to pursue it to continuing for too long in the mold in which burnish their image with government and the they were created. If the original purpose was public. In reality, though, this amounts to the to overcome a market failure and jump-start banks having adopted the original poverty the growth of microfinance, should apexes agenda rather than serving as an example of have a sunset clause? inclusion and mainstreaming of SHG lending.145 Except partly in the Indian case, there is little In South Asia, apex funding institutions have evidence thus far that, having played their played an important role in scaling up original valuable role, apex funding institutions microfinance but have had a smaller impact on 102 have done much to help MFIs graduate to promoting sustainable MFIs. Except in some become market players no longer requiring limited situations, they have mainly pursued a subsidized funds. In fact, subsidies are often poverty agenda without contributing used to tie MFIs to the apex for the long term significantly to the wider vision of an inclusive rather than to help them move on. There is also financial sector that is now emerging. a question of whether the role of apexes needs to change as microfinance sectors mature. For example, this could include financing a wide 145 The interest rate politically acceptable under the SHG link program (12 to 14 percent) simply is not sufficient to enable the banks to lend to these groups on a scale that goes beyond a very small proportion (5 percent) of their portfolio. MFI rating ratings in Pakistan so far, largely through a recent SBP requirement that microfinance banks be rated annually if they take deposits or Rating addresses the problem of information have been in existence for three years; it also asymmetry between lenders and investors, on rated a microfinance bank in Afghanistan. the one hand, and MFI performance and capabilities, on the other. Thus, MFI rating can Given the availability of widely accepted be a key factor in establishing links between professional expertise in the field of MFIs and the investment community. South microfinance rating, South Asia is well Asia is one of the worldwide pioneers in the positioned to facilitate links between MFIs and field of MFI ratings: Micro-Credit Ratings investors. Indeed, the past couple of years have International Limited, based in India, is one of seen a widening investor profile in South Asian the first group of three microfinance raters microfinance, particularly in India, with the established internationally and accredited by advent of individual investors, international the Inter-American Development Bank (IDB)- funds, and venture capital initiatives. These CGAP Rating Fund.146 M-CRIL emerged out of developments have begun to attract other the microfinance assessment and appraisal corporate rating agencies, as well as expertise developed by EDA Rural Systems specialized rating agencies based in other Private Limited, a poverty and livelihoods regions, to consider entering the South Asian consultancy. From the start, M-CRIL market. positioned itself as an international agency and conducted its first commercial rating in Bangladesh. By November 2006, it had conducted 387 ratings in 14 countries, of Credit bureaus which about 300 were in India and another 44 in other South Asian countries. The dominance Like rating agencies, the purpose of a credit of India in this rating profile is attributable to bureau is to overcome information SFMC, the most active of the apex funders, asymmetries. While in the rating case, the which adopted ratings as an essential part of asymmetry is related to the lender its appraisal mechanism for lending to MFIs. understanding and being assured of the With increasing investor interest in MFIs, performance of the borrower, in the case of however, there is also now a growing the credit bureau, the service provides the independent MFI market for ratings. lender with information about the extent and historical record of the borrower's Based on M-CRIL's success, and encouraged indebtedness. Rating occurs at the investor to by SFMC, Credit Rating and Information CHAPTER 8 MFI level, whereas credit bureaus address the Services India Limited (CRISIL), a corporate asymmetry at the MFI to retail client level. rating agency based in Mumbai,147 launched an Over the past couple of years, the possibility of MFI rating service in 2001. CRISIL has establishing credit bureaus has become a undertaken some 50 ratings so far, mostly in common discussion in microfinance. Credit 103 India. In addition, JCR-VIS, a corporate rating bureaus with a microfinance focus have been, agency based in Pakistan, recently launched a or are being, established in a number of Latin microfinance rating service that subsequently American countries (El Salvador, Bolivia) and formed a joint venture with Microfinanza, an in Africa (Uganda). Italian-based specialized microfinance rating agency that had not previously been active in In South Asia, serious consideration of South Asia. JCR-VIS has undertaken a few establishing such a bureau for microfinance has 146 The other two raters are MicroRate and Planet Rating. Chronologically, M-CRIL was the second microfinance rating agency to be launched (trial ratings began in early 1998 and it conducted its first commercial rating in September of that year). 