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While everyone emphasizes the importance of outreach in microfinance, they often overlook the negative implications of excess supply of microcredit. Economic theory suggests markets work best if demand and supply are matched, and when there is a shortage or excess of either force, sellers may be left with unsold stock, or buyers may be left with unmet demand.
For micro-institutions (say, fishing) to grow at a healthy rate, there needs to be excess demand for the product (say, dried fish). One or two fisheries may be sufficient to serve a community, but easy access to credit may encourage several people to setup fish selling businesses in one area (assume this is a coastal city with plenty of fish in the ocean). Suddenly, there are 5 or 6 shops selling the same thing (dried fish) that nobody wants anymore (after all, there is only so much fish one can eat).
As a result, market growth may stagnate, micro-enterprises may have to diversify their product line (not always an easy task), some businesses may shut down and clients may not be able to pay back their microloans.
The positive side to this is that it will teach micro-entrepreneurs to operate and survive in the capitalist economy. As for clients who cannot adapt competitively to their environment, microfinance institutions can train them to enter other lines of work (a rather costly solution).
A few months ago I blogged about the purpose of credit bureaus and some operational elements involved in setting them up. This is a continuations of that post.
Risk Assessment Features of a Microfinance Credit Bureau
- Risk assessment based on the profession of a borrower - A borrower who already has a low-income yet stable job, or runs a business, may be entitled to a larger loan than a client who has no former experience with microcredit or running businesses. Each borrower can build his/her credibility over time in order to become eligible for bigger, or flexible loans.
- Risk assessment based on use of mobile banking records – Payment histories can be created by tapping into the transaction histories of mobile money accounts (Easy Paisa, M-Pesa, MITRA, Wizzit, which are services in Pakistan, Kenya, India and South Africa, respectively) of borrowers. Read Kenyan case study about this possibility.
- Detailed credit ratings versus blacklist – The credit bureau can either disclose client names, histories, risk and mathematical credit ratings to MFIs (positive credit bureau) or simply provide the names of high-risk clients (negative credit bureau). In Pakistan and other countries that see high-growth in the microfinance sector as well as high poverty rates, a positive credit bureau would be better than a negative one because it allows microfinance providers to analyze detailed information about the poor, and design products to suit their particular risk profiles.
Pitfalls to be Prepared For When Setting Up a Credit Information Bureau
- A dearth of information about borrowers is a major issue for a microfinance credit bureau because of the nascence of the sector and varied book-keeping styles.
- Specialized microfinance credit bureaus (limited to certain towns or cities) may capture the nuances of micro segments in the market, but their data can neither be analyzed nor used by a large number of MFIs.
- Containing costs will be difficult considering the small number of large accounts that need to be maintained. Grants and subsidies can be offered to cover costs, as in India.
Mobile banking and financial inclusion go hand in hand, as recently revealed by a survey (summary posted by GSMA Blog) that examine the adoption of the famous branchless banking solution in Kenya, M-Pesa. William Jack and Tavneet Suri from Georgetown University and Sloan School of Management analyzed data from 2008 and 2009 and made a few pleasant, yet expected discoveries:
- The mobile banking solution (M-Pesa) was not introduced as a service purely for the poor, yet its initial penetration into middle-class households was quickly followed by mass uptake by poor households, both in urban and rural areas,
- When comparing usage growth, there was a proportionately greater increase in use by lower income households than upper income households,
- Women are quickly becoming active users of the mobile banking service (a little under half the users are female).
Jack and Suri point out that the mobile banking service’s rapid penetration was accompanied by a speedy increase in M-Pesa’s distribution network.
We learn that cash-in and cash-out agents developed a relationship with clients based on a high level of trust, which can partially explain the rapid uptake of the service in rural areas.
The authors also explore the value proposition put forth by the mobile banking service, which are linked to reduced cost of sending money over large distances and security of funds.
Another major finding was that the financial management of the M-Pesa mobile banking service improved during hard times, perhaps owing to precautionary savings and ability to seek funds from others who are in a better financial situation. You can read the detailed blog post about the survey results here, and see the survey results here.
In conclusion, we see mobile banking is fulfilling its vision of financial inclusion in the developing world, whether the parties drawn into the financial network are upper, middle or lower class groups. Certainly, the service can be used as a tool in spreading the benefits of microfinance to people far and wide.
This is the continuation of an earlier post about problems faced by microfinance institutions.
Microfinance Challenge 5: Mixing Charity With Business
Since credit without strict discipline is nothing but charity (Professor Yunus), if microfinance providers fail to protect themselves against loan delinquency, they will, in effect, prioritize social objectives at the expense of financial sustainability.
Improper delinquency management is a result of inadequate implementation of corporate governance principles, and formal as well as semi-formal microfinance providers often suffer from this. As a result, looser controls over microfinance deals will lead to higher default rates. Read more about the difficulty inmixing charity with business.
Microfinance Challenge 6: Lack of Customized Solutions for the Poor
Inappropriate targeting of poor households by microfinance programs is a common problem because MFIs fail to understand the varied needs of micro entrepreneurs. MFIs must spend time in the field with their clients and his/her business, and then use this research to develop customized microfinance tools for each micro entrepreneur.
