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The microfinance revolution: sustainable finance for the poor.

31 May 2001-

About: The article was published on 2001-05-31 and is currently open access. It has received 1160 citations till now. The article focuses on the topics: Geography of finance & Structured finance.

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Jump to: [Introduction] – [Preface] – [The Emergence of the Microfinance Revolution] – [Gradually,a paradigm] – [Acknowledgments] – [Estimating the Demand for Microfinance] – [Informal Commercial Moneylenders and Their Interest Rates] – [The Economically Active Poor and the Extremely Poor] – [A Poverty Alleviation Toolbox] – [A Fork in the Road] – [Financially Self-sufficient Microfinance Institutions] – [Reaching scale] – [Why Has the Demand for Institutional Commercial Microfinance Not Been Met?] – [Why Does Meeting the Demand for Institutional Commercial Microfinance Matter?] – [Access to financial services] – [Building the self-confidence of the poor] – [Notes] – [Financial Markets in Developing Countries] – [Development of the Financial Systems Approach to Microfinance] – [Microfinance in the 1980s: Going to scale] – [Microfinance in the 1990s: Developing the industry] – [Institutional Sustainability] – [Levels of sustainability] – [Pioneers in Large-scale Commercial Microfinance] – [Microbanking at Bank Rakyat Indonesia] – [During the crisis the] – [The Old Paradigm: Subsidized Credit Delivery] – [The New Paradigm: Sustainable Commercial Microfinance] – [Basic operating principles] – [Meeting the Demand for Microfinance] – [Compulsory savings] – [In this chapter poor people from 16 developing coun-] – [Do They Know How to Use Them?] – [TB is a client of the Association for Social Advancement (ASA), a microfinance institution in Bangladesh. Her story shows clearly the complex decisions that the poor make in managing their scarce resources.] – [Peru: Credit as a launch pad] – [Bangladesh: Saving for the future] – [Can Microfinance Help the Economically Active Poor Expand and Diversify Their Enterprises and Increase Their Incomes?] – [14 liters of peanut oil and 5 liters of peanut residue (which she sells as livestock feed) a week.She travels to the nearest market town every Sunday to sell her produce and to replenish stock needed for her food processing activities.] – [Can Access to Financial Services Enhance the Quality of Life of the Clients of Microfinance Institutions?] – [Uganda: Overcoming malnutrition] – [Indonesia: Saving for children’s education] – [Can Access to Microfinance Help the Economically Active Poor in Times of Severe Household Difficulty?] – [Ecuador: Rebuilding a business] – [Can Successful Microfinance Institutions Promote the Self-confidence of Their Clients?] – [1950s in the context of the post–World War II development] – [II era of the late 1940s and the 1950s. The theory came from] – [Supplying Finance in Advance of Demand] – [How Credit Subsidies Prevent Sustainable Microfinance] – [1980s (ignoring recoveries from the loss-making national agricultural insurance company).Recoveries for the smallholder Agricultural Credit Agency in Malawi plummeted from almost] – [Subsidized Credit Programs for Microenterprises] – [1993, p. 5; see also Otero and Rhyne 1994). Some formal institutions began to onlend subsidized government or donor funds to small and microenterprises in urban areas at below-market interest rates.] – [Self-sufficient microfinance institutions are rare—] – [Information Flows in Rural Communities of Developing Countries] – [Informal commercial lenders] – [Informal Commercial Lenders in Microfinance Markets] – [The Size of Informal Credit Markets] – [Debates about Moneylenders and Their Interest Rates] – [Informal moneylenders: “value for the people”10] – [Policy implications] – [Characteristics of Informal Commercial Loans from Moneylenders] – [Interlinked transactions] – [Availability of loanable funds] – [The “Too Many Lenders” Problem] – [A borrower typically receives credit from one informal commercial lender] – [Transaction Costs and Risks for Informal Commercial Moneylenders] – [The transaction costs of lending] – [Risks] – [The nature of the data] – [The poor are charged] – [What Are the Transaction Costs and Other Noninterest Costs for Borrowers?] – [The Costs of Borrowing: Comparing Moneylenders with Bank Rakyat Indonesia’s Unit Desas and BancoSol] – [Making Microfinance Competitive] – [Mobilizing Microsavings: Five Broad Patterns] – [Forms of Informal Savings] – [Cash] – [Grain and cash crops] – [Animals] – [Land] – [ROSCAs and RESCAs] – [Raw materials and finished goods] – [Construction materials] – [Saving by lending] – [Advantages and Disadvantages of Informal Savings and Financial Savings] – [Long-term investments] – [Social and religious obligations] – [Old age and disability] – [Why Does the Formal Sector in So Many Countries Fail to Mobilize Microsavings?] – [The Mobilization of Public Savings by Sustainable Microfinance Institutions] – [Preconditions] – [Sequencing a savings program] – [Who Benefits?] – [Benefits to individuals and enterprises] – [Benefits to governments and donors] – [Glossary and Acronyms] – [BKK Badan Kredit Kecamatan (Indonesia)] – [CDF Credit and Development Forum (Bangladesh)] – [Finamérica Financiera América (Colombia)] – [HIID Harvard Institute for International Development] – [K-REP Kenya Rural Enterprise Programme (Kenya)] – [MFI microfinance institution] – [RRB Regional Rural Bank (India)] – [SEWA Self-Employed Women’s Association (India)] and [UNDP United Nations Development Programme]

Introduction

The authors in Indonesia have a special, longstanding interest in the emerging microfinance revolution,which has made it possible for large numbers of low-income people to access institutional financial services—often for the first time.
The reform of BRI’s microbanking system was undertaken in order to bring about a major increase in the availability of financial services—initially for the rural population and later for low-income urban residents as well.
In sharp contrast to the Indonesian banking sector generally, commercial microbanking at BRI’s unit desa system continued its wide outreach, high repayment rate, and profitability throughout 1997–99.
The economic meltdown that hit Indonesia in 1997—and one can hardly describe it differently—had multiple causes.
BRI’s unit desa system has made great progress since 1984, rapidly becoming a financial institution capable of contributing to rural development and rural employment.

Preface

When I began life as a social anthropologist in the 1960s,carrying out field work in remote areas of developing countries in Asia, outsiders rarely visited the villages where I lived.
This, it was thought,would both help feed the population and increase rural economic growth.
As an Over the years I noticed that the few outsiders I encountered in villages were less likely to be missionaries—and more likely to be bankers ancient Indian proverb has it, a village can be formed wherever there come together “a river, a priest, and a moneylender.”.
During this period the idea took root in many countries that financial services should and could be made widely accessible to low-income people through the formal financial sector.
Financial services are, of course, not a panacea for poverty alleviation.

The Emergence of the Microfinance Revolution

The emerging microfinance revolution—the large-scale provision of small loans and deposit services to low-income people by secure, conveniently located,competing commercial financial institutions—has generated the processes needed to democratize capital.
Sustainable Finance for the Poor, also known as Xxx The Microfinance Revolution.
Why many of these theories were wrong, and how the resulting development mistakes occurred, are documented and analyzed throughout the book.
The primary problem was that banks were using government or donor funds to provide subsidized credit, an approach that continues in many countries today.
But many low-income people in industrial countries lack access to financial services, also with pervasive negative effects on society and the economy.

Gradually,a paradigm

Shift took place— from the delivery of government- or donor- subsidized credit to the development of sustainable financial intermediaries A reader who wants to learn about a particular microfinance institution— such as Bangladesh’s Association for Social Advancement, Bolivia’s BancoSol, or Mexico’s Compartamos—can find these institutions in the indexes of these volumes and read about them.
Once after a long discussion, I rose to leave a small group from whom I had been learning about their social and economic activities and their political environment.
My knowledge of local financial markets comes largely from those who participate in them: people of varying ages and both genders employed in a variety of occupations, from different social, economic, religious, and political backgrounds.
As a policy adviser on microfinance, my role has been to learn the country’s policy goals and its constraints, to provide information to decisionmakers about their country’s microfinance demand and its relevance to development more broadly, and to suggest strategies to achieve policy objectives,drawing on lessons from the country’s financial markets and from international best practices in commercial microfinance.

Acknowledgments

During the years that I have been learning about microfinance, I have become greatly indebted to many people.
As coordinator of the CPIS local banking group,which provided assistance to BRI from 1983–90, I learned much from Ismah Afwan,Hilman Akil,Kwan Hwie Liong,R.J.Moermanto,Ilyas Saad, L. Hudi Sartono, Bambang Soelaksono, Sudarno Sumarto, and others.
He has been invaluable in the effort to understand, untangle, clarify, document, and analyze the many issues discussed here, and I am much indebted to him.
Among the economically active poor of the developing world, there is strong demand for small-scale commercial financial services—for both credit and savings.
The microfinance revolution is emerging in many countries around the world.

