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Dr. Marco Elia, University of Turin - Italy

Belgrade, 28th November 2007

Microcredit and Microfinance

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1. Introduction – What is Microfinance? The Institutionist and the Welfarist approach

2. Microcredit and Microfinance

3. Commercial approaches implemented by international and domestic banks in microfinance

Agenda

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What is Microfinance?

“The provision of small scale financial services to

low-income people excluded from the formal

financial system”

Almost general agreement on this definition

-Commitment to provide credit

-Common concern for low income people

1. Introduction

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Unity of commitments and concerns

It masks different approaches

Different types of institutions, borrowers, delivery systems put

(sometimes incorrectly) under the term “MICROFINANCE”

1. Introduction

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MICROFINANCE

SPECIALIZED FIELD THAT COMBINES BANKING

WITH SOCIAL GOALS

1. Introduction

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Institutionist approach (WB, CGAP, USAID)

Focus on Financial self-sufficiency (FSS) and institutional

scale

Welfarist approach

Direct poverty alleviation among the very poor

Jonathan Morduch(1998) “The Microfiance Schism”

1. Introduction

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THE INSTITUTIONISTS

Emphasis: FSS and breadth over depth of outreach

Center of attention: The institution

Main success index: achieve Financial Self Sufficiency

(FSS)

1. Introduction

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THE WELFARISTS

Emphasis: Depth of outreach

Center of attention: Clients

Accept and require subsidies

Grameen Bank of Bangladesh

THE INSTITUTIONISTS HAVE CLEARLY WON THE DEBATE TO DATE

1. Introduction

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PRACTICAL IMPLICATIONS

Different clients served

Different methodologies

Different institutional structures and financing

1. Introduction

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The Institutionist argument

Recognition of scarcity (potential demand cannot be met only by

donors)

Poverty reduction requires massive scale

BEST PRACTICES: essential step for FSS, CAPITAL MARKET

ACCESS and MAXIMUM OUTREACH TO POOR CLIENTS

1. Introduction

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The Welfarists

Depth over breadth of outreach

FSS desirable, not necessary

Concerns that “profit-making MFIs” will lose their “social mission”

1. Introduction

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Microfinance must be integrated into the formal financial system

Annual spending of the donor community on microfinance:

$800 million - $1 billion per year (CGAP, 2004)

Potential demand : 500,000,000 clients far exceeds the capacity

of donor funding (World Bank)

1. Introduction

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.. a short history

1960s – 1970s : credit provided to rural farmers by many state-run dev.

Institutions (RDIs)

RDIs almost always failed

Grant mentality

High transaction costs

Heavy corruption

Limited impact

BELIEF THAT LOW INCOME PEOPLE ARE UNBANKABLE

The Institutionist approach is partially an outcome of these

failures

1. Introduction

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June 2004: The Group of Eight (G8) endorsed the 11 key

principles developed by CGAP (a consortium of 28 public and

privaste member donors) at the meeting in Sea Island

(Georgia) They intent to build a base a basic principles to

support a diversity of approaches

2005 has been declared Year of Microcredit by the United

Nations

In 2006 Yunus and the Grameen Bank received the Nobel Peace

Prize

1. Introduction

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Furthermore must be highlighted that:

Major innovations came from highly subsidized MFIs

The relationship focus on the poor and profit orientation is not always

clear

CGAP admits that the majority of the MFIs do not have the potential to

be FSS in the near future

For certain target groups the benefits of ongoing subsidization may

exceed their costs

1. Introduction

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1. Introduction – What is Microfinance? The Institutionist and the Welfarist approach

2. Microcredit and Microfinance

3. Commercial approaches implemented by international and domestic banks in microfinance

Agenda

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• Lack of clarity in using the terms

• The two ideas must be clearly differenciated

“ Microfinance is he provision of small scale financial services (Microcredit,

Microsavings, Microinsurance, money transfer) to low-income people”

MICROCREDIT IS A PART OF THE FIELD OF MICROFINANCE

2. Microcredit and Microfinance

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• The term Microfinance was first introduced in the 1990’s as a

transformation, or extension, of the already popular and successful

poverty alleviating idea of microcredit

• The “first generation” of institutions (NGOs) delivered almost only credit

• Successful example of Bank Rakhyat Indonesia in providing savings

accounts poor people

2. Microcredit and Microfinance

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• Savings services are as important as loans

• All the financial services, and not just loans, help low income

people to smooth consumption, stabilize income and protect

against risks (Broadening of the concept of microfinance)

• Importance of money transfer services

• Training to client is a non-financial service

• CENTRAL ROLE OF CREDIT METHODOLOGIES

2. Microcredit and Microfinance

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2. Microcredit and Microfinance

Microenterprise Development, Microfinance and Microcredit

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1. Introduction – What is Microfinance? The Institutionist and the Welfarist approach

2. Microcredit and Microfinance

3. Commercial approaches implemented by international and domestic banks in microfinance

Agenda

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4. Commercial approaches

Direct (downscaling, MFI at the outset) vs. Indirect approach (Loans to MFIs, partnerships, etc..)

Legal constraints mainly related to interest rates celings

Evidence from the current practice around the world show a “dual approach”

The potential for grow is huge especially for additional financial services besides credit (strategy of Bank Rakyat vs. BancoSol)

The key constraint is the “lack of institutional and human capacity” (CGAP, Key Principles of Microfinance)

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References

•Easton, T. (2005). The hidden wealth of the poor. Survey: Microfinance - The Economist, November 3rd 2005

•Harper, M. and Arora, S.S. (2005). Small Customers, Big Market: Commercial Banks in Microfinance. New Delhi, TERI Press

•Meyer, R. and Zeller, M. (2002). The Triangle of MICROFINANCE: Financial Sustainability, Outreach and Impact. John Hopkins Press, Baltimore and London

•Morduch, J. (1999). The microfinance promise. Journal of Economic Literature, 37, 1569-1614

•Morduch, J. (2000) The Microfinance Schism. World Development Vol.28, No.4, pp. 617-629

•Shreiner, M. (2003). A Cost-Effectiveness Analysis of the Grameen Bank of Bangladesh. Center for Social Development, Washington University in St. Louis

•Silverman, R. E. (2006). A New Way to Do Well by Doing Good – Microfinance Funds Earn Returns on Tiny Loans To Poor Entrepreneurs Abroad. The Wall Street Journal, 5 January

•Yunus, M. (1998). Banker to the Poor: The Autobiography of Muhammad Yunus, Founder of Grameen Bank. The University Press Limited, London

marco.elia@unito.it