147 Now a subsidiary of Standard & Poor'sthe international rating agency. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor taken place only in Pakistan (by the national may need to wait. The relationship between network, PMN). While this initiative is at an cost and technical innovation for early planning stage, the problem of microfinance is a critical one, as discussed in establishing unique identifiers for microfinance the following subsection. Many MFIs have so clients could take a while longer to solve. In far seen little reason to use and pay for credit Bangladesh, PKSF is developing a database of information services, because their own the client profile of the MFIs it supports, but approaches allow them to find new clients and this initiative has a long way to go to become a manage risk reasonably well, although most useful borrower credit information system. do not have operations that are significantly Until biometric identification systems become influenced by competition with other MFIs. available at a reasonable cost, the possibility of providing credit bureau services in the region The Role and Potential of Technology Technology has considerable potential to Some leading MFIs with relatively stable reduce delivery costs and expand the scale of information systems have experimented with financial services for poor people. Using low- more advanced technologies during the past cost hardware and ubiquitous mobile phone several years. These experiments, by MFIs such networks, banks and MFIs may find it possible as SKS and BASIX in India, generally took to deliver financial services less expensively advantage of more advanced information than was earlier possible, even in rural areas. system technologies, such as handheld Such initiatives in the Philippines, South Africa computers, to achieve greater staff and Brazil, in particular, appear to have productivity in the field. Loan officers used the successfully included more low-income people devices to record client and loan information. in the mainstream banking system, and these However, most such attempts were initiatives are increasingly attracting attention discontinued or were not scaled up when it was from commercially oriented microfinance found that manual operations achieved similar providers in South Asia. levels of efficiency over time. Advanced MIS implementations have been successful when Still, banks and MFIs in the region are only the technology is used as part of a core beginning to consider the potential of process, or for multiple purposes, and justifies technology. Most MFIs, which have specialized its costs. SafeSave's use of handheld devices in in serving poor people, are still putting in place urban Dhaka is one such example. basic information systems that track lending operations and can automate accounting and Commercial banks typically have a strong case management reporting. These systems are the for using technology to deliver financial foundation for more advanced technology services to poor people and can usually applications, such as bankcards for use at allocate greater resources and expertise to 104 ATMs and point-of-sale (POS) devices, and technology implementation than MFIs. This is mobile telephone banking. Although some true of banks in South Asia that have organizations, such as ASA in Bangladesh, increasingly become interested in serving low- have grown large using manual instead of income people, such as ICICI Bank in India and computerized information systems, most MFIs Hatton National Bank in Sri Lanka. These face constraints to growth because their banks lack a rural distribution channel or find information systems cannot track ever-larger that their rural branches are not well-suited to numbers of transactions and branch accounts. handle poor customers and small transactions. Typical branch hours of operation, processes, introduce a whole range of new players into and costs preclude serving individual the microfinance sector. There are already microfinance customers. The same is generally plans or initiatives under way in Bangladesh, true of bank branches in urban areas. India, Pakistan, and Sri Lanka to use mobile telephone technology to increase access to Technology can enable alternative channels for financial services for poor people.148 banks to serve poor customers, particularly in rural areas. ICICI Bank in India is trying to develop low-cost ATMs to disburse and collect cash in rural areas. The bank is seeking to reduce costs and improve efficiency for its MFI partners by creating a single information system platform that all MFI partners can use and by automating cash transactions in the field. Instead of having loan officers collect and travel with cash, MFIs will be able to issue smart cards to customers and enable payments at rural retail outlets equipped with card readers. Banks in Bangladesh and Sri Lanka are exploring similar technology options to reduce the cost and risk of handling cash. In Pakistan, Tameer Bank, a newly established microfinance bank with an urban focus and a consumer finance approach, has introduced biometric identification technology and ATMs in its branches and is exploring the use of mobile telephone technology to expand