Estimating the Demand for Microfinance

The microfinance revolution is best understood in the context of the population and income levels of developing countries, and of estimates of unmet global demand for formal sector commercial financial services.
In 1999, 4.5 billion people, or 75 percent of the world’s population, lived in low- and lower-middle-income economies.
Until the 1980s the presence of in- Supply and Demand in Microfinance 11 Microfinance demand can be met on a global scale only through the provision of financial services by self-sufficient institutions formal microenterprises—street vendors,home workshops,market stalls,providers of informal transportation services—was generally perceived by policymakers and economists to be a result of economic dysfunction.
Since the “problem”of informal microenterprises was seen as one that would be resolved through better macroeconomic performance, there was no reason to focus on the contributions of this sector to the economy or to improve the environment in which it operated—including increasing access to formal financial services (Webster and Fidler 1996).
The growth of the already large informal sector was a predictable, rational response to structural adjustment.

Informal Commercial Moneylenders and Their Interest Rates

Financial institutions that provide commercial microfinance help poor people manage enterprise growth and diversification and raise their household incomes.
His first BRI loan, provided at the standard 2.8 percent effective monthly interest rate, was an 18-month loan for 600,000 rupiah ($273); the loan was taken in 1994 for working capital to develop his business.
While the transaction costs of obtaining a loan are normally higher for a borrower who obtains credit from a commercial microfinance institution than from an informal moneylender, the difference in interest rates is often so large that the total cost to the borrower is much lower at the institution (see chapter 6).
JR and TR, husband and wife, have operated a small shop out of their home in Yogyakarta for more than 15 years; they sell vegetables, rice, snacks, tea, sugar, and other basic foods.
The loans from the moneylender had to be repaid in daily installments, with a 50 percent flat interest rate for the month (equivalent to an effective monthly interest rate of 132 percent).

The Economically Active Poor and the Extremely Poor

Poverty comes in many forms and causes multiple harms.
The distinction between the extremely poor and the economically active poor is not precise.
Even within a single household, women may be poorer and more malnourished than men.
While the extremely poor may not be directly affected by commercial microfinance, they can benefit indirectly from its development.

A Poverty Alleviation Toolbox

Alleviating poverty requires many tools, including food, shelter, employment, health and family planning services, financial services, education, infrastructure, Supply and Demand in Microfinance 19 Savings facilities are often more in demand among the poor than credit services markets, and communication.
But other tools are required for the very poor who have prior needs, such as food, shelter, medicine, skills training, and employment.
When loans are provided to the very poor, the borrowers may not be able to use the loans effectively because they lack opportunities for profitable self-employment, and because the risks involved in using the credit may be unacceptably high (see Hulme and Mosley 1996, vol. 1, ch. 5).
The first column in the figure shows three income levels: lower-middle income, the economically active poor, and the extremely poor.
The people represented in figure 1.1 whose demand is suitable for commercial microfinance inhabit most of the households of the developing world.

A Fork in the Road

Microfinance in the 1990s was marked by a major debate between two leading views: the financial systems approach and the poverty lending approach (see Rhyne 1998 and Gulli 1998).
As a global solution to meeting microfinance demand, the two views on microfinance—and the means they advocate—are not equal.
This is a point on which the “poverty camp“ frequently misstates the motives of the “sustainability camp.“.
Donors and governments, both notably prone to fads, are unlikely to continue subsidizing microfinance indefinitely and are not generous enough to do so on a major scale.
Low-income people throughout the developing world need continued access to credit and savings services,with the option of gradually increasing the size of their loans as borrowers become qualified through repayment records and enterprise performance.

Financially Self-sufficient Microfinance Institutions

Sustainable microfinance is carried out by commercial institutions that deliver financial services to the economically active poor at interest rates that enable the institutions to cover all costs (including the commercial cost of funds) and risks, and to generate a profit.
In contrast to informal commercial moneylenders and informal savings methods,formal institutions providing commercial microfinance can make financial services—both credit and savings—widely available at a cost that enables both the profitability of the financial institutions and the growth and diversification of their clients’ enterprises.
For both kinds of microloans, however, commercial microfinance institutions must charge interest rates that are significantly higher than the normal lending rates of the country’s standard commercial banks.
Infrastructure and communications in the areas serviced are often rudimentary.
More than 15 years later, savings services for the poor remain forgotten in many countries—not only in rural areas but also in low-income urban neighborhoods.

Reaching scale

The defining characteristic of the microfinance revolution is its large-scale outreach in the provision of financial services to low-income clients—a scale that is made possible by regulated, self-sufficient financial intermediaries.
Her sales, and thus her income, are directly proportional to the time she is sitting on the street, offering her goods.
The preceding section reviewed the ample evidence that many poor people can pay, and therefore MFIs can charge, rates of interest that are much higher than the rates that commercial banks charge to their usual customers.
Management and organizational systems with the capacity to deliver finan- cial services efficiently to low-income people throughout a large country.
In many parts of the developing world,microfinance continues to be perceived by the formal financial sector as unimportant for the economy, 34 The Microfinance Revolution: Sustainable Finance for the Poor More than a hundred institutions are developing sustainable microfinance programs, and the number is steadily increasing unprofitable for financial institutions, and unnecessary for the poor.

Why Has the Demand for Institutional Commercial Microfinance Not Been Met?

Other reasons that most of the demand for microfinance remains unmet include the generally limited interest in microfinance among policymakers and managers of financial institutions (international and corporate banking are considered “sexy”postings—microfinance is not),prohibitive government regulations (especially with regard to ceilings on loan interest rates), lack of basic infrastructure, and sparsely settled populations.
The formal financial sector has been poorly advised from many quarters, including people who: Supply and Demand in Microfinance 35.
The leaders of the microfinance revolution—microfinance institutions;central banks, finance ministries, and bank superintendencies; foundations and networks; donor agencies; and others—have begun to be effective, both individually and collectively, in making the principles and practices of sustainable microfinance known in countries around the world.
The microfinance revolution has benefited greatly from its emergence in history at the same time as the information revolution.

Why Does Meeting the Demand for Institutional Commercial Microfinance Matter?

First, it provides the financial services that many need to expand and diversify their economic activities, to increase their incomes,25 and to improve their lives.
As shown in chapter 3, the first things that many poor families do when their income rises is improve their nutrition and send their children to school.
Microfinance plays an important, if not yet well recognized, role in promoting education and health and in decreasing child labor.
The subsequent growth and diversification of the enterprises, in turn, build continuing and increased self-confidence for their proprietors.

Access to financial services

Formal sector commercial credit services provide microloans offering a range of amounts, maturities, and repayment terms.
I was able to get a little better price from the wholesale food sellers because I could buy more supplies at one time.
When borrowers with good repayment records have reached the loan ceiling of a commercial microfinance institution, they are often eligible for standard loans from commercial banks.
A couple who lives in the Dhaka slums of Bangladesh and saves in SafeSave,a cooperative institution (see chapter 17),provide a good example of the demand for savings services among the lowest levels of the economically active poor.
The couple’s income is derived from their work of breaking bricks into small pieces to be used as construction materials—for which they receive a daily wage.

Building the self-confidence of the poor

By showing respect to customers and indicating confidence in their enterprises, microfinance institutions help to set the example that many poor households are well regarded and worthy of trust.
In addition, most had accomplished some or all of the following:purchased or improved land,constructed wells or houses, installed electricity, purchased pumpsets, and repaid old debts to moneylenders.
I got a loan from the bank and planted mango grafts.

Notes

Deposit and savings accounts have been defined in a variety of ways.
Because these distinctions are not always relevant in the microfinance market and because others are more important, the terms deposit and savings (when used to describe accounts and services) are used synonymously in this book.
In matrilineal societies (descent through the female line) a man will normally be expected to support his mother’s brothers in old age, rather than his father.
For an example of the assumption that propensity to save is low in most rural areas and that rural savings mobilization is difficult, see Braverman and Guasch (1986).

