It discusses key issues that the rapidly growing microfinance industry currently faces, and offers interesting views and analysis of topical matters concerning the microfinance realm. Springer Professional. Back to the search result list. Table of Contents Frontmatter 1. Dilemmas and Directions in Microfinance Research Abstract. Associating microfinance with alleviation of poverty has become a truism. Subsequently, the microcredit movement has enjoyed wide support from governments, international development agencies, wealthy philanthropists, renowned financial institutions and even the Noble Peace Prize Committee.
Consistent with this trend, success stories abound on the internet and in countless reports of microentrepreneurs who set up successful businesses, lifting their families and neighbouring poor out of poverty. We study whether microfinance institutions MFIs have improved the availability of credit to microenterprises in Eastern Europe and Central Asia ECA in the first half of the past decade. Our approach is different from that of a typical microfinance impact study, which focuses on evaluating social or economic impact of a single MFI or product.
Countries in the ECA region are appropriate for such an approach because, during the study period, they had an educated but impoverished population and limited credit supply. The remarkable growth in microlending during the past four decades has been accompanied by numerous credit impact assessments that initially reported microloans were quite effective in alleviating poverty.
An explanation for these diverse results might be found in the problems involved in documenting credit impact.
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In Section 2, we briefly summarize the findings of numerous impact assessments. Section 3 discusses the major problems faced by those doing these evaluations. In Section 4, we offer our explanations for the widely diverse results that are being reported. Placing more emphasis on jobs might, in turn, require the microfinance industry to rethink its concerns about mission drift and graduation of successful borrowers, and instead capitalize on its opportunities to go up-market and support small enterprises that grow and hire more people.
The small credit amounts used in microfinance seem to suit women better than men, and women can also be used as vehicles for credit delivery. Microfinance is generally viewed as a powerful tool for empowering women and improving their livelihoods. Addressing gender issues in microfinance interventions, however, means more than targeting a programme towards women, or counting the number of loans made to women. A gender-sensitive approach would imply examining both women's and men's economic and social position in the family and the community.
It also implies analysing how their position is reinforced through the institutions that they deal with and how it is governed by national laws and customs. Most microfinance institutions provide savings and loan facilities and other microfinance services to groups, thereby reducing the number of individual transactions. Through group outreach microfinance institutions can also avail themselves of the groups and their representatives for a number of activities such as the disbursement of individual loans, the collection of individual savings and repayments, peer monitoring, and repayment pressure.
Transaction costs may be too high to provide microfinance services individually, both sustainably and often enough, especially in areas of difficult access and sparse population such as forest regions. Although bigger and stronger forest-based small-scale enterprises may afford to visit the microfinance institution branches when needed, group outreach can be a successful mechanism for microfinance institutions to expand their outreach with limited increases in costs.
Financial sustainability is necessary to reach significant numbers of poor people in a stable and durable manner. Sustainability is the ability of the microfinance provider to cover all of its costs, and is therefore the only way to reach significant scale and impact beyond what donor and government agencies can fund.
Sound, efficient and sustainable microfinance institutions should ensure high loan recovery rates, charge appropriate interest rates, increase productivity and the number of borrowers, and reduce operating costs with efficient delivery systems. Sustainability is closely linked to outreach since most poor people are not able to access financial services due to the lack of strong financial intermediaries, which are the only way to guarantee continued provision of microfinance services for poor people.
To achieve the viability and good financial performance necessary to service small-scale enterprises reliably and continuously, microfinance institutions should be able to charge cost-recovering rates and at the same time ensure transparency in pricing to protect consumers. Viable and sustainable microfinance institutions, focusing on reducing transaction costs and developing new products and services, will be able to better provide microfinance services to poor people. Promoting competition and institutional efficiency will facilitate the reduction of interest rates over time.
Several microfinance indicators, benchmarks and rating systems have been developed to assess microfinance institutions' performance and their sustainability Table 2. Transaction costs, including credit and economic risks, and interest rates are the main financial factors, together with the cost of funding, affecting the viability and sustainability of the institution.
