microfinance crisis - did point of view (eng)

7/29/2019 Microfinance Crisis - DID Point of View (ENG)

1/6

June 2011 Page 1 of 6

THE MICROFINANCE CRISIS:THE DVELOPPEMENT INTERNATIONAL DESJARDINS POINT OF VIEW

BACKGROUNDOver the last ten years the microfinance sector has developed at a fast pace allowing poor communities in

developing countries to obtain increasingly wider access to basic financial services. By December 31, 2009 there

were 3,589 microfinance institutions (MFIs) throughout the world serving over 190 million clients, of which 128

million individuals were classified as among the poorest and who were largely excluded from traditional financial

services. Among the poorest clients, 82 percent were women.1

Microfinance, as a tool for fighting poverty, benefits from a great

amount of goodwill. However, some events have tarnished this image,

with microfinance making headlines for its negative impact. In one

example, in response to a wave of suicides by overindebted borrowers,

a political party in Andhra Pradesh, India, advised clients of

microfinance institutions to no longer repay their loans since theinterest rates were considered too high and collection methods,

unscrupulous.

The No Pago movement endorsed by Nicaraguan President Daniel

Ortega supports thousands of borrowers who are refusing to pay off

their loans and are demanding lower interest rates. The movement has

expanded to Bolivia and even to Pakistan where activists and politicians

have urged borrowers to stop paying their loan installments. Some

MFIs have been bankrupted by these events.

Sometimes seen as a panacea able to improve the living conditions of the poorest, revelations during these crisisnow show that some microfinance practices have gone off track. Commercialization of microfinance has been

identified as one of the underlying reasons. Some MFIs, required to make payouts to shareholders and post financial

results to increase the value of their commercial venture, have been accused of putting priority on profit to the

detriment of their primary mission by promoting doubtful practices for collection and recruiting of clients.

This situation is disturbing for Professor Mohammad Yunus, Nobel Prize winner and microcredit promoter, who,

over the last few years, has denounced the listing of microfinance institutions on stock exchanges, which, in his

opinion, sends the wrong message that profits can be generated from helping the poor. The debate was ignited

when the Banco Compartamos was listed on the Mexican stock exchange in 2007 making shares in this institution

subject to speculation in the marketplace. For the initial offering, demand for Compartamos shares was 13 times

oversubscribed with the amount of the transaction topping US $450 million and a price-to-book value ratio of over12. In light of the Compartamos situation and that of other MFIs, the Consultative Group to Assist the Poor (CGAP)

took a different position from that of Mr. Yunus, stating there was no problem in having shares produce a profit on

an investment in an MFI and that this could even be beneficial for the microfinance sector.2

1REED, Larry R., State of the Microcredit Summit Campaign Report 2011, Washington. 2011

2Consultative Group to Assist the Poor(CGAP), IPO Represents a Critical Transition for Microfinance, http://www.cgap.org/p/site/c/template.rc/1.26.14251/

It is true that microfinance

results on an individual scale are

modest but they are real. And

because they affect 200 million

people, they have a multipliereffect making this one of the

strongest programs in recent

decades.

Esther Duflo, MIT Economics

Professor and promoter of an

incremental small step approach

to poverty alleviation


2/6


From the client's point of view, the excesses made many of them overindebted, due to an increase in consumer

loans over lending for productive purposes, along with practices which encourage microfinance kiting.3

Consumer

credit is now under scrutiny. Such loans are used for health expenses, to improve small lodgings or for expenses

related to education for children and obviously are useful purposes and may even be of crucial importance to the

clients, but they do not generate income to repay the loans. While these types of loans are necessary, abuse is likely

when lending procedures do not distinguish between the types of loans and the true ability to pay by the borrowers

is not properly assessed. In addition, loan officers are remunerated in relation to the number of loans made and

their loan collection results which can encourage microfinance kiting practices. By suggesting that families pay off an

already contracted loan with a new loan, these loan officers can post a 100 percent collection rate and increase the

number and volume of loans made. Along with such practices which lead to the overindebtedness of households,abusive loan collection methods can place excessive pressure on borrowers.

THE POSITION TAKEN BY DIDWhat have been perceived today as excesses are partly the result of the widespread popularity ofmicrocreditwhich

was highly touted as a tool in the fight against poverty. For DID, the real issue has always been to promote access to

financial services for all men and women, including those in the poorest communities. The outcomes that are

expected from such an approach are all the benefits which accrue from lifting the barriers on development for

individuals, families and communities resulting from the lack of access to quality, diversified financial services that

are secure. We can only imagine what it would be like without access to the full range of financial services that are

currently available to us in our daily lives to understand what an essential service this is to ensure the smooth

running of our economic activity.

For DID, access to financial services for all is just as fundamentalas access to education when all the negative effects andconstraints on development caused by a low level of bank use in

communities are taken into consideration. It is so important that

the rate of bank use should, in fact, be included among the

Millennium Goal performance indicators. Consequently, the

excesses that have been identified and which are related to

lending practices, should not serve to call into question the

development outcomes for investments aimed at improving

access to financial services for all types of communities.