Financial Markets in Developing Countries

In rural areas and low-income urban neighborhoods of developing countries, local financial markets typically include a mix of formal, semiformal, and informal components (see Germidis, Kessler, and Meghir 1991).
Each borrower or household forms an egocentered network with its own pool of potential lenders and borrowers.
Informal financial markets coexist with the formal financial sector, interacting with the formal sector in numerous ways—especially, although not exclusively, at the local level.
Different local situations, of course, provide different kinds of market interlinkages.
One of the reasons that banks have chosen not to enter microfinance markets commercially is that they believe (incorrectly, as will be shown) that they cannot compete successfully with moneylenders, who are thought to have much better information about local borrowers than banks could obtain costeffectively.

Development of the Financial Systems Approach to Microfinance

A few scattered, early pioneers—such as the Badan Kredit Desa (BKD) village banks and the Bank Dagang Bali (BDB) in Indonesia, the Self-Employed Women’s Association (SEWA) Women’s Cooperative Bank in India, the early ACCIÓN affiliates in Latin America, and various NGOs,credit unions, and cooperatives in a variety of countries—led the way in developing the financial systems approach to microfinance.
In addition, by 52 The Microfinance Revolution: Sustainable Finance for the Poor Banks can serve microfinance markets profitably and on a large scale.
Both BDB and SEWA operated from the start without subsidies, emphasized voluntary savings as well as loans, set interest rates to cover all costs and risks, and developed early models of sustainable microfinance intermediaries.
Before that, large,poorly designed subsidized rural credit programs dominated the institutional approach to microfinance in developing countries.
This pattern still holds in many countries.

Microfinance in the 1980s: Going to scale

By the 1980s, however, numerous institutions in many parts of the developing world were providing microcredit and recovering their loans.
In the 1980s BRI developed the first large-scale sustainable microbanking system operating without subsidy.
These include methodologies for both individual and group lending, new financial products suitable for poor borrowers and savers, interest rate spreads that permit institutional profits, innovative operating methods and information systems,widely dispersed small service outlets, specialized staff training and incentives, the financing of loan portfolios from locally mobilized savings and from commercial debt and investment, and others.
In other cases, however, institutions choose to adopt some aspects of Shifting the Microfinance Paradigm: From Subsidized Credit Delivery to Commercial Financial Services 53 Some institutions, however, have shown that they can provide small loans and savings services profitably on a large scale.

Microfinance in the 1990s: Developing the industry

The 1990s saw accelerated growth in the number of microfinance institutions created and an increased emphasis on reaching scale.
Internationally, a microfinance industry began to develop.
Sustainable microfinance on a national scale depends on institutional governance, management, and organization as well as on products, pricing, and 54 The Microfinance Revolution: Sustainable Finance for the Poor Their success has spawned both imitation and competition within their own countries and adaptation and extension of their methods by institutions in other developing countries.
BRI’s unit desa system and BancoSol are discussed later in this chapter.

Institutional Sustainability

The authors of a 1995 study by the U.S. Agency for International Development of sustainability in 11 microfinance institutions in Asia,Africa, and Latin America developed a framework for evaluating the self-sufficiency of microfinance programs.
This section is drawn from that study, and the definitions of institutional self-sufficiency developed there are used throughout this book.
The institutions examined were selected as a sample of the best-performing microfinance programs in developing countries.
The analysis was based on 1993 data adjusted for subsidies, inflation, and provision for loan losses so that the institutions could be compared with one another, and with the private sector, on a fully commercial basis.

Levels of sustainability

For purposes of comparative analysis, the USAID study divided the continuum into three categories of sustainability: ● Institutions in which revenues from interest and fees do not cover operating costs.
Institutions in which revenues cover operating costs but do not cover the commercial costs of loanable funds.
Some NGOs that are at or close to full self-sufficiency are applying for licenses to become banks or regulated nonbank financial intermediaries in order to increase scale.
A growing number of microfinance institutions are seeking to become part of the regulated formal financial sector in order to increase the scale of their operations Large-scale outreach depends on access to commercial sources of finance which in turn depends on institutional sustainability.
The average loan balance as a percentage of GNP per capita is 81 percent in the institutions that are less than three years old, while it is 59 percent in those that are three to six years old and 55 percent in those more than six years old.

Pioneers in Large-scale Commercial Microfinance

BRI’s microbanking system in Indonesia and BancoSol of Bolivia are introduced here as among the most advanced examples of the microfinance revolution.
They are discussed further in later chapters.
Many of the other institutions that have played crucial roles in developing commercial microfinance are discussed in chapter 10 and part 4.

Microbanking at Bank Rakyat Indonesia

BRI,a century-old state-owned commercial bank,has traditionally held a special assignment from the government to provide banking services to the rural areas of Indonesia,with particular emphasis on agricultural credit.
IMF, Financial Statistics Yearbook 1998 and 1999 and International Financial Statistics 1999, also known as Source.
By mobilizing rural savings . . . [the unit desa system] was not only provided…with a stable source of funds, it also kept financial savings in rural areas, thus helping development growth in the countryside.
The severe economic, financial, and political crisis that began in mid-1997 showed BRI’s microbanking system to be one of the most stable institutions in Indonesia porary high of 22 percent on some savings accounts and 60 percent on some fixed deposits.

During the crisis the

Compulsory savings range from 8–10 percent of the loan.
Like the unit desas, the BKDs continued to be profitable during the crisis years (BRI 1998a, p. 9).
27The visitors represent many institutions that are at various stages of learning about the commercial institutional approach to microfinance and adapting this approach to conditions in their own countries.
They have started to adapt lessons from successful institutions, to invent complementary strategies, to expand the models, and to exchange information across international borders.

The Old Paradigm: Subsidized Credit Delivery

The new microfinance paradigm is emerging,but the old one remains entrenched in many places.
Governments of the many newly developed nations placed high priorities on economic development, and especially on increasing food cultivation.
Under the subsidized credit model, financial institutions,whether savings-driven or credit-driven, have not and cannot provide microfinance— credit and savings services—on a large scale.
In the second, institutions perform well in lending but poorly in mobilizing savings.
But two problems can arise when training is linked directly to credit programs.

The New Paradigm: Sustainable Commercial Microfinance

The new paradigm emphasizes the idea that, given enabling macroeconomic, political, legal, regulatory, and demographic conditions, commercial institutions can be developed to provide financial intermediation for the economically active poor and can deliver services at the local level profitably, sustainably, without subsidy, and with wide coverage.
Thus, Rutherford shows that the poor use both savings and loans to acquire the lump sums they often need for such purposes as emergencies,social and religious obligations (puberty ceremonies, marriages, funerals), and investments in their enterprises (Rutherford 2000; see also Rutherford and others 1999).
The mix will probably change as the industry develops ●.
Are active, committed, and accountable for the financial health of the organization.
Managing the microfinance division of a full-service commercial bank can be a difficult job because most banks do not yet consider microfinance to be “real” finance.

Basic operating principles

Loan repayment is very high in fully sustainable microfinance programs.
Staff maintain ongoing relations with their clients and develop information networks through which they locate potential savers.
Local savings mobilization can work well when staff treat clients helpfully; when savings products are offered that meet clients’ needs for security, convenience, liquidity, confidentiality, and returns; and when institutions have good internal supervision and effective management information and cash management systems.
Incentives may be provided to borrowers for timely repayment.
Where microfinance is offered by a division of a commercial bank, the bank’s owners and managers must understand that microfinance is a different business from the bank’s other activities.

Meeting the Demand for Microfinance

The microfinance revolution is rooted in the new paradigm.
Both institutions began their current microbanking activities in the mid1980s, and by the end of 1995 the number of active borrowers was roughly comparable at 2.1 million for Grameen and 2.3 million for BRI’s unit desas.

Compulsory savings

As a condition for obtaining a loan and the collection of voluntary savings reflect two completely different philosophies was $180; however, a 1995 unit desa survey showed that 71 percent of the unit desa account balances in the survey were below $87.
In 1989 the Grameen Bank’s index was 130 percent, indicating that “the average on-lending interest rate would have had to be increased by 130 percent (from 12 percent to 27.6 percent [a year]) to compensate for the full elimination of the subsidies received by [the Grameen Bank] in 1989” (p. 67).
In 1995 the subsidy dependence index for BRI’s unit desa division was –44.5 percent, indicating that profits had grown substantially since 1989 (Yaron and Benjamin 1997, p. 42).
The large profits of the units have been used to cross-subsidize BRI’s wealthier clients in the bank’s other divisions, resulting in regressive income redistribution (Yaron, McDonald, and Charitonenko 1998).