and improve its services. Everywhere, and in each case of technology application, the main issue is the extent of efficiency gain achieved from introducing the technology relative to the cost incurred. Although thus far the cost has outweighed the gain, as in all modern technology applications, the trend is positive. With further innovation, it CHAPTER 8 will not be long until technology applications could have a revolutionary impact on microfinance and could build a more 105 democratic, inclusive financial sector. This is especially true for mobile telephone technology because coverage levels are already ahead of western countries and growing rapidly, even in poorer populations, and could 148 One of the more interesting initiatives to employ technology to increase outreach and reduce costs might begin soon in the Maldives. The government is working with the two mobile telephone companies and the largest commercial bank to see whether they can establish a mobile telephone payment system. The Bank of Maldives already makes extensive use of ATMs, including mobile ATMs for remote islands, but mobile telephone banking, along with the introduction of POS units connected over the same telephone system, will considerably expand access in a country that has 200 inhabited islands with small populations, especially because mobile telephone coverage extends to almost every household. In this case, high mobile telephone coverage levels combined with sparse populations living at considerable distances from each other ensure that the application of new technology will make a significant difference in increasing access to the general population, including poor households. CHAPTER 9 Conclusions and Future Perspectives M icrofinance in South Asia gathered considerable momentum over the past 25 years. The microfinance movement challenged conventional financial sector and government thinking, in the process fundamentally altering the financial landscape in favor of the poor. A growing microfinance sector with an increasingly wide range of products and more sophisticated support structures has improved access to financial services for many people previously excluded from the system. This has occurred largely through the creation of an alternative financial system, a parallel world of financial instruments and support mechanisms with tenuous links to the “mainstream world� of sophisticated financial markets. While the emerging financial landscape is more inclusive than before, microfinance clients and practitioners are still largely regarded by the formal economy as a curiosity more than a real business opportunity. Microfinance Today There is considerable opportunity for Afghanistan; Nepal is faced with stagnation microfinance outreach to grow to meet the still because of the country's disturbed political substantially unmet demand for microfinance conditions. services. Poor families alone number around 86 million, without taking into account the Each country has different institutional borderline poor and other low-income clients, structures for microfinance. Afghanistan, while client outreach so far amounts to no Bangladesh, and Pakistan are dominated by more than 35 million, including some non-poor MFIs; Sri Lanka and Nepal have substantial low-income clients. Aggregate demand for outreach by cooperatives. In India, SHGs are microcredit is conservatively put at $15 billion dominant, although MFIs also make a compared with estimated outstanding substantial contribution. All countries except microfinance loans of just $2.3 billion in 2005. Bangladesh and Afghanistan have links with the commercial banking sector, although Despite great progress over the past few examination reveals that the number of links is decades, outreach to the poor is still limited. It quite small compared with each bank's total is estimated that about 17 percent of poor assets and is motivated more by corporate households in South Asia are served by social responsibility and public recognition microfinance. Coverage ranges from good in than by business considerations. Bangladesh and Sri Lanka (where at least 60 percent of the poor have access to The financing structure of MFIs has substantial microfinance) to poor in Afghanistan and donated equity in Afghanistan, Bangladesh, Pakistan (less than 10 percent), with coverage and Pakistan, while debt is an important in India and Nepal falling in between but closer source of funds in India and Nepal. Although to the low end. Outreach growth rates are some of the debt financing comes from particularly high in India, Pakistan, and commercial banks, much of it originates in the apex funds established by each country, often backed by donors. Deposits make a significant reporting on the steps that are likely to lead to contribution everywhere, particularly in Sri impact rather than on proving end results Lanka where this funding source drives the alone. Both social performance management community-based institutions that provide by MFIs and social rating by external rating virtually all the microfinance outreach. agencies could constitute a useful and Voluntary deposits in Sri Lanka imply a greater relatively low-cost means of keeping track of degree of commercial financing than do the and reporting on the achievement of compulsory