Dedicated for over 40 years to improving access to financial

services in poor communities, DID is extremely concerned with

such misdeeds linked to microfinance, and aware of the difficultenvironment in which microfinance institutions must operate.

DID is cognizant that disreputable practices can occur at any

microfinance institution. However, DID is convinced that focusing on control of financial institutions that arecommunity-owned and involved in community development provides a formula that can mitigate specific risks.

DID is convinced that its promotion of the cooperative formula helps limit the risk of excess associated withmicrofinance. The concepts of collective ownership and strong community involvement by the institutions DID

supports along with local management serve to restrain the more aggressive practices in the microfinance sector.

DID believes that by encouraging the creation of cooperative institutions whose members take part in governance,the interests of the members are better taken into account when MFIs make decisions. In the case of partner

institutions that are not organized as cooperatives, DID has encouraged the development of engagement with

clients conducting business with the institution, especially through the establishment of client share purchase plans.

3In the consumer area, microfinance kiting refers to cash-strapped borrowers taking out sequential loans using each new loan to repay a prior loan.

In Sri Lanka, rice growers and their families now have

coverage against the effects of bad weather thanks to

the crop insurance plan instituted by DID and its

partners. To date 3,500 crop insurance policies have

been written.

PROTECTION OF ASSETS

X 3,500


3/6


The education of members and clients by DID partner finance

institutions, another principle common to cooperatives, also helps

mitigate risks related to consumer lending, microfinance kiting

and overindebtedness. Education, training and information givemembers better understanding of credit, making them better able

to assess their capacity for borrowing and comprehend the

commitment made when a loan is contracted.

Through its support for regulation by national governments oflocal microfinance and support for MFI supervision operations,DID has also demonstrated its own concern for maintaining

honest and consistent lending practices by its partners. That is

why DID backs strong external supervision of its partners in

addition to suitable self-directed supervision methods. Access to

financial services is more than simply providing products or

developing methodologies. The services are delivered by

institutions which must raise their levels of professionalism and

operate in compliance with the laws and regulations in effect.

Therefore, it is just as important to focus on the availability of services as on capacity building for local institutionsas well as on strengthening external supervision over these institutions. In our opinion, it is much more appropriatefor governments dealing with specific excesses by MFIs to strengthen clean-up efforts in the sector, along with

supervision mechanisms and regulatory oversight instead of setting a ceiling on interest rates or urging borrowers to

stop paying back their loans which can create negative effects as bad as the excesses initially targeted for correction.

DID contends that the recent events underscore the importance

of making loans in relation to the economic value of the venture

being financed and in relation to the borrowers ability to pay.

Loans must be processed by loan officers who possess proper

qualifications, which is why DID and its partners urge enhancingthe professional practices of staff involved in managing lending.Analysis of the economic benefit of the projects planned by

borrowers must be based on excellent knowledge of the incomegenerating activities. The finance products must be carefully

suited to the specifics of those activities. That is why DID has been

working for several years to improve specialized financial services

such as financing for small enterprises, agricultural finance and

financing for small housing projects. Although all these services

may be called financing, they differ greatly in terms of operations

and adaptation to the needs and circumstances of the member

clients.

In a concern for equity and accessibility, DID adheres to the

principle of transparency and advocates that interest rates posted by its partners be calculated using a declining-balance method instead of the so-called flat rate method. However, when all actors in the same market post only

straight line rates, the apparent rates posted under such practices put DID partners at a disadvantage. Efforts must

be made to properly explain to each member client the meaning and the calculation methods used for the rates that

are applied.

In Haiti, 90 percent of the children whose parents have

taken out education loans complete their school year

in comparison with an average completion rate of 60

percent. Since this innovative product was introduced,

nearly 4,000 loans for schooling have been granted to

Haitian families.

In Burkina Faso, the financial centres for entrepreneurs

set up in rural areas over the last two years have

allowed 5,400 farmers to finance crop intensification

and diversification.

EDUCATION

X 4 000

X 5,400

FOOD SECURITY


4/6


DID promotes sound microfinance practices as reflected in the microfinance client protection principles outlined inthe Smart Campaign

4. A highly concerted effort has been made to encourage all members of the Proxfin

international association composed of 20 DID partners to endorse the campaign.

DID is of the opinion that certain microcredit practices, such as

solidarity guarantees and incremental approaches, have

contributed to the current difficult situation, especially by

promoting automatic increase of the importance of the loan

while lowering application examination standards. Such

methods should be limited to very specific target groups andoperated using clear guidelines.

Far from limiting itself to microcredit, DID works in collaboration

with its partners to set up a wide range of financial products andservices that are accessible to the disadvantaged and designed forthem. These services include mobilization of savings deposits

which helps lower the costs of funds made available to clients and

increases the room for maneuver by MFIs in setting loan terms

and conditions as well as having them participate in creation of

community-based wealth within targeted communities.

When providing coaching services to partners, DID also takes a

sound, methodical, and time-based approach. These collaborativeeffects set up over long periods of time provide for better

understanding of partner practices and the constraints they are

facing as well as for better in-depth supervision based on shared

values. This approach is not always acknowledged at its proper

value by donor agencies which are not focused on deeper

partnerships but instead on maintaining a relationship of

dependency. Best practices however are transmitted through an

educational approach and cannot be imposed from the outside.