In this chapter poor people from 16 developing coun-

Tries tell about their experiences in using institutional mi- crofinance services.
In the early 1980s, before the transformation of Bank Rakyat Indonesia’s (BRI’s) microbanking system, I was talking with a carpenter and his wife in their small home in rural Java.
The carpenter, PN, said,“It is good to save in wood because you can buy when the price is low.
Coming from widely varying cultures,economies,and environments, there are, of course, differences among them.
Those to whom the authors listen here demonstrate that institutional microfinance has helped them overcome obstacles, improve their enterprises, and increase their incomes and quality of life ed below help to shape their understanding of the role of finance in the lives of the poor.

Do They Know How to Use Them?

During the early 1980s, when the Indonesian government was beginning to consider changing BRI’s unit desas to a commercial microbanking system, Indonesian officials expressed considerable concern that “our villagers are not ‘bankminded.
But BRI pays 15 percent a year interest on savings, also known as MSR.
But the printer made a mistake—the poster is wrong.
The account that allows withdrawals at any time would be good for me because I can afford to buy only one radio part at a time.

Peru: Credit as a launch pad

DM was born in a rural area in Peru and orphaned at an early age; after marriage, she migrated to Lima with her husband and two young children.
DM was interviewed many years later in 1996; by that time she and her husband had six children and numerous grandchildren—and many things had changed.
She sells staple food products, operating the business out of her stall in the morning and out of her home in the afternoon and evening.
One runs a combined printing business and paper goods store located across the street from the family home; he has also established a beauty salon in the store that is contracted out to local beauticians.
DM qualifies for and receives loans from Accíon Comunitaria on the basis of her market stall.

Bangladesh: Saving for the future

The following interview was conducted by S.K.Sinha of SafeSave.
I see you save pretty regularly but you have never withdrawn or borrowed money, also known as SKS.
For my future, like everyone else does, also known as AF.
At the time of the interview DM had taken 91 successive loans from.

Can Microfinance Help the Economically Active Poor Expand and Diversify Their Enterprises and Increase Their Incomes?

In the majority of developing countries only a minority of informal firms with four workers or less experience growth of any sort.
The examples below provide a sense of the range of enterprises and households served by microfinance institutions and show how access to financial services can help the economically active poor develop their enterprises and increase their incomes.
”Three subsequent loans (of $308, $385, and $500) enabled her to meet expenses even with the higher prices of raw materials, to hire employees, to expand her enterprise, and to succeed in what had become a competitive business.
After investing in her enterprise, BR’s productivity rose from 1,500 bricks to 5,000 successive FINCA loans in materials and equipment.
He rents the house to the local BDB branch manager.

14 liters of peanut oil and 5 liters of peanut residue (which she sells as livestock feed) a week.She travels to the nearest market town every Sunday to sell her produce and to replenish stock needed for her food processing activities.

At the time of her first loan BG earned about $5 a week on the processed peanut products; she sold the sheep she had raised for $97.
This sale enabled 112 The Microfinance Revolution: Sustainable Finance for the Poor “Earlier I could not even express myself or stand before people.
In the second loan cycle BG borrowed $94; she bought two sheep for $59 and sold them after six months for $106.
She purchases ingredients in the early morning and cooks during the day; in the evenings she sells enchiladas, carne asada, rice and beans.
After 1991 DT’s vegetable business prospered and he bought dairy cows; by 1994 the farm fed his family and produced a surplus of $36 a month.

Can Access to Financial Services Enhance the Quality of Life of the Clients of Microfinance Institutions?

When used by clients in ways that expand household economic activities and increase incomes,microfinance services can contribute in multiple and far-reaching ways to the quality of life of household members.
“Tell your husband that Grameen does not allow borrowers who are beaten by their spouses to remain members and take loans”, also known as Bangladesh.

Uganda: Overcoming malnutrition

TA’s husband (who is employed as a janitor-watchman at a feed store),TA and her two co-wives,her mother-in-law,six children, three grandchildren, and four orphans whose households were devastated by acquired immune deficiency syndrome (AIDS).
The whole family was becoming thin and wasted.
She purchased feed on credit from the store where her husband worked, and she used the profits from her grocery stand to make her weekly payments to the village bank.
By her seventh four-month loan she had reached FINCA/Uganda’s maximum loan size of $600 and was managing a flock of more than 500 birds.
Voices of the Clients 115 “Tell your husband that Grameen does not allow borrowers who are beaten by their spouses to remain members and take loans” “Now I don’t have to ask my husband for anything,”TA said.

Indonesia: Saving for children’s education

JB migrated to Bali from Java in 1973 and began working as an itinerant peddler selling ice cream.
JB and his wife use their savings primarily for their children’s education: in 1994 one child was in primary school, one was in junior high, and one was in high school.
Providing university educations for sons and daughters AM started a tiny business selling sweets in the late 1980s, also known as Bolivia.
Gradually, with 10 loans over five years, she built her business into a general shop where customers can buy a variety of articles, including clothing and shoes.
Being able to provide for old age, both one’s own (AF in Bangladesh) and that of one’s elderly relatives (AD’s mother in Nicaragua) is another way in which the quality of life improves with the income increases that can accompany the use of microfinance.

Can Access to Microfinance Help the Economically Active Poor in Times of Severe Household Difficulty?

When disasters hit and people unexpectedly lose their jobs, homes, incomes, and assets,many survive by turning to self-employment in the informal sector.
Supporting the family after her husband left them AL helped her husband build a small ceramics business, also known as Mexico.
With the new loan and the help of her children,AL pulled the business out of debt.
Supporting a displaced family with her husband in jail AG and her family were displaced from Eritrea and began a new life in Ethiopia, where AG had relatives, also known as Ethiopia.
She gradually increased the amount of land she rented, creating employment for herself and for her husband after his return.

Ecuador: Rebuilding a business

EC comes from a long line of herbal healers; she learned curing from her mother, who ran an herbal stand in the public market and was well known for her healing abilities.
“He really had nothing,” a loan officer from Fundación Emprender remembered.
”AR’s mother-in-law lent her $250 with which she sublet a tiny kiosk in the market.
She increased her inventory and turned a profit of more than $6 a day, half of which she gave to her husband and the children living with him on the collective farm.
Whether it is the dissolution of a marriage, the displacement of a household, the loss of a business, the loss of a job, the effects of hyperinflation, or the 120 The Microfinance Revolution: Sustainable Finance for the Poor AR received a loan for $230.

Can Successful Microfinance Institutions Promote the Self-confidence of Their Clients?

Clearly, successful microfinance institutions can boost the self-confidence of their clients.
The process happens in many ways and at many levels.
”TA, in Uganda,with her grocery and poultry businesses, ended her family’s malnutrition, put her children in school, and financed a new house.
Both men and women can gain the confidence to overcome severe setbacks.
Most of the developing world does not yet have access to the microfinance services that helped these people to build their enterprises, control their lives, and care for their families.

1950s in the context of the post–World War II development

Agricultural growth was given high priority, with an emphasis on the high-yielding agri- cultural technologies that were beginning to become avail- able.
Because their interest rates on loans are too low to permit full cost recovery and profitability, these programs have limited the volume of financial services available to the poor—helping for decades to suppress the development of large-scale microfinance.
The conclusions of the imperfect information models and the realities of the markets are often far apart models and the realities of the markets are often far apart.
A variant of monopolistic competition best explains informal commercial moneylending flows from local networks, political alliances, religious af- filiations, and others, make it possible for informal lenders to obtain high repayment rates.

II era of the late 1940s and the 1950s. The theory came from

The combination of three ideas: that the governments of newly emerging nations were responsible for their eco- nomic development, that it was crucial for economic growth that high-yielding agricultural technologies be adopted rapidly and extensively, and that most farmers could not afford the full costs of the credit they would need to purchase the inputs for the new technologies.
Depress both savings mobilization and institutional sustainability— because the interest rates on loans are too low to cover the operating costs required for the effective combined operation of savings and credit programs, and too low to permit institutional profitability.
—Lewis 1955, cited in Penny 1983 Supply leading finance is the creation of financial institutions and instruments in advance of demand for them in an effort to stimulate economic growth.

Supplying Finance in Advance of Demand

Extensive reevaluation of the role of the state in economic development accompanied the independence of many of today’s developing countries.
The avoidance of rural credit on the part of private financial institutions was partly a result of the extensively held—but unexamined—beliefs that few rural households would be willing or able to pay commercial interest rates, and that institutional commercial loans in rural areas would be difficult to collect.
It is perhaps relevant to note in this context that most supply-leading finance theorists were not financial specialists, but economists concerned primarily with the development of the real sector.
By the late 1960s and early 1970s serious difficulties with subsidized rural credit programs had begun to become apparent.