Generalized solutions may work for large companies dealing dealing with large homogeneous customer groups, but microfinance providers need to serve the varied needs of individuals in each micro market segments.
Microfinance Challenge 7: Lack of microfinance training for Human Resource in Microfinance Institutions
Working in the microfinance sector is a different ball game compared to the traditional financial sector. For instance, microfinance officers and volunteers need to talk a different language, build lasting relationships with individual micro entrepreneurs, understand the unique needs of the poor, evaluate the borrower’s sustainability, and grasp the cultural nuances of the borrower’s communities (I’m sure I’ve missed a few).
Of course, all this needs to be done by large financial firms as well, but the needs and characteristics of the two markets are very different. It’s no surprise microfinance providers need special training to ensure they avoid problems such as intimidating or under-serving clients.
Read about developing a good human resource environment in microfinance institutions.
Microfinance Challenge 8: Poor Distribution System of Microfinance Institutions and lack of information about microfinance investment opportunities
There are over 10,000 MFIs across the world, but their reach is only 4% of the potential market.World Bank, 2001
Firstly, microfinance providers may be complacent with their client base in certain cities and feel no economic need (ignoring the social need to eradicate poverty) to spread out their distribution system to cater to the poorest of households. Secondly, micro entrepreneurs are sprawled over large geographical areas, often in remote places, which often makes them inaccessible to MFIs. This is a slight problem because even though there are over 10,000 MFIs around the world, they may not know about the existence and needs of certain micro entrepreneurs.
Microfinance Challenge 9: Dual mission of Microfinance Institutions to be Financially Sustainable as well as Development Oriented
Microfinance providers tend to forget their main objective is social development and not profit creation. The principle of ‘one micro entrepreneur – one micro loan’ is overlooked by profit-hungry MFIs who end up targeting the same individual for many loans and cause multiple borrowing (also known as credit pollution). This is a major problem because at the end of the day, that individual gets burdened by mounting interest payments and is pushed deeper into the folds of poverty. Poor governance on the side of MFIs as well as the micro entrepreneur are to blame for this.
All these problems can broadly fall into either financial and operational in nature and we can therefore see that they should not be impossible to solve as the microfinance sector moves towards it optimal performance level in the next several years. In other words, despite these problems, the prospects of microfinance are quite bright. In the coming weeks, we will look at potential solutions to all these problems, which aren’t difficult to adopt (a couple have been already been mentioned above).
This is the continuation of an earlier post about challenges faced by micro-entrepreneurs. You can read about challenges faced by microfinance providers, here.
Microfinance Challenge 5: Inability to exploit growth opportunities
The last point is a contributor to this problem, because a lack of access to funds means micro entrepreneurs cannot inject money into their businesses (say, to buy more resources or hire more people) to grow them after observing a surge in demand. Moreover, the remote locations of micro businesses means they have little information pertaining to their markets, such as customer needs and competitor strengths and weaknesses and so on. As a result, many critics may find faults with the idea of microfinance, not realizing that this isn’t really a problem, but just a challenge that can be overcome as the business grows and increases its capital base.
Microfinance Challenge 6: Few organizational resources and poor governance
Micro entrepreneurs have limited skills, qualifications and exposure to handling businesses. While they need to be trained through capacity building initiatives by the MFIs, many micro entrepreneurs may not grow as planned because of these problems. For instance, they may borrow more money than needed, or mis-allocate it in their business and end up bearing the burden of large interest payments instead of enjoying the fruits of their business. Again, critics may say microfinance is an ineffective way of alleviating poverty but this isn’t true. The flip side of this problem is linked to the governance issues faced by MFIs, which is discussed in the first part of this article.
Microfinance Challenge 7: Low bargaining power
In case micro entrepreneurs operate in competitive markets, their individual bargaining power is diminished when dealing with customers because of their small size. However, at the other end of the spectrum, there still isn’t any respite because micro entrepreneurs deal with MFIs on an individual basis, which also erodes their bargaining power. This isn’t really a problem for microfinance, but rather micro entrepreneurs.
Microfinance Challenge 8: Vulnerability to economic shocks
Micro entrepreneurs are particularly susceptible to sudden changes in customer demand, or the weather (even thoughmicrofinance can help with natural disasters) because their businesses cannot sustain losses owning to their small size (low capital). This may be a problem for the social objectives of microfinance providers but MFIs ensure their economic performance is untarnished by charging high interest rates to compensate this risk (read 4 ways to control high interest rates).
Most problems faced by micro entrepreneurs are caused by their small size, varied locations and improper skills. Naturally, once the venture secures a loan and begins to grow, these problems will eventually subside. One may think the problems at the MFIs’ end, therefore, need greater attention but that wouldn’t be correct because poverty eradication is a very socially-integrated endeavor. Despite all this, one can say with great certainty that the prospects of microfinance are still great so these issue are certainly worth solving.
This clever cartoon hits two birds with one stone:
- It explains that one of the reasons microfinance is vital for the poor is the apathy of governments of developing economies to help the poorest of the poor. Plus, even if public plans are initiated, their trickledown effect is weak.
- It mentions that poverty alleviation is a long-term process, which requires a multi-lateral strategy targeting food security, health and education facilities, business development, etc., which is what some microfinance programs attempt to offer alongside basic financial services.