These information and education efforts require bonds of trust

and the time needed to pass on the practices and integrate theminto the operations run by partners as they increasingly take

control over their own progress. At the same time, partner MFI

self-sufficiency means that DID cannot be held responsible for

possible wrongful practices at these MFIs unless such practices

were specifically recommended by DID.

Under the current circumstances, DID has little faith that creditbureaus can be effective in controlling the excesses seen in the microfinance sector. Such measures remain symbolicand are often ineffective in a highly competitive climate in which institutions have inadequate management

information systems, borrower identification controls can often be extremely complicated due to lack of a reliable

national identification system and MFIs are not able to pay the costs related to using a credit bureau which wouldonly be passed on to borrowers during the lending process. Strengthening MFI governance and consequently the

strategic role fulfilled by boards of directors is in our opinion a better strategy for preventing such excesses.

4The Smart Campaign (www.smartcampaign.org) is a global campaign committed to embedding client protection practices into the institutional culture and

operations of the microfinance industry.5

Based on the Social Return on Investment (SROI) calculator developed by the Calvert Foundation (www2.calvertfoundation.org/impact/calculate/index.cgi)

In Vietnam 10,000 inter-coop transactions every

month are now being conducted between different

People's Credit Fund financial cooperatives by

members. Making a trip from one coop to another is

no longer necessary when transferring funds to

another location.

In Africa, each loan made to a small business creates an

average of 1.4 jobs.5

The 7 financial centers for

entrepreneurs set up with support from DID in various

African countries provide more than 200,000 loans and

are growing fast.

GROWTH

X 200,000

INTERCONNECTIONS

X 10,000


5/6


Concerning risk management, DID contends that MFI collectionpractices must be thorough. As a rule of thumb, interest rates atMFIs must reflect the costs related to community finance

services. In order to reach low income clienteles, MFIs make

loans for small amounts that are more costly to monitor and

manage in relation to the amount of the loan. The rate of interest

must therefore be higher for these MFIs to cover the cost of

managing the loans and keep the institution viable. To avoid

excessive increases in interest rates, these MFIs must ensure a

suitable collection rate and remain watchful over upstream anddownstream lending operations.

DID is also aware that when MFI members and clients are facing

difficult circumstances, the same applies to their institutions.MFIs often operate under difficult circumstances that can be

economic or regulatory - especially in terms of their legal

recourse before the courts. While not excusing certain doubtful

practices, this does offer a partial explanation for differences that have been observed with the developed world.

The disparity seen in practices with developed countries is even more obvious when analyzing the interest rates

charged by MFIs. Because the operating conditions are so extremely different, especially concerning the cost of

funds, nominal comparisons are unsatisfactory.

The interest rates must cover the both costs and risks while allowing for expansion (capitalization). However,considerable efforts must be maintained to increase efficiency and reduce the costs of distribution in order to lower

the fees on products and services.

Access to capital is a strategic challenge for microfinanceinstitutions. The fact that an increasing number of investors are

looking at this sector is a very positive development. However,

focusing solely on profitability can lead to excesses - although it is

not the only reason. DID has been working for over 15 years with

investors in the microfinance sector and is looking to work with

those who share its vision of development. Efforts must be madeto understand this sector better so that the capital that is

available has a positive impact on access to financial services.

Lastly, DID issues a warning against the disinformation that hasbeen spread during the debate over microfinance, as was the

case for the Andhra Pradesh crisis in which MFIs were accused of

causing difficulties for which they were only partially responsible

since many borrowers had gone to informal lenders for their

loans. In fact, a study financed by the Government of India six

months before the crisis broke, revealed that most overindebted

households in Andhra Pradesh had taken out loans, not fromMFIs (11 percent), but instead from informal lenders (82

percent).

In Haiti, members are proud of their financial

cooperatives. The financial cooperatives associated

with the Le Levier Federation serve over 375,000

Haitian families and have helped them deal with the

aftermath of the 2010 earthquake.

Today, DID partner institutions, working together within theProxfin association, are helping 8.8 million families with

their financial progress and could increase outreach by at

least 10 percent a year for many years to come.

OWNERSHIP

X 375,000

IMPACT

X 8,800,000 and +


6/6


CONCLUSIONFor DID, active in the area of development for 40 years, and specializing in promoting and improving access to

financial services, it is essential to maintain a realistic outlook on development in this sector and not lose sight of the

ultimate goal.

Sustainable increases in access to financial services in developing or emerging countries will rely on numerous levers

for development and must go hand-in-hand with expansion of the financial sector in the targeted countries.

Microfinance, or inclusive finance, is one part of finance and must therefore make use of best practices while

eliminating practices that exclude communities to participate on the economic and social progress of their countries.In fact, implementing best practices and maintaining a constant concern to increase the number of individuals using

the formal financial system is what motivates DID and its partners.

microfinance crisis - did point of view (eng)

Documents