How Credit Subsidies Prevent Sustainable Microfinance

Documentation of the problems of subsidized credit programs and analysis of the reasons for their widespread failures have grown steadily for more than 30 years.
Most poor farmers are still unable to obtain formal loans, and those who succeed in using such credit are often unnecessarily and inequitably subsidized.
These problems persist after three decades of development assistance.
Viewing credit as an input, like fertilizer, causes people to conclude that farmers have specific credit needs that can be met by delivering predetermined amounts of loans to farmers.
Measurement of the impact of a loan requires the collection of costly information on all changes in these sources and uses of liquidity that are contemporary with loan receipt and then a comparison of the “with” and “without” loan situations.

1980s (ignoring recoveries from the loss-making national agricultural insurance company).Recoveries for the smallholder Agricultural Credit Agency in Malawi plummeted from almost

90 percent to less than 20 percent during the most recent elections; the agency was subsequently declared insolvent.
Subsidized credit, channeled to local elites, buys political support for governments—and once offered, is difficult to dislodge In many 144 The Microfinance Revolution: Sustainable Finance for the Poor “Seeds produce plants, fertilizer stimulates plant growth, and diesel fuel powers engines.
This process both raises the transaction costs to borrowers and encourages a culture of corruption among the staff.
Loan products are inappropriate for borrowers’ needs Loan products in subsidized credit programs are usually rigidly determined; the purposes, amounts, and terms of loans are prescribed with little or no regard to borrowers’ needs and income flows.

Subsidized Credit Programs for Microenterprises

In the mid-1980s, driven by the mounting international economic crisis, increasing attention began to be paid not only to agricultural loans but also to the financing of small enterprises and microenterprises and of low-income people more generally.
Thus “the original concern with ‘small farmer credit problems’has become only a proxy for a preoccupation with difficulties of access to financial services by particular groups of society” (Gonzalez-Vega.

1993, p. 5; see also Otero and Rhyne 1994). Some formal institutions began to onlend subsidized government or donor funds to small and microenterprises in urban areas at below-market interest rates.

But other microfinance institutions, while funded by low-cost credit from governments and donors, began to lend to borrowers at or near interest rates Supply-leading Finance Theory 147 A borrower who requests a loan for six months to expand his small shop is given a five- year loan for a well and pumpset that would enable full cost recovery.
Even donor-funded institutions that lend at rates that cover their operating costs and that maintain high repayment rates usually cannot raise sufficient capital to meet local demand for microcredit.
There are far better ways to spend less money for much better results in microfinance Supply-leading finance theorists believed that subsidized credit programs were needed to stimulate economic growth and agricultural production.
Many countries (such as China, India, and Vietnam) continue subsidized rural credit programs today—with continuing low repayment and high defaults.

Self-sufficient microfinance institutions are rare—

As noted in chapter 4, supply-leading finance theory and subsidized credit programs have been a major constraint to the development of such institutions.
The imperfect information paradigm helps explain a wide variety of economic behavior.
Banks may raise interest rates to compensate for risks related to their inability to distinguish between high-risk and low-risk loan applicants.
While imperfect information models of rural credit markets vary considerably, overall their conclusions suggest that it would be difficult for banks both to operate profitably in developing country credit markets and to attain extensive outreach.
Stiglitz and Weiss’ s (1981) application of imperfect information theory to credit markets suggests that raising collateral can increase the riskiness of loans and have adverse selection effects.

Information Flows in Rural Communities of Developing Countries

7The discussion begins with information channeling in the context of the local political economy and then moves to the more specific kinds of information flows available to informal moneylenders as members of their local communities.
Some information may be scarce, valuable, and privately owned by individuals or groups in the community; it can be bought, sold, traded, and inherited.
One common feature of many rural communities is that much local information does not flow freely Villagers were threatened with severe punishment for any of these infringements, and they were expressly forbidden from conveying any information to the boycotted brother or the members of his household (Robinson 1988).
Imperfect Information and Rural Credit Markets Rural credit markets in developing countries tend not to be competitive, especially for low-income borrowers.

Informal commercial lenders

Informal moneylenders wear multiple hats in their communities.
The Imperfect Information Paradigm 161 Informal commercial lenders typically do not want to increase market share or lower interest rates Formal sector financial institutions operating commercially in rural credit markets.
In addition, because these banks are commercially financed and are not capital constrained, there is no need to ration credit because of lack of funds.
According to another view, however, collateral requirements may have adverse selection effects, increasing the riskiness of loans and decreasing the expected returns to the lenders; the possibility of credit rationing remains (Stiglitz and Weiss 1981, 1986, 1987).
Second,unlike most moneylenders, the banks have an incentive to attain wide client outreach.

Informal Commercial Lenders in Microfinance Markets

In examining informal financial markets, this book focuses on commercial moneylenders—because of their importance to the microfinance revolution.
Better knowledge of moneylenders can help commercial microfinance institutions develop in two ways.
Practice of repeat lending to borrowers who repay promptly, with gradual- ly increasing loan sizes.
A brief comment needs to be made about the many loans that are taken from family, friends, and neighbors.

The Size of Informal Credit Markets

If informal credit markets were small, or if they were large and operated competitively, this chapter would not be necessary in a book on the microfinance revolution.
In 1973 Marvin Miracle estimated that more than 90 percent of the credit provided to small farmers in most developing countries went through the informal credit market—though, as he noted, this share was declining (Miracle 1973b,excerpted in Von Pischke,Adams, and Donald 1983,p.214).
Reporting in the same volume on their study of rural credit in Thailand, Siamwalla and others (1993, p. 155) found that “almost 75 percent of those active in the credit market still used the informal sector; in many cases, those households also used the formal sector.
Thus no attempt is made here to use this material for direct intercountry comparisons.
There is no doubt that informal credit markets are widely prevalent in many developing countries and that informal commercial moneylenders play an important role in many of these markets.

Debates about Moneylenders and Their Interest Rates

The demand for credit among low-income borrowers is typically for short-term working capital loans made available at convenient locations with easy processes, appropriate payment schedules, and quick delivery,and with interest rates that the borrowers can repay from household income sources while also permitting their enterprises to grow.
It has long been observed that moneylenders often charge high interest rates; for decades there has been extensive debate about the reasons (see Von Pischke 1991 and Germidis, Kessler, and Meghir 1991).
Roth (1983) discusses “debt farming”in India:managing credit so that the debtor defaults and the lender gains control over his labor.
As a result, the number of potential lenders in a given area is limited, and the degree of market power thus conferred on them may range from pure monopoly (one lender to a village) to some point short of perfect competition.

Informal moneylenders: “value for the people”10

A strongly held belief by traditionalists is that moneylenders are evil and charge exorbitant rates of interest.
This statement, made in the introduction to the classic 1983 volume, Rural Financial Markets in Developing Countries, signaled a new view of informal finance associated primarily with the Agricultural Economics Department of Ohio State University (United States).
The theory of monopolistic competition was developed by Chamberlin (1933) and Robinson (1933); see Negishi (1987) for definitions,history, and overview of the concept.
Lenders generally do not want to increase their market shares (because of the risks of lowering the quality of their portfolios if they lend outside the areas over which they exert influence), have access to good information, and maintain interlinked transactions with borrowers.
There are degrees of monopoly power, and informal com- Informal Commercial Moneylenders: Operating under Conditions of Monopolistic Competition 183 Moneylenders range from helpful to malicious, although they generally lend at high interest rates throughout the range mercial moneylenders range from helpful to malicious, although they generally lend at high interest rates throughout the range.

Policy implications

The value of savings among the poor is, in fact, immense—forty times all the foreign aid received throughout the world since 1945.
Because the rights to these possessions are not adequately documented, these assets cannot readily be turned into capital,cannot be traded outside of narrow local circles where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.
A growing number of institutions are seeking to meet the criteria that would permit them to mobilize public savings Microfinance is an important part of the solution to poor people’s problems with dead capital.
Savings accounts in regulated financial institutions are legally recognized assets, often the first that poor families acquire.

Characteristics of Informal Commercial Loans from Moneylenders

The literature on moneylenders is difficult to compare and to analyze because the data, like those on the extent of informal credit, have been collected under different conditions, for different purposes, at different periods, and in many parts of the world.
Flow credit and stock credit People at all socioeconomic levels participate in informal commercial credit markets, and many are both lenders and borrowers.
First, borrowers are typically limited to a few people the lender knows well and with whom he maintains extensive interlinked transactions in other markets.
Informal commercial lenders are not especially interested in the purpose of the loan.
If all else fails, the lender may bring to bear other sanctions on the defaulting borrower, including ostracism, informal economic sanctions, damage to the borrower’s enterprise and reputation, and physical harm to the borrower or a family member.