deposits generated by MFIs in microfinance's social mission. other countries. Throughout the region, strengthening links with the commercial sector There is growing interest in regulation remains a major challenge. throughout the region, although generally as a separate activity from the regulation of the Products offered by MFIs have shown overall financial system. In some cases, the increasing flexibility based on growing regulation includes establishing separate responsiveness to client needs. Not only is regulatory institutions apart from the central there increasing experimentation with more bank. While appropriate regulation can help flexible credit products, but deposit products strengthen and expand the provision of have also been more widely offered in more services to poor people and lend the flexible ways to the extent allowed by legitimacy to MFIs that comes from formal regulatory constraints. In addition, insurance recognition, it is not clear that regulation services have gained some momentum initiatives are as enabling or “inclusion (especially in India and Bangladesh), there is oriented� as they could be. some engagement with money transfers (Bangladesh, Pakistan, and India), and Apex funding institutions have played a key microleasing has emerged (Bangladesh and role in all countries except Sri Lanka, where Pakistan). most microfinance services are not provided by institutions that the apex supports. Although The sustainability and performance of MFIs their role has been important and influential in reflect a common pattern. A relatively small the early stages of microfinance development number of increasingly efficient institutions are (PKSF in Bangladesh being the most prominent responsible for a large proportion of the example), with the exception of some increase in outreach, but the majority of experience in India, these institutions have not institutions are relatively weak and are been successful in moving MFIs away from propped up by subsidies from donors and subsidies and toward greater use of governments. Sound research on depth of commercial funding sources. Nor have they outreach is relatively limited, but this seems to taken on a major role in promoting change (for CHAPTER 9 indicate that there are no clear trade-offs example, supporting the introduction of new between sustainability and poverty outreach. products or the use of new technologies). Evidence from India and Bangladesh shows that MFIs can balance poverty outreach with MFI rating has become well established in the 107 sound financial performance, in the process region with one specialist institution and two managing efficient operations with excellent corporate rating agencies engaged in the portfolio quality. activity. Credit bureaus are increasingly discussed. Microfinance yields significant benefits to clients, in comparison with nonclients, and has Experimentation with technology has been a greater impact on poorer households. Given limited to a few leading MFIs, although mobile the methodological difficulties in impact telephone technology holds considerable measurement and the high cost of sound promise for the future. The main issue in these research, there is a shift towards managing and experiments is whether efficiency gains from introducing technology outweigh the costs. 2006 Microfinance in South Asia Toward Financial Inclusion for the Poor Future Perspectives Microfinance provides most of the access to The microfinance movement of the past few financial services available to low-income decades has fundamentally changed the people in South Asia, but it is still largely financial sector, a change process that is separate from the financial system, with few gathering momentum. And there are examples of direct service provision to the opportunities to take the microfinance poor by mainstream commercial institutions. movement to the next stage of its development, And despite the growing discussion about and a stage in which a more inclusive financial enthusiasm for developing a seamless inclusive sector can be shaped to better serve the needs financial sector, there is little evidence that this and interests of the poor. is happening yet. Only in India are there significant examples of bank involvement in Evidence suggests that for the next few years microfinance. This includes the link models at least, most of the growth in microfinance with MFIs, the large and growing bank-SHG will come from a few large, profitable, links, and involvement in the market of several specialized institutions that might in some large commercial banks. Several local and ways rival smaller banks in their respective international social investment funds offering countries. This primary focus on strong, debt and equity products are active in India, growing institutions at the heart of serving the something that has not taken off elsewhere in poor has been achieved in Bangladesh, and the region. But even in India, aside from the there are signs of it emerging in Pakistan, bank-SHG model, which has its own special India, and Afghanistan. Such institutions will characteristics, evidence of mainstreaming is be able to gain greater legitimacy by having still limited to a relatively small part of total well-managed, efficient, and profitable