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 is the second part of a two-post series on regulations in microfinance.
The Obvious Tradeoff: Product Range Versus Cost
As evident from the above list, prudentially regulated microfinance institutions (microfinance banks) are subject to strict rules regarding risk management, which requires MFBs to inject additional capital. The benefit of incurring extra costs is that MFBs are allowed to offer a full range of financial services to the public, including micro-savings, which offer a low-cost source of funds for MFIs.
This strategic benefit is beyond the grasp of non-prudentially regulated MFIs (such as NGOs and NBFCs) because public deposits may not necessarily be safe with them. However, MFIs free from the financial and monitoring burdens of prudential regulations enjoy greater flexibility in their operations.
Scope of Regulations for Nonbank E-Money Issuers
However, regulators around the world are beginning to introduce laws for non-bank issuers of e-money (i.e. branchless banking operators) that ensure customer funds are secure with them, according to a recent report by CGAP.
Microfinance was born to reduce poverty, but now it is notorious for providing exceptionally high returns to shareholders. The fierce debate over the commercialization of microfinance has many sides to it, and this series of blog posts looks at the different arguments for and against the practice of profiting off the poor, and ends with a practical (read, compromised) solution.
Commercialization will help raise funds
MFIs generally bemoan a lack of low-cost funds to support the growth and sustainability of their operations. Commercial banks lend to MFIs at market rates and there is only so much development aid to go around, which may push MFIs to access equity markets for funds.
The success of two MFIs in the capital markets (Bank Compartamos of Mexico and SKS of India) will improve the ‘credibility of microfinance in capital markets’ (CGAP) and help attract the much needed funds from social and commercial investors. These funds can be re-invested to grow the microfinance program.
“The only place you can get the amount of money that is needed to help the poor is in the capital markets… That’s why we are doing this IPO.” Vikram Akula, founder and chairman of SKS, to WSJ.