Interlinked transactions

As noted, lenders often have interlinked transactions with their borrowers in other markets.
Interlinked transactions can work to the benefit of both participants,or they can be exploitive.
As Hellman (1994, p. 129) comments about Mexico,“the more distant the peasant from market, the more isolated the village, the more complete is the control of the moneylender who is the only one equipped to move the crop of a poor peasant from the field to the marketplace.”.
A 1984 survey of 111 borrowers and 16 lenders in 14 villages in three rural provinces in the Philippines found that linked loans accounted for 79 percent of the volume of credit in the marginal regions of the study area and 82 percent in the developed regions (Floro and Yotopoulos 1991, p. 75).

Availability of loanable funds

Siamwalla and others (1993, p. 172) comment on the availability of funds in Thailand’s informal rural credit markets: “In their extensive interviews with informal lenders in Thailand, there is very little evidence that the volume of their business is constrained by the availability of funds”(see also Aleem 1993).
Indeed, a major benefit to the lender from nonspecialization [as a moneylender] was the access trading activities gave him to low-cost and subsidized institutional credit.”.
Extensive arbitrage is also reported from some areas of India.
Generally the main constraint is the number of low-risk borrowers available to each lender.

The “Too Many Lenders” Problem

In his study of moneylenders in Pakistan,Aleem (1993) says that each lender is perceived by borrowers to offer a different product; each faces a downwardsloping demand curve.
In informal commercial credit markets there is high demand for loans, but in general each lender wants to lend to relatively few borrowers.
Each lender prices her own interest rates based on the conditions of her business and her ability to collect loans.
On the one hand, the new lender may refuse to lend to the borrower because of the risk of collecting loans in another lender’s territory.
In all cases [moneylenders] lived and operated within their respective communas [minor civil divisions], and their operations usually were found no more than 1 to 2 miles from a rural village or were confined to the rural neighborhood.

A borrower typically receives credit from one informal commercial lender

In a given period (usually several years) borrowers take loans from only one informal moneylender (see Gamba 1958; Nisbet 1967; Robinson 1988; and Siamwalla and others 1993).
Of the 14 Chambar market lenders studied, 10 said they were not prepared to give loans to farmers borrowing from other lenders as well.
In one common version a large informal lender, instead of lending directly to end borrowers (except those with whom he has long-standing personal relationships), provides loans to smaller lenders with whom he has close connections.
Floro and Yotopoulos (1991) studied credit layering as part of their extensive 1984 survey of informal lenders and borrowers in rural areas of the Philippines.
Furthermore, all five of these traders obtained their credit capital from two large Chinese vegetable wholesalers.

Transaction Costs and Risks for Informal Commercial Moneylenders

Lenders’ transaction costs and risk premiums have been debated at length.
At Ohio State University’s Department of Agricultural Economics, the view has been, rightly, that most moneylenders are not malicious monopolists.
But according to this school of thought the observed interest rates of informal commercial lenders are accounted for primarily by transaction costs and risk.

The transaction costs of lending

Transaction costs for lenders include the costs of collecting information about potential borrowers and updating information about repeat borrowers; assessing collateral when relevant;and extending,recording,and collecting loans.
It has been argued for decades that high interest rates are a result of high transaction costs as well as risks.
“The high cost of administering small loans and persistent repayment problems lead to high interest rates in informal rural money markets in the developing world.” ● Von Pischke (1991, p. 175)—.

Risks

A distinction must be made, however,between lenders who lend their own or borrowed funds and bear the risk of default, and those who act as brokers, matching savers with borrowers and charging the borrowers a commission.
But they can also be low, especially for repeat borrowers.
Even within a village one borrower may have several sources of loans, while another lacking alternatives may be forced to pay monopolized rates.
Overall, lenders’ transaction costs and risks can be high,but—especially when there are interlinked transactions with borrowers in other markets—they are often low.

The nature of the data

While data about moneylenders’ interest rates are extensive, they are difficult to compare and analyze.
Not only is it common for researchers to receive inaccurate reports, but there are also uncertainties and disagreements in the rural population itself as to what rates are conventional.”.
First, there is a wide range of interest rates in informal moneylending, the result of multiple types of credit arrangements (see Germidis, Kessler, and Meghir 1991).
The poor are charged higher interest rates because they have low bargaining power,and because the transaction costs to lenders in making small loans are essentially the same as those in making larger loans.

The poor are charged

Sometimes the borrower repays years later, when he again wants support from the lender.
At the time I lived in the village, borrowers who had defaulted on loans and become bonded laborers as a result had been bonded for periods ranging from one month to more than 30 years.

What Are the Transaction Costs and Other Noninterest Costs for Borrowers?

Among all the debates about moneylenders, there seems to be little or no dispute about borrowers’ transaction costs: typically they are low.
Loan amounts, maturities, and payment schedules are flexible.
I paid the tehsildar’s servant 25 rupees and got the signature.
Applicants fill out a short loan application.
For 212 The Microfinance Revolution: Sustainable Finance for the Poor Borrowers’ transaction costs at BRI’s unit desas are higher than most borrowers incur when obtaining credit from moneylenders.

The Costs of Borrowing: Comparing Moneylenders with Bank Rakyat Indonesia’s Unit Desas and BancoSol

The examples of interest rates discussed in this chapter are shown in table 6.1, excluding loans taken before 1980.
Table 6.1 shows annual inflation rates for the year (or range of years) when the loans from moneylenders were made.
In addition to this statistical nightmare, many of the relevant data are missing: More than three-quarters (76 percent) of the moneylenders’ monthly effective interest rates are more than three times BRI’s rates and BancoSol’s rates for loans in dollars, and they are more than twice BancoSol’s rates for loans in bolivianos.
Yet it seems likely that many poor borrowers would probably prefer to bear the transaction costs of a loan from a BRI or a BancoSol if they could obtain credit at an interest rate that is one-third,one-tenth,or even one-twentieth the rate charged by their local moneylender.

Making Microfinance Competitive

Von Pischke (1991, p. 185) comments on the five-six terms found in the Philippines and elsewhere:“Monopoly profits of the sort implied by these examples would surely attract vigorous competition that would severely erode returns.
Most formal sector financial institutions have not been interested in competing for low-income rural clients on a commercial basis.
As shown in figure 6.1, BRI’s unit desas, BancoSol, and other commercial microfinance institutions can provide microcredit profitably at much lower interest rates than most moneylenders charge.
It has long been known that large-scale financial intermediation is crucial for economic growth.

Mobilizing Microsavings: Five Broad Patterns

As noted in chapter 2, the collection of voluntary savings by microfinance institutions falls into five major patterns.
Under both kinds of subsidized models (credit driven and savings driven), financial institutions have not, and cannot,meet the demand for microfinance—for credit and savings services.
Institutions that provide commercial microfinance have strong incentives both to provide deposit instruments that are appropriate for small saver demand and to lend out the deposits locally in small loans.
The poor savings record of BRI’s unit desas at that time was not a result of low demand; it was a direct result of bad policy by the government and the bank.
A review of rural credit in developing countries reports:“Commercial banks and state-funded institutions have not mobilized much rural savings.

Forms of Informal Savings

Developing countries show considerable similarity in the informal methods used by the poor for saving, in the reasons they save, and in the ways they match the type of savings with the saving purpose.
This discussion is not intended as a complete account of the forms in which poor people save; it simply covers some of the most common of these.
First, I have little experience with herding societies.
Cash and gold can generally be used as savings for all purposes.
Medium-term savings or investment goals (paying for religious ceremonies,purchasing tools or machinery,managing irregular income streams) can be met, in addition to cash and gold savings,by saving in such forms as grain,cash crops,animals, and ROSCAs.

Cash

In monetized areas it is generally thought important to hold some cash in the house, primarily for emergencies.
Security is a major reason for not wanting too much cash in the house.
Some liquidity Quality deterioration in some cases cash crops .
Now that she’s dead I just haven’t got anyone I can trust like that.
It’s much harder to make sure I’ve enough for the fees.

Grain and cash crops

Attitudes toward saving in grain tend to be similar to those expressed about cash.
Almost everyone wants to have enough grain or other staple food on hand to meet a reasonable level of unexpected need above anticipated requirements, but farmers often do not want to store grain beyond a particular time or above a certain amount.
Farmers also try to save cash crops that are not easily perishable, such as cloves, nutmeg, rubber, cotton, and coffee,until prices rise.
At that time they may switch to another form of savings, such as cash, gold, or animals.
In general, farming households wait, if possible, until the price for their crops is high, then sell them and save in another form.