The adjusted return on assets ROA and the portfolio at risk PAR are among the most significant indicators of overall financial performance. The adjusted ROA shows the profitability of the microfinance institution, after discounting possible grants and subsidies from government or donors, and therefore its sustainability. The PAR tells how well the microfinance institution achieves its basic goal of lending money and receiving it back. More detailed indicators are provided in CGAP Detailed microfinance benchmarks, for example, by lending method, by region, by target market, are provided in the MicroBanking Bulletin www.
Table 2 Microfinance institution financial indicators and performance benchmarks. Transaction costs are those connected with the provision of microfinance services, such as the collection of savings, disbursement of loans, collection of repayments and provision of other services such as insurance and transfers other than the cost of funding.
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Provision of microfinance services to small-scale enterprises is likely to entail greater transaction costs than the already costly provision of traditional microfinance, because the population density is generally low and households generally live in remote access areas. The higher transaction costs of microfinance institutions are largely a result of the need to travel long distances to reach a dispersed rural clientele, the poorly developed rural transport and communication infrastructure, and poor knowledge of heterogeneous rural households, their economic activities and their financial needs.
Normally, labour and transportation costs represent more than 60 percent of the total administrative costs of the microfinance institutions. It should be noted that for the clients, in addition to the costs of borrowing, there are other high additional costs: opportunity costs working time , transport costs, fees and unofficial payments, delays, excessive paperwork and collateral documentation.
The delivery mechanism for microfinance services also has important consequences on transaction costs; in order to achieve greater outreach, some microfinance institutions provide doorstep services to the client, whereby their staff visit households instead of requiring clients to come to the branch. This reduces the costs for the clients and facilitates access to services, but entails greater transaction costs for the microfinance institution.
Although most investments in forest-based small-scale enterprises are expected to yield benefits in the medium and long term, forest activities are perceived to be subject to uncertainties. The larger the size and the longer the term of the loan, as is the case for initial fixed investments such as tree planting and purchase of equipment, the more important are frequent contacts with and supervision of the borrower.
This should control the risk of loan default, which is costly and time-consuming. Microfinance institutions will therefore tend to incur greater costs and require higher collateral when servicing forest communities than in the case of other clients. Providing microfinance to poor individuals is deemed to involve high risks. The management of these risks contributes to the transaction costs, both in acquiring information on the borrowers and their economic activities, and in making the necessary provisions against possible non-repayment.
Credit risks relate to moral hazard, which is the possibility that borrowers may skip the repayment, while external economic risks relate to the future economic and financial viability of the investment financed. Lenders must carefully screen and select borrowers in order to reduce moral hazard risks, and to ensure that the entrepreneur has sufficient management skills and that the economic activity will generate enough profits to repay the loan.
Credit risks are normally assessed by creating a client profile including track records, range of experience, existing assets and labour force. Credit risk is normally higher for a client that the microfinance institution has no previous experience of, so usually new borrowers receive smaller loans with shorter repayment periods, while borrowers with good loan repayment can gradually receive larger amounts for longer terms. Frequent payments in small instalments are a strong tool for maintaining contact with the borrower and the lender, thus controlling this risk, although they increase transaction costs.
If repayment is based on the projected cash flow generated by the investment, supervision should ensure that the disbursed loan is used for the purpose stated in the loan contract. Mobilization of savings is an alternative way to build additional ties between borrowers and lenders, reducing credit risk and providing for partial loss coverage in case of non-repayment. To a certain extent, risks and information-related problems and costs can be reduced by the use of collateral.
Collateral serves two important functions: it acts as a screening device to reduce wilful defaults on loans, and it reduces lending risk by providing the lenders with an additional source for repayment. Due to costs and risks involved in liquidating the collateral, the lenders tend to require collateral valued at 1.
The collateral requirement has a negative impact on poor people because it tends to limit loans to wealthier individuals.