outreach. operations; by becoming regulated; and by growing links with mainstream commercial In some countries, major impediments need to institutions. Furthermore, such large be removed before an inclusive financial sector institutions will offer more flexible loan and can develop. In Sri Lanka especially, the deposit services, will add other financial dominating presence of very large government- services such as insurance and money subsidized microfinance programs impedes the transfers, and will have the strength to reach growth of well-managed MFIs and commercial out to poorer people, including through links banks that want to enter the sector. In with safety net programs, and more remote Pakistan, most NGO-MFIs and microfinance regions. Conversely, there is little to suggest banks are not profitable and do not charge that large commercial banks will take on a interest rates that would support profitable much greater role in direct service provision to operations, largely because they still receive poor people. significant donor- and government-funded subsidies. Recently in India, competition The dominant institutions that do emerge over between subsidy-oriented government the next few years will have access to and 108 programs and MFIs has resulted in a state make more use of commercial sources of government placing pressure on financially funding. Links with commercial banks and sustainable MFIs to lower their interest rates to social investors will become increasingly unsustainable levels. This sends an obvious important, not only affording these institutions message to banks that might otherwise a source of funds to support their donor- or consider retail products for microfinance. government-dependent growth, but also Reforms are needed to remove impediments bringing more discipline, transparency, and before a healthy, inclusive financial sector will accountability to their operations. At the same be able to emerge. time, the development of enabling regulatory environments should allow good MFIs to increasingly mobilize deposits from their and microfinance. members as well as others. This is beginning to happen in Bangladesh and Afghanistan, and New technologies promise new ways to such opportunities should expand to other improve efficiency and expand outreach faster. countries. But to grow and be able to use more Already, some MFIs are using ATMs and commercial sources of funds, the environment handheld computers, but more significant will also need to allow for market-based changes might become possible as mobile pricing. Instead of interest rate controls, the telephone outreach and Internet access expand way to reduce interest charges paid by low- more widely and become less expensive. This income clients lies in the proven formula of could lead to new kinds of microfinance opening opportunities for investment by service providers that are based on mobile removing the idea that there is a socially telephone banking. acceptable interest rate for lending to the poor. Another step in the region's financial At the same time, by putting substantial liberalization could occur if the wider political resources into improving the management and social environment changes to recognize capacity of MFIs, they can increase their that economies of scale exist in financial efficiency and reduce their costs. In South service delivery–cost is inversely proportional Asia, this could lead to the cost of to the size of accounts. Central banks and microfinance to the client settling at an finance professionals will need to take the lead effective rate of 21 to 24 percent per year and to urge politicians and media to help change outreach throughout the region expanding to the conservative economic environment 50 to 60 percent of the poor in less than a relative to the poor. Without such decade. Bangladesh has made considerable liberalization, the process of microfinance progress in this direction. evolution is likely to slow down as it hits the Greater interest in regulation holds out the barrier of sustainability, particularly if the prospect of increasingly mainstreaming formal sector reaches a point at which the microfinance within the larger financial sector. marginal return to corporate social This involves improving existing regulations, responsibility falls below the losses associated advocating for or creating new regulations, with microfinance service providers and low- setting up new regulatory bodies, and income clients. That point has not been improving transparency and self-regulation. reached yet, although in India some banks are Although there is a lot of activity, more already testing its limits. As long as experience and clear thinking are needed to engagement with low-income clients in South channel these efforts in ways that will lead to Asia is largely a matter of social responsibility, financial inclusion will remain a dream. CHAPTER 9 good enabling environments. One of the most constructive regulation initiatives has been adopted in Afghanistan, where microfinance is in its infancy, while the country with the best 109 microfinance performance, Bangladesh, has so far only gone part way to create regulation that will enable the sector to make an even greater contribution. 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