Animals

In developing countries, rural households that can afford to do so typically keep a few large animals.
They perceive the opportunity costs of household members’ time and the liquidity problems caused by the indivisibility of animals.
In some cases animals are given out on a shareherding basis, to be cared for by people who live near better grazing lands.
If made visible to the community, gold and other valuables can also serve as status symbols and can sometimes be used as collateral for loans.
”Another commented,“In the old days there was always somebody at home.

Land

In all areas where land is valuable and privately owned, its ownership is a long-term investment that can increase in value over time.
Without clear title, the use of rural land may be subject to dispute and litigation; in urban areas such land may be lost to urban development.
The often lengthy process involved in purchasing land is perceived by prospective buyers as a reason for holding savings, especially in liquid forms.
Land ownership by low-income households can be risky; it is not always possible for small landholders to provide the labor resources,capital for inputs, and water required for cultivation.
In countries with land ceilings, such as India, buying land beyond the legal limit may be risky.

ROSCAs and RESCAs

ROSCAs and RESCAs/ASCAs are found in many variations and at many financial levels throughout developing countries (see Rutherford 2000).
Each time the members convene and submit their contributions, a new fund is formed but is depleted immediately again.
—Bouman 1989, pp. 52–53 ROSCAs, RESCAs/ASCAs, and other informal savings and loan associations are extremely popular in most developing countries, and many people are members of more than one such group.
For low-income people these groups can permit reasonably secure savings and facilitate regular savings habits.
Some ROSCA managers receive benefits (such as receiving the funds at the beginning of the cycle) in return for their management duties.

Raw materials and finished goods

Saving in raw materials is common among goods producers.
The advantages are that the materials can be purchased when prices are low and saved for later use.
Thus a dressmaker operating a microenterprise in Kenya commented that when she had made a big sale the previous year, she had not known what to do with the money.
Eventually she decided to use the cash to purchase a large bolt of cloth.
Microentrepreneurs who produce or trade goods also frequently save in finished goods that are ready for sale.

Construction materials

For microenterprises that are engaged in construction as a business, saving in construction materials falls into the category of saving in raw materials.
But many other people also save in construction materials.
Houses are often built or ren- Savings and the New Microfinance 241 While ROSCAs work well generally, they are vulnerable to collapse if managers are corrupt, members are undisciplined, or a collective shock occurs ovated bit by bit.
These materials may be used for construction or sold when prices rise.
When I got some money I made bricks, when I got some more money I built up to the window level.

Saving by lending

Many people, not just professional moneylenders, lend cash and grain.
Savings services are in such great demand in developing countries that the poor are often willing to pay for the opportunity to save outside the house,entrusting their savings to paid collectors.
. . .When the contract is fulfilled—when the client has saved Rs 5,220 times .. .the client takes her savings back.
The disadvantages are the negative returns and the risk that the savings collector, who often is not formally registered or supervised, may abscond with the funds.
The advantages of saving in labor obligations owed to you are that this provides access to a supply of labor as needed and enables the fulfillment of social and religious obligations without exhausting more liquid forms of household savings.

Advantages and Disadvantages of Informal Savings and Financial Savings

Emergencies and unexpected investment opportunities Saving for emergencies is probably the most common reason for saving among low-income households in developing countries.
In general,only deposit accounts with no restrictions on withdrawals will draw savings that are being kept for emergencies.
The advantages of financial deposits in this case are that the funds are generally secure, the returns provide a flow of income in low-income periods, and, unlike most ROSCAs, for example, the savings are available when they are needed.
Real value of savings may decline due to inflation or currency devaluation Transaction costs to the saver Interest may be taxed Savers with very small accounts may earn no returns Risk of the institution’s failure or bankruptcy.

Long-term investments

Households often save to finance long-term investments such as land purchase, children’s education, and house construction.
“Like most parents, the authors have faced a lot of trouble with school fees, and only that [Uganda Women’s Finance Trust] savings account could come to my rescue.
”Alice’s husband’s business had once again hit a snag,and so the children returned to school while the fees remained unpaid.
When financial instruments are available, fixed deposit accounts are commonly selected for saving for long-term goals.
But semiliquid and liquid instruments are also used.

Old age and disability

Saving for old age and disability takes both direct and indirect forms.
13 Direct forms involve saving in such forms as land, gold, cash, and animals.
Advantages of financial deposits include the security of the savings and the possibility of substantial returns earned over long periods.
The recent experience of BRI’s unit desas is instructive in this regard.

Why Does the Formal Sector in So Many Countries Fail to Mobilize Microsavings?

In some countries government regulations—such as mandated interest rate spreads that are too low for institutional profitability—impede the mobilization of microsavings.
14 These mistaken perceptions can largely be overcome with information, incentives, and political will.
A study by CGAP’s Working Group on Savings analyzed the cost of savings in BRI’s unit desa system in 1996 and estimated that the total cost of mobilizing savings and deposits, including the liquidity cost and reserve requirement, was 15.4 percent of the deposit balance (Maurer 1999, p. 134).

The Mobilization of Public Savings by Sustainable Microfinance Institutions

New microfinance institutions or those that fall into pattern 2 (good lenders but weak savings mobilizers) must consider three issues if they want to mobilize public savings.
The answers to these questions will vary somewhat depending on the country and region.

Preconditions

There are five main preconditions for a microcredit institution to begin mobilizing public savings.
Microfinance institutions cannot be expected to operate sustainably in countries suffering from hyper- 256 The Microfinance Revolution: Sustainable Finance for the Poor Collecting public savings enables widespread service to poor savers, makes more funds available for small loans, and helps attain institutional profitability inflation or in regions experiencing continuing warfare or endemic and severe civil strife.
As discussed in chapter 20,commercial institutions that provide microfinance need appropriate regulations on such matters as interest rates, capital requirements for opening an institution, capital adequacy ratios, liquidity ratios, accounting and audit standards, requirements for opening branches, and reporting requirements (for discussion, see Berenbach and Churchill 1997;Christen 1997c;Churchill 1997b;Rock and Otero 1997; Ledgerwood 1999; and Christen and Rosenberg 1999).
These clients also require a choice of savings instruments, including fixed deposit accounts.
Such savers would also typically not receive interest on liquid accounts because their monthly balances would be Savings and the New Microfinance 259.

Sequencing a savings program

Some institutions serving microsavers begin with savings services, some start with savings and loans together, and some add voluntary savings mobilization to ongoing microcredit institutions.
During the pilot phase attention should also be given to the planning, logistics, management information systems, asset-liability management, and wider staff training that will be needed to expand the savings program.
One bank manager who sought to expand directly from the pilot phase to immediate savings mobilization in all the bank’s branches learned the hard way.
While waiting, she told me that this was the third time she had tried to withdraw funds from her account, but on the other two occasions she had not been successful because the computer had been down.

Who Benefits?

The answer is almost everyone involved: individuals, women,households, and enterprises; groups,organizations, and institutions; the implementing financial institutions, governments, and donors; and the economy.
Self-financing of investment is especially important for low-income households and microenterprises.
The many benefits of effective institutional savings mobilization are summarized below.
These benefits assume careful government supervision of the financial institutions involved.

Benefits to individuals and enterprises

When voluntary savings are locally mobilized by microfinance institutions,households and enterprises can benefit (see table 7.2).
Savings accounts not only provide security, legal recognition of the asset, and returns, they also improve household financial management.
Thus on the day that SIMPEDES accounts were introduced in one region a street fight broke out in front of a unit desa between members of the local horse cart association and its treasurer.
Group savings of the first type have been reported to improve the financial security of the group, to decrease opportunities for corruption,and to improve the accountability and financial management of group funds.
Benefits to the implementing financial institutions Deposits mobilized in conjunction with commercial credit programs enable the growth of sustainable microfinance institutions.

Benefits to governments and donors

Governments and donors benefit because the funds they previously provided to finance microcredit portfolios can be used for other development purposes.
Higher domestic savings then enable higher gross domestic investment, con- 264 The Microfinance Revolution: Sustainable Finance for the Poor Institutional savings mobilization at the local level deepens financial markets, contributing to economic growth and equity tributing to higher economic growth.
Institutional commercial loans and informal commercial credit both have the capacity (present or potential) to meet much of the demand for microcredit.
In addition, many savers say that access to voluntary savings accounts imposes better discipline on them, and they save more.
Overall,microfinance fosters growth in low-income segments of the economy and improves the distribution of income.