Forest-based small-scale enterprises are likely to face greater requests for collateral because of greater uncertainty about their ability to repay given the longer-term nature of the investment being financed and the higher probability that some negative unexpected event will occur during that time. This is a problem in many developing countries, and in particular for enterprises and households living from forest activities, given that forest land is in many cases government-owned, and households often lack formalized ownership titles and registers for real estate assets.
Examples of external risks that can affect forestry activities are: natural disasters such as storms and fires; technical production failures such as tree crops damaged during the immaturity period or equipment breaking down; and changes in economic conditions, for example, a lower demand leading to a lower price for the product. Investments for immobile assets such as land and buildings are generally less risky for the lender because the assets along with the borrower cannot easily disappear and can be used as collateral. Semi-immobile assets such as tree crops share many of these characteristics but need more supervision.
In order to reduce financing risks, mobile assets such as certain types of machinery may require either additional collateral or a proper registration system and a legal framework that facilitates repossession. To achieve sustainability, interest rates of microfinance institutions should cover all costs including costs of funds, administrative costs and provision for loan losses and inflation. Microfinance institutions often charge interest rates of 2 to 3 percent per month or even more; these rates are mainly a result of high transaction costs and risks in financial intermediation.
Loan administration costs in terms of personnel and resources are approximately the same irrespective of the loan size, and thus have a higher impact when dealing with small loans. To cover these costs and allow for their growth, microfinance institutions should therefore be allowed to charge interest rates that are above the average bank loan rates. When servicing forest-based small-scale enterprises they may have to charge interest rates even higher than average microfinance rates, given the higher transaction costs involved in rural areas.
For most rural people the alternatives to sustainable microcredit are money lenders, input suppliers, inflexible and risky local savings circles, or nothing at all. Although the rates of interest charged by microfinance institutions to cover the costs of microcredit are relatively high, they are still below what poor people usually pay to money lenders and middlemen. Ensuring transparency and competition among microfinance institutions will, on the other hand, help prevent those excessive rates and other fees from being passed on to the clients to cover operational inefficiencies.
The interest rate directly affects the financial costs of loans for small-scale enterprises and therefore the viability of the investments. High interest rates have a significant impact on profitability, particularly that of longer-term investments such as tree crops, given the large loan amounts to be repaid over a long period.
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If high interest rates are applied to larger loans with longer maturities, then the resulting financing costs may exceed the profitability of the specific term investment opportunities. On the other hand, longer-term loans have the primary advantage of spreading amortization payments over a longer period, making these loans more affordable.
Although high interest rates may be a disincentive for forest-based small-scale enterprises in investment and economic development, in order not to compromise the sustainability of microfinance institutions, more favourable interest rates should be pursued by increasing efficiency, strengthening financial performance, ensuring high productivity of staff, introducing innovations that reduce transaction costs, facilitating access to cheaper commercial sources of funds and promoting greater competition.
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Microfinance institutions that offer savings facilities, generally banks, have a cheap source of funds for further lending. Since poor clients are usually not very sensitive to interest rate incentives, especially where alternative savings services are unavailable, but rather to savings flexibility and accessibility, savings have the advantage of usually being an inexpensive source of funds.
Mobilization of savings is therefore an important means to reduce microfinance institution costs, leading to more sustainable operations while charging lower interest rates. Efficient wholesaling or apex institutions, and a developed network of linkages among the various layers of financial institutions are also important to reduce provisioning costs for microfinance institutions that rely on commercial sources of funds. To allow efficient microfinance institutions to reach sustainability and facilitate their growth it is important that governments do not impose interest rate ceilings or provide unsustainable, subsidized credit programmes.
Such programmes distort the markets and are often plagued by very poor repayment records, undermining the operations of sound microfinance institutions. Past experiences with subsidized targeted credit have generally been unsatisfactory, with low repayment rates, and have shown that it is difficult to target subsidized credit due to rent-seeking behaviour of larger or better-off customers, political patronage, and an easy diversion of loan funds for other purposes.
A problem with subsidized credit is that borrowers tend to feel less compelled to repay government-subsidized loans.
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