Glossary and Acronyms

Some informal commercial moneylenders take subsidized loans from banks and use some or all of the loan funds to lend to borrowers (often poor ones) in the informal credit market at higher interest rates.
ASA Association for Social Advancement ASCA accumulating savings and credit association (also known as RESCA) asymmetric information a situation in which one party to a transaction has more (or different) information about the transaction than 269 does the other party.
In credit markets, the borrower has more information about his or her creditworthiness than does the lending institution.
Attached labor a system in which a borrower takes a loan from an informal lender and becomes “attached” to the lender: the borrower’s labor (or that of a member of his or her household) belongs to the creditor until the loan is repaid (under a variety of payment systems).

BKK Badan Kredit Kecamatan (Indonesia)

Bonded labor a subset of attached labor found especially in underdeveloped areas.
The terms of the loan do not permit the borrower’s work to provide both subsistence and loan repayment within the period specified.
This practice typically aims to establish a long-term supply of cheap labor for the lender.

CDF Credit and Development Forum (Bangladesh)

CGAP Consultative Group to Assist the Poorest, a multidonor international consortium formed in 1995 to assist the development of microfinance internationally.
Also called forced or mandatory savings, such savings usually cannot be withdrawn until the loan is repaid or longer, and sometimes not until the borrower leaves the institution.
Compulsory savings raise a loan’s effective interest rate.

Finamérica Financiera América (Colombia)

Financial intermediaries organizations that provide financial products and services (credit, savings, payment services, transfer facilities), intermediating between borrowers and lenders/savers FINCA Foundation for International Community Assistance.
A nonprofit antipoverty organization based in Washington, D.C. that promotes the village banking method of microcredit delivery internationally.
Flat interest rate interest rate calculated on the original face amount of the loan (rather than, as in effective interest rate, on the declining balances owed after successive installment payments).

HIID Harvard Institute for International Development

International Monetary Fund informal commercial unregulated lenders whose subsidiary, primary, or moneylenders sole occupation is the provision of credit with the ex- pectation of profiting from the loan.
Some lend at their Glossary and Acronyms 271 own risk, others intermediate between savers and borrowers—in which case the savers bear all or part of the risk.
Interlinked transactions transactions in which the parties trade in two or more markets and the terms of the trades are jointly determined.
A rice merchant provides loans to farmers who are also the merchant’s rice suppliers; the terms for the loan and the purchase of the rice are set jointly.

K-REP Kenya Rural Enterprise Programme (Kenya)

KUPEDES Kredit Umum Pedesaan, the loan product of BRI’s unit desas.
KUPEDES is an acronym for general rural credit, but after 1989—when these loans were offered in urban units as well as rural ones—KUPEDES became widely known as general purpose credit.

MFI microfinance institution

Microfinance small-scale financial services provided to low-income clients MicroRate Private Sector Initiatives Corporation, known as MicroRate.
Informal commercial moneylenders often operate under conditions of monopolistic competition.
In the credit market context, the lender cannot fully monitor or enforce contracts because the lender cannot observe the borrowers’ use of the loan funds.
Yet the borrowers’ limited liability provides an incentive to use loan proceeds for risky investments.

RRB Regional Rural Bank (India)

Savings collector an individual or association that holds the savings of clients (usually poor savers) and charges a fee for the service.
Savings collectors typically operate in the informal, unregulated economy, but some are registered entities.
SBP Sustainable Banking with the Poor, an international collaborative project sponsored by the World Bank and other donor agencies to promote microfinance.

SEWA Self-Employed Women’s Association (India)

SIMASKOT simpanan kota (urban savings), a savings product offered in BRI’s urban unit desas SIMPEDES simpanan pedesaan (rural savings), a savings product offered in BRI’s rural unit desas subsidized credit Credit in which interest rates and other fees do not cover the full cost of making and collecting the loans.
The full cost of providing microloans, as a percentage of the loans, is higher than the market rate for standard bank loans (so the market rates of conventional loans are usually subsidized rates if used for microloans).
When a lender (formal or informal) provides a loan to a borrower, both parties bear transaction costs.
For the lender such costs include obtaining information about the creditworthiness of the borrower, administering the loan, and collecting it.

UNDP United Nations Development Programme

The lowest level permanent outlet of BRI’s microbanking system.
Unit are located at the subdistrict level and provide financial services to the villages of that subdistrict.

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Figure 1.1 Financial services in the poverty

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The Microfinance

Revolution

Sustainable Finance for the Poor

1818 H Street, NW, Washington, D.C. 20433 USA

Manufactured in the United States of America

First printing May 2001

The findings, interpretations, and conclusions expressed in this book are entirely those of the

author and should not be attributed in any manner to Open Society Institute or to the World

Bank, its affiliated organizations, or members of its Board of Executive Directors or the countries

they represent

Library of Congress Cataloging-in-Publication Data

Robinson, Marguerite S., 1935–

The microfinance revolution: sustainable finance for the poor / Marguerite S. Robinson.

p. cm.

Includes bibliographical references.

ISBN 0–8213–4524–9

1. Microfinance—Developing countries. 2. Microfinance. 3. Financial institutions—Develop-

ing countries. 4. Poor—Developing countries. I. Title.

HG178.33.D44 R63 2001

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2001026146

Edited, designed, and laid out by Communications Development Incorporated, Washington,

D.C. and San Francisco, California

The Microfinance

Revolution

Sustainable Finance for the Poor

Lessons from Indonesia

The Emerging Industry

Marguerite S. Robinson

The World Bank, Washington, D.C.

Open Society Institute, New York

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Frequently Asked Questions (14)

Q1. What are the other sources of funds appropriate for financing microfinance?

other commercial sources of funds—such as debt and investment—are also appropriate for financing microfinance loan portfolios.

Q2. What countries have used agricultural credit programs as a main component of their rural development strategies?

Among others, Brazil, India, Jamaica, Mexico, the Philippines, and Thailand have used agricultural credit programs as a main component of their rural development strategies.

Q3. What are the main preconditions for a microcredit institution to begin mobilizing public savings?

Before mobilizing voluntary public savings, a microcredit institution should have demonstrated accountable ownership, effective governance, and consistently good management of its funds.

Q4. Why do some people pay an unnecessarily high price for credit?

But because informal credit markets typically are not competitive, low-income borrowers pay an unnecessarily high price for credit.

Q5. Why do informal moneylenders have to ration credit?

Because of the constraints that informal moneylenders face as participants in the local political economy, they must ration credit; banks need not.

Q6. Why do borrowers understand that their ability to reborrow is based on their own?

Because profitable commercial institutions can usually mobilize local savings or leverage capital as needed,borrowers understand that their ability to reborrow is based on their own performance, not on external factors.

Q7. What are some of the reasons why people with long-term goals may use fixed deposit accounts?

Farmers and others with seasonal incomes may also use fixed deposit accounts for some of their savings, as is also common with people saving for long-term goals.

Q8. What is the way to obtain information on the creditworthiness of potential borrowers?

Information on the credit worthiness of potential borrowers can be obtained easily and relatively cheaply, since lenders usually live and work in the circumscribed area of their financial operations, which also allows for effective follow-up on outstanding loans.

Q9. What are the three issues that must be considered if they want to mobilize public savings?

New microfinance institutions or those that fall into pattern 2 (good lenders but weak savings mobilizers) must consider three issues if they want to mobilize public savings.

Q10. What are some other practices that inflate the effective monthly cost of a loan?

Other practices that inflate the effective monthly cost above the stated rate include collecting interest at the beginning of the loan, charging a loan fee, and requiring daily or weekly repayment (which raise the effective monthly cost by more frequent compounding).

Q11. Why did the 1980s show that commercial microfinance institutions need not remain capital constrained?

And because microfinance institutions have begun to mobilize public savings and access capital markets, they have realized that they need not remain capital constrained.

Q12. Why do the analysts suggest unnecessarily bleak prospects for financial institutions?

But because analysts understand the problems caused by imperfect information better than the solutions, their conclusions suggest unnecessarily bleak prospects for financial institutions operating in rural areas, and for microfinance generally.

Q13. What is the proxy for depth of poverty?

Although amount of loan balance as a percentage of GNP per capita is commonly used as a proxy for depth of poverty (because it is widely available), this is an imperfect proxy.

Q14. What is the first step in designing and pricing savings instruments?

The first step in designing and pricing savings instruments for the microfinance market should be careful market research and the design of savings and deposit instruments and services appropriate for demand in this market.